A penny saved is a penny earned. This is a fundamental truth for SaaS companies today. Funding is hard to come by, clients are looking to cut costs, and the overall economic situation is hard to ascertain. Such times call for a serious look into the budget and how the company is using its resources.
Zero based budgeting (ZBB) is ideal for just this kind of situation.
Zero based budgeting often gets a bad name for being a purely cost-cutting approach to budgeting. In reality, though, it’s a lot more than that. It's a budgeting process that helps to tease out unnecessary expenses and unproductive costs that might otherwise be obscured in aggregate.
Zero based budgeting helps you strategically reallocate the money ‘saved’ to high-priority initiatives that will move the business forward. Think of zero based budgeting as the catalyst that unlocks strategic reinvestment of financial resources to help you meet your company’s long-term goals and objectives.
What is zero based budgeting?
With zero based budgeting, every line item in the budget from the year before is reset to zero. Starting with a ‘zero base’ means that every team within the organization must start from scratch, analyzing each need and the related costs to build a budget.
Zero based budgeting is one of four strategic budgeting methods, which are different from traditional, incremental budgeting.
With traditional budgeting, the previous year’s budget is used as the starting point and each line item is adjusted as needed based on past performance and forecasts.
Strategic budgeting methods – driver based budgeting, activity based budgeting, value proposition budgeting and zero based budgeting – approach the task of determining resource allocations from different business perspectives.
One thing all of them have in common is that in addition to helping companies reach their annual targets, strategic budgets are fully aligned with the company’s long-term goals and strategic vision. Choosing the right strategic budgeting approach can unlock a host of benefits for SaaS businesses.
Zero based budgeting in 6 steps
Step 1. Revisit your strategic plan
Given that the imperative is to start from zero, the first step is to determine the financial goals, performance goals so you can figure out where to prioritize your resources in a way that aligns with your company's strategic plan.
For example, your three-year goal business goals might be to increase ARR from $5M to $15M, reducing churn rate by 25%, or decreasing your customer acquisition costs (CAC). Each of these goals would require somewhat different approaches and thus priorities in your budget.
Step 2. Gather the data you need for creating a budget
Before getting into planning and budgeting, it’s important to have a thorough understanding of the trends in the market and to gather your financial data so you can analyze your organization's past spending patterns.
Step 3. Categorize your costs, setting each category to zero
In SaaS, common cost categories for zero based budgeting are those associated with:
- Delivery of the product or service
- Research and development (R&D)
- Sales and marketing (S&M)
- General and administrative (G&A)
Each expense category will start with a zero budget. As you create the new budget, you’ll justify and allocate funds based on the strategic priorities you identified in Step 1.
Step 4. Start with the non-negotiables
Identify the non-negotiable costs across your categories. Some of these include recurring expenses such as cloud hosting, domain name and SSL certificates as well as more or less fixed costs such as infrastructure, salaries, office rent, and utilities.
Your non-negotiables don’t significantly change from month to month. However, they’re not always fixed either. For example, cloud hosting costs are variable while office rent, utilities, and salaries are more or less fixed but both are necessary to run the business.
For these costs, the question isn’t one of whether or not they’re justified. Rather, it’s how much you need to allocate. Historical data can be of value here.
Step 5. Prioritize the variable costs
After you have the fixed costs plugged into your budget, you can add in the variable costs.
This is the step where a lot of evaluation happens and is probably the most time-consuming as it requires collaboration between finance teams and business leaders in different departments.
Department heads will have to justify every expense within the context of the goals and objectives and it must be weighed against all the other variable costs.
For each variable cost, one must answer two questions:
- Is this activity and associated expense justified (i.e. should it be in the budget)? This is best answered in terms of their business value, ROI, and alignment with strategic objectives.
- If so, how much should be allocated for it? This requires a great deal of collaboration with department heads to understand the individual cost drivers for each activity in order to arrive at the right allocation.
Make sure to build in the resources needed to support continued growth. Every SaaS business wants to grow. This being the case, growth-related activities are always going to be a high priority in your budget.
Step 6. Evaluate existing contracts
In this step, you’re looking for additional opportunities to optimize costs when it comes to existing vendors. When it comes to zero based budgeting, everything is on the table.
The importance of this step is to eliminate waste and identify any savings that can be reallocated to high-priority initiatives.
First, review every contract. Then you have some different options:
- Negotiate lower costs with your vendors.
- Try to bring in a full-stack product in place of multiple best-in-class software tools. It’s all too easy to rack up significant costs when you’re building a stack from different vendors, not to mention the extra work involved in getting them all to work well together.
- If replacing a certain vendor would have a significant negative impact on your company’s work culture, another option is to keep things as-is and plug that expense back into budget at the same cost.
The point of this exercise isn’t necessarily to cut the number of vendors you use. Rather it's to evaluate each vendor in terms of the value created and make an informed decision.
Make your zero based budget a rolling budget
A rolling budget (often called a rolling forecast) is one where you can make changes as often as you need to based on market conditions or other internal factors.
Rolling budgets are updated throughout the year, usually quarterly but ideally monthly, based on performance in the previous period.
This kind of budget isn’t set in stone, and the flexibility it provides enables companies to adapt faster and stay competitive instead of sticking to a budget because it was ‘agreed’ upon at the start of the financial or calendar year.
If you think zero based budgeting is the right method to go with, making it a rolling budget will make it easier to hit your annual targets and reach your strategic goals. This is because you’re able to use data-driven insights to make informed decisions about budget adjustments in real time.
While it does require you to implement a system to track budget vs. actual performance, conducting regular reviews of the budget and revising it as needed is certainly worth the effort.
Rolling budgets are easier to implement with a financial planning and analysis (FP&A) tool like Drivetrain. Built for strategic finance, Drivetrain aggregates all your data and makes it available in real time, making it ideal for financial planning and budgeting.
Best practices for zero based budgeting
Zero based budget, not just about cost cutting. It's about cost visibility and getting the most out of every dollar. To do this effectively, data is paramount and spreadsheets won’t cut it, especially if each team has its own sheet.
In addition to using modern strategic finance software, there are a few other best practices CFOs and other finance leaders can implement to help maximize the impact of limited resources.
Consider building in a line item for contingencies
Building in a contingency fund will help you respond more quickly to changes in the market, either to seize new opportunities or reduce spending to extend the runway, without drastically altering your budget.
Create cost accountability across the entire organization
With zero based budgeting, each business unit must be accountable for its own budget. They need to understand their budgetary constraints and adhere to them.
Once the budget is finalized and after having weighed all the pros and cons of each variable cost, individual teams must take ownership of their departmental budgets and exercise fiscal discipline to control costs.
Monitor and adjust as needed
Accountability is important but monitoring your budget vs actuals is key to ensuring the cost control zero based budgeting can provide.
If you implement your budget as a rolling budget, monitoring is essentially built-in, giving you the ability to adjust as frequently as you update the budget.
It is really important to have modern FP&A software to closely track the metrics. It will also enable you to make any adjustments when required thanks to the easy availability of the necessary data.
Use the evaluation you did for your first budget to inform the next
If this is your first time implementing a ZBB approach, you’ll spend a lot of time on Step 5. While your next budget will reset to zero, the evaluation of expenditures you did in that step can help inform the process in the next budgeting cycle.
Using a zero based budgeting process is easier with a platform like Drivetrain because it allows you to track and monitor data at a very granular level giving you all the information you need to make data-driven decisions that make every penny count.
In contrast, traditional methods of tracking using spreadsheets are tough to maintain, prone to error, and hard to scale.
Drivetrain also makes it easy to do scenario planning, running what if analyses with different costs for variables to project how scenarios (external or internal) could play out. These what ifs will help you make informed decisions.
A good fit for uncertain times
Adopting zero based budgeting might seem like you’re switching into ‘Scrooge mode’ because you’re scrutinizing every dollar to stretch it as far as possible. However, given the times we live in, the benefits of this approach are worth giving it a shot.
In an era where saving money is a necessity, zero based budgeting becomes an important way to create a culture of cost management exercise that enables companies to reach their goals while keeping a keen eye on their spending.
Coupled with a modern strategic finance platform like Drivetrain, SaaS companies can use zero based budgeting to not only eliminate inefficiencies but also optimize costs and cash flow in ways that prioritize growth.