What is zero-based budgeting?
Zero-based budgeting (ZBB) is a budgeting method that doesn't make assumptions about the past—instead of starting with last year's budget and making adjustments, it starts from a base of zero. (Thus, the name!)
Because it starts from zero, the budget is built up by adding all your expenses one at a time—everything you're planning to spend—so every dollar is considered and justified.
Companies like Kraft Heinz Co., Unilever PLC, and Walgreens Boots Alliance Inc. rely on zero-based budgeting as a practical, flexible way to manage income and expenditures.
How is a zero-based budget different from traditional budgeting?
Traditional budgets tend to start with all the budget categories of the previous budget (from last month, quarter, or year), and then make any adjustments for the new accounting period.
For many companies, there are a lot of costs that don't change much from one year to the next. Maybe the mortgage doesn't change, or maybe there's a lease that's locked in for several years. Subscriptions for software or cloud-based services probably won't change a lot either.
When a company has a lot of expenses that don't change much, it makes sense to start with the same expenses you had last year and then adjust them to reflect this year's rates.
A zero-based budget, on the other hand, builds the budget up from scratch every time you go through the budgeting process, whether that's monthly, quarterly, or annually.
As you can imagine, zero-based budgets often take longer to build, but they're extremely helpful in financial planning for corporate finance and even personal finance, especially when irregular expenses or variable expenses are a normal part of your operations.
Zero-based budget vs. traditional budget — which should you use?
Here's another way to think about the difference between the two:
- Traditional budgeting considers the previous budget's expenditures and asks for incremental increases over previous budgets.
- Zero-based budgeting starts with annual, quarterly, or monthly income, divides up that money among spending, savings, and debt repayment, and ends with zero.
There was a time when many businesses didn't change much from one year to the next, and in some industries that may still be true. In those cases, traditional budgets might still make sense.
- Expense categories don't change much
- Major budget decisions are already established
- The company's financial situation is stable
- Next month's budget will look a lot like last month's
Today, technology is changing rapidly, so the way many companies spend money can change dramatically over a relatively short period of time.
Production might suddenly be outsourced, or might be brought back in-house. Your spending categories may change as you add new tools.
And your total monthly income might swing with your advertising spend.
Zero-based budgeting forces managers to consider and justify expenses, asking them to demonstrate a clear benefit from the resources they're requesting.
The ins and outs of a zero-based budget
So, how do you create a new budget every time? Isn't that a lot of work?
Of course it is. But in practice, a zero-sum budget isn't as tedious as it sounds. Fixed expenses, for example, can be accepted immediately. A spending category like rent isn't going to change unless you're planning to break your lease.
Bank statements can highlight the spending that doesn't change. The finance department may ask teams to justify their spend for each new period, but that will often be as simple as recognizing that the spend is still needed. Every single dollar is considered and accounted for, but in some cases, that's an easy process.
Of course, sometimes that's not an easy process at all. That's when your company has to dive into the nitty-gritty details of building a zero-based budget.
Breaking down the zero-based budgeting method
To use zero-based budgeting, start with this simple formula:
Monthly income
For many companies, income can change from month to month, especially at certain times of the year. Holiday shopping may bring in a lot more cash for retail companies in December. Air condition repair shops will see revenue spikes in the summer months.
Because a zero-based budget starts with your income, make sure you're forecasting your funds as accurately as possible.
Financial goals
Remember to include financial goals like debt repayment and savings goals in your plan—this is as true for companies as it is for individuals and households.
Like other budgeting methods, a zero-based budget needs to take your short-term savings, long-term savings, and other plans into account. If you need capital for an upcoming expansion, make sure you're taking that need into account.
Subtract that extra money from your monthly income before you allocate the rest for expenses—that will help you make sure you've set aside enough money to cover your money goals.
Monthly expenses
A zero-based budget puts what's left toward each expense until income minus spending equal $0.
Start with every expense you have to meet—this includes contracts, minimum loan payments, and any spend that's necessary for your day-to-day operations.
For any money you have left, determine where those extra funds will provide the most value—that's a great problem to have. Will you get more benefit from additional advertising or by putting that money toward shop upgrades?
Allocate any remaining amount until every dime is accounted for, but remember to include some kind of savings you can dip into in case your income doesn't hit your target or you run into unforeseen expenses. In other words, be sure to plan for the unexpected!
See an example of a free zero-based budgeting template.
Advantages and drawbacks of zero-based budgeting
As with any budget method, zero-based budgeting has pros and cons. Carefully consider these advantages and drawbacks before deciding whether it's the best method for you and your business.
Advantages
Strategically focused operations
By justifying every expense, managers are strongly encouraged to focus their resources toward the highest revenue and value for the company.
Lower costs
When every dollar spent is thoroughly vetted, there's a much higher chance of finding places where you can save money. In fact, one of the biggest drawbacks of traditional budgeting is that historical expenses can easily be accepted from one year to the next even though new, more efficient solutions may exist.
Budget flexibility
This is only an advantage of zero-based budgeting if you remember to plan for it. When you have a built-in emergency fund, you can spend that money where you need to.
You can also build in flexibility by allocating funds at a high level. For example, give your marketing team a specific advertising budget, but don't micromanage that money—let the marketing department decide whether to spend it on Google Ads or TikTok videos.
Communication and teamwork
Determining what business goals you should focus on allows for innovation across your team and encourages everyone to stay focused on the big picture—and on your company's bottom line.
It's a key aspect of keeping your business budgeting intact.
Drawbacks
Timely and costly
The more often you need to change your budget, the more time it takes—and with zero-based budgeting, you'll need to reassess how you're allocating your income regularly.
May overlook long-term goals
A zero-based budget forces managers to justify the return on each dollar they spend. That's great in the short term, but it can also create an unwanted blindspot for long-term projects and plans.
Manage and lower costs strategically
Whether you select the zero-based budgeting process as your primary method or decide to opt for a different method to manage your business budget, you'll need financial budgeting software that can keep up with your business.
BILL's financial automation platform can help.
For an easier way to manage your budgets, consider BILL Spend & Expense. Enjoy real-time spend visibility, budgets you can control, and expense reports that take just a few clicks.
