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The benefits of budgeting

FINANCE

Introduction Zurich’s ethos is underpinned by its core values:

Zurich Insurance Group is a leading global provider of insurance Integrity Openness, reliability and honesty
services. Zurich’s mission is to help customers understand and
Customer centricity Putting the customer first and at
protect themselves from risk. The company employs 60,000 staff
the centre of all operations
and serves customers in 170 countries around the world.
Sustainable value creation Generating value for customers
Zurich offers General Insurance and Life Insurance products, and shareholders on a secure,
for example: long-term basis
• General Insurance: car insurance, home buildings and contents
Excellence Quality in management, operations
insurance
and products
• Life assurance: life insurance, investment and pension plans.
Teamwork Pursuing strategy through sharing
Zurich offers its products to retail customers (mainly individuals) expertise and ideas
and corporate customers (i.e. businesses).
A key component of Zurich’s values is corporate responsibility.
Life is full of uncertainty. The building you work in could catch fire. Being a responsible company is fundamental to Zurich’s long-term
Your computer could be stolen. You may have an accident. These sustainability. For example, Zurich Community Trust in the UK
are all risks with a small but real probability that they may occur. actively helps over 600 charities make a difference to the lives of
Insurance provides protection against that risk. In return for a fee thousands every year.
(a premium) it provides a financial payment in the event of
financial/personal loss. Insurance is an extremely competitive market. Customers will
obtain quotes to find the best value either from Zurich directly or
So what makes Zurich one of the leading insurance companies? It through a financial adviser. This case study shows how Zurich’s
starts with Zurich’s brand, reputation for quality customer service careful approach to budgeting is a contributory factor in gaining
and solid financial strength. The insurance industry is tightly competitive advantage.
regulated, requiring strict standards and highly skilled finance
professionals. Zurich, therefore, aims to attract the best graduates. What is budgeting?
An organisation must earn enough revenue so that, after all costs
have been subtracted, there is a profit remaining. One of the most
useful financial tools is the budget. A budget is a business plan
expressed in financial terms. Budgets can be drawn up for sales,
costs or investment spending.

A budget will include a degree of prediction of performance which

is usually based on past data e.g. sales.

Curriculum topics covered: • Types of budgets • Setting a budget

• Using a budget • Benefits of budgeting
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It is important that it is a realistic financial plan that the business can Benefits of budgeting
fulfil. Managers at all levels will have their own budget plans, designed
to co-ordinate with and contribute to the overall plan or master Budgets are a financial representation of an organisation’s strategy.
budget. Therefore, managers need to be involved in contributing The process of budgeting requires managers to plan ahead, for
information to the budget to which they will be committed. example, to identify the resources required to meet targets. This is
particularly important in the insurance industry due to the complex
Budgets should be stretching but achievable. They should enable nature of the products offered. Insurance generally addresses
companies to meet both short- and long-term financial and strategic medium- and long-term needs of customers. Decisions taken now
objectives whilst providing motivational targets (potentially linked to are likely to have financial implications for many years to come.
bonus payments) for managers to promote the right behaviours. All
budgets must be carefully monitored, reviewed and, if appropriate, For example, in the UK, Zurich
re-assessed as internal factors (e.g. a major project costs offers a protection product which
significantly less or more than expected) and external factors provides a payment in the event
(e.g. regulatory developments) change. of the death of the policyholder
to pay off an outstanding
mortgage. Typically, this product
Profit objectives are set by the company
offers protection for 15 to 25
years. Zurich guarantees a price
Sales budgets are determined to allow profit to the policyholder for the whole
objectives to be met
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
Production budgets are drawn up which illustrate policies are cancelled than expected), Zurich will either make a profit
the costs required to meet the planned sales
or a loss on that product. Due to the long-term nature of these
products any profit will emerge over many years.
Zurich has three core business segments: General Insurance (e.g.
car, home), Global Life (e.g. life assurance, pensions and The budgeting process can be used for monitoring and control of
investments) and Farmers (core North-American business). These financial performance. Results can be reviewed as frequently as
segments are divided into regions, for example Europe, and then necessary against budgets to identify good and poor performance
into business units, for example UK Life. Through discussion with areas. Managers need to investigate the difference or variance
various stakeholders, budgets are set for each business unit, with between budgeted and actual results. Where actual figures are
the combined budgets supporting Zurich’s overall corporate aims. worse than budgeted, these are called adverse variances. Adverse
variances may suggest problems. Where budgets are not being
For example, the table below shows the revenue and expense met, action can be taken. Budget targets can be highly motivational
budgets for UK Life. The expenses budget is broken down by and staff who meet or exceed budgeted targets may be rewarded
function. (All figures are for illustration only.) with bonuses.

UK Life – Revenue and Expense budget (6 months to end June 2012)

JANUARY FEBRUARY MARCH APRIL MAY JUNE

Revenue budget 2012 (£m) 48 62 70 63 66 61
Expenses budget 2012 (£m)
Sales 9 11 13 12 12 14
Propositions 6 7 8 7 8 9
Operations 14 19 21 19 20 22
Finance 4 5 6 5 5 6
IT 8 11 12 9 11 13
Control function 2 3 3 2 3 3
Total 43 56 63 54 59 67
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Setting and using budgets

Having established the core financial objectives, often referred to
as key performance indicators, the strategies to achieve them can
be set in one of two main ways. The budgeting process can be:
• 'top-down' - i.e. set by senior managers and directed
downwards, often based on previous results
• ‘bottom-up’ - i.e. evolving upwards from middle managers,
through the use of detailed analysis, for confirmation by senior
management.

Challenges of effective budgeting In practice, at Zurich

there are elements of
Suppose sales volume, prices and costs were all projected to rise both approaches. Senior managers
annually by 10% (incremental budgeting). This would make set strategy
Senior management and key
budgeting easy, but it is highly unlikely. To increase sales may undertakes the top- assumptions
require price reductions and discounts. Successive rises in sales down 'ambition
volume might bring economies of scale, but might need setting'. This gives the
investment to expand production in order to meet that demand. Business
strategic context. Partners
Managers then
Effective budgeting is full of challenges. Whilst financial accounts Middle managers
consider historical Back to senior
respond with
relate to the past, budgets are about the future. All data is therefore managers
data, prevailing trends to confirm detailed
planned rather than actual, probable rather than definite. Budgets are proposals*
and any new drivers
based on a number of assumptions. Some of these are explicit, such in order to formulate * For each department
as what the cost of labour and raw materials will be or what market proposed budgets.
research results indicate about likely customer demand. Others are
more implicit. A change in leadership in the sales team, a good
Zurich Business Partners help to ensure 'joined-up budgeting'
relationship with a new supplier or changes in the organisation's
between areas of the business:
external environment could all affect budget projections.
• Revenue centres generate income. They prepare sales budgets.
• Cost centres generate expenses. They prepare operating or
Zurich may face unanticipated changes in legal or financial
production budgets.
regulations or a change in market dynamics brought about by
• The profit budget draws together all the budgets for revenues
economic factors or the actions of competitors. An insurer needs to
and costs to meet overall financial objectives.
predict the risks its insurance policies protect against, both short-
term risks, such as floods and earthquakes and longer-term risks, An alternative approach to incremental budgeting is zero-based
such as mortality rates. Budgets also need to reflect the business’ budgeting. This means that each expenditure budget starts with a
need to invest in specific projects or long-term improvements. zero allocation each year. Managers must justify each element of the
budget they propose. This has the advantage of making managers
Budgets may also cause conflict between departments. For think proactively about what funds they need. It also avoids the
example, the allocation of additional budget to sales and marketing tendency simply to add a percentage of the previous year’s budget
could result in operational areas receiving a reduced budget. Within or assume that expenditure will remain the same. However, one
Zurich, conflict between departments is resolved with the help of major disadvantage of this approach is the increased demand on
Business Partners. These work with the different departments to staff time, which is an expensive resource with an opportunity cost.
achieve an appropriate and fair division of the budget, in line with
the business’ and senior management’s objectives. The first results against budget may show that the business is not
exactly on target. The budget then becomes a ‘dashboard’ to
Analysing budgeting data may uncover opportunities that would assess all the factors and make the necessary changes to reach
otherwise have remained hidden. Therefore budgets must be set goals. Variance analysis is used to identify differences between
using the best information available but have flexibility in order to budgeted and actual figures. This can be demonstrated using the
respond to the changing business environment. illustrative expenditure budget for UK Life.
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www.zurich.co.uk

UK Life - new business UK Lifedashboard

Expenses budget - Expense2012
budget
£m dashboard 2012 £m to end-June)
(6 months
FUNCTION YEAR TO DATE (end April) FULL YEAR OUTLOOK
Budget Actual % budget Budget Forecast % budget Trend
Sales 45 48 107 137 134 98
Propositions 28 33 118 82 100 122
Operations 73 64 88 229 212 93
Finance 20 19 95 60 55 92
IT 40 45 112 123 134 109
Control function 10 8 80 30 23 77
TOTAL 216 217 101 661 658 99

KEY A deviation may be explained by an unforeseen event; it may be

the beginning of a major adverse trend that requires a counter-
Worse than a 10% adverse variance (i.e. >110% of an
expense budget or <90% of a revenue budget) strategy. Analysing recent trends can act as an ‘early warning’
system and may indicate how the business’ performance will
Less than 10% adverse variance
evolve in the future.
Favourable variance
Improving trend Conclusion
Stable trend
Worsening trend
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
Results better than or on budget are ‘green’ and represent no
responding quickly to emerging risks and opportunities. This
immediate problem. They may be worth investigation to
allows Zurich to deliver what matters when it matters.
understand new practices or to exploit new opportunities. Results
that are only mildly outside expectations are 'amber'. These may The budgeting process is a source of competitive advantage.
need attention particularly if there is a worsening trend. Finally, Effective budgeting requires careful research and realistic planning
there are the adverse (‘red’) results. Red areas demand immediate as well as collaboration. It can help to set high objectives or move
investigation and remedial action to bring performance back to the business into new territory. The level of ‘stretch’ or challenge in
budget. All results should be investigated based on the level of a budget will depend on an organisation’s culture and ambition.
risk each deviation poses to meeting the overall business goals, Some businesses may be prepared to accept a higher risk profile
but priority should be given to red areas. for a better return. This in turn will depend on the influence of key
stakeholders, such as shareholders.
Zurich Business Partners assist managers in understanding and
explaining current performance by identifying the root causes of To ensure the company has the capability to achieve its aims,
any deviations from the budget. They also look forward – known Zurich employs graduates and finance professionals who are
as forecasting – to assess how those deviations will affect the skilled in managing and interpreting budget dashboards.
performance compared to the budget over the remainder of the
period and in the context of overall objectives.
1. Describe the main purpose of a budget. (2 marks)
Exam-style questions

2. Explain how an organisation’s profit budget can help it

meet overall financial objectives. (4 marks)
3. Using Zurich as an example, draw up a mind map to
show the internal and external factors affecting the
preparation of budgets. (6 marks)
4. To what extent is budgeting an effective tool for
business management? (8 marks)

Zurich | The benefits of budgeting