Editor: Sejal Shah. Read time: 7 mins.
Are you a startup or an MSME trying to gauge the best method to budget? It is very crucial that business financial planners of such companies focus on the right budgeting method that matches their long-term and short-term goals with resources available to meet them. This blog is a crisp beginner’s guide to the nuances of Zero-Based Budgeting – an important tool for startups and smaller companies for allocating budgets wisely.
Business Planning for Startups, Business Financial Planner, Financial Modelling startup
The importance of budgeting can never be underestimated! Says Jacob Lew – the 76th United States Secretary of the Treasury, “The budget is not just a collection of numbers, but an expression of our values and aspirations.”
Now, the most traditional form of budgeting is reviewing the past and forecasting for the future. But it might not always be the most effective way to plan for an entity, especially for small companies. Typically, business planning for startups is hung on a rather experimentative basis fraught with various uncertainties. Plus, there are challenges in terms of funding, high risks of cash burning, poor or inaccurate startup financial modelling amongst many others.
Another option that could be of possible importance to such business is Zero-Based Budgeting (ZBB).
What is ZBB?
ZBB derives its name because the budget starts from scratch or zero! It is not based on previous or past budgets. In ZBB, every expense is justified before its inclusion in the budget and not added as a 2% growth due to inflation.
The idea of ZBB is to reduce the expenses through a focus on cost-cutting by including only those areas of expenditure that are required and pruning away the unwanted items.
All levels of the organization need to be integrated into ZBB as employees know the exact and kind of expenses incurred and help the organization in reducing the expenses. If the expense is not value-adding or beneficial, or if there is a case of captive consumption, it is discarded from the budget.
This form of budgeting is rather time-consuming as it is made from scratch therefore entities usually benefit from it even by making it once in a few years and preparing the traditional budget otherwise.
ZBB v/s traditional budgeting
|Past records||Considered and accordingly adjustments are made||Not considered as all activities need to be revaluated|
|Time consumed||Less time is required||More time is required as it made from scratch|
|Expenses||Certain unnecessary expenses may be identified by allocating smaller budgets to various departments||No wasteful expenditures are incurred as all unnecessary costs are cut and only those that directly benefit the entity are considered|
|Principles||It is accounting oriented||It is decision making oriented|
|Justification||Justification for each line item of the budget is not required||Justification for each line item of the budget is required|
|Decision Making||Top Management undertakes allocation of amount to be spent||Managers involve themselves as they know the day-to-day reality|
|Approach||Monotonous approach||Straight forward approach|
What are the Advantages?
- Accurately identifying each item of the budget
- Increase in organization efficiency
- Coordination and communication increase throughout the organization
- Helps in removing unnecessary activities and expenses
- There is no more budget inflation taking place as a percentage of past performance
- Motivates the employees in making decision making
- It is better than traditional budgeting due to its clarity and responsiveness
What are the Disadvantages?
- Time-consuming since it is complicated compared to the traditional form of budgeting
- Highly skilled manpower is required to prepare the same
Various points to be kept in mind while processing the budget shall include the following steps:
- Identifying the business goal
- Develop and analyze ways to achieve the goals
- Obtain various funding processes to the business
- Prioritize the funds
This shall help in identifying the real costs that have a direct impact or benefit to the entity.
How it can help small businesses?
- ZBB is an important tool for a startup because that does not have any past data to prepare the traditional form of budgets.
- This form of budgeting helps one save money and improve profits for the year. Unnecessary expenses are removed. This method helps in strategizing the effective use of money.
- A small businessman shall know where all the money is being used.
- It helps in channelizing the scarce resources of the smaller companies in meeting short term and long-term goals.
A hypothetical example
Zeba is a boutique of garments for women. It realized that the total cost for tailoring incurred in the previous period was Rs. 5,00,000. After the implementation of ZBB, Zeba’s leadership team realised that having in-house tailors on the payroll could save the company Rs. 60,000. This leaves Rs. 4,40,000 in the budget.
Due to ZBB, Zeba identified various other means of advertising on social media by recruiting graphic designers and saving costs on payments to advertising companies. This might lead to another form of cost-saving. Thus, ZBB helps Zeba to optimize its expenses and allocate funds based on priority.
Unilever for example used ZBB to tide over uncertain market conditions in 2016. Paul Polman, the then Unilver’s CEO said in the 2016 first half-yearly report, “we continue to drive agility and cost discipline, implementing the key initiatives announced at the end of last year: net revenue management, zero-based budgeting and ‘Connected 4 Growth”. This had helped them grow their sales by 4.7% despite challenging economic conditions.
According to CNBC’s article by Lauren Hirsch dated 27th October 2018, Kraft and Heinz managed to cut down $1.7 billion after its merger in 2015.
If this is an inspiration enough for you as a startup, ZBB is worth giving a thought to!
Though this blog contextualizes ZBB for its suitability to startups and small companies, it is by no means restricted to them. Biggies such as Unilever and Kraft Heinz have implemented them and have reaped huge returns.