What is Zero-Based Budgeting (ZBB)? Definition & An Overview
Zero-based budgeting (ZBB) is a budgeting approach in which you account for each dollar during a budgeting period. Each period begins at a base of zero, meaning that you start fresh from previous budgets. You assess needs for the upcoming period and build your budget around specific expenses. When using this budget, you don’t attempt to “make” your budget fit with what you previously did. Instead, you recognize the way your budget ebbs and flows.
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- Companies and families alike can use the zero-based budgeting method.
- Many times this budgeting strategy goes from month to month.
- ZBB accounts for irregular expenses that happen from month to month.
- Zero-based budgeting is a great method to use if you want to have greater cost awareness.
- The idea behind the zero-based budgeting process is that you have zero dollars left at the end of the month. You allocate each dollar to an expenditure, even including savings as a line item.
How a Zero-Based Budget Works in Business
When you look at the zero-based budgeting system from a business perspective, the goal is to tie dollars to strategic priorities. You group costs together into categories, even assigning goals to each spending category. Then you can measure success compared to what you anticipated. ZBB is great for tracking high-level organizational goals.
Once you establish a zero-based budgeting plan, you can slowly assess budget areas over a period of years. Zero-based budgeting helps you focus on details and pinpoint ways to decrease your spending. It is important to keep in mind that this method of budgeting can be time-consuming because of its granular nature.
This type of budgeting can be great for tracking variable expenses like personal expenses and utility payments. You can also track variable income to see how you can increase your profit margin.
The ZBB approach to budgeting is primarily for businesses, but families use it too. You spend or allocate your money down to zero each month. This doesn’t mean you have to actually buy things with your money if you have any leftovers. Instead, you add a line item for additional savings and note what you’re allocating the dollars toward. Examples include:
- Additional retirement savings
- Emergency savings
- College fund
- Long-term savings
Traditional Budget vs Zero-Based Budget
Various methods of budgeting offer their own unique pros and cons. A traditional business budget usually plans for incremental budget increases over time. Traditional budget methods also focus more on new spending and less on recurring expenses. You expect increases with traditional budgeting, so you may be less likely to look closely at recurring expenses. With traditional budgeting approaches, the annual budgeting process is the only time you cut costs.
With a zero-base budget, you look for cost reductions across all of your spending in each budget cycle. You don’t accept the status quo. You have more frequent budget discussions and pay attention to details like:
- Cost Base
- Managing A Tight Budget
- Financial Planning
- Cost Structure
- Performance Measures
- Cost Discipline
- Capital Expenditures
- Future Growth
- Cost Drivers
Example of a Zero-Based Budget
Let’s say that you manage a small local credit union. You outsource credit card management to a vendor for a set price each year. Your contract is up for renewal, and the price increases 10% over the previous contract. Your leadership team researches the cost and commitment of managing credit cards in-house. You find that it’s cheaper than paying a vendor for the same services, even with the addition of new positions and salaries.
With a traditional budget, you likely increase the vendor cost and keep going. ZBB means that you commit to assessing budget items large and small. Improvements are always possible when you take a more granular look at your spending. ZBB also keeps you and your team in the mindset of looking for potential savings. It becomes your new mindset.
How to Implement a Zero-Based Budget
There are five steps in transitioning to the ZBB method.
- Add up your monthly income.
- Detail your month-specific expenses, including discretionary spending.
- Your monthly spending should subtract from your income to equal zero. Make sure that you allocate each dollar to a spending category.
- Throughout the month, track all of your expenses. This includes cash spending.
- Make flexible spending decisions when your income and expenses fluctuate.
Taking a Long-Term Approach with Zero-Based Budgeting
One pitfall of zero-based budgeting is that your focus tends to be on the short term. Traditional, cost-based budgeting includes more long-term spending. But there are ways to make sure long-term goals get addressed. Keep an outline handy of goals that are months and years ahead, along with associated expenses. When you can, allocate dollars from your monthly budget toward those goals.
This is a great approach in two ways. When you have extra funds, you automatically have future goals in mind. You’re setting your business up for long-term success. When you don’t have extra money in the budget, it pushes you to find ways to cut costs.
Zero-based budgeting is a way to account for all of your income down to the penny. This method is more of a short-term approach. It allows you to account for budget variations that occur from month to month. Zero-based budgeting is a great way to gain awareness of your business spending.
FAQs on Zero-Based Budgeting
What are the pros of zero-based budgeting?
With ZBB, you constantly look for ways to improve your spending habits. This budgeting solution is a great way to categorize types of expenses and identify savings opportunities.
What are the cons of zero-based budgeting?
A ZBB is time-consuming. Since there is a strong focus on a single budget period, long-term goals may get overlooked.
Can you make a zero-based budget with an irregular income?
Yes. In fact, ZBB is ideal for an irregular income. During each budgeting period, you create a budget from scratch. You take what you learned from previous budgets and apply those lessons to your current income and expenses.
Who uses zero-based budgeting?
Companies primarily use zero-based budgets. However, families or individuals can use this budgeting method as well. The zero-based budget method works for anyone who has fluctuating income and expenses.
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