Zero-based budget Print
Written by Yordan Nedev   

In the last two years many companies concentrated on cost cutting and raising efficiency. These initiatives often went in vain when things inevitably got to digging into the P&L row-by-row. What comes next is either cutting the Gordian knot with a sword of -10% or taking piecemeal compromise decisions without taking account of existing relationships and the overall effect on the final goal.

The zero-based budget solves this issue and helps produce effective and accurate targets, from a strategic point of view though. This type of budget aims to answer the question: “If I start my business now from zero what costs would I incur in achieving the revenues I expect to generate?” Based on our experience, in this article we have briefly touched upon the main challenges in building a zero-based budget.

The budget is an operational instrument for short-term planning. It is usually prepared for a year ahead. In the budget we make a forecast of the revenues and expenses of the company for the following fiscal year. We might expand it towards a cash flow forecast for the same period. This report should be relatively elaborate so that it could be used for goal-setting and measuring the execution of operational tasks, which need to be clear, concrete, and achievable.

We worked with one of the largest Bulgarian logistics companies on a project for building a zero-based budget for the following fiscal year. The target-setting function of the zero-based budget was of great importance. The top management of the company realized the necessity of an independent viewpoint that would outline more clearly the targets for the business, which, if achieved, would result in optimized operations. The chosen instrument – zero-based budget – allowed precisely that because past data was only marginally relevant to the exercise. Our approach limited the transfer of inefficiencies from the past into the future. It rather used as a basis our deep understanding of the client’s business and detailed description of the optimized business processes. In this manner, the zero-based budget set the benchmark of optimal revenues, expenses, and profit for the company.

During the goal-setting phase for the sales team of the company emerged one of the main challenges of the project – cost-to-client allocation. In fact, the peculiarity in the applied financial expertise was in setting the right indirect cost centers and in choosing the right cost allocation bases by clients for these costs. We guaranteed this by thoroughly studying and understanding our client’s business. As a result, we proved that some of the large clients that operated at special price terms actually functioned as an elementary sum of smaller firms with no synergies among them whatsoever, which compromised the more favorable conditions they were given. We also calculated the breakeven price for each customer (for the forecasted loads and types of freight) – the price at which the revenue generated by the client equaled all the costs attributable to that firm for the forecast period.

In general, it is good to start building the budget at the lower hierarchical levels of the organization and then correct it and complete it in an interactive manner with the upper levels. This way staff is better motivated to achieve the targets since an excuse of the type “it’s dropped from above, no one asked us” is no longer valid. The instrument zero-based budget, however, is a product of the top management because its methodology requires a strategic point of view over the business model and processes and the way they form the value chain of the company. Its application goes through the following steps:

  1. Develop a map of the value chain of the business and put all major processes on it
  2. Map in detail all business processes
  3. Restructure and optimize the business processes
  4. Identify all key resources and define their physical measure (hours, kilograms, kilometers, pieces, etc.); link forecast revenues to business processes and their physical measures
  5. Evaluate each business process in physical and monetary amounts
  6. Count the necessary number of recurrences of each business process in order to achieve the forecast revenues


In conclusion we present a short and simplified example of the application of the instrument in the operations of our client:

One of the first processes in the value chain of the logistics company was receiving a freight query from a customer. After a comprehensive analysis, we revealed the following dependencies: in an optimized state of work, an employee needed 20 minutes to process a query (0.04 man-days). In addition he would have used office premises, furniture, computer equipment, office expenses and utilities. We calculated the cost of one man-day to be BGN 50 including remuneration, depreciation and rent of the utilized fixed assets, current office expenditures and normal level of utility usage. In order to achieve the forecast revenues we estimated that the clients would make 100 000 freight queries. This gave us a total of 4 000 man-days, which translated into BGN 200 000 of total cost.

 

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Business processes mapping - We track all business processes in the company and define those which are critical for it, and we give recommendations for their optimization.
Financial management - We help our clients to establish the set of goals that guarantee financial stability of the business in the long run.


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