Zero-based budgeting (ZBB) has potential for unlocking 'tremendous shareholder value' and yet many companies haven't embraced this budgeting methodology. Here are four reasons why they should.
ZBB requires companies to start each budgeting period from a basis of zero, by justifying all expenses (new ones as well as recurring expenses that have been approved in past budgets). The budget for the period in question is then tailored according to the requirements, rather than being based on past budget amounts. However, many companies remain unconvinced because the process requires time-consuming attention to details and takes much longer than traditional budgeting processes.
Despite the downsides, ZBB has been hailed by some as a robust, more efficient and cost-saving budgeting method. A recent article by McKinsey explores some of the reasons that might put companies off ZBB, despite its potential for unlocking “tremendous shareholder value well beyond the consumer sector”.
Here are some of the reasons why ZBB could benefit your company's working capital:
1. A ZBB programme can vary in scope and size
This is a positive element, yet some companies could be deterred if they think that ZBB won't have a far-reaching effect throughout the whole company. However, McKinsey acknowledged that a cultural change is needed for ZBB to be effective in the long term. It states: “A few organizations have tried to omit the granular, bottom-up budgeting and resource-reallocation decisions that ZBB calls for. Those tasks are essential to reinforce ZBB as a mind-set, and not including them in the process risks leaving the organization with just another cost-cutting project whose effects fade within a year or two.”
2. ZBB is not just cost-cutting
Rather than looking for the biggest areas to cut costs, each division of the company needs to reconstruct its budget from the bottom up, with no carry-over from the previous budget period. This shifts the 'burden of proof' from those trying to cut costs to managers across the organisation. This has the additional benefit of getting front-line managers throughout the company on board with monitoring costs and gives them more control to make cost-savings where possible. McKinsey's authors write: “This process identifies many small pockets of waste that add up to big savings. It also yields a better fit with the business’s priorities by tapping broader management understanding of choices and trade-offs.”
3. ZBB first emerged 50 years ago – so what's new?
McKinsey says that digital innovation has made ZBB less onerous for companies and more sustainable. The article states: “In place of central teams coordinating thousands of spreadsheets, new digital solutions manage enormous quantities of data almost instantaneously. This not only reduces the need for cumbersome data-gathering exercises but also enables organizations to bring ZBB to scale much faster.”
4. ZBB drives reinvestment and growth
By reducing budgets where it's not needed, companies can free up capital to plough back into projects that could drive growth and greater revenue. McKinsey writes: “ZBB helps companies overcome the difficulty of managing aggregated revenue inflows and cost outflows, and it increases the likelihood of profitable growth.”
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