This technique is used by many large corporations to create a lean, focused spending plan. The recession has now arrived - and businesses everywhere will be seeking to design their expenditure plans from first principles.
The business concept
Zero-based budgeting is a deceptively simple idea. The business starts with a blank page, tearing up last year's budget and starting with no preconceptions or assumptions. Then the company will start adding proposed spending allocations, forcing itself to justify every single line item of cost from square one. Each spending commitment has to be justified in its entirety before it can be included in the budget. Typically a finance committee has to approve every decision.
This process is time consuming but reduces costs to the bare essentials, and makes sure there is a powerful motivation behind every cash allocation. It can also be demonstrated a glance that each item of spending is fully supportive of the organisation's mission and objectives.
Apply to your life
There's an old adage that work expands to fill the time available. The same principle is true for money, since personal expenditure usually rises to match - or exceed - income. Most people don't even budget - but those who do typically start with their net salary as a comfortable reference point to govern their spending decisions.
The credit drought and consumer recession are now here. Many people will be forced into reactive, even hasty spending cuts - a response to events rather than a driver of them. How do you know if you are cutting muscle rather than fat? Sentiment and intuition drive poor investment decisions; data drives smart decisions.
How do I do it?
Design your spending plan from scratch. Start with your key personal objectives and the critical path you must follow. Design your spending commitments around achieving these goals. Justify every expenditure category. Put on the hat of "devil's advocate" and actively argue against every single one of your shopping, consumption and investment choices - what better decisions could be taken? What cheaper outlets used? Are there ideas and opportunities for cost reduction overlooked? Consider the opportunity cost of every pound spent. Only when you have a robust, dispassionate justification for every spending activity should it go forward into your master budget. All income over and above the minimum baseline can be used for a contingency fund, or invested.
Drawing up the budget is of course only the first stage in the battle. Ensure you use proactive feedforward controls to compare planned results against current forecasts. Take control action early to eliminate any difference between anticipated and planned results.
Summary
Building your budget from first principles is not a fun, quick exercise. It can require painful choices, but delivers multiple rewards. If every pound is systematically allocated to ensure maximum impact in building your future, you will be ideally placed to weather any financial storm.
(c) WestOcean 2008
