Zero-Based Budgeting

Definition

Zero-Based Budgeting (ZBB) is a type of budgeting in which all actual spending must be justified and approved right from the start for every new accounting period, rather than simply being an adjustment to the previous year's budget. It's called zero-based budgeting because the process starts from a "zero base," which means every department or function within the company is analyzed for its current needs and costs, and budgets are built around what's necessary for the upcoming period without regard for past spending habits.

Why it matters

ZBB helps firms make laser-focused financial decisions, ensuring that much-needed funds go into what truly drives impact. With ZBB requiring a clear reason for every expense from every department, it can have a positive effect on the bottom line by removing waste and optimizing spending. Sure, it does take longer than doing traditional budgeting, but the benefit in most cases is greater accuracy in cost control and budgets more closely aligned with the firm's actual goals.

Important notes:

• Implementation challenges: ZBB is relatively inexpensive, but it does require extensive resources in terms of time and effort. In fact, organizations that intend to adopt it may need to purchase special software or even provide training to manage such an elaborate process more effectively.
• Short-term vs. long-term focus: Not surprisingly, ZBB has traditionally favored projects or departments that generate immediate tangible revenues; this may mean the underfunding of long-term investments in research and development.
• Best practices: In applying ZBB, organizations should adopt modern budgeting tools that'll enable them to make decisions based on data and to encourage cross-functional collaboration in order to ensure well-coordinated plans that fit within the overall business objectives.