Zero Based Budgeting
Cost reduction usually starts in the Finance Director's office with a review of the budget requests for next year, an assessment of forecast income versus expenditure requirements followed by an arbitrary slicing of costs with simultaneous exhortations to grow income. Having made the arithmetic fit the plan, such as it is, passes to the various departments to make it happen. Inevitably the first reaction of any organisation wanting to cut costs is to "top slice" all costs across the board. It's easier to do it this way and implies a sense of fairness aligned with the view that we are "all in this together".
The problem is that the cost base upon which the estimates were originally built is often an historic one where year on year some degree of cost inflation has been added to last year's outturn with little or no thought to the budgeting process. In some organisations (and particularly the public sector) this behaviour is exacerbated by the policy of "use it or lose it" implying that if you really have no use for the money this year then clearly you have no use for it next either.
Although it takes time to complete, a Zero Based Budgeting (Zbb) exercise is effective at cleansing the budget of all historic assumptions and presenting the organisation with a reasoned and logical approach to the question of costs and importantly why they are there. It is work that can usefully involve wide numbers of people and give them much greater ownership of the eventual budget they will be asked to own.
The basic techniques consist of asking managers to justify any level of expenditure they include in their budget requirements but forbidding the explanation of "prices have gone up". To be completed properly Zbb must start with a clean sheet of paper. As an example consider the department providing a service to members of the public. The first question to be answered is
• How many members of the public will we serve next year?
Understanding the basic level of demand on any department is crucial to developing the budget from a zero base but we know that for many this is the most difficult bit.
However there are many departments in an organisation that cannot measure their demand or even output in the same way. For these people the issue of justification becomes more difficult but is no less important.
• How big should the HR department be?
• How do you determine the amount of resource required for policy?
The properly constructed Zero Based Budget starts with the most readily understood areas of demand and builds from there. The justification process gives a total budget which is almost always smaller than one constructed from a top slicing approach and provides managers with an in-depth understanding of all their costs.