What is zero-based budgeting?

Definition

Zero-based budgeting is the practice of building each spending line from a blank start every cycle. You justify what this period needs, instead of copying last year's amount and changing it a little.

On the books, it is a planning method. It is not an account in the general ledger, and nothing posts until real spending happens later.

The zero is the starting point for the line. Last year's cleaning bill, software seat, or supply run does not carry forward on its own.

Where it shows up

P&L: Related to rebuilding each expense from nothing rather than last year's number.

Balance sheet: Related to nothing extra; the method is about building the plan.

Cash flow: Related to the cash the rebuilt plan implies.

See also: Budget · Operating Expenses · Cost Center

When you look at your Income Statement, this work is aimed at the expense lines you still have to set. The method lives in the planning file, not as its own printed row.

The Balance Sheet does not hold a zero-based-budgeting balance. Nothing extra sits in assets or liabilities just because you rebuilt a line.

Cash will follow the rebuilt plan only if you later spend that way. Building the line does not move the bank account.

Managers usually rebuild inside a spreadsheet or a planning workbook. Each cost needs a current reason and a current number.

How it works

Open a line at zero. Then ask what this cycle actually requires, and write the amount next to that reason.

Current support sits behind the figure:

• Current quotes
• Staffing notes
• Usage

Last year's invoice is background, not the answer.

A line that was $5,200 last year does not become $5,200 plus a percent. Someone has to show the work that supports $6,000, or a smaller number, right now.

The rebuilt lines add up to planned spending for the period. After they are approved, those amounts are what later actuals are compared against.

The rebuild of each line is the work. The finished spending plan is a later packet.

When the period begins, the books still record real operating expenses as they occur. The rebuilt number is the yardstick, not the posting.

If a line cannot be justified, it stays at zero or a lower amount. Habit from last year is not enough on its own.

A cost of goods sold line can be rebuilt the same way as overhead. The method is the blank start, whatever the line is for.

Example

A coworking space is setting next month's cleaning line. Last year that line was $5,200 a month, and the manager does not copy it.

Three vendors quote the current square footage and the current cleaning days. The quote that matches the work the space needs now is $6,000 a month.

The manager puts $6,000 on the cleaning line and attaches the quote. The old $5,200 is last year's fact, not this cycle's start.

If membership had fallen and fewer days were needed, the same rebuild might have come in under $5,200. The point is the fresh build, not a raise.

When next month's cleaning bills post, they hit operating expenses. The rebuilt $6,000 is the number those bills are compared with.

The space can rebuild rent, software, and snacks the same way. Each line starts at zero and has to earn the new amount.

Common mix-ups

Zero-based budgeting is not the same as the approved spending plan. The method is how each line is built from nothing; the plan is the finished set of numbers.

Zero-based budgeting is not the same as projecting a line from volume and a rate. Counting cars times a ticket is a different way to build a figure.

Zero-based budgeting is not the same as variance analysis. Variance work explains why actuals missed the plan after the month; this work happens before the month starts.

Related terms

• Budget: The approved plan of revenue and spending for a coming period.
• Annual Operating Plan: The full-year plan tying revenue targets, spending, and headcount together.
• Operating Expenses: The ongoing costs of running the business that are not direct costs of sale.
• Cost Center: A part of the business tracked for its spending rather than its profit.
• Budget Versus Actual: The comparison of planned amounts to what actually happened.
• Driver-Based Forecasting: Building projections from the underlying volume and rate assumptions.
• Variance Analysis: Investigating and explaining differences between two sets of numbers.
• Forecast: An updated projection of where the numbers are actually heading.