What is zero-based budgeting – and can it save your business money?

Solid financial planning and reporting is at the heart of any successful business. And while a lot of forecasting is based on learnings that have come before, it can be helpful to start from scratch. Here’s how zero-based budgeting can help you take a fresh look at your finances.

Zero-based budgeting can help you streamline your expenses and make cost savings. Keep reading to find out:

• what is zero-based budgeting?
• pros and cons
• how to do zero-based budgeting
• example of zero-based budgeting

What is zero-based budgeting?

Zero-based budgeting is a way to manage your income and expenses by starting each year or month’s budget from scratch – the ‘zero base’.

While a traditional budget builds on the plan for the previous budgeting period and introduces incremental changes across the board, zero-based budgeting flips this and creates a budget based on current market conditions and needs.

The idea is that every expense is accounted for and you’ll have zero left over. But that doesn’t mean spending all your money every month – savings and business investments are included as outgoings in your calculation.

It’s possible that more businesses are choosing to use this budgeting method as a way to manage or cut unnecessary spending during the cost of living crisis.

Pros and cons of zero-based budgeting

It’s important to consider advantages and disadvantages when deciding whether this budgeting method is right for you.

Zero-based budgeting advantages

• analyse every business expense so every pound is accounted for
• flexible approach to budgeting – expenses can go up and down with each period
• highlights where potential savings could be made – so you continue to get good return on your investment (ROI)

Zero-based budgeting disadvantages

• time-consuming to build a budget every month
• doesn’t allow for longer term planning
• adds complexity as every expense needs to be justified and reviewed

How do do zero-based budgeting – 5 simple steps

1. Choose a tool to record your budget – this could be an Excel spreadsheet, Google Sheets, or a budgeting app.
2. Work out your regular monthly income and expenses – estimating where needed.
3. Consider how much money you need to put away in savings or a ‘rainy day’ fund.
4. See how much is left over for additional spending like training, marketing, and new equipment.
5. Check your income minus expenses is equal to zero in your budgeting spreadsheet.

You may need to update your budget as expenses come in, making sure you account for any cost increases or changes in the business environment.

Some banks also offer budgeting tools and ‘savings pots’ to help you manage your business finances – our guide to challenger banks can help you understand more about this topic.

Balance your income and expenditure

As we’ve mentioned, income and outgoings should cancel each other out when using a zero-based budgeting system. Here’s an example of zero-based budget for a hair salon:

These figures are for illustrative purposes only.

As you can see, the total income minus the total outgoings equals zero.

Example of zero-based budgeting

Let’s say your small business uses a booking system to manage appointments and you notice the cost of using this third-party software has increased every year.

As you’re using zero-based budgeting, you analyse the cost and work out that you have the skills and resources in your team to manage this yourself – and that this would save you money.

If you were using traditional or incremental budgeting then you might have just accounted for the annual increase in your budget. However, by taking a detailed look at each individual expense, you’ve identified where you can make savings.

Envelope budgeting and other methods

Zero-based budgeting is similar to another technique called ‘envelope budgeting’. This system involves putting the physical cash in an envelope labelled with the expense it’s going to be used for.

You can also create digital envelopes (or pots) in the same way. The idea is that all your money is accounted for and you won’t use the money for anything else.

You might also have heard of 50/30/20 budgeting. This is more suitable for a personal budget where you’d use 50 per cent of your business income on essential costs, 30 per cent on things you want, and the final 20 per cent should be savings.

Business finance is a complex topic. This article is intended as a guide and you should always seek professional advice if you’re not sure of anything.

Financial guides for small businesses

• What is a cash flow forecast?
• Late payment letter template
• Best invoice apps for small businesses
• What type of business insurance do I need?

Have you tried zero-based budgeting for your business? Let us know your experience in the comments.