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.
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.
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.
Creating a zero-based budget
Zero-based budgeting can help startups better manage cash flow by carefully monitoring spending. With that in mind, let’s look at some steps for creating a ZBB:
1. Set goals for your startup
The initial stage of zero-based budgeting involves identifying the objectives and goals of the organization — this should be the first step for any budget! This step is crucial, as it sets the foundation for the budgeting process and ensures that all expenditures and activities are in line with the organization’s strategic direction. In this environment, for startups that are venture capital-backed, the objective should be to reach a point where they can secure another round of financing, grow into their current valuation, or achieve cash-flow break-even. I personally hate the goal of simply surviving for a year, but for some startups simply surviving a recession may be all they can plan for.
2. Start from scratch
Come up with every activity you need to do to achieve your goals. In a perfect world, you’d start from a blank slate, without using the prior year’s actuals. This will keep your ZBB from having previous expenses “embedded” in them, and instead sets spending levels at the bare necessity level. That being said, having your accountant pull your general ledger or run a vendor report from your accounting system can help you make sure you don’t forget about an important spend category.
3. Justify every budget component
This can get time-consuming, but it’s essential. Managers should account for every program, service, or activity, to see if those areas will be increased, maintained, reduced, or eliminated. They need to focus on objectives and make sure spending is tied to outcomes and milestones. If managers and departments can’t explain why they need a specific expenditure, it’s probably unnecessary.
4. Streamline your spending
Focus on your strategic plan. What are your goals? What milestones do you need to hit? If an expense isn’t driving toward your goals, you need to reconsider it. This allows you to allocate your spending more strategically. Additionally, look cross-functionally to make sure that there aren’t duplicate efforts, vendors, or spending. You’d be surprised how many startups have several of the same software subscriptions, or old subscriptions that aren’t being used, for example.
5. Analyze the plan
Start by putting your plan into a budget template. Either use your existing template, or get a free one off of the internet. Analyze your plan holistically, to see if you have enough resources to hit your goals, and to make sure that your burn rate and cash-out date are adjusted as you had expected.
6. Compare the plan to your recent historical results
ZBB purists will find this point controversial, but I think the best plans are based on reality. And in the startup budging world, that means the recent historical results. To ensure that the budget is grounded in reality, it’s important to incorporate your historical actual results into the budget template. Although it’s not typically advisable to have a sudden break or significant deviation between historical results and the first month of projections, zero-based budgeting is an exception. A notable variance between the previous month and the projected month indicates that the budget discovery process is functioning effectively and identifying ways to decrease the burn rate. But you should understand the differences between your recent historical performance and the reality you’ll be living once you execute the plan.
7. Execute your plan
You need to communicate your budget along with everyone’s roles and responsibilities. This can be a culture shift for some employees, so you need to make sure they understand that “we’ve always done it that way” doesn’t align with the new focus.
8. Monitor and review the budget
After creating the budget projections, it’s important to continuously monitor and review the budget. This involves keeping track of actual spending and comparing it to the budget to identify any variances. It’s crucial to make necessary adjustments promptly to ensure that the organization stays on course to meet its objectives. If your cash flow is closely managed, we highly recommend conducting monthly budget-versus-actual analyses to stay on top of any discrepancies and take corrective action as needed. Regular monitoring and review of the budget is vital for maintaining financial stability.
Your startup can apply ZBB as needed
As mentioned earlier, many startups begin with a zero-based budget and then move to a traditional budget. You can switch between budgeting methods, using ZBB while you’re trying to get spending under control, and then move back to a more traditional budgeting process. You can also apply ZBB selectively to specific parts of your organization. For example, selling, general, and administrative (SG&A) expenses incorporate a lot of indirect costs, so a founder or CEO might use ZBB to help understand the company’s overhead. You can also use ZBB for new projects, or initiatives that request additional funding, and use more traditional budgeting for ongoing activities. Zero-based budgeting doesn’t need to be seen in opposition to traditional budgeting, but can be positioned as an additional tool that can be used periodically or applied judiciously to refocus your spending on strategically important activities.