There are occasions when expenditure outside of existing budgets is required to bring in an otherwise unattainable benefit to the business. At these times it may be appropriate to propose expenditure to senior management to justify and gain endorsement for your initiative. The proposal of expenditure requires forethought, planning and influence.
Prepare valid, accurate and clear proposals
There may be a case for proposed expenditure outside the scope of your own budget that needs to be approved at a higher level. This may be for items that will increase the cost-effectiveness and therefore it makes sense to spend in order to make savings, but the additional expense must be justified.
Proposed expenditure may be considered justified if you can guarantee improvements in:
- Profitability
- Quality of service
- Environmental impact
- Productivity and team motivation
- Working conditions and working relationships
There are two commonly used methods to prove that the extra cost is justified.
Cost benefit analysis
This method involves working out the implementation costs and the short and long-term benefits. Costs should include:
- The capital cost of purchasing new equipment or introducing new methods
- Training costs
- The cost of lost productivity during training with new equipment or methods
Benefits may include:
- Short-term savings as a result of efficient work methods
- Long-term increases in revenue due to improved quality of work
Differential analysis
This is a method for comparing one option to another. For example, to compare the options of:
- Increasing the price of a product
- Employing more sales staff to increase the volume of sales of the product at the same price
The costs of each option are calculated and compared to work out the best return.
Either method can be used to viably justify proposals for expenditure. The most important consideration is to ensure the proposal is complete, clear and compelling. It needs to provide all the required information necessary to make a decision and be compelling enough to influence a positive endorsement.
Address net benefits and contentious issue
When justifying proposals for expenditure it is helpful to consider the likely or projected financial return or impact on the proposed expenditure. There are two key ways in which this can be done, return on capital employed and return on investment.
Return on Capital Employed (ROCE)
Return on Capital Employed (ROCE) is the amount of Earnings before Interest and Tax (EBIT) the business is making as a percentage of the owner’s equity (cash) and interest bearing liabilities (loans). ROCE should normally be higher than the company’s borrowing rate – otherwise the business is paying more in interest to the bank than it is generating in EBIT (profit).
This calculation should be conducted whenever a business is looking to take on further borrowings to ensure that the ROCE remains higher than the borrowing rate otherwise an increase in borrowings will reduce the owner’s earnings.
Return on investment (ROI)
Return on Investment is a calculation used to determine the attractiveness of any particular investment. The calculation is simply the return generated by an investment divided by the amount invested, expressed as a percentage. For example, if you invested $100 and got a return of $120 the calculation would be 120: the 100 invested = 20, therefore, 20/100 = 20%.
Using this calculation, investors can compare the attractiveness of any number of investments to determine where best to invest their money.
Likewise business can use this calculation to judge the attractiveness of a number of investment opportunities available to them. It is often used when contemplating the opening of a new store to see if the store will justify the investment of opening it.
Compare outcomes to improve future proposals
There is considerable value in reflecting upon past performance. Implementing a process of comprehensive evaluation and review of the outcomes of proposals for expenditure can assist in future planning in several ways. In order to conduct such a review, the actual performance of the proposal for expenditure needs to be compared and contrasted with the budgeted projections.
Invariably there will be variations in elements of the actual vs. projected outcomes. Most commonly, variations occur when timing and resourcing have been underestimated which has a financial impact that tends to ‘blow out’ the budget. Of specific interest when reviewing and evaluating actual vs. projected outcomes is how quickly were variances observed and how successfully was corrective action taken. The resulting information can be highly valuable in assisting in the development of future proposals that may have similar intended outcomes.
To ensure the most value is received through the review and evaluation of proposals for expenditure it is necessary to compile and share the data of greatest relevance with key business stakeholders that may benefit.
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