Zero-Based Budgeting For Your Business


Budgets come in all shapes and sizes. Different types of budgets can be drafted to monitor various financial aspects of your business. Some of the many types of budgets include: operational, cash flow, capital and static budgets. An operational budget is the most common type of budget. It forecasts and tries to closely predict yearly business revenue and expenses. To create an accurate picture, operating budgets must account for factors such as sales, production, labor costs, materials costs, equipment and administrative expenses. Managers can compare these reports monthly to see if a company is performing to plan.

There are two basic formats for any type of budgeting: traditional and zero-based. Business planning is usually a combination of the two. Traditional budgeting is based on a review of historical performance, sound projections and timely modifications. Zero-based budgeting is the creation of a completely new budget from the ground up — as if no history existed. When using this method, the business operation must justify and document every expense and income as new.

Zero-based budgeting aims to put the onus on management to justify expenses and drive value for an organization by optimizing costs, not just revenue.

Zero-based budgeting is a logical approach to planning and decision-making that reverses the working process of traditional budgeting. In traditional incremental budgeting, management justifies only variances versus previous years. By contrast, in zero-based budgeting, every line item of the budget, rather than only the changes, must be justified. Zero-based budgeting requires that the budget line be re-evaluated thoroughly, starting from zero. This involves preparation of a fresh budget every year without reference to the past.

Here are advantages to zero-based budgeting:

  • Efficient allocation of resources, based on needs and benefits rather than history.
  • Drives management to find cost-effective ways to improve operations.
  • Increases staff motivation by providing greater initiative and responsibility.
  • Increases communication and coordination within the organization.
  • Identifies and eliminates wasteful expenditures and obsolete operations.
  • Identifies opportunities for outsourcing/in-sourcing.
  • Facilitates more effective delegation of authority.

And disadvantages to zero-based budgeting include:

  • More time-consuming than traditional budgeting.
  • Justifying every line item can be problematic for cost centers with intangible outputs.
  • Requires specific training, due to increased complexity versus traditional budgeting.

Zero-based budgeting step-by-step

Developing a zero-based budget is a step-by-step process of review and analysis, requiring collaboration among the production team, management staff, office staff and the executive team. This new process should be rolled out in stages to allow time for training staff on the necessary tasks.

Step 1. Establish your production capacity.

  • Calculate your revenue per production person/per unit or crew.
    • Based on service line.
    • Based on season/time of year.

Step 2. Establish your growth goals.

  • Project your base contract growth goal.
    • Build growth goals around production units.
  • Project your extra work growth goal.
  • Determine the capital required to fund production unit investments.
  • Determine the staffing required to produce this amount of work.
    • Project when the staffing needs will occur.
    • Develop recruiting and training plan for staffing.
  • Adjust your goals as needed to reflect reality.
    • The goal needs to match your ability to access needed capital.
    • The goal needs to match your ability to hire and train staffing levels needed.

Step 3. Establish your revenue streams.

  • Factor in your historic/typical retention of existing base contract work.
  • Project new sales of base contract work.
  • The total of these two lines — retained work + new sales — should equal your pre-established growth goals.
  • Project when the sales/ production of base contract work will occur (historical trends).
  • Project new sales of extra work (historical trends).
  • Project when the sales/production of new sales of extra work will occur (historical trends).

Step 4. Establish your material usage.

  • Project material usage/needs by class of service line.
    • Based on service line
    • Based on season/time of year (historical trends)
  • Create purchase plan and bid process for vendors.

Now you know the following:

  • What your revenue by service line is
  • What your capital investment requirements are
  • What your staffing needs are
  • What your materials needs are
  • The timeline for when all of these processes are in play

Step 5. Build your financial plan.

  • Create a cash flow budget to determine funding capability
    • Use the revenue stream projections you have created.
    • Use the capital investment projections you have created.
    • Use the staffing projections you have created.
    • Use the material purchasing projections you have created.
    • Determine gaps to be covered by line of credit, loans, etc.
  • Create operational budget.
    • Establish revenue stream by class and by month.
    • Establish direct costs of staffing, subs and materials by class and by month.
    • Establish the in-direct costs of equipment, supervision, etc., by month.
    • Establish the administrative overhead costs by month.

Step 6. Create your sales action plan.

  • Create a base contract sales plan.
    • Establish sales goals by salesperson.
      • Build sales goal around your pre-established revenue goals.
      • Total sales needed to replace cancellations, plus new sales, equals total sales needed to achieve overall revenue goal.
    • Establish sales/proposal activity goals.
      • Determine average job size for current year.
      • Determine how many average jobs required to meet the sales goal.
      • Determine closing ratio for salespeople (historical trends).
      • Create proposal goals in daily and weekly increments.
      • Determine cold call to proposal ratio (historical trends).
      • Create cold call activity goals in daily and weekly increments.

Step 7. Determine your measurement plan and metrics.

  • Establish a timeline for implementation of the action plans.
  • Sales action plan timeline
  • Staffing and recruiting plan timeline
  • Capital acquisition plan timeline
  • Materials purchasing plan timeline
  • Establish metrics and process for routine status review of action plans.

Zero-based budgeting at work

One industry firm that has embraced the concept of zero-based budgeting is Weed Man. This lawn care franchise system has been practicing zero-based budgeting for many years. It’s used at the corporate level as well as the local level with each franchise unit. They attribute a significant portion of their success to this budgeting process.

Annually, they go through an all-hands-on-deck effort to establish the following year’s budget through this process. They set aside a block of time each fall to accomplish this: typically two to three days for the average franchisee and their team. Some larger, multi-unit organizations take up to five days to create their plans.

Once they are completed and approved, they are embedded in the day-to-day routine of the team and reviewed on a weekly and monthly basis. These specific and routine measurements give each team a consistent snapshot into the current reality of the plan and allow for the operations to be nimble in adjusting to variances in an effective and timely manner.

Additionally, this process makes long-term forecasting a practical and reasonably reliable process. Weed Man routinely has five-year plans in place for all of their individual franchise owners and has the ability to project realistic 10-year plans for larger multi-unit organizations.

“All of our systems flow from zero-based budgeting,” says Jennifer Lemke, COO, Weed Man USA. “It’s the core of everything we do, and it has been one of the keys to our success. Zero-based budgeting is embedded into our culture as an organization.”

It’s important to think of your budget as a “living” document. By careful planning, it will help you anticipate and prepare for changes in your business. But it can also be adjusted to accommodate the changes you couldn’t anticipate like weather.

Zero-based budgeting can drive significant and sustainable savings, but it’s much more than simply building a budget from zero. Zero-based budgeting programs build a culture of cost management through unprecedented cost visibility, a unique governance model, accountability at all levels of the organization, aligned incentives and a rigorous and routine process. Zero-based budgeting frees up unproductive costs and allows those savings to be taken to the bottom line or redirected to more productive areas that will drive future growth.