Zero-Based Budgeting: Rebuild Your Costs From Nothing

Most budgets start from last year's figures and add a bit for inflation. Zero-based budgeting (ZBB) starts from zero: every cost has to be justified as if you were deciding to spend it for the first time. Costs that nobody would choose today, such as unused subscriptions, old contracts or habits, show up quickly.

The method was set out by Peter Pyhrr of Texas Instruments in a 1970 Harvard Business Review article, "Zero-Base Budgeting". It was later used by governments and large companies.

Why it suits small businesses

In a small business, many costs were set up years ago and simply renew. Software subscriptions, phone contracts, insurance, leases and memberships roll over without anyone asking whether they are still needed or still the best price. A zero-based review is a structured way to ask.

You do not need to rebuild the whole budget at once. Doing one area each quarter is more realistic and still catches most of the savings.

How to do it

1. List every cost line from the last 12 months of bank and card statements. Statements catch the small direct debits a budget misses.
2. For each line, ask what it achieves. If nobody can say, it is a candidate to cancel.
3. Price it from zero. If you were buying this today, what would you buy and what would it cost? Get one alternative quote for each of the bigger lines.
4. Compare with what you spend now. The gap is the saving.
5. Act on the biggest gaps first, then set a date to review the next area.

Worked example

A small marketing agency reviews six cost lines:

The software line gives the biggest saving: three tools that did the same job and seats for people who had left. Vehicle leases show no saving yet, because the leases run for another two years; they go on the list for review before renewal.

Run your own review

Pitfalls

• Cutting what earns money. Marketing that brings in profitable work is not a cost to cut blindly. Check what each line produces before cutting it.
• Ignoring contract dates. Note when each contract can be ended, and diary the review for before that date.
• Doing it once. Costs creep back. Repeat the review for each area every year or two.