The coronavirus pandemic has created a period of extreme economic uncertainty. The truth is no one knows what economic conditions will be one month from today, let alone 6 to 12 months. While we would all like to believe that things will return to “normal” in the near future, that’s wishful thinking at best. Given the heightened uncertainty, one of the most critical priorities for companies is to accept the current environment as the “new normal,” which means having a financial strategy that will allow them to survive for the next 12-18 months.
Central to that strategy is a detailed understanding of projected sales, spending, and cash requirements for that period. This blog will focus on spending since this is the area that every company has the most direct control over.
When business volumes decline quickly, the natural reaction is to slam on the spending brakes across the company. While that is effective in the short-term, it is not an optimal financial strategy over a more extended period. Reducing spending may be essential, but if that’s the only goal, then that’s all it can achieve, which would be a significant missed opportunity. A more important goal is to understand what you’re spending money on, why you’re spending it, and whether continued spending in a particular category will provide the highest ROI for the company, given the existing resource constraints and competing priorities.
Instead of asking, “where can we cut?” the question becomes, “why are we spending?”. Spending, particularly in the current environment, should be intentional, rather than a continuation of legacy practices.
To help our clients address these questions, we frequently work with them to implement a zero-based planning process. Also known as a zero-based budget, the process deviates from traditional planning in that the spending plan is developed from scratch rather than building it incrementally off the previous period.
Moving to a zero-based process requires managers to thoroughly understand and justify how they spend every dollar relative to the company’s current opportunities and resources. They need to view their spending from a perspective that’s focused on value rather than cost. While easier said than done, the goal is to get managers to think like investors when developing their spending plans.
As a company goes through this process, it will quantify savings opportunities across all functions. Companies may be tempted to stop there, happy to have reduced their spending. However, there’s much more to be gained by evaluating reallocation opportunities. The long-term health of the business depends on reinvesting some of the identified savings into the areas with the highest potential ROI. When done right, the process allows you to eliminate inefficiencies across the company and target your spending where it matters most.
So why doesn’t every company utilize zero-based planning? The truth is it requires more time and resources than traditional planning. This isn’t an exercise that can be handed off to the Finance team to prepare on their own. It requires the active involvement of managers with responsibility for spending decisions across all functions.
Is the extra time and effort justified? Under more predictable conditions, it might be considered overkill, particularly for smaller companies with limited resources. But in the current environment, I believe the deep insights on spending that result from a zero-based planning exercise are well worth the effort. Companies can benefit significantly from utilizing a flexible process to aggressively cut spending while reinvesting some of those savings in activities that are essential to the company’s future and to adjust spending plans as needed in response to a broad range of economic conditions.
At CFOs2GO, we’re ready to provide financial support to help you navigate through the current fog of economic uncertainty.