Implementing Zero-Based Budgeting: Benefits, Myths, and Goals
If you are in the finance world, then you probably have heard of zero-based budgeting. Investopedia defines zero-based budgeting as “a method of budgeting in which all expenses must be justified for each new period. The process…starts from a "zero base," and every function within an organization is analyzed for its needs and costs.”
There are many reasons that financial professionals decide to use zero-based budgeting. For one thing, it goes hand-in-hand with a centralized system where information can be shared - something at which Excel spreadsheets are terrible. Furthermore, developing a centralized system enables you to scale to your needs as your company grows. Lastly, it enables financial analysts to spend more of their work week analyzing data instead of curating a financial system and worrying if the numbers match.
At Alithya, we have found with our past clients that a successful zero-based budgeting implementation resolves numerous problems. The two main things clients hope to achieve is growth across multiple business units and developing sustained cost reduction. With zero-based budgeting, you can earn long-term savings that can directly translate into sustainable growth.
Earning Long-Term Cost Savings
Zero-based budgeting becomes a daily exercise in cost savings for your financial teams. One method in achieving cost savings is renegotiating costs. For example, instead of taking the run-rate of 3% from last year’s numbers, perhaps you can contact your vendors to bargain for a better deal or switch to a different vendor with a more competitive price. Or how about having your analysts ask the IT department why it costs $38.03 per phone? What makes up that entire $38.08? Don’t assume that there aren’t any negotiable components of a cost.
The reason zero-based budgeting is so effective at long-term savings is that it is not a one-off fix. Many teams tend to implement one-off fixes, and then find that those fixes do not provide sustainable cost savings. A common example is offshoring your call center which might get you an immediate win in the cost column. However, this strategy typically reduces customer service quality while also limiting your ability to evolve with your business as it grows.
When enacting this type of program, you will analyze the costs of your business at every level. This may seem tedious, but what you will find is a clearer understanding of where your money is going. This can mean acquiring a greater understanding of contract labor costs as well as improving purchasing and procurement procedures, just to name a few. Moreover, when properly implemented, zero-based budgeting can reduce SG&A costs by 10 to 25 percent, often within as little as six months,” according to McKinsey & Company.
Debunking Myths Surrounding Zero-Based Budgeting
There are many myths surrounding zero-based budgeting that have sadly created an artificial barrier that CFOs and their teams do not want to cross. Many financial professionals think that it means cutting the budget down to the bare bones, but rather, a zero-based budgeting program analyzes costs from the top-down. Moreover, it is the CFOs’ duty to outline cost-cut targets so that their team’s efforts are focused.
Another misconception is that zero-based budgeting only helps with cutting the costs of SG&A. Actually, it can do much more, such as breaking down the Cost of Goods Sold (COGS) and help teams make investment choices on the capital expenditure with the greatest ROI.
Just because your business is not in decline or stagnating doesn’t mean that you can’t adopt a zero-based budgeting program. If you are already achieving growth, you can use this type of budgeting method to keep the overall business leaner so that you can provide more runway for growing business units.
Do you really start from zero? This is a common question that we are asked, and many people think because of its name that you do always start from zero. Technically, this is true, but this is the core component that drives the cost management culture change that will be introduced in the next post in this series.
However, not all things have to start from zero. At Alithya, we have been through many implementations where parts of the P&L are driver-based or zero-based. This can be achieved with a detailed, structured, and interactive system (like Oracle PBCS/EPBCS) that gives you real-time feedback.
How Does Oracle PBCS and EPBCS Help Achieve ZBB goals?
The main feature you acquire when you implement an Oracle PBCS or EPBCS system with your zero-based budgeting program is deeper analytics. This data enables you to dig into the “why and how” of your P&L.
For example, you could pose the question what driver did they use? Did they just simply take last year’s actuals and add 3%? Did they take a cost-per-head and budget it manually, or did they take the easy way out? All are important questions that force finance teams to be more accountable when it comes to everyday decisions.
Recapping the Benefits of ZBB
By implementing a zero-based budgeting program with a centralized system, you can hold your analysts more accountable to cost figures while making them own up to how the costs are managed. It allows you to recognize any unwanted costs that can be diverted into certain growth areas as well as breed a culture of cost reduction and visibility. The latter requires that you to start a culture change within your team. It is an essential part of having success with a zero-based budgeting program which is why we will cover it in greater detail in the next post.