To stay on top of your business expenses, you need to constantly plan and update your small business budget. When you make a traditional budget, you use the previous budget and tweak it. This might not be the most effective way to make a budget, especially for small companies. Another option is zero-based budgeting. What is zero-based budgeting?
What is a budget?
Before learning about zero-based budgeting, it’s important to understand the different parts of a typical business budget. Here are three things a budget needs to do:
- Project revenue: How much will you earn?
- Determine expenses: How much will you spend?
- Predict profits: How much will you have after expenses?
What is zero-based budgeting?
Zero-based budgeting (ZBB) is an approach to making a budget from scratch. The budget is not based on previous budgets. Instead, the budget starts at zero.
With zero-based budgeting, you need to justify every expense before adding it to the official budget. The goal of zero-based budgeting is to reduce spending by looking at where costs can be cut.
Your employees might be involved in creating a zero-based budget. You can ask employees what kind of expenses they will have and figure out where you can reduce business expenses. If an expense does not benefit the business, or if it can be done in-house, it is axed from the budget.
Zero-based budgeting process
There are a few different steps in zero-based budgeting to keep in mind. The process of zero-based budgeting follows the same basic steps:
- Identify business goals
- Develop and analyze new ways to achieve goals
- Discover new ways to fund business processes
- Prioritize funds
By following these zero-based budgeting steps, you will determine what expenses go toward achieving business goals that directly benefit your company. Then, you can find new ways to spend.
With ZBB, you might find that your budget fluctuates significantly between periods. You might have a budget of $50,000 one year and $35,000 the next, since budgets aren’t based on previous ones.
When to use zero-based budgeting
As a small business owner, you’re busy. You might not have time to make a budget from scratch every few months or even each year.
Some companies might benefit from creating a zero-based budget once every few years and using a traditional budget in the meantime.
Zero-based budgeting vs. traditional budgeting
Unlike traditional budgeting, zero-based budgeting does not look at budgets made in prior years. Traditional budgeting looks at prior-year budgets and adjusts based on the information in those budgets. For example, if you hire one new employee, you would increase your budget since you would add new wages to your payroll expenses.
Zero-based budgeting is more time-consuming than the traditional approach because you need to start from scratch and strategize where your expenses can be cut. You need to know where every dollar is going to implement zero-based budgeting.
Both zero-based and traditional budgeting are important in creating departmental budgets. If you have managers of different departments, you might allocate funds to them for the year. With traditional budgeting, managers are encouraged to spend their allowance so they don’t lose it. Zero-based budgeting is a little more frugal, and you might not see unnecessary spending, since every expense is accounted for.
How can zero-based budgeting help small businesses?
Zero-based budgeting is a great way to improve and manage your small business budget. It can help you:
Create your first budget: Zero-based budgeting is necessary if you are a startup. Startups do not have previous budgets to look at, so you would need to start from scratch. This gives you the chance to really plan your budget and shop around for the most inexpensive vendor.
Save money: Zero-based budgeting can help you save money and improve your profits for the year. By analyzing where unnecessary business expenses are coming from, you can eliminate them. Instead of doling out cash for the same things that have no benefit to your business, you can strategize how to effectively spend money.
Know where money is going: If you give managers a budget, you want to know where the money is going. Managers must write a description of how much money they need and what they will use it for.
Zero-based budgeting example
Let’s say you run a hair salon and sell shampoo and conditioner to customers. Last year, you purchased these products from another company for $30,000.
You decide to use zero-based budgeting for the upcoming year. As you’re listing expenses, you realize you can make your own hair products for cheaper than the supplier’s price. Making your own products will save you $22,000.
When creating your zero-based budget, you would only mark $8,000 ($30,000 – $22,000) as the expense budget for the beauty products.
You also realize that you can cut back on advertisements. Instead of spending $10,000 in this example of zero-based budgeting, you only need to spend $3,000. You would mark $3,000 for advertisements.
And, you find out you can get a better rate from a different office supplier, saving you $500. Instead of $1,500, your supplies will now only cost you $1,000.
If you had based your upcoming budget on a previous year’s budget, you might not have realized the different expenses you could cut back on. But with zero-based budgeting, you make sure that every dollar is accounted for.
Want to know if you’re sticking to your budget? You need a way to keep track of the money coming into and going out of your business. Patriot’s online accounting software lets you easily track income and expenses, so you can make adjustments to your budget. Try it for free today!
This article is updated from its original publication date of July 27, 2017.
This is not intended as legal advice; for more information, please click here.
