PRODUCTIVITY - 27.11.2019

Bottom up changes

This first problem

A vast number of cost budgets plan for overheads on the basis of “last year + X%”. However, to identify cost savings you need to question each line of your accounts instead. Let’s take your rent as an example. These are the questions you need to be asking:

• Why aren’t we moving premises?
• Do we need the space we have?
• Could we be better located?
• Could we change the production process, e.g. by subcontracting a task, and save space that could either be disposed of or let out?

Better approach? Don’t forget, if you start to challenge your current rental arrangements you could save more. For example, if you downsized and used hot-desking this would cut your utility bills. Even with something as straightforward as rent, don’t base it on last year. Instead, move towards zero-based budgeting (ZBB).

What is ZBB?

Most businesses use an incremental budgeting process in which the new budget starts with costs from the previous period, e.g. last year + 10%. This “bakes” existing activities and expenditures into the budget, which encourages spending as much as possible before the end of their financial year. In zero-based budgeting, all cost headings start at zero and managers have to justify all expenditure, rather than just the increases.

Pros. (1) The identification and elimination of activities within a business that have been perpetuated by habit; and (2) it will detect inflated budgets.

Cons. (1) Lack of familiarity means you will need to educate budget holders; and (2) it requires more detailed analysis than traditional budgeting, so it takes more effort to complete your business planning cycle.

How to do it?

Step 1. Review the most recent annual P&L account to identify major areas of expense where the biggest savings could be generated.

Step2. You may need to rework the P&L account so that the full cost of providing overhead services can be determined. For example, IT costs in the P&L adjusted to include the cost of software, maintenance, IT support staff, depreciation of equipment and the rent on space used by IT.

Tip. Use a spreadsheet to build up the total cost of a particular function, e.g. for IT have two columns to separate out the fixed and variable costs.

What next? Let’s say that during your ZBB process you’ve identified a number of areas where costs are not under control, ranging from telecommunications to car leasing.

Step 3. Employ someone to negotiate these savings and manage the necessary changes to achieve them. This could require some external support but it could well be worth it.

Tip 1. Before you decide to implement ZBB ensure that you are able to allocate the time resources necessary to meet your budget deadlines.

Tip 2. ZBB can be used incrementally, e.g. just applied just to the distribution activity.

Step 4. Develop a revised costing (identifying fixed and variable costs) at normal levels of business.

Tip. When looking at costings, also consider whether there are any alternative methods of providing the service, e.g. outsourcing.