FROM THE EDITOR

Let’s get it right

Adit Jain As business enterprises enter a new calendar year and more significantly, the last quarter before their annual stumps are drawn, they scramble towards revenue and profit targets. Nevertheless, CFOs have one eye keenly aimed on the budgeting process for the year ahead. Increasingly, some have resorted to Zero-Based Budgeting (ZBB), which works on a premise that there are no holy cows and all costs are subject to question. However, this is hard to do. In the first instance, it involves a considerable hike in effort not only for the finance function but also for business operations and consequently, needs a solid shove from top management.

Often, functional managers hurry along to spend allocated funds before they lapse at the end of the year, even when the expense is not completely essential.

The way it works is quite simple. All expenses must be justified for the new period and every function is analysed for its needs and costs. Budgets are then assembled around what is actually required, regardless of whether each entry is higher or lower than in the previous year. It works on the hypothesis that simply because we’ve done it before, cannot be the basis of doing it again. The process allows strategic priorities to be implemented into the budgeting process by knitting them into functional areas. Because of its detail-oriented nature, ZBB may be a rolling process, undertaken over several years, with a few functional areas reviewed at a time. It helps lower costs by avoiding blanket increases or reductions to previous budgets, but it is more time consuming. Traditional ways of budgeting look at incremental costs or new expenditures. ZBB, on the other hand, starts from zero and every expense has to be prudently justified. It places the onus on business managers towards devising arguments in defence of their demands. The idea is to sponge value out of every penny spent.

The standard practices of inserting 3-5% inflation, creates needless inefficiencies.

ZBB comes with a host of merits – greater efficiency to start with, in the allocation of resources, as the budget does not look at previous numbers but actual sums judiciously calculated and defensible. Many functions hurry along to spend allocated funds before they lapse, even when completely unjustifiable. I remember an occasion when I spent a few days at a top luxury hotel in the Himalayas, to find the entire Human Resource department of a consulting firm, on whose board I sat, enjoying a few days of tranquillity on the pretext of some ridiculous internal strategy planning session. Since the money was previously allocated it had to be spent, or the budgets next year might risk a bout of pruning. Zero based budgeting eliminates redundant activities and savings take place in areas previously never known and often of sizeable amounts. When managers look upon existing operations with fresh eyes, they can reshape their organisations radically, by channelling funds into areas that will drive growth and productivity.

ZBB ensures better communication within and between departments, as employees are inspired to join the budgeting process.

More importantly, the process is actually more accurate as every department needs to re-examine each item of their cash flow, whilst computing their costs. The standard practices of inserting 3-5% inflation, creates needless inefficiencies. It ensures better communication within and between departments, as employees are inspired to join the budgeting process.

Be that as it may, CFOs must be prepared for greater time allocation by business units and functions. The process is often burdensome and time consuming. Frequently, there is a lack of expertise and managers therefore require training. But in the end, it saves costs and improves margins. Most significantly it creates a culture of accountability, which quickly spreads across an organisation, even in areas far removed from mundane spread-sheets. ZBB, the evidence suggests, is worth considering: CFOs should have a serious think.

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Adit Jain, Editor