On the other hand, if a company wants to improve its operating margin, it will look to find ways to cut operating expenses. It might also look to improve efficiencies in its supply chain, driving down the cost of goods sold.
Managers must justify every dollar in the budget, identifying how it drives the business toward its strategic goal for that period. If a dollar doesn't move the business closer to its goal, it might be cut. That can drive meaningful cost improvements and better results for the business.
Zero-based budgeting vs. traditional budgeting
Traditional budgeting typically takes the previous budget and makes incremental adjustments to each item. It focuses on the best way to allocate the increase (or decrease) in the budget instead of how best to allocate the total budget.
In other words, traditional budgeting is focused on what to remove; zero-based budgeting is focused on what to keep. This can result in significant cost cuts when moving from a traditional budget to a zero-based budget.
Traditional budgeting may focus on existing activities. Zero-based budgeting may push managers to come up with new solutions to problems that are a more effective use of money than current activities. For example, management may outsource or in-source certain activities when they move to a zero-based budget.
