Zero-Based Budgeting Has Never Been More Necessary – Or Accessible

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In the early days of the COVID-19 pandemic, about two weeks before the state-wide Declaration of Emergency,  I was called by a prospect to postpone an engagement to identify and evaluate his business’s sources and uses of cash, cash conversion cycle, capital expenditures, capacity utilization and the like.  Basically to discover how this busy enterprise was perpetually short of cash.

The reason for the postponement was the expected decrease in business activity, an expectation that, unfortunately, proved correct, as it has for most businesses in the world in 2Q and into 3Q20.  Nevertheless, an opportunity was missed – an opportunity that all businesses that intend to survive can act upon.  Specifically, the vast majority of small and medium sized enterprises (SMEs) have a problem similar to my aforementioned prospect: they do not understand the core economics of their businesses.

An SME owner is generally not a professional manager.  This hierarchical layer is typically not installed until businesses grow much larger.  SMEs are typically managed by someone who is the expert in the product, service, or technology (collectively product) that the business is monetizing.  That is, by someone who is not trained in management and, even if they were trained in management, their comparative advantage would still recommend a focus on the product.

That notwithstanding, a slow-down affords time for strategic planning, which is why most of our strategic planning takes place over the year-end holidays.  Today’s crisis was not on the calendar, but still permits allocation of resources to restructuring, targeting efficiencies and outright survival planning.   One of the most powerful cash management tools is a budget, particularly a zero-based budget (ZBB) and the time to implement one is now.

Indeed, of all the reasons to not implement a forecasting initiative, the time requirement to do so is, in our opinion, the most compelling.  Again, we perform these exercises internally during less busy times, because less busy means less expensive (in terms of opportunity cost).  Though a dire economic crisis is amongst the worst circumstances that can create time, hay can still be made while this paradoxical sun shines.  The Small Business Administration has provided special loan programs to create liquidity to help SMEs survive long enough to restructure and emerge healthy, hopefully healthier than ever.

A zero-based budget is particularly necessary in times of cash flow difficulty, though the return on this investment is likely to prove beneficial in any environment.   The key element is that all budget line items are zeroed at the end of every budget period, as contrasted to a plus/minus adjustment to the last period’s budget.  You’ve probably heard in a movie about someone having to spend the rest of the year’s budget before the year ends or that budget will be lost next year.  ZBB is meant to, amongst other things, eliminate this practice.

Though definitions and applications of ZBB differ greatly, we use it here to also mean budgeting to a set bottom line rather than budgeting and then seeing what the bottom line is.  Budgeting this way requires understanding of variable, fixed, and sticky costs (e.g. labor) and will bring quality of earnings to the fore.

When this crisis is behind us, participants in each industry will fight fiercely for a share what will often be a smaller market.  Thousands of bankruptcies will fill the system in the second half of this year and well beyond.  An old business aphorism says there is nothing better for a business than competitors exit.  The fight will be adjudicated by capital, management, and nimbleness.  You can’t know your business without knowing your numbers, and you can’t run your numbers without knowing your business.  As always, as Peter Drucker instructs – if you can’t measure it, you can’t manage it.

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