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Zero based budgeting

17 July 2018

Business Advisory

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Most businesses, of any size, go through an annual budgeting exercise, but there are differing approaches to how this is done.

One common way of looking at costs is to work out the top line for sales, and then “tweak” the cost structure in response to this, with marginal changes to reflect matters such as inflation and other specific factors. However, a more radical way of looking at costs is to reset the dial to zero.

What is zero based budgeting?

Zero based budgeting means that a business must justify costs starting from scratch and build up the budget from there. Used with care, it can be a good way of increasing profits by stripping out unnecessary processes and costs. This can be a difficult concept for individuals to deal with – if there’s been a tea trolley three times a day for the last 30 years, zero-based budgeting will challenge if it’s still needed in the future.

What can go wrong?                                                                  

In its most extreme form, as used by some private equity groups, zero-based budgeting can mean that employees feel they are in a permanent state of change and insecurity. This is the first big danger of this approach – it can be demotivating for a workforce and lead to a drop in workplace wellbeing and productivity. The second is that zero-based budgeting can lead to valid costs being cut which can damage longer term profitability. Examples would be reducing investment in equipment, marketing and training, and there is evidence that focusing too much on cost can take attention away from revenue generation.

As demonstrated in the examples above, zero based budgeting needs to be handled properly and with care.

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