Zero-based budgeting refers to a method of budgeting in which all expenses are justified for each and every new period. As its name suggests, budgeting starts from a “zero base”, and each and every activity and ongoing expense within an organisation is analysed for its relevance and overall value, sometimes as frequently as every new quarter.
"Zero-based budgeting is a 'clean sheet' approach to the budgeting process where each division/function of an entity starts with a zero base," explains Teresa Morahan, partner and head of audit, BDO.
“Each division and function within an organisation must analyse its requirements and the costs associated with these requirements. Budgets are then developed based on this analysis. The big difference between this approach and the traditional budgeting methodologies is that historical budgets/results do not play a significant part in the budgeting process.
Time consuming
Zero-based budgeting means more focus on analysis of the finer details – in stark contrast to more traditional budgeting models, which are generally based on a percentage increase or decrease of historical costs and budgets, which allows for only limited analysis of change in the business, such as the impact of an increased workforce on future budgeting.
The types of organisations, therefore, which would utilise zero-based budgeting are more sophisticated organisations who have sufficient resources, together with the required level of expertise, or those organisations who have clear visibility on future costs.
“The benefits of using a zero-based budgeting process are that it generally produces a more accurate budget upon which more reliance can be placed upon,” says Morahan. “It can also drive cost savings as the budgets only include costs which are actually required, and allows for more involvement of management/function heads in the budgeting process, leading to greater accountability overall,” she adds.
The main drawback to zero-based budgeting is the amount of labour and time required to stay abreast of the significant level of detail involved that must be overseen by someone.
“The challenges are that it is a very time -consuming process and involves a significant level of management resources due to the level of details involved,” says Morahan. “There is also a risk that those individuals involved in the process do not have the necessary skills and knowledge. Hence investment may be required to train individuals and provide them with the requisite knowledge in order that they can produce high quality budgets.”
Fintech improving efficiencies to zero-based budgeting approach
There is no doubt that the chief driver of rapid change in the Irish corporate finance landscape is a growing availability of data. Can big data help reduce the burden of labour involved with existing zero-based budgeting approaches?
Making sense of all the data available is the main challenge. The success of companies in this space is driven by their ability to leverage relevant data while simultaneously adapting to rapidly changing economies.
CFOs are struggling to adjust to the increased volume and speed of data available to them and are investing in new technologies in order to become more agile. Reliance on new technologies for greater agility, however, inevitably result in the need for increased focus on cybersecurity, data management and training.
Banks and investors are demanding faster turnaround of historic trading information with increased emphasis on real-time cashflows and rolling forecasts. No longer are finance teams focused on historic reporting but businesses are investing in strategic analysts to examine key market and operational trends. Management teams are expected to know and understand the impact of global trends and undertake scenario planning to consider the effect of these uncertainties on their business. And while this is possible in most large corporates, the strain on traditional SMEs has been significant as they struggle to keep up with the pace of change.
All the rage: multinationals use zero-based budgeting to cut costs
It’s not often one finds examples of the private sector adopting financial strategy approaches learned from the state. But former US president Jimmy Carter was the first state governor and the first US president to implement zero-based budgeting. After its success at state level, Carter then insisted it be used as the platform for the 1976 federal budget approach.
Forty years later and private multinational companies like Diageo have come out as newly-anointed converts to the zero-based budgeting approach. Diageo's new general manager for Great Britain , Ireland and France, recently declared publicly that zero-based budgeting was now the "new normal" for business, describing it as "a requisite for being a world class organisation".
Other major players have subsequently followed suit. In January Unilever announced it would start using zero-based budgeting more and more. Now Coca-Cola, Kellogg's and Campbell Soup are all talking about adopting zero-based budgeting.
It's not just global conglomerates who have caught on. Private equity and venture capital funds are also big supporters of zero-based budgeting, believing it will encourage management teams to think harder about how they invest shareholder funds and in turn help drive shareholder returns. 3G Capital, which partnered with Berkshire Hathaway to buy Heinz in 2013, is a big supporter of zero-based budgeting.