Zero-based budgeting can help in financial planning amid COVID-19: Shripati Acharya, Prime Venture Partners
It’s not just startups; even multinational companies face challenges when it comes to revenue flow and financial planning. And in unprecedented times like these, when markets are shifting without a moment’s notice, financial planning can be a startup’s greatest defence.
Shripati Acharya, Managing Partner at Prime Venture Partners, says, “You must estimate all possible revenue cuts. Plan for those situations. And be prepared to make your firm survive and see the tough times through.”
Sripathi asks us to consider the sales figures of the Indian auto industry. The sector recorded sales of a total 250,000 vehicles in April 2019. A year later, in April 2020, three of the biggest players in India - Hyundai, Maruti Suzuki, and Mahindra - sold no vehicles at all as the beleaguered world battled coronavirus.
“That is equivalent to exactly 100 percent revenue cut for these companies in the sales department. Most companies plan for 10 to 20 percent revenue declines, but this example shows that a 100 percent cut is no more an alien concept,” Shripati says.
So how can entrepreneurs deal with the situation? In this week’s episode of Prime Knowledge Series, Shripati talks about the zero-based budget (ZBB) technique and why it can be the best practice in financial planning for dire situations.
ZBB not only helps remove common biases, but also decision-making pitfalls that founders and their financial analysts fall victim to. The technique can help entrepreneurs plan, eliminating the unnecessary and keeping things are absolutely necessary.
What is zero-based budgeting?
ZBB requires starting from a “zero base” and building up by estimating the costs and needs of every wing of one's organisation. In the end, every expense must have a justification and is subject to change over time.
“If you want to apply ZBB to your firm, you must bring down all the allocated budgets to zero. Now, take every department of your business, like marketing, customer service, product, sales and engineering, and keep adding required amounts to each section. As per the definition, you will end up with a budget that you absolutely need to survive and steer your firm with no extravagant expense on anything,” Shripati says.
It is always better to overestimate a crisis rather than underestimating and exploding. ZBB helps one do just that.
“When you start with a zero base and justify all your spending, you are basically planning for the worst-case scenario or 100 percent revenue cut,” he says.
What about traditional budgeting?
In traditional budgeting, on the other hand, the starting point is generally the last budget that was formulated. After that, one either adds or slashes two percent in each segment, depending on the current market and business requirements.
Thus, traditional budgeting is a planning-down technique that might not capture the worst case when things are actually going well. Additionally, ZBB eliminates all anchoring bias.
Having said this, Shripati believes that nothing is absolute and while ZBB has its advantages, one must not stick to the method with eyes closed.
“Not all expenses can have a justification. Impromptu business opportunities might not allow you the time to think over your investments deeply,” he says. Thus, a certain percent of the overall budget will need to be set aside, away from the ZBB analysis, and may need you to apply the traditional two percent budgeting method. Additionally, when one starts from scratch with zero base, the budget can drag on for months before one can reach a final conclusion.
It is thus advisable to depend on ZBB to plan for uncertain times, but also keep the other techniques in one’s arsenal as each has its own budget.
(Edited by Teja Lele Desai)