If you’re involved in the corporate world, you may have heard the term Zero-Based Budgeting being tossed around. I sure have. It’s often associated with cost-cutting and aggressive financial restructuring, but I wouldn’t say those things are synonymous with the term. In fact, I’d say that Zero-Based Budgeting is a type of planning for the future that makes a lot of sense — to a point. Let me explain.
Many companies budget for a particular year based on the prior year. They simply look at the overall number, or perhaps the number per department, assume that they’ll need to spend the same amount next year or a flat percentage increase or decrease, and write that new number down in their budgets. If your business is fairly stable in its expenses, that makes sense: it saves a lot of time budgeting, and gives you a solid baseline for coming years. However, when you budget based on the prior year, this kind of thing might happen:
To recap, department or branch heads might not want a savings to appear on their final numbers for a year, because it would mean budget cuts for next year — if you didn’t need it this year, why would you need it next year? It’s kind of sketchy, and it also leads to something else you saw in the video: managers not understanding their budgets. I know, I know, it’s Michael Scott. But if the budget is just a big pool of money, it’s not a stretch that those in charge might not know where it’s all going.
So what can businesses do instead?
Let’s consider personal finance for a moment. How do you build your own budget for your household (if you have one)? If you’re starting from scratch, you might get out a piece of paper or a spreadsheet and start listing monthly expenditures:
- House payments
- Car payments
Then you’ll come up with how much each of those line items will cost you in the month. That may be based on an actual bill amount, last month’s spending, or an educated guess (e.g. “We’ll probably go to the movies once a month, so that’s about $80 if we get popcorn, and maybe out for dinner…” — you get the idea). Once you’re done, you have a full budget, and you know where all of the money needs to go.
This is Zero-Based Budgeting.
Whether it’s applied to your personal life or your business, Zero-Based Budgeting is simply the concept of starting from scratch (zero-based) and building up a budget based on specific line items. It creates more accountability, visibility, and practicality than plucking some big, round numbers from last year’s budget. And knowing where your money is going can lead to savings, because you don’t budget beyond what you really need. Obviously, it’s a little harder with a large company, because the expenditures can come from more than a handful of people, who can be spread out beyond the confines of a single household. Some companies will have Zero-Based Budgeting officers or teams to manage the process as they prepare a reasonable budget throughout the year for next year.
But what are the downsides?
When you are creating your own personal budget, you want to balance smart choices with quality of life. Sure, you could budget $0 for entertainment or clothing and save all of that money, but is that realistic?
But when Zero-Based Budgeting is used in the workplace, there are other factors at play — specifically, shareholders, boards of directors, executives, and all the other people that want to see a great bottom line. So while you may have come up with a perfectly reasonable zero-based budget for your team, there may still be pressure to cut the budget by a certain percentage or eliminate additional costs. And then what? You have to choose between those carefully-selected line items and values, and decide what you will do without for the year, even though each item was something you interpreted as a need for your business function.
Another shortfall of Zero-Based Budgeting is the potential absence in a corporate budget of something that most people build into their personal budget: an emergency fund. If you’re unsure about the need for an emergency fund in your home budget, check out this article by the fab financial guru Gail Vaz-Oxlade. But as I mentioned earlier, some key players in your company may not want to see “just in case” line items in your budget, because that money may be frittered away à la Michael Scott in the video. So that’s one of the first lines to get cut.
And what happens when there is an emergency, or even just a change of plans (or something that was forgotten during the budgeting process)? Then you don’t have the money in the budget to accommodate, and because each dollar is assigned to a particular expenditure, you can’t just move money around to make it work. You may have to beg or barter your way out of this one. And every one after that.
What’s the solution?
Zero-Based Budgeting is a fantastic idea, if your company allows budgets that are realistic and flexible enough for contingencies. In order to be sustainable, these budgets should include an emergency fund, just like a personal budget. And if no one uses the emergency fund in a given year, it’s illogical to take it away for the following year. Keep the savings, of course, but still include an emergency fund in the next budget.
But who am I to make these recommendations? Well, the way I see it, Zero-Based Budgeting is all about common sense and transparency. And if you’re transparent about using common sense to plan for the unexpected, then Zero-Based Budgeting will be a great way to manage your personal and professional finances for many years to come. For a deeper dive into ZBB, check out this paper from Deloitte.
What are your thoughts on Zero-Based Budgeting?
P.S. This is the last post in the Blogging from A to Z Challenge! We made it! Thanks for joining me on this fun and hectic journey over the past thirty days.