Zero based budgeting - as easy as 1, 2, 3
February 05, 2019
Companies are experiencing increased financial pressure and consequently there is an increased focus on cost reduction. If you are looking at cost reduction, Zero based budgeting (ZBB) might be one of the solutions.
ZBB methodology starts the budgeting process with a clean slate (from zero) and builds the future costs up from the lowest possible level. This gives true visibility of cost base and its drivers, and subsequently helps to create consistent tracking KPIs and a culture of cost consciousness.
We have discussed in Blog 1 (Don’t believe the hype - Zero Based Budgeting is about providing more choice) how you can choose the degree to which you change your corporate culture. Every successful ZBB programme relies on the following crucial pillars:
- Visibility - budgeting for smallest product or activity at the lowest cost centre level to enable transparency and ability to challenge
- Accountability - budget owners at all levels responsible for managing spend appropriately
- Governance - routine monitoring and reporting to keep costs from creeping back in
Companies often budget top down at aggregate levels that hide details and therefore cause them to miss opportunities for cost reduction and even risks of under budgeting. Building budgets upwards from zero, for each activity and each business unit, helps bring visibility at all levels and enables comparison and internal benchmarking. Importantly it improves a company's ability to take informed decisions and achieve stakeholder buy-in.
We looked at £20m maintenance budget across 20 plants for a global food manufacturing company. Using the more common budgeting method of extrapolating historic trends, the budget was in line with inflationary expectations. However on closer inspection, there was room for 10% reduction in budget overall and a better allocation of budget across sites. This disproportionate budget split across sites was also an effective evidence to achieve the team buy-in for a cost reduction program.
A further problem with budgeting top down at aggregate levels is that it creates lack of ownership. How many times have you heard a demotivated budget owner shun the responsibility of meeting targets because he/she did not create the budget in the first place? It is easy for a budget owner who was involved in its creation to take ownership and equally to hold him/her accountable.
In the above example of maintenance budget for food manufacturing business, budget owners when prompted, themselves identified areas of overspend and initiated a project to revise contracts and budget.
After all of above, a well-planned budget is still susceptible to uncertainties and businesses need to be agile to proactively manage any headwinds during the year. You can achieve good governance through disciplined monitoring and standardised reporting.
For example, when there was an unanticipated and unavoidable overspend in the maintenance budget, an avoidable spend in another area was postponed for next year. The judgement on which spend is unavoidable and which can be postponed came from the ultimate budget owner who had also created the budget in the first place and therefore held this knowledge.
Implemented this way, ZBB creates the right environment for cost reduction. Most importantly, if everyone embraces the three pillars and uses them consistently, it can drive behaviour change, encouraging everyone to prioritise their expenditure and enable cost reduction.
To find out more, please contact Zena Alston or Aditi Gandhi.
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