Justify Every Cost Item, to Generate More Cash Flow and Profits
By Richard J. Maturi
The harsh reality of today’s declining economy, shrinking markets, and rising costs, makes it time to take a hard look at zero-based budgeting. What is zero-based budgeting? Zero-based budgeting is the budgeting process where every single item has to re-justify itself in order to get approved. It’s a no-nonsense approach to cutting costs, improving cash flow, and generating more profits for your home-based business.
In order to be successful, zero-based budgeting relies on a clear concept of your firm’s long-term objectives, specific short-term goals, and available financial resources. Each expenditure analysis should include an analysis of cost, purpose, expected benefits, alternative courses of action, and measures of performance and review. The exercise strengthens your firm’s planning and decision-making by concentrating on what expenditures improve your operations and move your business toward achieving its goals.
Rethinking and Building a Budget
Zero-based budgeting forces owners to “rethink” their business operations and build a budget from the ground up; taking into account new input, the current market situation and other factors not considered or known during the previous budget generation process. In essence, you focus on the things that are essential to making your business as profitable as it can be. It forces you to find more cost effective ways to conduct your business. It may also create outsourcing opportunities that reduce costs. Zero-based budgeting is also known as priority-based budgeting since it concentrates on giving priority to the activities that further your firm’s goals.
Concentrating on What’s Essential
In other words, you don’t look at last year’s budget and factor in an inflation estimate. With zero-based budgeting, you forget your previous assumptions and concentrate on what is essential to your cash flow, profits, and ability to run a successful business. For example, last year’s budget may have factored in X amount of dollars for print advertising based on current ad rates. With zero-based budgeting, you analyze what type of advertising is required to reach your potential audience/customer base. You may determine that an email campaign is more cost effective and fruitful than print advertising.
In other words nothing is taken for granted…you need to justify each and every expenditure and what benefits will be derived from that expenditure. The process forces you to analyze and compare various spending options. Numerous benefits derive from employing the zero-based budgeting process. It helps eliminate built-in cost increases, improve cost containment, remove inefficiencies, and increase discipline in budget creation.
Inflated budget items are uncovered since no expenditure is approved without an analysis of how that expenditure improves the operation of the business and its profitability goals. A firm’s resources are limited, and each expenditure proposal competes with all of the other expenditure proposals to justify its place in the final budget. You achieve a more efficient use of your firm’s limited resources by concentrating on absolute needs and benefits. Wasteful and inefficient operations are identified and eliminated when their expense levels cannot be justified.
Focusing on Expenditure Activity
Zero-based budgeting focuses on the expenditure activity rather than department or type of budget item. You may get more bang for the buck from a certain type of sales expenditure versus the same dollar amount spent in another business function such as administration. It forces you to focus on the overall mission of your firm. If a cost cannot be justified in terms of supporting your firm’s overall goals, it should be eliminated. Since zero-based budgeting may result in decreased expenditures, rather than increased expenditures, your firm’s cash flow and profits can rise as a result of increased profit margins and slashed costs.
Of course, there are some tradeoffs when you employ the zero-based budgeting approach. It takes much more time to rethink your operations from the ground up than to employ incremental budgeting where approval for the previous budget base spending is assumed and only percentage increases over the prior budget need to be justified. Likewise, some expenses are hard to quantify in dollars and cents cost/benefit analysis. For example, business gifts to key customers may not directly result in increased sales and profitability. You have to be brutally honest in your cost/benefit analysis, or else your bias may creep into the process.
Using the zero-based budgeting tool can help you successfully plan, coordinate, and manage your business. While routinely putting this tool to work for you may not be practical, a periodic zero-based budgeting review may keep your business on track and expenditures back in line with the benefit expected to be derived from those expenditures. HBM