Sunday
Jul132008
Tackling overhead
Sunday, July 13, 2008 at 8:00PM
There are generally two approaches to tackling overhead intelligently. There are a multitude of ways to do it wrong, but we won't go over all of those. The bottom line is that if you proceed deliberately rather than reactively you'll be much better off.
The first approach is to zero budget. This means you start from ground zero and question every expense. Zero based budgeting was created to combat the idiocy of incremental budgeting. Incremental budgeting is the lazy way out. It says "If we spent 'Y' amount last year we should expect to spend 'Y' amount times some percentage this year." Often the same percentage is applied across all categories. For instance, sales might be projecting a 5% increase in revenues so all overhead items are also increased 5%. There's no good logic for why overhead would increase 5%, but it's a lot easier than going through each category and trying to figure out how much overhead will be needed to support the expected increase in sales.
Zero budgeting requires that each dollar be justified, not just the increase. Take office supplies for instance. Rather than applying a blanket percentage increase zero budgeting requires the amount of needed office supplies to be estimated each year. One might review the organization chart or current and expected head count to get a sense for how many personnel will need to be supplied. Then price lists for the various vendors would be reviewed to determine if there are any changes that need to be incorporated. Next, alternatives for high volume supplies would be explored. The process continues until a budgeted figure for office supplies is arrived at.
The advantage to zero budgeting is that it takes nothing for granted. In this type of comprehensive exercise opportunities for savings almost always result. The downside is that it is time consuming and the benefit may not be worth the cost in terms of lost labor and production capacity while people are chasing down all the required elements to put together a budget. I usually save zero based budgeting for situations where budgets have never been done or for cases where operations have changed drastically. In these cases the process will not only result in savings but will also shed a lot of light on how things are being run.
The other "smart" budgeting method I like is what I call "responsibility" budgeting. In this system everyone is given responsibility for a particular area of overhead. It is that person's job to report back to the group the factors that affect their particular area of overhead, how these factors are expected to play out over the next year, and where cost savings can be expected. In his book The Great Game of Business Jack Stack talks about his company's efforts to build intelligent budgets. Everyone on the team was given an area to study. One guy drew toilet paper and spent the next several weeks learning everything he could about toilet paper. He found out for instance that during periods of slow production the company went through much more toilet paper than it did when there was a large backlog.
Toilet paper isn't the first place I'd look for massive savings, but the story illustrates the potential you can let loose in your organization if you give people the responsibility to go after money saving ideas. The other reason I like this method is that it tends to make everyone accountable for overhead costs. After all the information is gathered it becomes the team's responsibility to organize and prioritize the best opportunities for savings. Instead of one champion for cost savings you get an entire organization committed to saving money and eliminating waste.
Both methods take more time and effort than incremental budgeting which is why they're rarely used. They also require a leader or facilitator who has been through the process. Otherwise it's easy to get bogged down and loose momentum. It's also important to be realistic about how quickly this stuff will come together. Good budgets take time to plan and you shouldn't expect to throw one together overnight. Most successful companies spend from three to six months building their budgets. Our clients can usually do it in less, but two to three months of fairly intense activity should be expected.
The first approach is to zero budget. This means you start from ground zero and question every expense. Zero based budgeting was created to combat the idiocy of incremental budgeting. Incremental budgeting is the lazy way out. It says "If we spent 'Y' amount last year we should expect to spend 'Y' amount times some percentage this year." Often the same percentage is applied across all categories. For instance, sales might be projecting a 5% increase in revenues so all overhead items are also increased 5%. There's no good logic for why overhead would increase 5%, but it's a lot easier than going through each category and trying to figure out how much overhead will be needed to support the expected increase in sales.
Zero budgeting requires that each dollar be justified, not just the increase. Take office supplies for instance. Rather than applying a blanket percentage increase zero budgeting requires the amount of needed office supplies to be estimated each year. One might review the organization chart or current and expected head count to get a sense for how many personnel will need to be supplied. Then price lists for the various vendors would be reviewed to determine if there are any changes that need to be incorporated. Next, alternatives for high volume supplies would be explored. The process continues until a budgeted figure for office supplies is arrived at.
The advantage to zero budgeting is that it takes nothing for granted. In this type of comprehensive exercise opportunities for savings almost always result. The downside is that it is time consuming and the benefit may not be worth the cost in terms of lost labor and production capacity while people are chasing down all the required elements to put together a budget. I usually save zero based budgeting for situations where budgets have never been done or for cases where operations have changed drastically. In these cases the process will not only result in savings but will also shed a lot of light on how things are being run.
The other "smart" budgeting method I like is what I call "responsibility" budgeting. In this system everyone is given responsibility for a particular area of overhead. It is that person's job to report back to the group the factors that affect their particular area of overhead, how these factors are expected to play out over the next year, and where cost savings can be expected. In his book The Great Game of Business Jack Stack talks about his company's efforts to build intelligent budgets. Everyone on the team was given an area to study. One guy drew toilet paper and spent the next several weeks learning everything he could about toilet paper. He found out for instance that during periods of slow production the company went through much more toilet paper than it did when there was a large backlog.
Toilet paper isn't the first place I'd look for massive savings, but the story illustrates the potential you can let loose in your organization if you give people the responsibility to go after money saving ideas. The other reason I like this method is that it tends to make everyone accountable for overhead costs. After all the information is gathered it becomes the team's responsibility to organize and prioritize the best opportunities for savings. Instead of one champion for cost savings you get an entire organization committed to saving money and eliminating waste.
Both methods take more time and effort than incremental budgeting which is why they're rarely used. They also require a leader or facilitator who has been through the process. Otherwise it's easy to get bogged down and loose momentum. It's also important to be realistic about how quickly this stuff will come together. Good budgets take time to plan and you shouldn't expect to throw one together overnight. Most successful companies spend from three to six months building their budgets. Our clients can usually do it in less, but two to three months of fairly intense activity should be expected.
Reader Comments (2)
Joey;
You are just fantastic to always have your client's best interest in mind. You always keep up informed and truly care about us and our financial well being. I know you have made a BIG difference in our financial situation and we will ALWAYS be very grateful for this.
Hope to see you soon and I just wanted you to know how very much we appreciate all you do for us.
Sincerely, Pat and Roger
Joey,
Great tips on different budgeting methods. I’m sure you see many who don’t plan to fail, but fail to plan in this area.
Thanks you for a push in the right direction.
david spire
business technology advisor
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