Zero-based budgeting is a repeatable process that applies a higher level of scrutiny and discipline to budgeting fixed costs – the selling, general, and administrative costs (or SG&A) – in an organization.
The classic approach to budgeting SG&A was typically based on a formula of using last year’s spend plus a minimal growth rate. If left unchecked this approach can lead to bloated operating expenses (or Opex) over time, diminished shareholder value, and a culture of overspending rooted in the “use it or lose it” mentality. Organizations need to think smarter about their spend, and that’s where a modern zero-based budgeting approach can help.
Why is modern zero-based budgeting important and how has it evolved?
Modern zero-based budgeting focuses on applying the optimal cost structure to the right parts of the business at the right stages of maturity. This approach supports maintaining and growing revenue while also identifying those areas with excess spend.
For large organizations with multiple business areas and models and significant SG&A spend across them, a single cost structure is not only suboptimal, it’s unrealistic.
Modern zero-based budgeting embraces an agile approach to spend management and leverages analytics and modern technology tools to continuously screen and re-evaluate which expenses are necessary and which are not.
Four steps to implementing successful zero-based budgeting
- Consider what you are measuring.
It is important to recognize that although zero-based budgeting is about spend management, the KPI used to measure performance should not be focused entirely on expenses only. Doing so would only promote the slash and burn mentality that modern zero-based budgeting tries to avoid. Rather, success needs to be measured using a more balanced measure such as SG&A divided by sales.
Assuming sales are growing over time, zero-based budgeting success can be achieved in one of three ways: by cutting costs, by holding costs constant, or by allowing expenses to grow, but at a slower rate than your sales growth. At end of the day, zero-based budgeting is about putting the right cost structure in place, and the only way to do that is to make sure that you are not eroding sales at the same time.
The simplest way to implement a cost transformation effort like zero-based budgeting is to start with transparency of costs – grouping expenses that have similar drivers, such as travel and events and ensuring these are applied across the entire business so it is easier to compare and manage spend. Most organizations can benefit from the cleanup and discipline that goes along with this effort.
- Understand your data.
Next, look for outliers. Why should one business unit have considerably more spend than another? Is it justified or is there a behavioral element there that needs to be reviewed? For example, why are all employees in one cost center staying at a high-priced hotel when the rest of the organization is staying at a preferred hotel vendor? Bringing outliers in line with the average is a great way to normalize expenses, cut costs, and apply controls.
But often this effort is not enough – and the focus needs to shift to making trade-offs across the various SG&A account lines.
- Establish the optimal mix of SG&A.
This task can often be much harder than setting the overall spend targets. In most cases, there is not a one-size-fits-all template that will remain constant.
FP&A teams need to continuously test and play with their SG&A mix to optimize the outcome of their business units. Modern zero-based budgeting is an agile process. What works today needs to be constantly monitored and reviewed for tomorrow. It is simply not a case of setting it and leaving it.
- Build a cost-conscious culture.
The most important – and often hardest – aspect of establishing a modern zero-based budgeting initiative is driving adoption and cultural change among employees. Regardless of what approach you take, the key is to be consistent in your messaging and your management approach.
When times are good, with a traditional budgeting approach, it might be natural to want to loosen the purse strings and allow for more spending. However, with zero-based budgeting, this is the opportunity to bank savings or invest to drive the business forward.
Allowing additional, unnecessary spend sends the wrong message to employees and thwarts your efforts to build a culture that rewards people for doing the right thing all the time, and not just when the company is looking for savings.
Establishing a modern zero-based budgeting approach and the right mix of SG&A spend is a continuous evolution. The best way to implement an optimal spend management strategy is to start with a balanced approach; monitor spend across the organization and ensure transparency; and foster a business culture that understands that a low-cost structure drives competitive advantage, shareholder value, and job security in both good and challenging times.