Your income minus your expenses should equal zero in a zero-based budgeting approach. Savings goals, debt repayment, and fun are all included. You are encouraged to spend every last penny of your monthly salary through the zero-based budgeting strategy. But that doesn’t mean you should go on a shopping binge. The plan includes important goals like conserving money and paying off debt, as well as spending on pleasant things. The goal of the zero-based budget, often known as the zero-sum budget, is to give every money a purpose. Let’s look at the definition, template, and examples of zero-based budgeting. This is how it works.
Zero-Based Budgeting Definition
ZBB is a method of budgeting in which all expenses for each new period must be justified. Every function inside an organization is assessed for its needs and expenditures as part of the zero-based budgeting process, which begins with a “zero base.” The budgets are then constructed around what is required for the next period, regardless of whether each budget is higher or lower than the preceding one.
How Zero-Based Budgeting (ZBB) Works
ZBB enables the implementation of top-level strategic goals into the budgeting process in business by attaching them to specific functional areas of the firm, where expenses may be first aggregated and then measured against prior results and current expectations.
Because of its detail-oriented character, zero-based budgeting may be a multi-year process, with managers or group leaders reviewing a few functional areas at a time. By avoiding blanket increases or decreases to the budget of a former quarter, zero-based budgeting can help reduce expenditures. Yet, it is a time-consuming procedure that takes far longer than conventional, cost-based budgeting.
The strategy also prioritizes areas that generate direct revenue or production since their contributions are more simply justified than those in client service and research and development.
Zero-Based Budgeting vs. Traditional Budgeting
Traditional budgeting advocates for incremental increases above previous budgets, such as a 2% rise in spending, rather than a justification of both old and new expenses, as zero-based budgeting requires.
Traditional budgeting simply assesses new spending, whereas ZBB begins with zero and requires justification of old, recurring expenses as well as new expenditures. Zero-based budgeting places the onus on managers to justify expenses, with the goal of driving value for a business by managing costs rather than just revenue.
Zero-Based Budgeting Template
The zero-based budgeting template is a budget generated primarily to justify costs for each new period, where the budget begins from zero, as opposed to a standard budget, where modifications are made in previous budgets. The difference between all sources of income and all sources of expenses must equal zero in order to create a zero-based budget.
Components of Zero-Based Budgeting Template
The following are the general details in the template for zero-based budgeting:
#1. Heading at the Top:
The template will include the header ‘Zero Base Budget Template’. It will remain unchanged for all template users. Furthermore, the heading informs the user as to why such a template was created.
#2. Budget Highlights:
This budget overview detail appears at the beginning of the template. It includes information on overall income and expenses for the period, as well as the total balance on an actual and anticipated basis. The values collected from the next stages will be used to populate these figures automatically.
#3. Fixed Expenses:
The user will enter all fixed expenses in planned and actual values from all areas.
#4. Variable Expenses:
The user will enter all variable expenses in budgeted and actual values from all areas in this section.
#5. Balance:
After removing the total fixed and variable expenses from the total income, the balance remaining will be determined automatically. As a result, this balance of predicted figures should equal zero, implying that the budget should be totally balanced.
How Should You Use this Template for Zero-Based Budgeting?
The steps for using the template for zero-based budgeting are as follows:
- While using this template, the user must provide all essential information in the fields that are not already pre-filled.
- To begin, all sources of income are recognized and recorded in the income/funds received during that period. Because budgets are built based on what the person expects to earn, the amount entered should be net take-home pay rather than gross pay.
- After the income data, the user will input all expenses that the organization plans to incur during the time period in question. To provide a clear picture of the nature of the expenses, these are further classified as fixed and variable expenses. However, the category in the template can be changed to meet the needs of the individual.
- The template will then calculate the remaining balance after subtracting the entire expenses from the total income. The difference between the period’s revenue and expenses should be zero because this is a zero-based budget.
- Following the budgeted information, the figures for real money received, as well as actual expenses paid for the period against each activity, should be entered.
- A variance will be determined automatically from the above data by subtracting actual figures from budgeted figures for each activity separately and for the total budget as a whole.
Zero-Based Budgeting Examples
If a construction equipment company launches a zero-based budgeting method, which requires a deeper look at manufacturing department spending. Every year, the company discovers that the cost of specific parts utilized in its final products that are outsourced to another manufacturer rises by 5%. The company’s employees can produce those parts in-house. After assessing the benefits and drawbacks of in-house production, the company concludes that it can produce the parts at a lower cost than the outside provider.
Rather than just increasing the budget by a specific amount and hiding the cost rise, the company can identify a situation in which it can select whether to manufacture the part itself or purchase it from an external source for its end goods.
Traditional budgeting may prevent the identification of departmental cost drivers. Zero-based budgeting is a more detailed procedure for identifying and justifying expenditures. Zero-based budgeting is more extensive, thus the costs of the process must be balanced against the potential savings.
How to Make a Zero-Based Budgeting
Log in to your bank account or pull out those bank statements from your drawer before you begin your zero-based budgeting. They’re useful when you’re wondering how much you usually make or spend on things. Check out these budget percentages and averages as well.
#1. Make a list of your monthly earnings.
You may do this the old-fashioned way with a piece of paper or you can use EveryDollar, a free budgeting tool.
What constitutes income? your regular paychecks and any extra money you expect to earn during the month (think side hustles or child support). Make a list of everything and total it! That is your entire monthly income, or how much money you have to work with this month.
#2. Make a list of your expenses.
You know what’s coming in, so now plan for what’s going. Consider everything you buy during the month. Make a list of your expenses like this:
- Giving (at least 10% of your income)
- Savings (This is determined by your Baby Step, which we will discuss later.)
- The Four Elements (The following are the most important bills to pay: food, utilities, shelter, and transportation.)
- Additional necessities (insurance, debt, childcare, and so on)
- Extras (Here is the exciting part: entertainment, fun money, restaurants, and so on.)
- Monthly expenditures (Are there any festivals, celebrations, or semi-annual expenses due this month?)
Don’t forget to include a miscellaneous category in your budget to give yourself some breathing space. That way, anything that comes up unexpectedly isn’t a problem because it’s been budgeted for.
#3. Calculate your income by deducting your expenses until they equal zero.
Examine your bank account for the last three months and make a list of all monthly expenses, including what they were (or where you spent the money) and the amount. Then, to make it easier for you, add that amount to categories, such as all the food in the groceries category, all the water and cable bills in the essential bills category, and so on.
Continue until your budget contains all of your loans, investments, and savings, or until you reach the value of $0. Then, if you don’t generally save, invest, or pay off debt, don’t worry about it and proceed to the next step.
#4. Keep track of your expenses (all month long).
So you can’t just create a budget and forget about it. That will get you nowhere with your money. You must log in and keep track of your transactions. Every single one of them. That is, whatever money comes in or goes out is allocated to the appropriate budget line.
#5. Create a new budget (before the month begins).
While your budget will not fluctuate drastically month after month, it will change. Hence, every month, make a fresh zero-based budget. Remember those monthly expenses we discussed in the second step?
Best Practices for Zero-Based Budgeting
#1. Adopt an optimistic attitude.
ZBB is doing more than just cutting costs. It’s an important step in freeing up resources and funds for business renewal and growth activities. Working with business executives, you can utilize internal and external benchmarking to highlight profitability gaps that need to be closed and explain exactly what will happen with the savings.
#2. Determine the easy wins.
First, concentrate your ZBB project on larger and more stable business units that are suffering with profitability, or on certain areas of overhead (such as sales, general, and administrative expenses) where there are significant indirect costs that are not well known. Not only would such options support the case for implementing ZBB, but they will also produce the greatest cost reductions with the least amount of disruption to the rest of the organization.
#3. Don’t try to accomplish it alone.
Assemble a cross-functional project team comprised of individuals from finance, information technology, and other relevant business units, preferably chaired by a C-level executive. The challenge and review process is at the heart of ZBB, evaluating every activity a department conducts to see if it can be canceled or done more cheaply. Paying an expert and objective third party to help negotiate the inevitable compromises may be worthwhile.
#4. Choose the best planning platform.
ZBB’s performance hinges on having precise insight into operational cost factors like as activity levels, productivity ratios, and input costs—none of which are included in traditional planning and budgeting software. Because these older systems only store highly aggregated financial data, they must be augmented with significant volumes of data from other sources, such as spreadsheets.
#5. Have a plan for long-term success.
Once you’ve successfully implemented a ZBB project, keep your skills sharp by moving on to other business units or spending categories and revisiting past initiatives to ensure the savings persist. Don’t put your ZBB model away either. The ZBB model can readily be evolved into a driver-based planning and budgeting model that can supplement or replace existing FP&A procedures since it incorporates the causal linkages between various activities, the resulting resource needs, and the expenses associated with those needs. Effective ZBB projects should result in a greater knowledge of the importance of cost control.
What are the Benefits of Zero-Based Budgeting
Zero-based budgeting has several advantages as an accounting practice, including focused operations, lower costs, budget flexibility, and strategic execution. When managers consider how each dollar is spent, the top revenue-generating operations become more visible. Meanwhile, cheaper costs may follow because zero-based budgeting prevents resource misallocation that can occur over time when a budget develops incrementally.
What are the Drawbacks of a Zero-Based Budget?
Many drawbacks exist with zero-based budgeting. For starters, it is both timely and resource-intensive. Because a fresh budget is created for each period, the time commitment may not be worth it. Using a modified budget template instead may be more effective. Second, it may incentivize short-term thinking in the company by directing greater resources to operations that generate the most income. As a result, areas such as research and development, or those with a long time horizon, may be disregarded.
What’s a zero-based budget and why is it important?
Zero-based budgeting is allocating all of your income to needs, wants, short- and long-term savings, and debt payments. By the end of the month, you should have zero income minus zero costs.
What is a simple example of zero-based budgeting?
When the sum of your income and expenses is zero, you are using zero-based budgeting. Isn’t that a great name? Hence, if you earn $3,000 per month, everything you contribute, save, and spend should total $3,000. Every dollar that comes in serves a purpose performs a function and achieves a goal.
What are the 3 types of budgets?
A surplus budget, a balanced budget, and a deficit budget are the three types of budgets. The state budget is a financial document that includes the year’s income and expenditures.
What are the 4 methods of budgeting?
Companies often employ four kinds of budgets: (1) incremental, (2) activity-based, (3) value proposition, and (4) zero-based.
What is the best budgeting method?
The 50/30/20 budget
This approach is tempting because it allows you to pay off debt, cover current expenses, and save for future expenses. It divides your earnings into three primary categories: needs, wants, and savings, and debt payback.
Conclusion
You’re prepared to give the zero-based budgeting approach a try now that you understand what it entails. Try another budgeting approach if it doesn’t work for you. If your financial position is complicated, you may benefit from consulting with a financial planner.
Related Articles
- BUDGET FOR A BUSINESS: What It Is, Types and How to Create It
- BUDGET MANAGEMENT TOOLS: Definition, and Best Budget Management Tools
- BUSINESS BUDGETING TOOLS: All You Need To Know, Types, and Free Budgeting Tools(
- 17 Best Personal Finance Software in 2023 (Free & Paid Options)
References
