Cost management is vital for every business and for most, setting budgets is based largely on what happened last year. But in the current business environment, where volatility and unpredictability are the watchwords, a more accurate method seems appropriate. We go back to basics with the concept of zero-based budgeting.
A 2018 Accenture report showed that over 91% of zero-based budgeting (ZBB) programmes met or exceeded their targets. Before 2011, only 2% of surveyed companies had initiated a ZBB programme but between 2013 and 2017, Accenture notes that ZBB adoption grew by 57% every year amongst the world’s 85 largest companies. ZBB, it seems, has arrived, at least on the big stage.
Does it work? McKinsey reports that “when properly implemented, ZBB can reduce selling, general and administrative (SG&A) costs by 10% to 25%, often within as little as six months”.
But it is not a silver bullet for cash management difficulties nor is it an easy fix, warns Accenture. Indeed, companies reported some serious obstacles to overcome before finally reaping the rewards: 67% said cultural buy-in was the hardest, followed by change management problems (41%) and the perennial issue of data visibility (33%).
Perhaps one of the key difficulties in getting buy-in is that ZBB is an ongoing process that represents, for some, both a cultural and business process about turn.
Accenture now advocates a far wider use case for the ‘zero-based mind-set’ (or ZBx, as it calls it), with potential, it argues, to tackle the entire P&L, including general and administrative expenses, direct and indirect labour costs, sales and marketing, logistics, and cost of goods sold. For now though, we’ll focus on its original target.
The ‘zero-based’ concept was the brainchild of Peter Pyhrr, an account manager at US technology firm, Texas Instruments. Pyhrr developed his concept in the 1960s and wrote about his success with it in a 1970 article for the Harvard Business Review. The Accenture report referred to earlier shows that it has since met with favour at many a large corporate and has been advocated for use by small businesses too because of its inherent accuracy.
ZBB requires a company’s income less its expenses to equal zero. In other words, its expenses need to match what comes in during the budgetary period. The idea is that every single unit of currency (euro, pound, dollar, yen, rupee et al) has a well-defined function, so that everything the company spends, saves, gives or invests is equal to that period’s income.
ZBB means there are no balances to be carried forward from prior periods and no expenses that are pre-committed. It is literally a zero-balance for each period. But it is more than just ‘a new budget from scratch’. It is, as McKinsey has argued, a way to “build cultures of cost management throughout the organisation by using a structured approach to facilitate cost visibility, cost governance, cost accountability, and aligned incentives.”
Indeed, by connecting the budgeting processes to the different business functions – production, sales and marketing, logistics and so on – it allows the grouping of diverse cost bases. Current but rather more granular expectations of expenditure across the business can then be analysed, giving a far more strategic view.
The ZBB model is a means of banishing arbitrary and potentially inaccurate and costly blanket increases or decreases over the previous period’s budget. It means that it is now possible to create an accurate and detailed rolling budget over an extended period. Here, reviews can be called from small groups of managers from different functions at different times, rather than imposing them en masse, and still maintain accuracy.
The fundamental process demands a re-evaluation of every line item of a cash flow statement, justifying every expenditure that is to be incurred by each department. Every expense for each new period is thus calculated on the basis of actual expenses that are to be incurred and not the rather less accurate assumption (as is the case with traditional budgeting) that previous incomings and outgoings will continue.
The idea that arbitrary incremental spending increases over previous budgets is somehow appropriate when costs and market conditions are as volatile as they are today seems wide of the mark. Whereas traditional budgeting seeks to justify only new expenditures, using the last period’s actuals as the template, ZBB wipes the slate clean for each new period.
The main aim of the ZBB model is to lower business unit costs by pinpointing where these can be sensibly cut. By knowing precisely where every dollar (euro, pound, etcetera) is going, the vagaries of the market can be more effectively managed. As McKinsey has pointed out: “A world-class ZBB process is based on developing deep visibility into cost drivers and using that visibility to set aggressive yet credible budget targets.”
The basic principles encourage:
Identifying specific business goals and/or tasks for each function.
Analysing and developing new ways of achieving these tasks.
Exploring new sources of funding for these.
Setting the budget numbers and prioritising the direction of funding.