It is a concept that’s been around for more than 50 years, yet periodically re-emerges as a “trending topic.” This is one of those times.
I’m referring to zero-based budgeting (ZBB) — an approach Harvard Business Review characterized as being “elegantly logical.” At its core, ZBB dictates that every expense be justified individually for each new budget period based on its merits (“bottoms-up”), as opposed to using last year’s budget as a starting point and adjusting higher or lower (“top down”). Desired result: heightened accountability, transparency, and focus on ROI.
At a time when costs are being given extra scrutiny, and the imperative for strategic investment is more intense, the case for implementing ZBB would seem to be a smart choice. Yet, in an April survey of more than 300 global finance executives, only 26% said they planned to zero-base their budgets due to the pandemic, according to Gartner.
So, if ZBB is so “elegantly logical” and suitable to the situation at hand, then why aren’t more organizations deploying it?
A good place to start in answering that question is the realization that, as with most things, change can be hard. Moving to a ZBB framework may be more time-consuming and require additional resources. Add the “politics” and biases that often accompany budgeting shifts specific to Opex, and the status quo inevitably prevails.
This is why zeroing-in on the capital budgeting process can be an excellent starting place to apply ZBB. Capex, after all, is eminently focused, rigorous and accountable.
Why Start with Zero-Based Budgeting for Capex?
Consider the components of managing a Capex budget and the logic of making this the place to “kick the tires” on ZBB become more self-evident. By their very nature, capital projects are discrete and have a set of financials that can be easily compared to other projects. This makes assessing the impact of your move easier to gauge over time.
Capital budgets are also sensitive to changing dynamics in the marketplace, such as competitive pressures/opportunities, economic conditions, changes in the regulatory environment, etc. Having a more fluid means of assessing them can improve how your organization responds to opportunities, or contends with unforeseen challenges and threats. (Such as a pandemic.)
Then there’s the issue of creating a more discerning framework for determining which projects have merit, and which don’t. Ask operations, manufacturing, and IT for a list of their “needed” Capex projects and you will undoubtedly get many more than you can possibly budget in one year.
In theory, then, if management evaluates every project request on its merits, and either approves or rejects it given the needs and strategy of the business, and an anticipated return, resources will be better aligned and outcomes improved.
All that sounds great, you may say, but still doesn’t address the elephant in the room: how can you implement zero-based budgeting for Capex without it adding undo time and complexity to the process? That’s where Finario, an enterprise capital planning solution purpose-built for Capex, comes in.
The Advantages of ZBB with Finario
Having consistent evaluation criteria is essential to making zero-based budgeting for Capex work. Not only does it ensure an “apples to apples” consideration of business impact, it vastly speeds the process. Finario captures all projects in a central location, within a standard format, and lets you apply an established financial/ROI model and what if analyses. As projects under consideration progress through your approval workflow, all project details and assumptions are there for evaluation.
Though projects are evaluated on their individual merits, there still needs to be context relative to the entire portfolio and available budget. Finario lets you sort and group projects by objective (cost reduction, growth, etc), location, etc. so it’s clear how the budget is being allocated. Moreover, project proposals can be compared to completed projects for proper perspective.
By grouping projects into portfolios you can compare the impacts of different budget strategies. For example, create a budget that is mostly focused on cost reduction and another that balances cost reduction with some growth projects and still another that is mostly growth oriented. With Finario, you create these portfolios by just clicking the projects you want to include and can quickly see how those choices impact the overall profitability index and ROI of the overall budget. It’s a bottoms-up/ZBB process in it’s most intuitive and immediately impactful way.
Lastly, zero-based budgeting for Capex relies on coordination and communication. ZBB fosters better communication because all information (budget proposal, financial models, supporting materials) is dynamically updated and available in a central location. Everyone can see questions and responses without hunting through email. No more version control issues and no more emailing “the master spreadsheet” around the organization.
Now’s the Time
Zero based budgeting captures the imagination of finance leaders for good reason. It is a 180-degree swing from the usual top-down approach which, given the current economic realities and uncertainties, isn’t up to the task of ensuring that available capital is being allocated strategically, effectively, and opportunistically.
To go from theory to practice, however, can be daunting if approached from an “all or nothing” point of view. Which is why applying it to Capex makes so much sense, particularly if you have the right systems and tools in place. Capital allocation is critical to business sustenance and success, and warrants the type of evaluation that ZBB instills.
Yes, ZBB is “trending” yet again. But there may be no better time to go from contemplation to action than the present.