Build your budget from the ground up with zero based budgeting
Zero based budgeting?
For you calendar year-Enders, it's budget season. Not a time for going through the motions but an opportunity to allocate resources, reset programs, and start new initiatives.
Zero-based budgeting (ZBB) is a budgeting method that starts from a "zero base," requiring every expense to be justified from scratch, regardless of past budgets. The goal is to allocate resources efficiently and identify cost-saving opportunities.
The most effective approach we have seen with utilities and cooperatives is to allow department heads and other budget controllers to build their budgets based on priorities and strategies. Preparing the budget should also be coupled with being responsible for the budget's results. This responsibility provides additional incentives for the budget creator to be realistic in their budget development (although, beware of budget makers who leave "sand in the bag" so they look like heroes when the budget year is over).
A zero based budgeting approach
An effective approach to ZBB follows these steps:
1. Define cost center level: Identify and define the cost center levels within your co-op or utility. How far do you wish to drill down, i.e., division, department, or manager level?
2. Identify Activities and Expenses: Budget managers should list the detailed people and activities that contribute to operating and capital construction. This should include all fully loaded overhead costs, such as payroll, equipment, and materials management.
4. Evaluate Activity Necessity: Evaluate the necessity and relevance of each activity. Ask questions like: "Is this activity essential for our goals?", "Can it be eliminated or streamlined without significant impact?"
5. Rank Activities: Prioritize activities based on their importance and impact on achieving strategies. Classify them into essential, necessary, and non-essential categories. For example, essential activities in the meter shop should be meter installations and testing existing meters. A non-essential immediate category (or essential, depending on the timing of strategy) would be researching potential AMI hardware and software.
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6. Team evaluation of activities: Hold meetings with your department team to discuss activities, implementation of strategies, ideas for cost efficiencies, or other support that is needed to complete the mission of the department.
7. Cost Analysis: Conduct a thorough cost analysis for each activity. Assess the resources required and the associated costs, including labor, materials, overhead, etc. For example, in providing maintenance of overhead lines such as tree-trimming, the resources would be the size of the crew, their payroll overheads, materials needed, and equipment time. Once these dollars are determined, an analysis can be made comparing the in-house costs for tree trimming vs. outsourcing to an outside contractor specializing in tree trimming.
8. Zero Base Review: Use the analysis work done in #6 to assemble an annual budget for the department's activities. Part of the budget process is developing materials for budget presentations to upper management with supporting details behind each budget line item.
9. Monitor and Review: Once budgets have been approved (and edited a few times before being finalized) and implemented, regular monitoring of the actual expenditures compared to the budget should be done by the department management that developed the budget. Make sure you are receiving the proper reports to do your analysis. Remember - budget development = budget responsibility. One of the criteria used in your annual evaluation is budget management.
12. Mid-course corrections: As the year progresses, shift resources in the budget to cover activities that may have been "under-budgeted". Meet with project managers within the department to identify any issues that may need more resources early. Job 1 is to effectively and efficiently deliver the mission of your department. If more resources are needed for delivering that mission, ask early. Deliver the service and ask for forgiveness later.
Balancing the budget
ZBB is an effective way to allocate resources for prioritizing strategies
Zero-based budgeting requires more effort and involvement than traditional budgeting, but it can lead to more efficient resource allocation and cost optimization. It forces co-ops and utilities to reevaluate priorities in delivering reliable customer service.
About Russ Hissom - Article Author
Russ Hissom, CPA is a principal of Utility Accounting & Rates Specialists a firm that provides power utilities rate, expert witness, and consulting services, and online/on-demand courses on accounting, rates, FERC/RUS construction accounting, financial analysis, and business process improvement services. Russ was a partner in a national accounting and consulting firm for 20 years. He works with electric investor-owned and public power utilities, electric cooperatives, broadband providers, and gas, water, and wastewater utilities. His goal is to share industry best practices to help your business perform effectively and efficiently and meet the challenges of the changing power and utilities industry.
Find out more about Utility Accounting & Rates Specialists here, or you can reach Russ at russ.hissom@utilityeducation.com.
The material in this article is for informational purposes only and should not be taken as legal or accounting advice provided by Utility Accounting & Rates Specialists. You should seek formal advice on this topic from your accounting or legal advisor.