In financial planning, whether it is for a business or personal finance, how you budget can impact financial performance. Zero-based budgeting (ZBB) has received attention in recent years as a budget method that challenges traditional budget methods. But what is zero-based budgeting? What does it mean and how is it distinctly different than the usual approaches?
In this blog post, we will explain what is zero based budgeting, outline the zero based budgeting process, discuss the benefits and challenges of zero based budgeting, and provide advice to help you implement zero based budgeting, also with some Canadian examples and thoughts.
What Is Zero Based Budgeting and How It Works
Zero based budgeting is a budgeting method where each new budget period begins with a zero base. In traditional budgeting, you often use the last year’s budget as a guide and you will often get a special revision to a previous budget. Zero based budgeting is different in that every dollar of expense must be justified for each new period. Previous budgets, or the assumptions about spending, are thrown aside; the budget is made using a blank slate.
The zero based budgeting process requires going line by line through all operating expenses to allocate funds for only those that are required for either necessary expenses or projects aligned with current strategic priorities and business strategy. The objective is to eliminate needless costs and wasteful spending by forcing all parties involved in the budget process to intentionally consider every element of the budget.
Zero-Based Budgeting vs. Traditional Accounting
In traditional accounting, budgets usually just grow on a percentage basis by a certain percent on last years budget for inflation, growth or other justifiable reasons. This creates a perpetual state of inefficiency over time, as the trends of expenditure behavior are based on past established budgets as opposed to what is happening now.
By contrast zero based budgeting would require managers to justify each area of cost and expenditure which opens the opportunity for cost control and possibly cost savings. The ZBB process is hard work and places the burden of analysis and evidence generation on every expenditure.
To get the details on what qualifies as urgency and what to save for, take a look at the Government of Canada’s emergency savings guidance.
The Zero Based Budgeting Process
The process for zero based budgeting has a defined and undisputed approach with a series of sequential steps that allows companies and individuals to become more aware of and in control of their expenses.
Step 1: Define the Budget Period and Associated Scope
Select the time period for your new budgeting period, most commonly a fiscal year, or a quarter. Determine the departments or units of business to be involved in the zero based budgeting exercise. In large organizations, like Texas Instruments, or the Government of Canada, many departments participated in the zero based budgeting effort which necessitated project management coordination across teams.
Step 2: Identify and Categorize the Activities
Document every activity and recurring expense that will be considered. Disaggregate operating expenses into estimated line items like staff salaries, marketing, utilities, travel etc.
Step 3: Assess and Justify the Costs
Every activity or expense must be justified in terms of relevant strategic objectives and purpose against the strategic alignment. This allows for the most useful application of resources to areas that clearly support a business strategy or personal financial planning goal.
Step 4: Create Decision Packages
Create decision packages for each intended expense and/or activity providing detailed costs, benefits and alternatives. Decision packages will ensure that management has the appropriate information to determine which expenses to approve, reduce or eliminate.
Step 5: Rank and Prioritize Expenses
Rank expenses in order of importance based on whether they support strategic priorities, contribute meaningfully to marketing productivity, or are otherwise necessary to accomplish the ongoing operation of the organization.
Step 6: Finalize and Approve the Budget
Once approved the packages can be compiled into the zero-based budget and communicated clearly to all employees as a plan. Since the budgeting process is a rolling process, a number of organizations refresh the budget often and make changes based on changing financial situations, shifting market conditions, etc.
Step 7: Track Expenses and Monitor Performance
Once the budget is implemented, it will be critical to track expenses regularly to ensure adherence to the budget, and ideally, work actively to take opportunities to further reduce costs.
Implementing Zero Based Budgeting: Effective Strategies and Challenges
Moving to zero-based budgeting is a true commitment and while it can yield real cash flow benefits in the short term and meaningful benefits in the long term, there will be challenges.
Effective Strategies for Moving to Zero Based Budgeting
- Top down: Leadership support is essential, with clear communication about why the organization is implementing ZBB.
- Cross-departmental engagement: Multiple teams need to collaborate to provide accurate revenue and cost information.
- Use technology: Tools like budgeting software can make ZBB less time-consuming.
- Clearly set strategic aims: Tie every budget line item directly to strategic goals.
- Training: Equip managers with the skills to justify expenses effectively.
Zero Based Budgeting Limitations
- Time consuming for larger organizations.
- Resistance to change from managers and employees.
- Dependent on accurate data.
- Complex to coordinate across multiple departments.
Even given these constraints, organizations like Texas Instruments have improved efficiencies with ZBB. Canadian organizations also use ZBB to create transparency and discipline.
Zero Based Budgeting in a Canadian Perspective
Canadian businesses and government organizations have distinct financial environments and challenges that can influence how ZBB works within Canada.
Managing Variable Costs and Inflation
With variable inflation rates in Canada, particularly post-COVID, incremental budgeting may cause overspending. ZBB provides a framework to reassess budgets based on current conditions.
Using ZBB in the Public Sector
Some provinces and municipalities in Canada have implemented ZBB to promote fiscal responsibility and reduce wasteful spending. For example, the provincial government of Ontario has explored ZBB to better align spending with priorities like healthcare and education.
Personal Finance Applications
Many Canadians use ZBB in their personal finances by allocating every dollar of income to essentials, savings, debt repayment, and discretionary spending. Helpful tools include CRA My Account and budgeting apps.
Comparing Zero Based Budgeting with Other Budgeting Methods
Traditional Budgeting
Uses the previous period’s budget with incremental increases. Simpler but risks perpetuating unnecessary costs.
Rolling Budgeting Process
Updates the budget regularly (often quarterly) as actual data becomes available. Flexible, but does not fully question existing costs like ZBB does.
Activity-Based Budgeting
Budgets based on activities driving costs rather than fixed line items. May overlap with ZBB but does not always start from zero.
Pros of Zero Based Budgeting
- Encourages cost reductions and savings.
- Aligns spending with strategic priorities.
- Improves cost transparency.
- Allows flexibility for changing market conditions.
Cons of Zero Based Budgeting
- Time and resource intensive.
- Requires cultural change.
Conclusion: Is Zero Based Budgeting Right for You?
In a world where every dollar counts, understanding what is zero based budgeting can give both businesses and individuals the clarity and confidence required to map out financial strategies. Whether you are part of a Canadian corporation, a government department, or managing personal finances, ZBB can be applied as a disciplined, transparent, and strategic approach.
Although full implementation takes time, the benefits of controlled spending, cost savings, and strategic resource allocation can significantly improve financial performance. Given Canada’s evolving economic conditions, ZBB offers a way to make deliberate and meaningful budget decisions each period.
For more insights, visit the Financial Consumer Agency of Canada and the Canadian Centre for Financial Literacy.
