Small business financial controls can be honed to follow the lead from one of the world’s largest private capital investors, 3G Capital, who own large stakes in globally recognized brands such as Burger King and Kraft Heinz. Their success is, in great part, attributable to the practice of zero-based budgeting. Many small companies are under the impression that budgeting requires too much time and effort, which ultimately provides inaccurate projections in an ever-changing market environment. But this puts them in the position of constantly having to deal with surprises instead of trying to foresee them in a properly executed zero-based budget plan.
When the budget process is recognized as the proper channel to set reasonable expectations on revenues and expenses it becomes a prime measurement tool for every department manager. Budgeting must involve the entire management team coordinated by the top financial officer. It is essential that they embrace the final projections and translate them into departmental goals and objectives. A comprehensive budget is a formal statement of management’s expected and preplanned financial performance and is indispensable no matter what the size of the company is. It serves as a control device to help management verify its performance against the plan, and analyze variances so that timely changes can be made early in the new fiscal year to improve future performance.
Budgeting can also be used as an effective device to evaluate “what if” scenarios using various alternatives, so the best course of action for achieving the company’s financial goals can be selected. The alternatives should consider low-medium-high growth expectations and choose the one that all the managers agree on, accurately supported by current market information.
In developing budgets, two primary approaches can be used. These are: traditional and zero-based budgeting. Traditional budgeting is based on the concept that the relationships between costs and revenues will remain the same. Therefore, if insurance is 4% of revenue and if revenue doubles then insurance expenses will also have to double. Traditional budgeting tends to carry forward the past inefficiencies. Zero-based budgeting requires that each line of expense be examined and justified each year. One advantage of zero-based budgeting is that inefficiencies are considered and factored out (or in). But it is not enough to put a comprehensive budget in place. It is essential to perform variance analysis on a monthly basis to assess the causes of budget variances from the actual.
The seven objectives of zero-based budgeting
1. To establish financial goals and objectives against which departmental and individual performances can be measured on a timely basis.
2. To create a measurement tool in order that unsatisfactory performance and deviations from budgets can be caught early through variance reports, and corrected immediately.
3. To formalize and force the process of thinking throughout the organization that focuses on justifying each expense item, every single year, always starting at possible elimination of the expense (zero-based).
4. To correlate departmental activities so that all managers share information, and can then work in concert to evaluate and make changes that impact the company’s zero-based focus for financial controls.
6. To focus management and staff on a collective commitment to improve efficiencies and productivity in every department in order to decrease expenses.
7. To provide a method by which to optimize the cost of adequately allocating the necessary human and material resources to match the zero-based financial plan.
The budget and variance reports are both fundamental and indispensable small business financial controls for the achievement of profitability. Profit must be viewed as the first line of expense. This means that all other expenses must be brought into line to ensure that the net profit is realized. In zero-based budgeting, the variance report is an early warning signal that must be carefully monitored every month to ensure that the net profit projections in the budget are being met in the short term. Deviations from the financial plan must be met with action that corrects a negative outcome.
Profit is not to be seen as the amount of money that is left over at the end of the year. It should be a reasonable figure that is chosen by management and represents a realistic and achievable goal that is commensurate to industry standards.
Budget planning is available within most small business financial controls software. But it is very useful to have a separate spreadsheet in which various possibilities can be played out without affecting other key data in the financial system. It also allows managers to follow up and exchange information without disturbing the central data.