The core concept of a budget is to control the amount that you spend. A budget acts as a check to ensure the levels spent correspond to what is expected. However, many companies find the budget process difficult. This is especially true for small businesses that are rapidly growing. How are future financial measures expected to be calculated if future financial measures are so unpredictable? Many companies fall back on simply growing previous budgets. However, another answer exists — the zero-based budget.
Defining Zero-Based Budgets
A zero-based budget is essentially a budget that starts from a clean slate. At the beginning of the budgeting period, all aspects of a company’s budget is set to $0. Then, activities are determined and justified before adding that amount to the budget. For example, the marketing budget last year was $7,500. Instead of simply growing this number by a fixed percentage, a small business sets the next year’s marketing budget at $0. Only if it can justify and rationalize a marketing campaign can the owner increase the budget during the budgeting process.
Popular Concepts of Zero-Based Budgets
Although it is not necessary, many zero-based budget concepts revolve around cutting costs. The strategy is to ensure only necessary costs are incurred – an idea that many companies take as cutting costs to the bone. In essence, the cost cutting strategy is developed by management and incorporated into the budgeting policy. For example, a small business may wish to cut expenses by 20%. It is this initiative by management that defines the level of cost-cutting, not the zero-based budgeting practice itself.
Benefits of Zero-Based Budget
A zero-based budget revolves around justifying costs. Instead of going through the budgeting process analyzing last year’s budget and spending, a company must explain each budget line for the upcoming year. A zero-based budget is the ultimate spending control, since management will know every line item is associated with a certain activity. Instead of having a bucket to draw from, each budget line has a specified purpose, saving the company from spending waste.
Downside of Zero-Based Budget
The downside to this budgeting process is the timeliness and cost. The zero-based budget is essentially a budget built from scratch each year. The budgeting process is more in-depth, requires more attention, and will take longer to develop compared to other budgeting processes. For this reason, not all members of a small business may buy into the concept of justifying every budget line specifically. Since it takes a substantial amount of time and resources to develop the budget, there are significant opportunity costs associated with the budgeting process.
Zero-based budgeting is more difficult for rapidly-growing companies in unpredictable markets. Companies with cash flow difficulties will appreciate the concept of reviewing every expense. In addition, companies with questionable revenue streams due to new products, new markets, or new competitors will struggle to establish relevant ranges. However, any company can implement a zero-based budget and incorporate flexibility by periodically assessing the market and its company’s position.