How Zero-Based Budgeting Improves Operations

By Robert Freedman01.13.2020

If you're not using zero-based budgeting in your accounting function, it may be worth considering; the method forces business leaders to look at their spending with fresh eyes, budgeting experts say.

Under zero-based budgeting, instead of using last year's budget as a baseline and adding money for initiatives on top of that, you build your budget from scratch. That way, you review existing expenses before moving them to next year's budget.

"It forces people to really justify their spending on a year-to-year basis," Gregory Panik, vice president of FP&A at International CTDI, a communications engineering company, said last week in a CFO.com webinar.

Panik said the budgeting approach could lead to a more reasonable IT spend by giving a tech executive a more nuanced view of what the business needs.

"Many times, our IT services will say, 'I need 99% on-time and I need it 24 hours a day, every day of the week,'" Panik said. "When you take a hard look at what it costs to provide that level of support, people start to step back and say, 'Oh, wow, I didn't realize it cost that much,' and it forces you to think about why that expense is on board."

Major Undertaking

Moving from traditional to zero-based budgeting is neither easy nor cheap, so company leadership must initiate the change, the budgeting pros said.

"It's going to take about three years, on average, to really refine and hone it," said Chris Vanacore, controller of Ithaka, a nonprofit technology platform for academics. "It's going to change the culture of your organization."

That's because it requires buy-in from all operational heads of an organization: HR, IT, product, sales and so on. These department heads have to look at their existing programs and come prepared to defend them and anything new they want to get, so the process requires more effort and time.

"You will get push-back from each of the operation [heads] who still want to go with that traditional budget approach," Panik said. "You ask them to cut back to their original budget, you fight for a little bit, and then you move on. This [by contrast] is much more business-centric, much more tied to the P&L for understanding what is the benefit to the organization, for every dollar of spend."

The benefit, though, is better alignment between what the organization is spending and its goals.

"Managers are hesitant at first," Vanacore said. "I think they view this as a way to just come in and cut expense. Well, that's not really the priority; the priority is to better understand all of our expenses in terms of the value they bring in. If we were to cut project XYZ, what would be the impact? That helps bridge the gap. It could be, 'Well, we can live with that,' and that's how you can begin to break down some silos."

Easier with Cloud System

Because the method relies on operational leaders digging into their annual spend, zero-based budgeting works best when it's built on a cloud-based system, which gives executives the ability to access, share and analyze their numbers at any time.

You can switch to the new system even if you're still using Excel spreadsheets, but you'll have to devise a way to give operational leaders what they need in a format they can use.

"The real difference is the data itself," said Panik, who transitioned to a zero-based system while he was a finance executive at Campbell Soup Co. and used the system at Deutsche Bank and at CTDI. "We used a hybrid approach, and we had strong enterprise resource planning (ERP), and reporting modules sat on top of it."

Beyond Transition

To benefit from the system after putting it in place, help operational leaders use and review their numbers. 

Vanacore suggested operational leaders look at their spend in terms of ranking. Line up all the programs the division spends money on and rank them in order of importance. Once a decision is made on what organization-wide spend will be for the year, the operational leader will know what to eliminate if cuts are needed.

"Go down to the bottom of the rankings — that particular expense that ranks 28th out of your list of programs and that returns very little or even has a negative value,"  Vanacore said​. "Instead of giving everyone an unfair across-the-board 5% cut, why don't you just cut that 28th project? If the dollars still don't add up, cut the 27th project, too."

Panik suggested trying an incentive system, which would give operational leaders a concrete reason to stay on top of their spending and be prepared to make tough choices each year.

"I don't know if you have alignment of the budget tied to your incentives, but that is always a wonderful way for people to get in the spirit of being accountable for their budgets," he said. "If people don't have skin in the game, they will continue to ignore it and just expect someone to come yell and scream at them or pull them into a meeting [but without any penalty]. People are willing to take that risk in some cases."

Reprinted with permission from CFO Dive, an industry publication operated by Industry Dive that reports on the latest news and developments in the CFO industry.