INCREASE PROFITABILITY WITH ZERO-BASED BUDGETING
Originally Published In the GEI Blog
In business, our basic financial objectives are to 1) increase the number of units sold; 2)increase profit margin per unit sold; and to 3) decrease fixed and semi-fixed expenses – all of this so that our company may consistently maximize profits [assuming, of course, that we do not sacrifice quality and service standards] as operations continue. While we have neither the space nor time to delve into the revenue and unit pricing objectives, we can tackle the expense reduction issue head on by utilizing zero-based budgeting.
Typically, budgets are mapped out or structured based upon existing expenses, which are looked at line by line, and where each expense line is multiplied, too often unquestioningly, by some increase factor (i.e., some percent per month or some percent increase per year). When the budget variance reports (actual versus budgeted expenses) are examined monthly or quarterly, the previously mentioned approach artifically inflates the quality of performance; if this budgeting approach is continued unchecked, actual expenses will be consistantly lower than their budgeted amounts (as if operations were running quite efficiently) even as the company is losing money by the boatload by overspending. This simplistic time-saving type of budgeting, while exceedingly common, leads to over-inflated budgeted expenses, poor variance feedback, and consequently, to poor expense controls and policies. Some real-life examples:
==+ In very large companies, I have actually seen cases where discontinued departments and functions were actually given budgetary expense allocations because nobody cared to check on whether or not those departments or functions were still in existence. And this error was compounded with each fiscal year. Governmental departments and divisions of Not-for-profit entities are notorious for doing this, as are some For-profit entities – especially the larger, more structurally complex ones.
==+ In other large companies, I have witnessed a managerial mentality where “If we don't spend every bit of what we were budgeted for this year, we'll lose our allocation for next year. We'd better use it before we lose it!” This type of thinking guarantees expense inflation and incredible waste. And once again, governmental departments and divisions of Not-for-profit entities are notorious for doing this, as are regular For-profit entities – especially the larger, more structurally complex ones.
Needless to say (but I'll say it anyway) the two above procedural and mindset errors create tremendous financial problems as well as a crass distortion in the evaluation of actual performance. The possible “cure” for this erroneous protocol and reasoning is to employ a zero-based budgeting session at least once per year. The process is actually simple, and I've distilled it into several straightforward steps which you can follow to do a zero-based budgeting at some regular intervals throughout the year:
Step 1: Create a Budget Review Group comprised of major stakeholders and other participants who will not be threatened by the results of the process and who have a substanital interest in the profitability of the enterprise;
Step 2: Access a line-by-line expense budget (like the type you would use to perform a variance analysis) as a worksheet;
Step 3: Examine each line of the expense budget in terms of its utility. What purpose does it serve? Is it necessary? Should it be discontinued or continued? Is its relevance increasing or declining? Does it directly serve the purpose of generating profits or of supporting profitable operations for the business?;
Step 4: Eliminate budgeted expense items as appropriate. Reduce other expense items to their appropriate level. Remember that the key question to ask in a zero-based budgeting scenario is “Does this expense support revenue growth or production of goods or services to support those revenues?” Reconstruct the budget based upon these crucial revisited assumptions;
Step 5: Take the reconstructed budget and make the necessary eliminations, cuts and reductions to the actual business, as if you were looking at the business as an outside “efficiency expert” or cost accountant. This is a politically perilous step, as it will likely undermine some free benefits to certain individuals, destroy some hidden agendas by starvation, and stop the methodical step-by-step process of internal fiefdom-building amongst certain power-mongers within your managerial infrastructure.
Despite the temporary discomfort caused by the reshuffling which invariably follows a zero-based budgeting “correction,” the results are almost always worth the investment of time and effort. In sum, zero-based budgeting can give your organization a refreshed and clear prospective that will enable you to more readily serve the purpose of profitability for all stakeholders.
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zero-based, budgeting, business, financial, analysis, increase, profits, success, cost containment, variance analysis, GEI Consulting, Douglas E. Castle, financial analysis, accounting
Thank you, as always, for reading me.
Douglas Castle for Global Edge International Consulting Associates, Inc. and The Global Edge International Blog
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