Zero-Based Budgeting is a unique accounting practice with specific advantages and disadvantages. It forces businesses to think about how each and every expense is managed in a specific budgeting period.
A detailed spending plan is still the fastest way to achieve your finance goals. In general, a budget can be used to determine where every single cent should go each month. A budget therefore gives you the freedom to spend money and to increase it. Zero-based budgeting is a unique approach to budgeting.
Where does the concept of Zero-Based Budgeting come from?
A Controller at Texas Instruments in Dallas, Texas, Peter Pyhrr, developed Zero-Based Budgeting in the 1960s and published an article in the Harvard Business Review in approximately 1970 that became very influential in the finance industry.
The unique feature of the method is that all expenditures for each new period must be justified and approved. In recent years, this budgeting technique has experienced a new upswing: it was introduced by some Fortune 500 companies as well as private equity firms.
Zero-Based Thinking on the rise
In 2018, Accenture Strategy published a broad-based study on “Zero Based Thinking”. The results were impressive: among the world’s 85 largest global companies, zero-based budgeting grew exponentially at a rate of 57 percent per year from 2013 to 2017. The companies include Kraft Heinz Co., Unilever PLC and Mondelez International Inc.
As the main reason for using zero-based budgeting, 96 percent of companies cited the method as a way to improve their profitability. 48 percent felt influenced by competitors and 40 percent cited slow growth as a catalyst for choosing the budgeting method.
Each budget period starts from zero
In traditional budgeting, the budget of the previous period serves as the starting point for a company. This is then used as the basis. As a result, 1) each new budget increases bit by bit compared to the previous period. 2.) Companies only have to justify new expenditures.
The biggest difference between zero-based budgeting and the traditional budgeting method is that the budget for each new period is created from zero. Any effort must therefore be justified before it is included in the budget – and this also applies to original and recurring expenses.
Weighing the advantages and disadvantages carefully
The main advantages of Zero-Based Budgeting are its flexible budgets, focused processes and more disciplined execution. Costs can also be kept relatively low.
A particular disadvantage results from the possibility of resource intensity. There is also the possible danger of budget manipulation by experienced managers and the orientation towards being too short-sighted in short-term planning.
Each organization must decide for itself whether the Zero-Based Budgeting method is the right fit for their planning, budgeting and forecasting needs.