2010

(a) Zero-based budgeting is a technique of planning and decision-making which reverses the
working process of traditional budgeting. In traditional incremental budgeting, departmental
managers justify only increases over the previous year budget and what has been already spent is
automatically sanctioned. By contrast, in zero-based budgeting, every department function is
reviewed comprehensively and all expenditures must be approved, rather than only increases. No
reference is made to the previous level of expenditure. Zero-based budgeting requires the budget
request be justified in complete detail by each division manager starting from the zero-base. The
zero-base is indifferent to whether the total budget is increasing or decreasing.

The term "zero-based budgeting" is sometimes used in personal finance to describe "zero-sum
budgeting", the practice of budgeting every dollar of income received, and then adjusting some
part of the budget downward for every other part that needs to be adjusted upward.

Zero based budgeting also refers to the identification of a task or tasks and then funding
resources to complete the task independent of current resourcing.

Advantage of zero-based budgeting

1. Efficient allocation of resources, as it is based on needs and benefits.
2. Drives managers to find cost effective ways to improve operations.
3. Detects inflated budgets.
4. Useful for service departments where the output is difficult to identify.
5. Increases staff motivation by providing greater initiative and responsibility in decision-
making.
6. Increases communication and coordination within the organization.
7. Identifies and eliminates wasteful and obsolete operations.
8. Identifies opportunities for outsourcing.
9. Forces cost centers to identify their mission and their relationship to overall goals.
10. It helps in identifying areas of wasteful expenditure and, if desired, it can also be used for
suggesting alternative courses of action.

Disadvantages of zero-based budgeting

1. Difficult to define decision units and decision packages, as it is time-consuming and
exhaustive.
2. Forced to justify every detail related to expenditure. The R&D department is threatened
whereas the production department benefits.
 3. Necessary to train managers. Zero-based budgeting must be clearly understood by
managers at various levels to be successfully implemented. Difficult to administer and
communicate the budgeting because more managers are involved in the process.
4. In a large organization, the volume of forms may be so large that no one person could
read it all. Compressing the information down to a usable size might remove critically
important details.
5. Honesty of the managers must be reliable and uniform. Any manager that exaggerates
skews the results.

(b) A measure of financial performance calculated as operating cash flow minus capital expenditures.
Free cash flow (FCF) represents the cash that a company is able to generate after laying out the money
required to maintain or expand its asset base. Free cash flow is important because it allows a company
to pursue opportunities that enhance shareholder value. Without cash, it's tough to develop new products,
make acquisitions, pay dividends and reduce debt. FCF is calculated as:

EBIT (1-Tax Rate) + Depreciation & Amortization - Change in Net Working Capital - Capital Expenditure

 It can also be calculated by taking operating cash flow and subtracting capital expenditures. Free cash
flow measures the ease with which businesses can grow and pay dividends to shareholders. Even
profitable businesses may have negative cash flows. Their requirement for increased financing will result
in increased financing cost reducing future income. Free cash flow (FCF) is cash flow available for
distribution among all the securities holders of an organization. They include equity holders, debt
holders, preferred stock holders, convertible security holders, and so on.

A measure of a company's ability to generate the cash flow necessary to maintain it’s operations. There is
more than one way to calculate free cash flow, but perhaps the simplest is to subtract a company's capital
expenditures from its cash flow from operations. Some analysts believe that free cash flow is more
important than other measures of financial health because it measures how much cash a company has
and can make. This differs from other measures, which are sometimes accused of using both legitimate
and illegitimate forms of accounting to make a company look healthier than it really is.

Strategic Business Unit or SBU is understood as a business unit within the overall corporate
identity which is distinguishable from other business because it serves a defined external market
where management can conduct strategic planning in relation to products and markets. The
unique small business unit benefits that a firm aggressively promotes in a consistent manner.
When companies become really large, they are best thought of as being composed of a number
of businesses (or SBUs).

In the broader domain of strategic management, the phrase "Strategic Business Unit" came into
use in the 1960s, largely as a result of General Electric's many units.

These organizational entities are large enough and homogeneous enough to exercise control over
most strategic factors affecting their performance. They are managed as self contained planning
units for which discrete business strategies can be developed. A Strategic Business Unit can
encompass an entire company, or can simply be a smaller part of a company set up to perform a
specific task. The SBU has its own business strategy, objectives and competitors and these will
often be different from those of the parent company. Research conducted in this includes the
BCG Matrix.

This approach entails the creation of business units to address each market in which the company
is operating. The organization of the business unit is determined by the needs of the market.

An SBU is a sole operating unit or planning focus that does not group a distinct set of products
or services, which are sold to a uniform set of customers, facing a well-defined set of
competitors. The external (market) dimension of a business is the relevant perspective for the
proper identification of an SBU. (See Industry information and Porter five forces analysis.)
Therefore, an SBU should have a set of external customers and not just an internal supplier.

Companies today often use the word “Segmentation” or “Division” when referring to SBU’s, or
an aggregation of SBU’s that share such commonalities. SBUs are also known as strategy
centers, Independent Business Unit or even Strategic Planning Centers.

Each Business Unit must meet the following criteria:

1. Have a unique business mission, independent from other SBUs.

2. Have clearly definable set of competitors.
3. Is able to carry out integrative planning relatively independently of other SBUs.
4. Should have a Manager authorized and responsible for its operation.

Performance of SBU measured?

Responsibility accounting occurs when an entity is structured into strategic business units and
the performance of these units is measured in terms of accounting results. Managers are then
held accountable and rewarded on the basis of the results of their department. Further explain
Responsibility Accounting.

Conditions required for creating SBU?

The main philosophical concept behind the formation of strategic business units is to serve a
clear and defined market segment along with a clear and defined strategy. These business units
have to contain all the needs and corporate capabilities of the respective organization. The entire
portfolio of the concerned business has to be managed by allocation of managerial and capital
resources for serving the overall interest of the entire organization. This helps in developing a
balance in the earnings, sales and the assets at a level which is controlled and acceptable for
taking the right amount of risks.

The strategic business unit (SBU) is created with the application of set criteria which consist of
the competitors, price models, customer groups and the overall experience of the company. It is
also sometimes seen that a number of different verticals present in the same organization having
similar competitors and target customers are amalgamated to form a single SBU. This helps in
strategically planning the overall business of the organization. This is also true for the company
which has different product ranges and some of them have similar capabilities in terms of
research and development, marketing and manufacturing. Such products can also be
amalgamated to form a single unit.

The main notion which rests behind the concept of strategic business units is to gain a
competitive advantage in the populated marketplace. This can be done because the SBU helps in
segmenting the activities of the company in a strategic manner and the resources are thus
allocated competitively.