Why Zero-Based Budgeting might be the spark of Innovation for Businesses
Zero-Based Budgeting – The spark for Innovation
Staying in control of your business expenses requires constant monitoring and careful allocation of your business budget. Most businesses rely on their traditional budgeting methodology, slightly tweaking and improving the new budget using the budget from the previous year, however, traditional budgeting might not always be an effective option, especially for startups. There is another option called zero-based budgeting that might prove to be very effective in improving the innovation with which a business plan and uses their budget.
What is zero budgeting?
The two techniques differ in significant ways, the traditional method focuses on previous period expenditure items whilst zero-based budgeting focuses on budgeting for expenditures that can actually add value to the business. Traditional budgeting does not demand any justification of the current or proposed budgeted amounts whilst zero-based budgeting calls for justification of current or proposed projects, taking costs and benefits into account. A standard methodology is applied when utilizing a traditional budgeting strategy whilst a more complex and detailed approach is used for zero-based budgeting. In addition, the level of clarity and responsiveness is somewhat higher in zero-based budgeting as compared to the traditional budget.
How does it differ from traditional budgeting?
Budgeting is a process of creating a budget, that has all the quantitative statements of income and expenses that are going to be required for a project, during a specific period and is approved with the aim of achieving the desired goals and objectives.
Generally, there are two techniques used to create a budget, first is traditional budgeting and the second is zero-based budgeting. Traditional budgeting is a method of creating a budget that takes the preceding year’s budget as the base budget. Usually, adjustments are made to the expenses, taking the current year’s inflation rate, consumer demand, and other factors into account. If you are unsure about where to start getting your budget ready hire a management accountant or outsource your finance department to a reputable accountant or accounting firm.
The two techniques differ in significant ways, the traditional method focuses on previous period expenditure items whilst zero-based budgeting focuses on budgeting for expenditures that can actually add value to the business. Traditional budgeting does not demand any justification of the current or proposed budgeted amounts whilst zero-based budgeting calls for justification of current or proposed projects, taking costs and benefits into account.
A standard methodology is applied when utilizing a traditional budgeting strategy whilst a more complex and detailed approach is used for zero-based budgeting. In addition, the level of clarity and responsiveness is somewhat higher in zero-based budgeting as compared to the traditional budget.
What are the steps taken by companies for zero-based budgeting?
To create and implement a budget using the zero-based budgeting method, companies are advised to take the following measures:
- Take important initiatives and build an ideal model by using a ”blank sheet of paper’’ approach.
- Envision your business from a different perspective, set a defined strategic vision and invest in the activities and resources after determining the path you are going to take to reach your business goals, taking the future market conditions into account.
- Build an ideal budget for the future based on what generates the most value.
- Provide justification for each activity suggested for resource allocation and note down how much cost each of these activities incurs, in order to meet the desired goals and objectives.
- Allow a frank discussion around the budget numbers being presented to spark an increased amount of creativity.
- Hire a specialist accountant, management accountant or finance director to lead and implement the process.
Why should companies prefer using zero-based budgeting?
There are a number of reasons why companies should use zero-based budgeting. A few of these reasons are as follows:
- To decrease the complexities introduced after a merger or acquisition in an organization.
- To help understand and fund important strategic activities whilst getting rid of non-value adding costs.
- To help provide justification for proposed activities and resources.
- To help utilize resources and align them to the goals and objectives of the project and the company.
- To encourage out of the box thinking by starting from a clean slate and not emphasising on what’s already been done previously.
What are the advantages of zero-based budgeting?
Senior managers find themselves investing resources on better teams who in turn have better plans to present, once they adopt a zero-based budgeting technique for budget preparation.
Mentioned below are some of the other benefits associated with zero-based budgeting:
- ZBB makes space to challenge the status quo
The constant debate that results between the teams and senior management due to zero-based budgeting, questions the status quo and highlights activities that previously went undetected. Zero-based budgeting also helps bring broader business objectives to be discussed on the table.
- Ensures critical evaluation of all the expenses
Zero-based budgeting ensures that the teams using ZBB critically think about how each pound would be spent for a project in an accounting period. This also provides businesses with an opportunity to identify the areas which are generating the most profits as every expense needs to be justified on the basis of returns and prospects. If you are a growing business it can be extremely valuable to ask your business accountant to help you identify, present and report on major variances and how they are impacting your business.
What are the disadvantages of zero-based budgeting?
- The substantial sacrifice of time and effort:
Critics blame that the time and effort dedicated to zero-based budgeting outweighs its benefit. Reviewing every minor budgeting element in detail takes a lot more time and effort than what would be simply done by just modifying existing budgeting whilst paying attention to a few new budgeting elements. You might want to have a periodic zero-based budgeting methodology, this means you generally prepare a traditional budget generally moving on to a zero-based budget once every three years or a frequency of your choosing.
- Complications arise when estimating benefits:
Some expenses are difficult to budget for, and as a result, some of the benefits arising from those expenses are complicated to estimate. To demonstrate the value of every activity proposed for budget planning can be tricky and not every activity has an ROI.
Does zero-based budgeting create the spark required for innovation?
Traditional budgeting has made businesses sluggish. Businesses create budgets for the sole purpose of the following process and are based on historical values, reducing the need for managers to justify the budget they require and how it will add value to the business. Zero-based budgeting has once again made cost allocation agile, in return increasing visibility, cost discipline and the need to think about spending on areas that bring value to the business.
Not only is ZBB seen as a budgeting exercise but as an exercise to refresh the direction and vision of the business. When starting with clean slate management have to justify their spending with the goals of the organisation resulting in either confirming their belief in the vision of the organisation or disputing it.
What has been observed historically is that many companies have adopted ZBB to create budgets with fixed costs and clear measurable results, instead of applying to non-revenue related departments such as marketing or accounts, because of complications in estimating the correct ROI. But the non-revenue departments of the modern world now have access to more advanced and sophisticated digital tools, and as a result are in a better position to identify and quantify those factors which are heavily influencing consumer decisions, in light of ZBB.
Digital zero-based budgeting, due to its preciseness and lack of dependency on historical figures can be a valuable option for commercial spending. Commercial spending is the spending done on advertising, discounting and for promoting the business. Digital ZBB has the potential to simplify the management of expenses without budgeting a cost just because it was incurred before.
Whilst many companies have climbed up the success ladder with ZBB, more strategic components and practices are required to implement it pragmatically for sustained budgeting.
The methodology behind ZBB ensures that there is no spending done on programs that don’t align with your business’s goals and objectives and are not promising high ROI. Businesses can utilize ZBB to help them allocate their spending on better initiatives that pay off really well.
What steps can companies take to implement digital ZBB?
The application of ZBB is broader than before, this is due to the increased use of digital analytics, AI and automated processes (such as data collection). Companies planning to implement Digital ZBB need to formulate a plan which emphasizes on the usage of tools that:
Amalgamates intelligent technologies:
The first thing companies need to do is reduce the effort and time in the work required to implement ZBB. These kinds of tools may also assist in eliminating significant implementation barriers whilst also identifying cost-saving opportunities.
Tackle the problem efficiently:
Companies that want to get a comprehensive understanding of the potential areas that may help them save costs, they need to find a tool that tackles the problem by using both approaches, bottom-up and top-down
Boost strategic drivers:
A tool that automatically introduces high-value improvements in the process and coordinates according to the businesses priority helping to reduce obstacles and barriers during the implementation of ZBB.
Budgeting can only add value for a business if implemented and monitored correctly. Using an expert such as an accountant, accounting firm or a business accountant that has the experience, skills, and access to the right tools can help make the process easier and quicker to implement.
Clear House Accountants are Accountants in London who have developed services such as their outsourced CFO, Finance Director and Accounting Department service which can help businesses outsource certain functions or complete departments while they focus on growing and expanding their business. Speak to us to learn more.