Why zero-based budgeting will dominate 2023 and beyond
The market downturn is causing greater scrutiny on finances and cost-cutting bolstered by ZBB – but frugality isn’t a bad thing, says Payhawk’s CEO and co-founder Hristo Borisov.
Revenue hides all sins.
That’s the philosophy that has guided the startup world for the past decade. Money was a free resource so fundraising was easy and top line growth was the only focus.
No one was concerned with the minutiae, like unit economics or profitability. But in the face of a shrinking economy, things are changing and everyone’s left to face their sins.
For instance, European venture funding is falling, down 44 year over year from $28bn to $16bn, according to data from Crunchbase. And this is part of a global trend. With less investment, companies are having to work harder than ever to justify their spend and make their money go further.
As a result, there’s been a shift in focus from exponential to sustainable growth, which is where zero-based budgeting (ZBB) can be a real boon.
Of course, it’s not a new concept. ZBB has been around since the 1970s, but fell out of favour when money became an abundant resource. It essentially means the budget for the next budgeting cycle starts at zero, as opposed to being based on levels set by a previous budget and increased by a set percentage. It forces companies to analyse every single cost to ensure it’s necessary and that there’s good ROI.
In 2023 the foundations of ZBB remain the same, but this iteration is enhanced by the fintech solutions available today. Companies require real-time insight into their total spend in order to scrutinise and learn from each outlay. Digitisation and high-tech tools render such information more accessible than it’s ever been.
While it may seem like austerity repackaged, ZBB actually offers myriad advantages and opportunities for growth. The obvious benefit is cost optimisation. ZBB forces an in-depth audit of expenditure across every department, meaning any spending deemed unnecessary can be curbed. It also helps prevent financial crime, since it becomes easier to identify unusual activity.
Savings are sizeable. According to Ernst & Young data, those using ZBB can save between 10 and 25 of their SG&A cost base. At Payhawk, we ourselves recently did a detailed cost review with a focus on our software and solution subscriptions in every area of the company, from legal to marketing.
We managed to optimise our spend by roughly 15 and have decided to do this once per quarter rather than once per year.
Secondly, it encourages innovation. With previous budgeting methods, the more you spent in a year, the more you’d get the next, resulting in the dissipation of funds. ZBB incentivises companies to find the best way to spend their money and to think more creatively about how to make it stretch further.
Finally, given that it’s focused on future projections, ZBB allows for more flexibility. Granted, a company using this method will operate with a fixed amount of budget, but since it’s not based on how it was spent previously it allows more freedom to move money around and spend it elsewhere within the business should priorities change.
Admittedly, adopting ZBB will slow down decision-making. Not only because the CFO will be involved in more decisions than previously to ensure everything has a business case, but also because larger, higher-risk projects are likely to be postponed. A downside for those looking to make big moves this year, but ultimately prudent.
In short, companies that don’t enact ZBB are taking a gamble on their budget for this year. It’s unlikely that the market downturn we’re seeing is a short-term circumstance – and even if it is, it’s better to be well-prepared and cautious, then ramp up spending when needed.
Pushing a company to think more rationally about how money is spent, ROI and how to be more efficient in meeting goals is helpful at the best of times. In a world recovering from a pandemic, where inflation is higher than it has been in decades, geo-political tensions are rising, and funding is declining, it’s vital.
While it certainly isn’t enough to protect a company from recession entirely, it’s certainly a stride in the right direction.
The views and opinions expressed are not necessarily those of AltFi.