Zero-Based Budgeting

A method of budgeting in which all expenses must be justified for each new period. Zero-based
budgeting starts from a "zero base" and every function within an organization is analyzed for its
needs and costs. Budgets are then built around what is needed for the upcoming period,
regardless of whether the budget is higher or lower than the previous one.
ZBB allows top-level strategic goals to be implemented into the budgeting process by tying them
to specific functional areas of the organization, where costs can be first grouped, then measured
against previous results and current expectations.
Because of its detail-oriented nature, zero-based budgeting may be a rolling process done over
several years, with only a few functional areas reviewed at a time by managers or
group leadership.
Zero-based budgeting can lower costs by avoiding blanket increases or decreases to a prior
period's budget. It is, however, a time-consuming process that takes much longer than traditional,
cost-based budgeting. The practice also favors areas that achieve direct revenues or production;
their contributions are more easily justified than in departments such as client service and
research and development.
Zero-based budgeting is a budgeting method that involves starting with $0 and adding only
enoughmoney in the budget to cover expected costs.
How it works/Example:
There are many ways to create company budgets. Let's take the marketing department of
Company XYZ as an example. Last year, the department spent $1 million. What's the right way
to set a budget for next year?
You might simply give the department $1 million again, but this might not reflect the changes in
the marketing programs next year, the need to hire more marketing people due to
additional sales, or other factors.
Another way might be to give all departments a 10% increase or decrease based on what
the board of directors would like earnings per share to be next year. This would give the
department $1.1 million or $900,000, depending on which way the board goes.
A third way would be zero-based budgeting, whereby the department starts with no
budgeted fundsand must justify every person and expense that should be included in the budget
for the coming year. This might result in a budget of, say, $1,024,314, which is higher than last
year but reflective of the actual needs next year.

Types of Audits and Reviews:

1.
2.
3.
4.
5.

Financial Audits or Reviews

Operational Audits
Department Reviews
Integrated Audits
Follow-up Audits

Financial Audit
A historically oriented, independent evaluation performed for the purpose of attesting to the
fairness, accuracy, and reliability of financial data. CSULB's external auditors, KPMG, perform
this type of review. CSULB's Director of Financial Reporting coordinates the work of these
auditors on our campus.
Operational Audit
A future-oriented, systematic, and independent evaluation of organizational activities. Financial
data may be used, but the primary sources of evidence are the operational policies and
achievements related to organizational objectives. Internal controls and efficiencies may be
evaluated during this type of review.
Department Review
A current period analysis of administrative functions, to evaluate the adequacy of controls,
safeguarding of assets, efficient use of resources, compliance with related laws, regulations and
University policy and integrity of financial information.
Integrated Audit
This is a combination of an operational audit, department review, and IS audit application
controls review. This type of review allows for a very comprehensive examination of a functional
operation within the University.
Follow-up Audit
These are audits conducted approximately six months after an internal or external audit report
has been issued. They are designed to evaluate corrective action that has been taken on the audit

issues reported in the original report. When these follow-up audits are done on external auditors'
reports, the results of the follow-up may be reported to those external auditors.

The Balanced Scorecard

Traditional financial reporting systems provide an indication of how a firm has performed in the
past, but offer little information about how it might perform in the future. For example, a firm
might reduce its level of customer service in order to boost current earnings, but then future
earnings might be negatively impacted due to reduced customer satisfaction.
To deal with this problem, Robert Kaplan and David Norton developed theBalanced Scorecard,
a performance measurement system that considers not only financial measures, but also
customer, business process, and learning measures. The Balanced Scorecard framework is
depicted in the following diagram:

Diagram of the Balanced Scorecard

Financial

Customer

Strategy

Learning
& Growth

Business
Processes

The balanced scorecard translates the organization's strategy into four perspectives, with
a balance between the following:

between internal and external measures

between objective measures and subjective measures

between performance results and the drivers of future results

Beyond the Financial Perspective

In the industrial age, most of the assets of a firm were in property, plant, and equipment, and the
financial accounting system performed an adequate job of valuing those assets. In the
information age, much of the value of the firm is embedded in innovative processes, customer
relationships, and human resources. The financial accounting system is not so good at valuing
such assets.
The Balanced Scorecard goes beyond standard financial measures to include the following
additional perspectives: the customer perspective, the internal process perspective, and the
learning and growth perspective.

Financial perspective - includes measures such as operating income, return on capital

employed, and economic value added.

Customer perspective - includes measures such as customer satisfaction, customer

retention, and market share in target segments.

Business process perspective - includes measures such as cost, throughput, and quality.
These are for business processes such as procurement, production, and order fulfillment.

Learning & growth perspective - includes measures such as employee satisfaction,

employee retention, skill sets, etc.

These four realms are not simply a collection of independent perspectives. Rather, there is a
logical connection between them - learning and growth lead to better business processes, which
in turn lead to increased value to the customer, which finally leads to improved financial
performance.
Objectives, Measures, Targets, and Initiatives
Each perspective of the Balanced Scorecard includes objectives, measures of those objectives,
target values of those measures, and initiatives, defined as follows:

Objectives - major objectives to be achieved, for example, profitable growth.

Measures - the observable parameters that will be used to measure progress toward
reaching the objective. For example, the objective of profitable growth might be
measured by growth in net margin.

Targets - the specific target values for the measures, for example, +2% growth in net
margin.

Initiatives - action programs to be initiated in order to meet the objective.

These can be organized for each perspective in a table as shown below.

Objectives

Measures

Targets

Initiatives

Financial
Customer
Process
Learning

Balanced Scorecard as a Strategic Management System

The Balanced Scorecard originally was conceived as an improved performance measurement
system. However, it soon became evident that it could be used as a management system to
implement strategy at all levels of the organization by facilitating the following functions:
1. Clarifying strategy - the translation of strategic objectives into quantifiable measures
clarifies the management team's understanding of the strategy and helps to develop a
coherent consensus.

2. Communicating strategic objectives - the Balanced Scorecard can serve to translate

high level objectives into operational objectives and communicate the strategy effectively
throughout the organization.
3. Planning, setting targets, and aligning strategic initiatives - ambitious but achievable
targets are set for each perspective and initiatives are developed to align efforts to reach
the targets.
4. Strategic feedback and learning - executives receive feedback on whether the strategy
implementation is proceeding according to plan and on whether the strategy itself is
successful ("double-loop learning").
These functions have made the Balanced Scorecard an effective management system for the
implementation of strategy. The Balanced Scorecard has been applied successfully to private
sector companies, non-profit organizations, and government agencies.

Strategic business units are absolutely essential for multi product organizations. These business units are
basically known as profit centres. They are focused towards a set of products and are responsible for each
and every decision / strategy to be taken for that particular set of products. Strategic business units can be
best explained with an example.
Example of Strategic business units The best example of strategic business unit would be to take
organizations like HUL, P&G or LG in focus. These organizations are characterized by multiple
categories and multiple product lines. For example, HUL may have a line of products in the shampoo
category, Similarly LG might have a line of products in the television category. Thus to track
the investments against return, they may classify the category as a different SBU itself.
There are several reasons SBUs are used in an organization and they are mentioned in my post on the
importance for using SBUs in a multi product organization. However, along with the reasons for using
SBUs there are also some powers which needs to be inferred on an SBU. Planning independence,
Empowerment and others are such powers which influence a SBU. 3 of such features are discussed below.
1) Empowerment of the SBU manager Several times the empowerment of SBU managers is crucial
for the success of the SBU / products. This is mainly because this manager is the one who is actually in
touch with the market and knows the best strategies which can be used for optimum returns. Thus several
times, the SBU manager might need a higher investment for his products. At such times the manager

should be supported from the organization. Only this confidence will help the manager in the progress of
the SBU.
2) Degree of sharing of one SBU with another This point is directly connected to the first one. What
if one SBU needs some budget but the same is not offered because the budget is being shared by 2 other
SBUs and as it is the budget is short. Thus the first SBU does not get the independence to implement
some important strategies. Similarly there might be other restrictions applied to one SBU as it is using
some resources which are shared by another SBU. This might not always be negative. Of one SBU
gains more profit then usual, this revenue might also become useful for the other SBU thereby promoting
growth of both of them. This is where sharing actually plays a positive role.
3) Changes in the market An SBU absolutely needs to be flexible because it needs to adapt to any
major changes in the market. For example if an LCD manager knows that LEDs are more in demand
now, he needs to communicate to the top management that he would also like a range of LED products to
make the SBU even more profitable. Thus by adding LED to its portfolio, the SBU can immediately
become double profitable. Thus by adjusting to change on SBU levels, the organization as a whole can
become profitable.
The key to Strategic business management is to have a strict watch on the investment and returns from
each SBU. The SBU manager too plays a crucial role in this and hence he is recruited from the industry
with extensive experience of that particular industry. Portfolio / Multi SBU management and is done at
the absolute top level of the management. Each and every change in the market, and its affect on SBUs is
anticipated which is then taken into consideration. Hence, for a multi product organization, business
management may actually mean product portfolio management or SBU management.

Free cash flow (FCF) is a measure of how much cash a business generates
after accounting forcapital expenditures such as buildings or equipment. This cash can be used
for expansion, dividends, reducing debt, or other purposes.
How it works/Example:
The formula for free cash flow is:
FCF = Operating Cash Flow - Capital Expenditures
The data needed to calculate a company's free cash flow is usually on its cash flow statement.
For example, if Company XYZ's cash flow statement reported $15 million of cash from
operations and $5 million of capital expenditures for the year, then Company XYZ's free cash
flow was $15 million - $5 million = $10 million.
It is important to note that free cash flow relies heavily on the state of a company's cash from
operations, which in turn is heavily influenced by the company's net income. Thus, when the
company has recorded a significant amount of gains or expenses that are not directly related to

the company's normal core business (a one-time gain on the sale of an asset, for example),
the analyst or investor should carefully exclude those from the free cash flow calculation to get a
better picture of the company's normal cash-generating ability.
Investors should also be aware that companies can influence their free cash flow by lengthening
the time they take to pay the bills (thus preserving their cash), shortening the time it takes to
collect what's owed to them (accelerating the receipt of cash), and putting off
buying inventory (again, preserving cash). It is also important to note that companies have some
leeway about what items are or are not considered capital expenditures, and the investor should
be aware of this when comparing the free cash flow of different companies.
Why it Matters:
The presence of free cash flow indicates that a company has cash to expand, develop new
products, buy back stock, pay dividends, or reduce its debt. High or rising free cash flow is often
a sign of a healthy company that is thriving in its current environment. Furthermore, since FCF
has a direct impact on the worth of a company, investors often hunt for companies that have high
or improving free cash flow but undervalued share prices -- the disparity often means the share
price will soon increase.
Free cash flow measures a company's ability to generate cash, which is a fundamental basis for
stock pricing. This is why some people value free cash flow more than just about any other
financial measure out there, including earnings per share.

A management control system (MCS) is a system which gathers and uses information to
evaluate the performance of different organizational resources like human, physical, financial
and also the organization as a whole considering the organizational strategies.
Management control system influences the behavior of organizational resources to implement
organizational strategies. Management control system might be formal or informal.
A management control system is a logical integration of management accounting tools to gather
and report data and to evaluate performance
Purposes of a management control system

clearly communicate the organizations goals

ensure that every manager and employee understands the specific actions required of
him/her to achieve organizational goals

communicate the results of actions across the organization

ensure that the management control system adjusts to changes in the environment

MCS STEPS:
1.Begin by specifying the organization's goals, subgoals and objectives

Goals are what the organization hopes to achieve in the long run
Subgoals or key success factors are more specific and provide more focus to
guide daily actions
Objectives are specific benchmarks which management would like to see
achieved
Important to keep all three in balance to avoid concentrating solely on short-run
achievements at the expense of long run goals

2. Establish responsibility centers

3. Develop performance measures
4. Measure and report on financial performance
5. Measure and report on non-financial performance

Responsibility centers:

Set of activities assigned to a manager or a group of managers/employees

Based on principle of responsibility accounting which holds that managers should be evaluated
on the activities which they can influence or control
Cost Centre
Area for which cost data is accumulated such as an assembly department
Expense Centre
Area dominated by discretionary expenses such as legal or accounting
Revenue Centre
Area primarily responsible for generating sales such as a sales office
Profit Centre

 Area responsible for controlling costs and generating revenues

Investment Centre
Area responsible for income (revenues - expenses) in relation to its invested capital