Don’t grow at all costs are out – and cutting fires and extending the runway is in. And with many startups living through the venture capital funding they raised in the pre-2021 go-go-go times, many founders face the difficult task of cutting costs to extend their runway.
As part of the financial advisory team of Kruze, I’ve worked with many startups that have had to extend their runways and realign their spending – many of them drastically. The best founders look for a framework to strategically reduce burns while keeping their startup’s value drivers functioning.
Enter zero-based budgeting.
Zero-based budgeting (ZBB) is a budgeting approach where companies have to build their budget from scratch each budget period to verify that all line items are relevant and cost-effective.
What is Zero Based Budgeting?
Zero-based budgeting (ZBB) is a budgeting approach required of businesses build their budget from scratch each budget period to verify that all line items are relevant and cost-effective. It is one of the most aggressive budgeting methods for keeping burns to the bare minimum. You’d be a masochist if you tried to do this more than a few times in your career – zero-based budgeting is painful.
That said, the process isn’t much different from how you built your initial budget, when your startup was just an idea, a pitch deck, and a spreadsheet (you did build a budget when you first presented it to investors, right?) . Often, however, after that first budget has been prepared, many companies switch to a traditional budgeting process.
This is not unique to startups, by the way. Many mature businesses rely on a traditional budgeting model, where the company simply adds a percentage increase to the previous year’s actual expenses. That is efficient from a time point of view, but also makes it easy for companies to continue operating in the status quo. There is no incentive to scrutinize spending and look for cost savings. Traditional budgeting can also foster the “use it or lose it” mentality, where managers try to spend their entire budget so they don’t get cut the following year.
Advantages and disadvantages of zero-based budgeting
ZBB strictly specifies and tracks spending by department, and can help CEOs and founders control costs, but there are also challenges when using ZBB. Some advantages for ZBB are:
- Operational focus. ZBB forces departments to take a closer look at their costs and expenses.
- Reduced expenses. The cash outflow is limited to the items included in the ZBB. Typically, the process will uncover and eliminate wasteful expenses.
- Responsibility. ZBB encourages managers to become more cost conscious and helps them see the impact of spending and see if it is effectively “moving the needle” toward strategic goals.
- Flexibility. Since ZBBs are developed from scratch each year and are not tied to previous budgets, this encourages creativity and innovation. Managers are encouraged to find better, cheaper or more efficient ways to achieve their department goals.
Possible disadvantages of ZBB include:
- Resource intensive. Zero based budgets have to be created every period and that takes more time and effort. Budgeting and automatic expense tracking software help streamline the process, but startups will still need managers to develop and justify budget expenses each time a new ZBB is created.
- Frustrating for managers. It’s painful to have to justify an expense that was previously justified. And if you had an intense discussion deciding whether to hire or start paying for a tool when you first started paying for it, your team may feel like they haven’t been listened to when the time comes to do it all again. So you need to remain empathetic and make sure you clearly explain why the company is doing this process so that your managers don’t get very frustrated.
- Short-term focus. ZBB typically focuses on the budgeting period, giving companies a detailed view of spending over that period. But it does not look at the previous budget period or the next budget period. That means your company may not be paying enough attention to long-term strategic projects, such as R&D spending.
My team has produced countless startup budgets, and I can say with 100% certainty that the drawbacks of ZBB are real – but that if you’re out of cash, it’s a proven framework for reducing burns.
Let’s take a look at the steps to run a solid zero-based budgeting process.
Janice has been with businesskinda for 5 years, writing copy for client websites, blog posts, EDMs and other mediums to engage readers and encourage action. By collaborating with clients, our SEO manager and the wider businesskinda team, Janice seeks to understand an audience before creating memorable, persuasive copy.