For This Year’s Budget, Don’t Rely On Last Year’s Numbers
A wise man once said a great novel must justify itself in every line. But what if your task is building a great business instead? Today, more often than not, budgeting is reduced to adding an arbitrary and often inflationary rate to last year’s figures. Further, this practice is often derived with minimal conscious analysis from the P&L statement, or participation and buy-in from the full management team.
What if there was another way? What if the annual budgeting exercise became a conscious and deliberate process that drove financial performance, achieved corporate transparency, improved team communication and collaboration, enlisted the personal accountability of every member of your team, and increased profitability, year after year?
That’s the concept behind zero-based budgeting.
Zero-based budgeting or ZBB is a “from-the-ground-up” approach to annual planning and decision-making. The process of zero-based budgeting establishes a cultural shift, one in which each budget request is reevaluated annually, starting at zero. Your department heads will be engaged in a conscious reallocation of resources based on real needs, not history or tradition. Management will be driven to find more cost-effective ways to improve operations and every investment will be analyzed based on its ability to help grow topline revenue.
Each department head is responsible for justifying the expenditures they legitimately need on a line-by-line basis. Senior management will review the submitted budget request and approve only after they feel comfortable the budgeted costs are supported by data, are absolutely necessary, and are convinced managers are committed to deliver the results.
The overriding dynamic of this kind of thinking feeds a cycle we call:
Cost – Redirect – Win
Unnecessary costs are squeezed out of the business through rigorous examination, team discussions and proactive management. These nonproductive assets (costs that don’t add value to customers or the business) are then redirected – or reinvested – into areas where they can help generate additional revenue – the “Win”. Reinvestments are typically applied to training personnel, improving the plant, merchandise for new accounts, advertising/marketing, trucks and other capital equipment.
Other advantages of ZBB include greater transparency, accountability, and communication amongst your entire management team. The process focuses on key performance drivers that you identify and improves management’s confidence in the budget at every level. Generally, each revenue, cost and capital expenditure category is assigned to a “package owner” (typically a department head), who will own the overall responsibility for that category. Package owners must provide support for their budgeting needs and expectations while committing to achieve specific results.
Success depends ultimately on the buy-in of the executive leadership and your team. Each member of the team needs to be engaged in the process and fully understand the upside of accountability – we recommend performance incentives based on total company cash flow. The process may be expected to take 6 – 10 weeks the first time, depending on the robustness and relative sophistication of your management team. The process and benefits will accelerate each year ZBB is implemented and becomes more familiar.
In order to truly reap the benefits of zero-based budgeting, some companies also implement Monthly Performance Reviews, or “MPRs”. MPRs are forums held on a monthly basis where ZBB package owners review financial performance for the month compared to the budget and prior year. The MPR’s foster a collaborative environment for the team to discuss how to proactively address key opportunities and challenges to the business (stay tuned to the next newsletter to learn more about MPRs).
“The value of the Zero Based Budgeting (ZBB) process and the rigorous Monthly Performance Reviews (MPRs) is evident in the increasing slope of the graphs of our financial results and the focused commitment of our top management team,” said Phil Sonnenklar, President of Iron City Workplace Services. “However, when bankers and lenders tell us that they do not see this level of sophistication even with their much larger corporate clients, it becomes clear that the trust and confidence that ZBB and MPRs establish inside our company also spread to those other outside partners that are so important to our success. ”
Once ZBB becomes your new normal you will see year over year continuous improvement and better team collaboration that consistently delivers increases in real value to your customers, your employees and the company.
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