Here we are, barely into Q2 of the calendar year, and many organizations are operating under a budget that is essentially irrelevant. For calendar year-end companies, operating under the current budget for the remainder of the year doesn’t make sense. Organizations with non-calendar fiscal years may be anticipating their next budget cycle at this very moment. But how? It’s the middle of April and still a tremendous amount of uncertainty lies ahead. Is it fair to think we have better information today to come up with a budget that is applicable three months from now?
Two planning tools can help: zero based budgeting and rolling forecasts. While used by some organizations, they aren’t widely adopted. However, the state of uncertainty today makes these tools more relevant than ever, as they can provide a major advantage for organizations trying to get through turbulent times while enabling them to quickly change gears to take advantage of the next growth cycle.
In a previous blog post, we addressed five steps enterprises should take to help shore up their cash and liquidity. The first and second steps were all about understanding your position today, in terms of inflows and outflows of cash, and building the ability to forecast and model the future to be more proactive in solving potential issues. Zero based budgeting and rolling forecasts can be instrumental tools in navigating both of those steps to better understand and plan for liquidity. These tools can be a differentiator in terms of helping make informed decisions while remaining nimble and flexible in a changing environment.
>> Read “5 Steps to Addressing Your Business’ Cash Management and Liquidity”
Zero Based Budgeting
Zero based budgeting is a process that allocates funding based on assessed value, program efficiency and necessity rather than budget history. With the typical budgeting process, the starting point is the current budget or the current year’s actual numbers. A top down budgeting approach may start with sales/revenue and use that as a baseline to inform nearly every other line item. It’s a straightforward process in theory but does not afford the opportunity to closely examine where spend and investments are occurring across the organization.
With zero based budgeting, you must review every program, investment and expenditure at the beginning of the budgeting cycle and justify each line item to receive funding. The process can be used across all enterprise expense categories: cost of goods sold, SG&A labor and non-labor, and capital investments. When done successfully, it not only produces substantial cost savings, but it also can instrumentally change a culture to be more forward thinking and fiscally responsible. But like all potentially worthwhile things, zero based budgeting doesn’t come without its share of risks and costs.
The zero based budgeting process can be challenging for many managers and departments. Culturally it’s a significant divergence from past practices and, if not managed carefully, can be threatening to some in the organization. While zero based budgeting forces an organization to prioritize investments based on value, this can become complex and taxing where value and output are more intangible in nature. Perhaps most significantly, the zero based budgeting process takes considerably more time and effort to complete.
Those who understand and embrace the process and put in practice active communication and training can see substantial rewards. Effective zero based budgeting can reduce SG&A costs by 10 to 25% in less than a year. In challenging times, that can prove to be a tremendous opportunity.
Advantages of Zero Based Budgeting
- Drives significant cost savings by avoiding annual budget increases
- Aligns spend/investment to value creation and business strategy
- Changes culture to challenge the status quo and drive collaboration
Disadvantages of Zero Based Budgeting
- Time consuming and resource intensive
- Complex and challenging when leadership is not experienced or trained in the process
- May be disruptive to organizational culture as well as day-to-day operations
Typically, monthly forecasts are an extension of the annual budget. They provide an opportunity to account for monthly fluctuations and update the remaining periods in an attempt to remain on track to meet the budget.
But what if the budget wasn’t any good to begin with, or what if conditions are changing more rapidly than you anticipated when you created the budget months ago? If there is a way to become more flexible and agile, have better visibility into the future and enhance your decision-making capability, wouldn’t you want to move in that direction?
Rolling forecasts are considered a best practice, and today many leading organizations have adopted it as a standard practice. With that said, 75% of all organizations today still use manual, offline forecasting, often treating the forecast as more of a formality than a decision driver.
What is it about rolling forecasts that make them so valuable in helping organizations better plan and thereby make better decisions? Well, the answer in large part comes down to having current and relevant information. With budget processes taking upwards of six months, key strategic decisions are being made based on data and insights from as much as a year ago. Rolling forecasts on the other hand give your financial planning and analysis team and department heads the ability to continuously reassess internal and external factors and incorporate those factors into the forward-looking plan. This process enables managers to see trends, patterns and anomalies before their competitors, allowing them to be more proactive and create a competitive advantage for the organization.
So, how can organizations begin to adopt and transition from their traditional forecasting process to a rolling forecast? We’ve provided several recommendations to help you in the transition:
- Plan. Start with the objectives and goal, then decide things like time horizon, frequency and level of detail planning that will occur.
- Align. A key objective of a rolling forecast is to revisit enterprise strategy and align and realign resources to support the strategy.
- Enabling Tools and Technologies. While not required, there are cloud-based enterprise performance management platforms that can help aid the transition and ensure a more integrated and effective forecasting solution.
- Communicate and Train. This is the time to evaluate who has direct ownership of and who should be directly involved in the forecasting process. Then be sure to actively communicate with those team members and train them on the new system and tools.
- Monitor and Adjust. Rolling forecasts allow for greater flexibility, and with that, the process should continually be reviewed and evolve to help become most efficient and of most value to the organization.
While both zero based budgeting and rolling forecasts are solutions that can stand alone, we believe you can unlock even more value by combining both of these processes together. Use zero based budgeting as a key tool to evaluate current enterprise spend and investments, and then transition the budget to a rolling forecast. This provides the best of both worlds by driving down spend, while adopting practices to help all of the organization become more nimble and make better decisions.
With a high proportion of organizations using antiquated processes and tools around budgeting and forecasting, now is the time to reevaluate and make these changes. Customizing these tools to fit your needs will not only help navigate near-term uncertainties but also help you get more value out of the next growth cycle.
Contact John Cavalier at firstname.lastname@example.org or a member of your service team to discuss this topic further.
Like what you read? Sign up to receive our latest tax, accounting and business blogs and podcasts.
Cohen & Company is not rendering legal, accounting or other professional advice. Information contained in this post is considered accurate as of the date of publishing. Any action taken based on information in this blog should be taken only after a detailed review of the specific facts, circumstances and current law.