Starting from Scratch
Zero-based budgeting can improve your institution’s analysis, forecasting, and decision making.
By Margo Vanover Porter
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Nobody ever said zero-based budgeting was easy. Yet varying types of institutions are giving it the old college try.
“With zero-based budgeting, you basically develop your budget as if you're starting from scratch,” says Louis J. Mayer, vice president for financial affairs and treasurer, Saint Joseph's University, Philadelphia. “You work from the bottom up, and you have to justify all your expenses as if you're developing a budget for the very first time. Many institutions currently use some form of incremental budgeting. They start with the base from the prior year and add to that some percentage increase reflective of their needs and the additional revenues they can generate. Their budgeting process focuses almost exclusively on the incremental component.”
Linda English, chief financial officer, Colorado Mountain College, Glenwood Springs, Colorado, fondly recalls using incremental budgeting, which she describes as simple and straightforward. “Our old budget system was so much easier than zero-based budgeting, where you have to build a budget line by line and justify it.”
Nevertheless, after completing two annual cycles of zero-based budgeting and now planning for the third, English doesn't regret the switch. “It's been a long and sometimes painful journey, but as I look back, I firmly believe we did the right thing. I absolutely recommend zero-based budgeting. Yes, it does take a lot of time, but the gains long term are great.”
She points to two obvious advantages: transparency and accountability. “Whether to students, taxpayers, or the state, we need to be accountable to those outside our system,” English says. She adds that the transparency of zero-based budgeting, as opposed to that of the incremental method, gives you better tools for reporting, which allow improved analysis, forecasting, and decision making.
Sharing the Wealth
Colorado Mountain College, a community college with almost 25,000 students and an annual budget of $55 million, opted for zero-based budgeting in 2009 at the recommendation of a quality improvement team. The goal: To rightsize the way money was divvied up among campuses and departments.
“We didn't go to zero-based budgeting to cut budgets. Our true reason was to achieve a more equitable allocation across the college.”
Linda English, Colorado Mountain College
“With eight campuses, we had gotten out of sync,” English explains. “Over the years, the campuses changed, but the funding didn't. We felt like we needed to reallocate among departments and campuses and try to get the budget more in tune to current needs. Think about it: Your base might have started 15 or 20 years ago, and lots of things can change during that time.”
To familiarize budget officers and staff with the new approach, English and her team packed up their spreadsheets and conducted face-to-face training on each campus. “We got a lot of questions,” she says. “The first year, people were a little apprehensive, because they had no idea what they were getting into. There was a certain amount of fear about 'What if I forget something, I absolutely have to pay for it, and it's not in my budget?' To alleviate that fear, we built in a small contingency—2.5 percent of their operating budget.”
The institution uses three formulas to calculate expenditures for adjunct faculty, professional development, and repairs and maintenance. “We said, 'Tell us who your full-time people are, and we will assign an amount for professional development based on their pay grade.' We have four different levels of dollars for professional development. The formula for repairs and maintenance is based on square footage.”
Budget officers use a spreadsheet tool that goes object code by object code through the account structure, performing calculations once the appropriate blanks are filled in. No full-time salaries are included. A five-person review committee composed of English, a senior vice president, the budget director, and two campus vice presidents then conducts a comprehensive review.
The first year, the committee discovered duplicate requests, as well as best and worst practices. For example, one campus developed a detailed budget for tutoring, offering students a choice of hours and days of the week. Another campus budgeted nothing for tutoring. “Wow. That really laid it out for us,” English exclaims. “Our students were not getting the same experience on each campus. We may not have the resources for high-end tutors across all campuses, but we can ensure that all campuses offer the service and that we spread our resources equitably across campuses.”
To guarantee that campuswide initiatives are met, the institution built into the spreadsheet a drop-down menu that aligns each expenditure with the college's strategic plan. “During training, we encouraged budget officers to stop doing things that did not tie to the plan. We said, 'If you want to put a line item in and you get all the way over to the right to pick from your drop-down menu and you really just can't fit it in somewhere, don't. We need to stop doing some things.'
“In higher ed, we want to be everything to everyone and so we keep adding and adding,” she continues. For example, the college recently started a Common Reader program that ties into a goal of increasing student engagement. Faculty, staff, students, and even members of the community read the same book and sometimes are able to meet and discuss the book with the author, on campus or in the nearby community. Increased resources toward tutoring also support this reading and engagement goal.
“We're not as good at stopping," English admits. "Few—if any—programs have been dropped, but the institution continues to work on that. It will take some time,” she says, “because our mission is to serve the community.
“We didn't go to zero-based budgeting to cut budgets,” she asserts. “Our true reason was to achieve a more equitable allocation across the college.”
Going Just So Far
When he joined Wheaton College in Wheaton, Illinois, almost three years ago, Dale A. Kemp considered a move from incremental to full-fledged zero-based budgeting. He decided against it. “There was no bridge burning,” explains the vice president for finance and treasurer. “There was no dire financial situation that required a redrafting of our procedures. All our budgets and systems were working fine, and it would have caused a fair amount of consternation by department managers to begin from scratch and build up from zero a full budget.”
Instead, Kemp chose a modified approach for the $125 million budget, requiring any expenditure above $20,000 to be justified. “We didn't actually use the term 'zero-based budgeting,'” he clarifies. “We merely explained in our budget instructions for the year that we would need to receive written explanations for all expenditures above the threshold.”
The verification process showed immediate results, according to Kemp. “There were some areas of the campus where we thought we might need to be thinning down or laying off personnel. We found that really wasn't necessary. We had areas of the college where we significantly overbudgeted and areas of the college that were forcing cutbacks.
“By virtue of having this modified approach, we were able to more adequately plan for and budget our resources, such that it eased the tension on certain strained departments. For example, we found that safety measures had reduced our budgeted uninsured losses, and our utility contracts had brought about continuing reductions in our budgeted energy expenses.”
He explains that certain areas of the campus had over the years developed a knack for crafting a financial cushion, while others were carefully counting pennies. “Without some level of oversight, those who were running lean were being inappropriately squeezed, while those who budgeted on a highly contingent basis were being rewarded.”
He paints the picture of employee resistance as moderate. “Had we gone all the way to zero, it would have been a much larger pushback,” he says. “Part of the wisdom was knowing where that threshold was. I would imagine a larger institution would have chosen a much larger number. For us, that was the right strike amount.”
Funding Strategic Initiatives
With a current budget of about $200 million, Saint Joseph's University recently announced a move to a modified zero-based budget beginning in 2013. “At least in the initial phase,” Mayer says, “we are making the assumption that our headcount for faculty and nonfaculty positions is appropriate. Headcount management will be analyzed separately. On a rolling three-year basis, we are going to look in detail at nonsalary budgets for all our departments.
“We're also going to develop a per capita expense allocation by department that is standard across the board. It will include items such as office supply costs, conference travel, computer replacements, and so forth. Part of the per capita analysis will involve assessing the average costs that are currently being incurred in those areas. Right now, our feeling is that some departments may have more nonsalary funding than they need, and others may not have enough.”
The administration, finance committee, and board all favored a move to modified zero-based budgeting, citing three primary factors.
Pricing strategy for a competitive marketplace. “We're a midsize private university with limited upside pricing potential,” Mayer says. “Historically, until recent years, tuition rate increases have been at the level of 6 or 7 percent annually. We expect future rates of increase to more closely comport with consumer price index increases because of competition from private institutions and prominent public institutions, as well as concerns about affordability by students and parents. Many families are shopping down, looking for less-expensive but high-quality public institutions. In the Philadelphia region, we operate in a significantly competitive higher ed marketplace, so we have to be extremely careful about our pricing.”
Preservation of a positive financial position and bond rating. Another constraint is the institution's need to maintain its strong financial profile and bond rating. “That means we have to have a bottom line net operating margin somewhere around 5 percent,” Mayer says.
Significance of tuition discounting. “A third factor,” he says, “is our tuition discount, which is tied to the pricing issue. To be competitive, we need to offer a competitive tuition discount rate. Ours has been below the national average but it has been gradually creeping up.”
With the additional scrutiny, Mayer expects to identify opportunities for reducing expenses and reallocating those funds to strategic uses. “The hope is that through this more-rigorous approach to budgeting, we can identify reallocation opportunities within the cost base that will identify resources to invest in strategic initiatives such as new academic programs and related faculty appointments. Like many institutions, we have significant funding initiatives and we have to find ways to accommodate them.
“More and more, institutions are going to have to fund those initiatives through cost reallocation,” he continues. “We can't just add the cost on to the base and raise the price higher. As a result, we need to more critically review and evaluate the cost base on an ongoing basis. Zero-based budgeting provides an opportunity to do that.”
According to Mayer, concurrent with more closely scrutinizing the operating cost base, the university is also exploring the possibility of implementing some form of responsibility-centered management, which will ultimately make individual colleges responsible for their own income, expense, and contribution margin, with the goal of combining academic authority with financial responsibility.
MARGO VANOVER PORTER, Locust Grove, Virginia, covers higher education business issues for Business Officer.