Benefit of Budgeting Case Study
Benefit of Budgeting Case Study
Benefit of Budgeting Case Study
Introduction
Zurich Insurance Group is a leading global provider of insurance services.
Zurichs mission is to help customers understand and protect themselves
from risk. The company employs 60,000 staff and serves customers in 170
countries around the world.
Zurich offers General Insurance and Life Insurance products, for example:
Life. Through discussion with various stakeholders, budgets are set for each
business unit, with the combined budgets supporting Zurichs overall
corporate aims.
For example, the table below shows the revenue and expense budgets for UK
Life. The expenses budget is broken down by function. (All figures are for
illustration only.)
Benefits of budgeting
Budgets are a financial representation of an organisations strategy. The
process of budgeting requires managers to plan ahead, for example, to
identify the resources required to meet targets. This is particularly important
in the insurance industry due to the complex nature of the products offered.
Insurance generally addresses medium- and long-term needs of customers.
Decisions taken now are likely to have financial implications for many years
to come.
For example, in the UK, Zurich offers a protection product which provides a
payment in the event of the death of the policyholder to pay off an
outstanding mortgage. Typically, this product offers protection for 15 to 25
years. Zurich guarantees a price to the policyholder for the whole term. If the
outcome is different to that which was assumed when the price was set (e.g.
fewer or more deaths occur or fewer or more policies are cancelled than
expected), Zurich will either make a profit or a loss on that product. Due to
the long-term nature of these products any profit will emerge over many
years.
Analysing Variances
The budgeting process can be used for monitoring and control of financial
performance. Results can be reviewed as frequently as necessary against
budgets to identify good and poor performance areas. Managers need to
investigate the difference or variance between budgeted and actual results.
Where actual figures are worse than budgeted, these are called adverse
variances. Adverse variances may suggest problems. Where budgets are not
being met, action can be taken. Budget targets can be highly motivational
and staff who meet or exceed budgeted targets may be rewarded with
bonuses.
Challenges of effective budgeting
Suppose sales volume, prices and costs were all projected to rise annually by
10% (incremental budgeting). This would make budgeting easy, but it is
highly unlikely. To increase sales may require price reductions and discounts.
Successive rises in sales volume might bring economies of scale, but might
need investment to expand production in order to meet that demand.
Effective budgeting is full of challenges. Whilst financial accounts relate to
the past, budgets are about the future. All data is therefore planned rather
than actual, probable rather than definite.
Assumptions
Budgets are based on a number of assumptions. Some of these are explicit,
such as what the cost of labour and raw materials will be or what market
research results indicate about likely customer demand. Others are more
implicit. A change in leadership in the sales team, a good relationship with a
new supplier or changes in the organisation's external environment could all
affect budget projections.
Zurich may face unanticipated changes in legal or financial regulations or a
change in market dynamics brought about by economic factors or the
actions of competitors. An insurer needs to predict the risks its insurance
policies protect against, both short-term risks, such as floods and
earthquakes and longer-term risks, such as mortality rates. Budgets also
need to reflect the business need to invest in specific projects or long-term
improvements.
The profit budget draws together all the budgets for revenues and
costs to meet overall financial objectives.
Zero-based budgeting
An alternative approach to incremental budgeting is zero-based budgeting.
This means that each expenditure budget starts with a zero allocation each
year. Managers must justify each element of the budget they propose. This
has the advantage of making managers think proactively about what funds
they need. It also avoids the tendency simply to add a percentage of the
previous years budget or assume that expenditure will remain the same.
However, one major disadvantage of this approach is the increased demand
on staff time, which is an expensive resource with an opportunity cost.
Monitoring the budget
The first results against budget may show that the business is not exactly on
target. The budget then becomes a dashboard to assess all the factors and
make the necessary changes to reach goals. Variance analysis is used to
identify differences between budgeted and actual figures. This can be
demonstrated using the illustrative expenditure budget for UK Life.
Results that are only mildly outside expectations are 'amber'. These may
need attention particularly if there is a worsening trend. Finally, there are the
adverse (red) results. Red areas demand immediate investigation and
remedial action to bring performance back to budget. All results should be
investigated based on the level of risk each deviation poses to meeting the
overall business goals, but priority should be given to red areas.
Zurich Business Partners assist managers in understanding and explaining
current performance by identifying the root causes of any deviations from
the budget. They also look forward known as forecasting to assess how
those deviations will affect the performance compared to the budget over
the remainder of the period and in the context of overall objectives.
A deviation may be explained by an unforeseen event; it may be the
beginning of a major adverse trend that requires a counter-strategy.
Analysing recent trends can act as an early warning system and may
indicate how the business performance will evolve in the future.
Conclusion
The Zurich brand is associated with trust and reliability. Quality is at the
heart of its customer appeal.
However, it is also about innovation and being an industry leader, both in its
operations and responding quickly to emerging risks and opportunities. This
allows Zurich to deliver what matters when it matters.
The budgeting process is a source of competitive advantage. Effective
budgeting requires careful research and realistic planning as well as
collaboration. It can help to set high objectives or move the business into