What is zero-based budgeting: a comprehensive guide

In a recent survey from FSN, only 13% of organizations said they use zero-based budgeting (ZBB). However, 54% of finance said they were looking to unify their budget model across the enterprise.

Para as empresas que ainda não implementaram o ZBB, pode ser uma questão de entender as vantagens e desvantagens do ZBB e como implementar efetivamente essa abordagem em sua organização.

Our comprehensive guide will teach you everything you need to know about zero-based budgeting, including:

O que é orçamento baseado em zero (OBZ)?

To help you get started with zero-based budgeting, we need to first define the approach and the role of “zero” in this context.

Definition and core concept

O orçamento base zero (ZBB) é quando você começa cada ano fiscal com uma base zero. Quando você cria um orçamento com base zero, cada departamento contabiliza suas necessidades até o item da linha, independentemente de o valor ser maior ou menor do que o orçamento anterior.

The "zero" in zero-based budgeting

A zero-base in budgeting means that every department must justify why they need the funds they’ve requested for the fiscal year, regardless of how much they were allotted the previous year.

This helps eliminate legacy costs and prompts finance leaders to look at their budgets with a critical eye as to what’s truly necessary to support business success, preventing small shifts in expenses that can impact financial performance.

Key principles of zero-based budgeting

With the basics of zero-based budgeting under your belt, let’s examine the key principles of this approach.

Starting from zero

Zero-based budgeting mandates that each expense be evaluated at the start of the budget cycle. This is where the concept of “starting from zero” comes from – department leaders must justify every expense to the finance team, explaining why and how they plan to use the funds. The aim of this process is to ensure resources are allocated effectively and that expenses align with the company’s strategic objectives.

Justifying every expense

As we discussed above, each expense must be justified in the zero-based budgeting process. The finance team’s goal when evaluating these requests is to eliminate unnecessary expenses, identify inefficiencies, and use the company’s resources more effectively. Justifying every expense also increases accountability and ownership among budget contributors, encouraging them to be an active participant in the process.

Aligning budget with goals

A company only has so many resources to allocate at the beginning of each fiscal year. To be successful, organizations must align their budgets with their strategic goals, ensuring there are enough funds to support the pursuit of these objectives. And since goals change each year, the zero-based budgeting process is an effective way to ensure no funds are going towards goals that are no longer a priority.

Zero-based budgeting vs. traditional budgeting

There are many budgeting methods out there, each with its own unique advantages and disadvantages. Let’s compare zero-based budgeting versus traditional budgeting, so you can choose the approach that best suits your company’s goals.

Main differences

Zero-based budgeting is often compared to more traditional methods, where company’s take an incremental approach to budgeting (i.e., businesses take their current budget and flex it a few percent for the coming year against high-level business forecasts and plans).

The danger with this approach, when compared to zero-based budgeting, is that the historic cost base becomes fixed, regardless of whether the costs are necessary to meet an organization’s presumed level of activity. It also assumes that the market will change and evolve in a controlled and predictable manner, which doesn’t reflect the current reality of business.

When to use each approach

Depending on how much time you can dedicate to the budget process and how many departments your organization has, traditional budgeting might be the preferred approach.

Zero-based budgeting can be complex and time-consuming, which can be a significant hurdle for companies to overcome. Traditional budgeting can also help you understand how historical performance affects future performance, whereas zero-based budgeting forces you to start from a blank slate.

However, zero-based budgeting encourages cost-effectiveness and is well suited to high growth companies who frequently adjust their strategic objectives. While particularly beneficial for companies looking to optimize costs and improve efficiency, ZBB can be applied to any organization regardless of its growth stage.

What are the benefits of zero-based budgeting?

Next, let’s discuss the benefits of zero-based budgeting and how it can benefit your organization.

Cost reduction

One of the primary benefits of zero-based budgeting is cost reduction. By asking each department to justify their expenses, it encourages budget contributors to reflect on what’s necessary to support the company’s goal. Zero-based budgeting is also an opportune time to evaluate fixed expenses like rent and utilities to identify opportunities where costs can be optimized.

Improved resource allocation

Beyond cost reduction, zero-based budgeting leads to better resource allocation. By evaluating the necessity and impact of each expense, organizations can ensure that funds are directed toward activities and projects that align with their strategic goals. This alignment helps maximize the effectiveness of the budget, ensuring that spending directly supports the organization's objectives and drives overall growth and efficiency.

Overall budgeting agility

Zero-based budgeting improves the agility of your budgeting process and your finance team. ZBB requires budget holders to ‘start from zero’ and justify their resource requirements at each budget setting, which is particularly valuable during times of economic instability.

Enhanced operational efficiency

By eliminating unnecessary expenses, zero-based budgeting can enhance operational efficiency by shifting your focus to the activities that add the most value.

Challenges and limitations of zero-based budgeting

Despite the benefits, there are a few potential drawbacks and limitations of ZBB, which we explain below.

Time and resource intensity

For organizations who are used to an incremental approach to budgeting, ZBB can seem labor intensive. Each department must justify their expenses and plans, without relying on assumptions from past years. While this is an ideal way to reduce overspending, ZBB does require collaboration with departments from across the organization.

Difficulties in long-term planning

By focusing only on the expenses for the upcoming fiscal year, ZBB can lose sight of long-term planning. It’s not uncommon to need to allocate additional funds for unexpected shifts in strategy or challenging economic circumstances, which can be difficult to do when you’re tasked with justifying each expense based on current trends.

Prioritizes tangible outputs

Zero-based budgeting tends to prioritize easily quantifiable outputs, as these are simpler to justify and measure. This focus can lead to the underfunding of less tangible but still important activities, such as employee training, brand building, and research and development. These areas, while harder to quantify, are crucial for long-term growth and innovation.

How to implement zero-based budgeting in your organization

Below is a step-by-step guide to implementing ZBB, ensuring you have a clear roadmap for adoption.

Preparation phase

The first step in the zero-based budgeting process is the preparation phase. This involves setting your corporate objectives (e.g., what you plan to achieve in the next fiscal year), selecting key stakeholders (e.g., what departments will be required to justify their expenses), and gathering the necessary data to assemble your budget.

Implementation phase

Next, you can begin implementing zero-based budgeting, which includes training your stakeholders on the process, explaining how and why expenses require justification, and then finally, creating a new budget from the ground up. Clear communication is crucial during this phase to ensure that all stakeholders understand the benefits and rationale behind ZBB. Effective change management can facilitate smoother adoption and reduce resistance, making the transition more seamless.

Review and adjustment phase

Every effective budget has an adjustment phase, where the finance team reviews how resources have been allocated and ensures they remain aligned with organizational goals and responsive to changes.

Industries and sectors that benefit most from zero-based budgeting

Now that we’ve discussed the principles, benefits, and challenges of ZBB, let’s look at why certain industries and sectors are better suited to this budgeting approach.

Manufatura

Since ZBB is focused on improving operational efficiency and reducing costs, it is well suited to the manufacturing industry. With so much uncertainty permeating the market, manufacturing companies can use ZBB to find cost savings and reallocate those assets to high-growth areas.

Varejo

In retail, ZBB aligns spending with customer demand and market trends in the current fiscal year, instead of relying on historical data. This allows retail companies to pilot new initiatives like online sales without worrying about how it will impact future budgets. 

Government and non-profit organizations

Governments and non-profit organizations often have to justify their expenses to citizens or donors, which makes ZBB an ideal approach. ZBB ensures accountability and optimal uses of funds in this sector where resource allocation is critical.

Como escolher um software de orçamento baseado em zero

With a foundation on zero-based budgeting, let’s discuss the key features and capabilities you should look for in ZBB software.

Data integration

You should prioritize ZBB software that has robust data integration capabilities. ZBB software should be able to compile and validate data from your ERP, HRMS, and CRM, without having to manually input numbers or formulas. Effective data integration ensures that all the financial planning data you need for ZBB is easily accessible and consolidated.

Fluxos de trabalho

Since many stakeholders and department leaders are involved in the ZBB process, it’s important to prioritize software that has built-in workflow capabilities. Workflows can help streamline the process by automatically assigning tasks, reviews, and approvals. Effective workflows improve company-wide collaboration, ensuring everyone is on the same page.

Inteligência artificial

Artificial intelligence can significantly enhance the efficiency and effectiveness of the budgeting process. AI-driven insights can spot trends faster, allowing organizations to understand variances over time or between scenarios, and identify the factors driving changes in their reports. By automatically generating narrative commentary and data visualizations, AI shrinks reporting windows and ensures all stakeholders are aligned with a consistent story behind the data. AI can also automate repetitive tasks, freeing up finance leaders to focus on more strategic initiatives.

Design intuitivo

An intuitive design for your ZBB software is crucial for simplifying the budgeting process and encouraging widespread adoption among users. User-friendly software reduces the complexity of ZBB, making it more accessible and less daunting for stakeholders at all levels. An intuitive interface also ensures that users can easily navigate and utilize the software's features without extensive training.

FPM software

The good news is that all the capabilities you need for zero-based budgeting are part of a Financial Performance Platform like Prophix One.

Prophix One supports ZBB with built-in workflows, data integration, artificial intelligence and intuitive design. Prophix One can also automate and streamline other budgeting approaches, making it ideal for companies who are unsure of what approach would suit them best.

Discover how Prophix One transforms zero-based budgeting in our demo – watch now.