In tough and uncertain economic times, companies need to make unbiased—and sometimes continuous—decisions about reallocating resources. As a result, there’s been a lot of growing interest in zero-based budgeting (ZBB) recently. But is ZBB something new and shiny that needs more study? Or is it a proven methodology that finance teams can adopt to improve their overall performance?
It turns out that zero-based budgeting has been around for over 40 years. It got its start back in the 1970s when it was developed by Pete Pyhrr, who was a manager with Texas Instruments. The original goal of ZBB was to help organizations cut costs and promote fiscal responsibility. Then it fell out of favor for a while, because it was often used for harsh, non-strategic cost-cutting during tough economic times. As a result, traditional budgeting became more popular.
Yes, ZBB as a business planning tool is effective in cost-cutting—but with a company-wide collaborative approach, supported by modern budgeting software, ZBB can be an extremely effective tool to help a company invest in profitable resources, find and eliminate duplication of effort, and focus on high-profit initiatives.
Before we discuss the differences between traditional budgeting and ZBB, let’s recap the key parts of a typical budget, and the main objectives it needs to meet:
At first glance, it may seem that the goal of a budget is only to generate profits. In fact, it goes beyond that; budgets enforce ownership and accountability so that expenditure decisions are made sensibly. They help companies project profits, spot potential problems, and identify new opportunities so that managers can make adjustments that keep the company financially stable. In addition, growing companies can use budgets to demonstrate their financial potential to investors and lenders.
Regardless of the budgeting technique being used, there are a lot of moving parts and data points involved. Let’s briefly look at these two budgeting approaches and see which one you identify with.
With traditional budgeting, the process of projecting your business’s revenue and expenses for the upcoming year is typically based on your previous budget—which is used to help you predict, analyze, and track your organization’s earnings and expenses. Virtually all enterprise resource planning (ERP) solutions offer this traditional budgeting capability. It’s a time-consuming process: On average, organizations take 93 calendar days to complete the annual financial planning process, with two to three iterations during the cycle.[i] You may wonder if it’s worth the effort; many departmental leaders could simply increase their numbers by a rule-of-thumb number and send it off.
With zero-based budgeting, you start your budget from scratch or a “zero base” each year. At first, the ZBB process may seem easier than starting with a prior-year number, but it’s not. With ZBB, every function within an organization is analyzed for its needs and costs while ignoring historic spending. Creating a zero-based budget normally involves all levels of the organization participating in the process of decision-making. The key difference is justification: ZBB budgeters need to review every expenditure at the beginning of the budget cycle, and they need to justify the need and impact of each line item before funding can be approved.
Each budget line item starts from scratch without the influence of the last period’s actuals as a baseline. Each item is carefully evaluated to determine if any programs, services, or activities will be increased, maintained, reduced, or removed. Managers need to account for all elements of the budget and identify cost-effective, relevant, and cost-saving areas.
This evaluation and justification process requires considerable “thought-provoking” effort as listed in Figure 1. According to Deloitte, “When successful, ZBB produces radical savings and liberates organizations from entrenched departments and methodologies. When unsuccessful, the costs to an organization can be considerable” [ii].
Figure1. Key differences between traditional and zero-based budgeting
Zero-based budgeting (ZBB)
Based on the previous year’s budget
Started from scratch (zero base)
Based on previous expense levels
Requires new expenditure justification
Justification is not typically required
Cost and benefit justification required
Management decides on expenditures
LOB management propose expenditures
Less clarity and responsiveness
Greater clarity and responsiveness
As good as ZBB sounds, it can be a very challenging methodology to adopt and could be one of the reasons why organizations have opted for the more traditional, but less accurate approach. ZBB is highly effective, but since budgets are created from scratch, there is a greater human resources requirement; it’s likely more time-consuming than the incremental budgeting approach which companies see as the path of least resistance. But as companies spend three months on traditional budgeting, the more complex ZBB is likely time well-spent. It requires that managers gain additional expertise providing justifications for their budget requirements at every line item.
Clearly, taking the ZBB approach while using old technologies that rely on spreadsheets, emails, manual, and otherwise less-automated collaboration tools can dissuade some companies wanting to adopt ZBB.
The good news is, there is a solution to addressing the challenges of implementing ZBB. Unlike other vendors that may have partial or incomplete offerings—which lack modern, innovative technologies, or rely on additional disparate or acquired 3rd party tools like SAP [iii] and Workday [iv] do—Oracle Fusion Cloud Enterprise Performance Management (EPM) delivers a complete and modern budgeting, planning, and forecasting solution.
Oracle Cloud EPM helps you implement ZBB processes efficiently, supported by leading, innovating technology for optimal ZBB. With profitability and cost management, narrative reporting, and scenario modeling, your budgeting process allows your company to consider what it really needs, as opposed to what you currently have or have been doing in the past. ZBB becomes a way of life, giving you a fundamental understanding of where your company makes money and where you spend it. You can then start to focus on how your company needs to change in order to keep up with the economy, your customers, and your competitors.
You’ll also gain from built-in AI and machine learning capabilities in Oracle Cloud EPM that make predictive analysis smarter, resulting in greater accuracy. You can even extended your AI/machine learning capabilities with the powerful Bring Your Own ML: Machine Learning Model Import feature. EPM administrators can import their own fully trained machine learning models in PMML (Predictive Model Markup Language) format, putting the benefits of machine learning and the power of data science into the hands of business users. This further enhances the planning, budgeting, and forecasting process, resulting in more accurate forecasts and better business decisions.
ZBB takes your company beyond just trimming costs; it lets you strategically put those savings to more strategic use, optimizing performance and encouraging growth.
In today’s post-pandemic realities, it’s more critical than any other time in recent history to consider your current budgeting approach, procedures, and the tools you use. Ask yourself if it can be done better so that your organization can continue to thrive and grow.
When implemented correctly, ZBB is clearly superior to traditional, incremental budgeting processes, and Oracle Cloud EPM helps you make the transition to ZBB efficient and effective.
|See how Oracle helped Kraft Heinz reduce its IT management costs by nearly 5X with zero-based budgeting while improving planning accuracy.
Zero-based budgeting may not be a new idea, but it’s a great one. Putting ZBB into practice has clear advantages over the traditional, less accurate budgeting approach. With Oracle Cloud EPM, you don’t have to settle for second best any longer. Now you can implement a world-class ZBB process enterprise-wide supported by a modern, innovative, intelligent, and collaborative cloud EPM platform—helping you take your organization to even greater heights of efficiency and profitability. As today’s world moves beyond the challenges of the recent past, you can be sure that Oracle will help you implement the strategic benefits that ZBB will deliver to your organization.
[i] Source: 2018 Gartner Budget Process Benchmarks Survey