Professional Documents
Culture Documents
What Is Zero Based Budgeting (ZBB) ?: Management Tool
What Is Zero Based Budgeting (ZBB) ?: Management Tool
Application
This type of budgeting usually occurs in the government and non-profit
sectors. The philosophy behind Zero Based Budgeting is good. However, it
should be noted that zero based budgeting requires frequent reviews.
In Zero Based Budgeting reviews are carried every year on account of the
fact that it is a time-consuming and costly process. Interim reviews can
be carried out but that is the organization’s choice with respect to time
and priority.
Zero Based Budgeting advantages
Zero Based Budgeting has the following advantages:
Disadvantages
There are also disadvantages to the application of Zero Based Budgeting:
Time consuming
Sometimes the necessary expenditures are hard to define for managers
as a result of which it becomes too time-consuming and exhaustive a
process to arrive at a solid foundation with respect to the decision-making
about the investment.
Requires manpower
This approach forces staff (especially managers) to justify every detail
related to the expenditures. For instance, because the R&D department
cannot completely underpin their intended innovation, this could have
advantages for the budgeting of another department because they are
able to justify their expenditures in great detail.
Requires knowledge
In order to apply this approach appropriately, it is necessary to train
managers well. For Zero Based Budgeting to be successfully implemented,
managers at all levels of the organization must understand how zero
based budgeting works in the organization as they are ultimately
responsible for the management, decision-making and the communication
of entire process.
Uniform
Honesty and consistency of the managers must be reliable and uniform.
Any manager that exaggerates affects the results negatively.
All these expenses must be justified to remain in the budget. For example, if
a company expects to incur $100,000 in salaries and wages and believes
that the full $100,000 is absolutely necessary to run the business smoothly,
it will stay in the budget.
All businesses use budgets to keep track of expenses and improve ways to
minimize costs and maximize profit. Budget amendments are usually based
on budgets from previous years. In fact, traditional budgeting implements
incremental increases or decreases in the previous years’ budgets by a
certain percentage to meet new goals. These percentages usually range
anywhere from 1% to 10%.
Sometimes, budgets can get out of control or in some years, may show
significantly higher or lower costs depending on the overall market outlook
and other external factors. In these scenarios, it does not make sense to
look at last year’s budget. The entire budget needs to be redone from
scratch, hence, a zero-based budget.
The final output is well justified and is aligned with the overall
business strategy.
Encourages more collaboration throughout the company
Improves performance and operating efficiency by challenging
assumptions
By avoiding traditional budgeting percentage increases, there is a
higher chance of overall cost reductions.
Free Accounting Courses
Final Thoughts
Incremental budgeting is a budgeting method where current year’s budget is prepared by making changes
in the past year’s budget. The changes are in the form of addition or reduction of expenses to last year’s
budget.
Following points will highlight the differences between zero-based budgeting and incremental budgeting.
WASTEFUL EXPENSES
Since zero-based budgeting is prepared from the scratch, any resource to an activity would be allocated
only after considering the risk reward ratio and cost benefit analysis. This eliminates all sorts of
inefficiencies that are present in an activity. Thus it avoids any wasteful expense. In the case of
incremental budgeting, wasteful expenses become the part of the budget. The inefficiencies present in the
activities are mostly ignored and only the increase in cost forms the part of incremental budget.
INNOVATION
Zero-based budgeting promotes innovation in the business. As budgets are prepared right from start for
each period, it forces the management to come up with innovative ideas to lower their costs so that they
can justify the allocation of resources. On the other hand, incremental budgeting leads the company into a
conservative mindset. As the budgets are almost same over the years, it does not promote any innovation in
the business. Therefore, zero-based budgeting is dynamic in nature whereas incremental budgeting is
conservative.
TIME CONSUMING
Zero-based budgeting is a time consuming process mainly because the budget is prepared right from the
start, which makes it a time consuming task. On the other hand, incremental budgeting is less time
consuming method because they are prepared by taking previous year’s budget as base and changes are
done in the previous year’s budget to meet the needs of current period.
EASE OF PREPARATION
Zero-based budgeting requires justification for allocation of available resources, which can be known only
after deep analysis and complex calculations. Thus, preparation of zero-based budgets is a complex task.
Whereas, incremental budgets are easier to prepare as it does not involve any complex calculations and can
be prepared by any department of the organization just by introducing the incremental changes.
TRAINING
Managers require special skills and knowledge to prepare zero-based budgets. Only a qualified and well
trained professional can prepare such budgets. On the other hand, incremental budgets are easy to prepare.
They do not require any specialized knowledge or training to prepare the budget. Any department can
make an incremental budget with ease.
Companies often shy away from the method because they fear it or believe it means
“budgeting from zero.” In reality, it’s a structured process that can build a culture of cost
management.
Zero-based budgeting is much more than building a budget from zero. World-
class ZBB efforts successfully build cultures of cost management throughout
the organization by using a structured approach to facilitate cost visibility, cost
governance, cost accountability, and aligned incentives. Fortunately the culture
shift isn’t left to chance. We believe that there is a proven, step-by-step
approach to implementing successful ZBB programs, and when this
implementation is done well, ZBB makes cost management a part of the way
every employee works on a daily basis.
Although very little has been written recently about zero-based budgeting, the
published content that exists often associates it with cutting costs to the bone,
using any means necessary (for example, eliminating mini refrigerators in
office kitchens to save electricity). While this may sometimes occur, it is by no
means necessary. Simply put, the degree (and aggressiveness) of each
company’s cost cutting reflects the size of its top-down savings target. For
instance, in the most aggressive situations, we’ve seen 30 percent reduction
targets in year one versus other situations that aim for 10 percent reduction
targets with an agreement to reinvest half of that into more productive areas,
therefore only taking 5 percent to the bottom line.
During the initial setup, a central coordination team develops deep visibility
into costs and sets detailed savings targets for the next budgeting cycle. That
team also ensures that the company’s systems and processes are in place for
the detailed reporting, governance, and performance management that a
world-class ZBB requires. In our experience, this setup period could take
anywhere from four to ten months and is primarily led by full-time support
from finance and IT, with part-time involvement from profit-and-loss owners
and cost-category owners across the company.
Organizations that are unsure about ZBB’s upside are well suited to pilot the
process. There are many ways to build these pilots, each of which can be
customized to meet the company’s objectives. One company, for instance, is
piloting a ZBB rollout across its global finance function. This approach builds
capabilities within the team that will help drive the program across the
enterprise while having the added benefit of helping team members achieve
their existing budget targets.
ZBB is not a slash-and-burn exercise that cuts costs without regard for the
expense. With deep visibility into costs, changes can be made to surgically cut
the fat and help build up organizational muscle.
ZBB is relevant for businesses for a number of reasons. First, the economy remains volatile,
and in times of volatility, profitable companies with a strong competitive edge are best
positioned to innovate, grow and beat the competition.
ZBB also helps companies identify wasteful spending, redundant processes, bureaucracy
and unproductive products and services that are not generating an adequate return. They
are surgically removed via ZBB, and strategically redeployed to fuel innovation and growth.
In today’s era of digital disruption, many use those funds to invest in new technologies and
capabilities to help them out-compete traditional and non-traditional, digitally enabled
competitors.
Companies that adopt ZBB are now investing in the management technique for the long
haul. They look for sustainable ways to fuel their growth, change spending behaviours and
negotiate better pricing based on an enterprise-wide view of spending. Rather than just
whittling away at costs piecemeal and tackling overhead, they use ZBB to focus resources on
core goals, shifting funds from products or programs that aren’t productive to those
activities that will drive growth.
While there may be differences from industry to industry, our experience suggests that a
company may identify as much as a third of costs to reallocate as they work their way
through the ZBB process the first time.
Take, for example, global consumer goods company Mondelez International. Using ZBB, it
has freed up capacity to fuel growth. The company was able to save $350 million in selling,
general, and administrative (SG&A) expenses in fiscal year 2014, and projected three-year
savings of $1.1 billion. It now aims to increase operating margins from 12 per cent in 2013
to 14-16 per cent by 2016. It enjoyed three consecutive quarters of adjusted margin
expansion through the third quarter of 2014, with adjusted operating income (OI) margin up
140 basis points to 13.6 per cent in the third quarter. These improved margins are helping
Mondelez step up investment in production facilities, especially in emerging markets. In
2014, it announced new plants in Bahrain and India, and an expansion of factories in Turkey
and Hungary, as well as Ireland, the UK and the United States.
In the process, ZBB transforms what may have been a culture of spend to one of
accountability and stewardship. Cost management becomes a continuous process, as it
fosters teamwork around budgetary goals. People are held accountable for categories of
spend, and they are encouraged to treat the company’s money like their own. As such, they
question the value of each expense.
Useful in both profitable and difficult economic times, ZBB drives behavioural change at all
levels of an organisation, leading employees to regularly question the need to spend.
Achieving that result requires a deliberate approach that incorporates a massive change
management effort. Employee communication that explains the need for the new approach
to spending is paramount.
ZBB is not an easy process. It requires a focused effort and ambition. Well worth the effort,
this management technique can transform companies and create a structure for
sustainable, strategic cost management that frees up funds to invest in innovation as
companies redefine how they compete and achieve sustainable growth in today’s digital
world.
Naturally, sceptics who haven’t been able to leave the legacy behind are smirking at this
point. They recall the pain of deep indiscriminate cost cuts. And, they recall that the cuts
didn’t stick once the good times were rolling again.
But, that is not the way of the modern zero-based budgeting, and that is not what
companies today are buying into. So what is it?
Zero-based budgeting is a strategic approach to identify the costs that aren’t producing the
desired return. Zero-basing a cost base is a form of should-cost modelling as it builds a
budget based on what the cost should be on the back of detailed analytics. It also identifies
the duplicative costs that do nothing to help an organisation achieve its objectives today and
in the future on the back of a digital revolution that has dramatically changed the way
business is done. And, it changes the lines of demarcation between competitive industry
sets.
To make this approach work, an organisation begins with a clean sheet, and they build the
budget from the ground up, justifying each and every expense. Is it a necessary expense?
Does the return justify the cost? Is it possible to lower the cost for the same result all the
while respecting strict policies and meeting top-down budget targets?
This very detailed approach allows for useful internal and external benchmarking,
comparing the cost of a process, operation or item with other organisations to identify
reasonable targets as set by cost owners. It’s also a transparent and open way of creating a
budget that generates insight for management into the organisation’s consumption of
resources.
This continuous process year-on-year helps an organisation actively manage its costs. The
budget is reviewed for unnecessary costs; those that balloon up are reined back in and
funds are redirected into areas where investment is needed to execute on the business
strategy to realise future growth.
Kris Timmermans
Kris Timmermans is senior managing director of Accenture Strategy, Operations. He works
with companies to adopt ZBB and helps them to build operations strategies and digital
supply networks to increase efficiency and profitability.
The Business Case for Zero-Based
Budgeting in Manufacturing
By Ron Giuntini
Published: 8/24/2015
The most popular budget technique employed for warranty claim accruals is the
incremental budget, which typically encompasses the following:
Define the Future of Finance
Looking for an FP&A event that's designed with you in mind? FinNext 2018 is the place to
discover innovative ways of thinking from inspiring speakers and build valuable connections with
your FP&A peers who are just as passionate as you are.
Learn More
But this budgeting process faces challenges when newly-designed products (NDPs)
are introduced as part of the mix of warranted products. NDPs are always defined as
being recently delivered for the first time to the marketplace. NDPs also contain a
combination of the following elements that differentiate them from warranty cost
drivers of previously designed products (PDPs):
Product design (e.g. new capabilities, and more reliability, maintainability and
capacity).
Different terms and conditions meeting product owner expectations (e.g. NDP
warranty duration of four years versus two years for PDPs).
Volatility of warranty claim settlements, driven by the production learning curve slope
(e.g. warranty accruals are 8 percent of revenues for the first 50 units of NDPs
manufactured due to quality and engineering issues, and then will decline to 2
percent starting at unit 200, which then aligns with that of PDPs). If learning-curve
projections are wrong, warranty claim settlements may be dramatically affected.
Relationship changes between the manufacturing organization of NDPs and its
suppliers.
The aforementioned may rule that the employment of the incremental budgeting
process is problematic for budgeting warranty claim accruals, but a product
manufacturer should first understand the financial materiality of those accruals. For
example, leadership and/or auditors may define the materiality threshold level as
being triggered when 20 percent of all warranted units are NDP units, and/or when
30 percent of all warranty expenditures are driven by NDP units. Note that a unit of
warranted NDP can incur warranty claim settlement costs that are 25 percent to 100
percent higher than that of a unit of warranted PDP.
Once materiality levels are developed, the warranty budgeting technique chosen can
embrace one of the following four scenarios:
1. If warranted NDPs do not meet the financial materiality test, incremental budgeting
can be continued to be solely employed for both PDPs and NDPs, with an
understanding that the budgeting of accruals might be slightly inaccurate compared
to that of claim settlements.
2. If warranted NDPs do meet the financial materiality test, an alternative should be
chosen to replace incremental budgeting in order to be more adaptive to a variety of
cost drivers and a more volatile business environment.
3. A manufacturer can select to retain the incremental budgeting process for warranted
PDPs and employ an alternative budget technique exclusively for warranted NDPs.
4. If warranted NDPs do not meet the financial materiality test, leadership may
nonetheless seek an alternative budget technique for the combination of all
warranted products.
One alternative budget technique to that of incremental budgeting for warranted NDP
is zero-based budgeting (ZBB), a technique in which budget inputs are completely
reset every budget cycle, with new inputs captured to reflect a changing business
environment. Note that ZBB requires that a working business model, with simulation
capabilities, drives the selection of all its budget inputs. The abandonment of all
analytics that were performed in the last budget cycle and starting from scratch in the
next budget cycle is not the modus operandi of ZBB.
The business model driving zero-based warranty budgeting includes such inputs as:
A previous version of this story misstated how much cost savings Campbell is
expected to receive. This version has been corrected.
With quarterly revenue reports plunging for many major packaged food and
beverage manufacturers, executives are left scrambling to find a solution to
stagnant top-line growth.
Packaged food manufacturers are seeing sales decline for a variety of categories
as startups disrupt those categories with innovative and better-for-you products.
Or declines occur as consumers turn away from a category en masse, such as
with soda and cereal .
The question is: how sustainable is this approach? A financial limit guides just
how far zero-based budgeting and other cost-cutting strategies can go. And once
these companies hit their cost-cutting goals over the next few years, what's next?
If they haven't determined how to turn around their top-line performance in that
time, investors' appreciation of higher profit margins may not carry the company
forward forever.
“The heightened strategic bent towards zero-based budgeting likely reflects the
slowing growth prospects the industry is facing,” Erin Lash, senior equity analyst
of consumer packaged goods at Morningstar, Inc., told Food Dive. “Several
packaged food firms have lowered their long-term top line targets from the 3%-
4% range down to 1%-3% over the last several quarters.”
Erin Lash
However, cost savings aren’t always about maintaining profitability alone, but
also about what manufacturers can do with those savings to grow their
businesses.
“We’ve long thought that these efforts don’t merely stand to bolster a firm’s
profitability, but rather stand to provide the fuel to reinvest behind brands,
including both investments in R&D as well as marketing support,” said Lash.
“Several firms in the space are taking actions to rationalize their manufacturing
footprint and/or drive efficiencies within their supply chain, as well as implement
zero-based budgeting,” said Lash. “And as such, the financial benefits from zero-
based budgeting can be masked.”
Get food news like this in your inbox daily. Subscribe to Food Dive:
Email:SIGN UP
Thanks to those efforts, Hushen said Campbell is now ahead of that schedule
and on track to deliver $300 million in annual savings by 2018. Zero-based
budgeting was one of three cost-reduction techniques Campbell implemented.
The other two included headcount reductions — “the bulk of which are behind
us,” Hushen said — and the formation of Integrated Global Services, which
Hushen described as “an organization that is a shared service group building
important capabilities while lowering cost.”
In fiscal 2015, Campbell had already achieved $85 million in savings. Since
officially implementing zero-based budgeting in fiscal 2016, Campbell
has delivered about $130 million in incremental savings, bringing the total to date
to over $200 million.
CFO Anthony DiSilvestro spoke at Investor Day about strategies for transforming
the way the company operated, such as expanding scope, re-engineering
processes and leveraging scale. DiSilvestro also discussed what Campbell
intends to do with those cost-savings: Continue adding to the business and
diversifying to stay competitive.
Though the food and beverage industry has seen many success stories with
zero-based budgeting—from Campbell and Mondelez to Kraft Heinz and PepsiCo
—that doesn’t necessarily mean all manufacturers should adopt this cost-cutting
strategy.
Still, Lash warns any food or beverage manufacturer to weigh all options before
launching into this type of cost reduction.
“In this vein, when you pursue a zero-based budgeting program merely focused
on cost cutting, challenges could arise,” said Lash. “From our perspective, firms
in the highly competitive packaged food arena will be ill-served by trying to cut
their way to growth, but rather will need to fuel brand investments in order to
reignite top-line gains in the longer term.”
“Continued adoption will depend on the ultimate success or failure that ensues
over a longer time horizon,” said Lash.
The "A Balancing Act" series is brought to you by BMO Harris Bank, a leader in
commercial banking. To learn more about their Food & Beverage expertise, visit
their website here . BMO Harris Bank has no influence over Food Dive's
coverage.
The venerable technique has vaulted back into the consciousness of corporate leaders—
for good reason. But getting it right is not easy and depends on five key elements.
ZBB of the 1970s was fundamentally about ascribing each company activity to
a decision “package,” evaluating and ranking these packages for their costs and
benefits, and allocating resources accordingly.3Today’s ZBB is much more than
that—it’s a repeatable process to rigorously review every dollar in the annual
budget, manage monthly financial performance, and build a culture of cost
management. What makes ZBB unique is not the budgeting methodology; it is
the mind-set shift that upends managers’ default assumptions. Rather than
compare this year’s spending to last year’s, ZBB looks instead for the most
efficient return on spending, from the bottom up. As one executive who
recently made the transition to ZBB told us, “It was more effective to talk about
every dollar spent in terms of efficiency, and ask if it was really necessary,
rather than to compare it to last year. It resets the discussion.”
ZBB is especially useful for private-equity firms. It aligns well with the return-
on-capital approach that the industry favors. It can eliminate unproductive
costs (often as much as 10 to 25 percent of SG&A in six months), allowing
owners to reallocate capital to growth, through marketing, sales, and M&A.
And ZBB is a standardized and replicable playbook that can be rolled out
across a portfolio of companies, ensuring aligned processes, controls,
cadences, and incentives. For private-equity operating groups seeking
standardization (with a helpful degree of flexibility), ZBB is the perfect fit.
Sticking too long with commonly held assumptions and accepted ways of
doing things can put even the biggest businesses at risk. For instance,
during the 1980s, IBM stayed focused on mainframes while servers and
PCs took over. More recently, Blockbuster clung to its retail outlets while
new technologies were changing the ways people could access movies.
Looking back, we are collectively astounded that such companies stuck
with the status quo for so long. But that’s exactly what we do when we
produce an annual budget by taking last year’s actuals and adding a few
percentage points to account for wage rises and inflation.
Such incremental budgeting may appear harmless, but if it persists
indefinitely, it can lead to inefficiencies and missed opportunities for cost
savings. That is why an increasing number of global companies are
challenging the status quo by adopting zero-based budgeting (ZBB), where
everything in a budget must be justified as both relevant and cost effective.