Growth at all costs is out — and cutting burn and extending runway is in. And now that many startups are running through the venture funding they raised in the go-go-go times of pre-2021, many founders are facing the difficult task of reducing expenses to extend their runway.
As part of the finance consulting team at Kruze, I’ve worked with many startups that needed to extend their runways and realign their spending — many of them drastically. The best founders look for a framework to strategically cut burn while keeping their startup’s value drivers functioning.
Enter zero-based budgeting.
<span style="font-weight: 400;">Zero-based budgeting (ZBB) is a budgeting approach that requires companies to </span>build their budgets from zero<span style="font-weight: 400;"> every budget period to verify all of the line items are relevant and cost-effective.</span>
What is zero-based budgeting?
Zero-based budgeting (ZBB) is a budgeting approach that requires companies to build their budgets from zero every budget period to verify all of the line items are relevant and cost-effective. It’s one of the most aggressive budgeting methods to cut burn to the bare minimum. You would be a masochist if you tried to do this more than a couple of times in your career — zero-based budgeting is painful.
That being said, the process isn’t too dissimilar to how you built your first budget, when your startup was just an idea, a pitch deck and a spreadsheet (you did build a budget when you first presented to investors, right?). Often, however, after that first budget is drafted, many companies shift to a traditional budgeting process.
That’s not unique to startups, by the way. Many mature businesses rely on a traditional budget model, in which the company simply adds a percentage increase to the previous year’s actual expenses. That’s efficient from a time standpoint, but also makes it easy for companies to continue to operate at status quo. There’s no incentive to examine expenses and look for cost savings. Traditional budgeting can also foster the “use it or lose it” mentality, where managers try to spend their entire budgets so they won’t have them reduced the next year.
Advantages and disadvantages of zero-based budgeting
ZBB itemizes and strictly monitors expenses by department, and can help CEOs and founders control costs, but there are also challenges to using ZBB. Some of the benefits to ZBB include:
- Operational focus. ZBB forces departments to examine their costs and expenses.
- Reduced spending. Cash outflows are limited to the items included in the ZBB. Typically the process will uncover and eliminate wasteful spending.
- Accountability. ZBB encourages managers to become more cost aware, and helps them see the impact of spending and if it effectively “moves the needle” toward strategic goals.
- Flexibility. Since ZBBs are developed from scratch every year and aren’t tied to previous budgets, this encourages creativity and innovation. Managers are encouraged to find better, cheaper, or more efficient ways to accomplish their departmental goals.
Potential drawbacks to ZBB include:
- Resource intensive. Zero-based budgets have to be created each 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 expenditures each time a new ZBB is created.
- Frustrating to managers. Having to justify an expense that was justified earlier is painful. And if you had an intense discussion to decide to make a hire or start paying for a tool when you first started paying for it, your team may feel like they haven’t been heard when it comes time to do it all over again. So you have to stay empathetic and make sure you clearly explain why the company is doing this process so that your managers don’t get super frustrated.
- Short-term focus. ZBB is typically focused on the budgeting period, giving companies a detailed look at spending during that time frame. But it’s not looking at the previous budget period or the next budget period. That means your company might not pay enough attention to long-term strategic projects, like R&D expenditures.
My team has produced countless startup budgets, and I can say 100% for certain that the drawbacks to ZBB are real — but that if you are running out of cash, this is a proven framework for reducing burn.
Let’s dig into the steps to run a solid zero-based budget process.