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Getting your bucks in a row.

GETTING YOUR BUCKS IN A ROW

A SECURITY PROFESSIONAL, HOW OFTEN have you heard responses like these when you asked upper management for funds for your projects? "There isn't enough money at this time." "This doesn't have a high enough priority." "Justify your request for funds." If your responses to these or similar comments didn't get the results you wanted, perhaps a different approach to the corporate budget process will help you next time.

One of the first things you should be aware of in the budgeting process is that upper management is faced with more requests for funds that they have funds to satisfy. Each requester undoubtedly feels quite justified in requesting these funds. The budgeting process is management's way to determine which projects will be funded.

This article contains some basics of budgeting and techniques for improving your chances for approval. The first section discusses types of budgets; the second section discusses information usually required to accompany budget requests; the third section covers techniques of financial justification; and the last section outlines a coordinated approach for presenting budget requests.

There are four types of budgets you are likely to encounter. They are capital improvement budgets, operating expense budgets, maintenance budgets, and emergency/contingency budgets. In the short run (within the next year), these budgets are separate and do not necessarily relate directly to each other. In the long run, they are interrelated, and one budget can affect the others.

Capital improvement budgets. These budgets are used to fund the acquisition of corporate assets, those items that will affect the firm's financial balance sheet. When put into service, these items will increase the asset side of the ledger while the means to fund them will correspondingly increase the liability side. Capital assets are expected to have economic lifetimes of more than one year. During their expected lives, the firm will depreciate them for income tax purposes so a portion of their cost will be deducted annually from taxable income.

Operating expense budgets. These budgets are used to fund the acquisition of the more or less routine expenses of the enterprise, such as labor, materials, utilities, building rental, and supplies. This is in contrast to capital improvement budget items because operating expense items are considered to be consumed with the normal conduct of business. As such, they have useful lives of less than one year.

Maintenance expense budgets. These budgets are used to fund expenditures for the routine upkeep of equipment and facilities. Many of these items occur periodically or predictably.

Emergency/contingency budgets. This budget category is used to provide funds for the unexpected. No matter how well you plan, you should expect the unexpected. There are always things that will occur outside the planning process; having a budget for them allows you to respond in a more timely fashion.

The first step before requesting funds is to convince yourself the funds are needed. To do that, you need to describe, in writing, what the project looks like. You should answer the following questions: Why should it be done? What will it accomplish? What will be the result if it is not done? Given the nature of the company's business, does it make sense from the company's perspective to do this project? If so, read on.

You usually need to present several types of information to management as part of your budget requests. The purpose is to define your project itself and list time requirements or constraints, financial aspects, and justifications.

Identify the budget category under which your project will fall. This often affects the way you present the information. Next, make a spreadsheet of the basic information you must present to management. Identify any alternative approaches that may be used to accomplish your objective. Estimate a cost for each, and identify the pros and cons of each method. This information should include time, costs, constraints, and penalties for not doing it. Are there any areas where savings will be realized directly as a result of doing the project?

The foundation of your budget request should be the explanation of how the funds will be used. What do you expect to accomplisy? You should describe the present physical, operational, and environmental conditions and costs. Then state how these will be changed as a result of your project. Discuss the specific problem you want to correct or the situation you wish to improve.

Next, state the time aspects of your project. How long will it take to implement it? How soon will the benefits begin to be realized? Will all the funds need to be committed at once, or will more than one budget period be involved? Are there times during which the project will be more meaningful and outside of which the project loses some or all of its usefulness?

Management will always want to know how much your project will cost. You will need to provide them with some idea of how much funding you will require to put the plan into action. The better your information in this area, the better off you will be. If you underestimate your project costs, management may authorize the project but regret the decision later and hold you responsible for wasting corporate funds. On the other hand, if you overestimate your project costs, management may end up rejecting a worthwhile project as being too expensive for the promised benefits.

Your job will be easier if the compelling justification is to stay in compliance with the law or to meet safety codes. The only question might be in complying in the least costly manner. Most often you will not have either of these justifications to use, and you will have to persuade management to fund your project for financial reasons.

THE NEXT SECTION OF THIS ARTICLE presents several concepts from the financial world to help justify your project to management. In presenting arguments to financial decision makers, you will be better able to gain their attention and confidence if you show them you understand their needs and speak their language.

Each community of experts develops its own jargon to enhance communications among its practitioners. Security professionals use terms such as vulnerability, audit trail, access control, and antipassback to stand for some rather specific and complicated concepts. In just a few words, you are able to convey a lot of information to others who understand the definitions of such terms.

The financial community has its own language. While it is not the purpose of this article to make you conversant with the more esoteric aspects of financial jargon, you will be more successful knowing a few of the basic terms and concepts that apply to your budget requests. Four terms will help a great deal -- if you are able to use them appropriately -- in justifying project budget requests: simple payback, cost-benefit ratio, present worth, and rate of return. These are methods for making economic comparisons between alternatives.

Simple payback. This method is the easiest to apply and provides a quick way to decide the merits of a project. The payback period is the result of dividing the total project cost by the expected annual savings. The equation is payback period (years) = total project cost/annual savings

For example, a proposed access control and closed-circuit television (CCTV) system is expected to eliminate one 24-hour-per-day guard post. The system is estimated to cost $250,000, and the annual guard costs are $100,000 per post. Assuming no annual maintenance (for simplicity), the computation is as follows: payback period (years) = $250,000/$100,000/year = 2.5 years

The accuracy of the simply payback method worsens as time periods become longer because the method does not take into account either the time value of money or the service life of the project.

Cost-benefit ratio. Another approach to evaluating possible investments is to compute the ratio of costs to benefits. When the ratio is less than 1.0, the project has favorable economics. The lower the ratio, the more attractive the investment will appear to be. Naturally, when the ratio is greater than 1.0, the project will not be very attractive. The equation is cost-benefit ratio = costs/benefits

You can see how this works by continuing to use the previous example. You need to know the useful life of the equipment to calculate the benefits. Assume a 10-year service life for the proposed access control and CCTV system. cost-benefit ratio = $250,000/10 years X $100,000/year = 1/4 = 0.25 or a 0.25:1 ratio

Present worth. Present worth analysis is a financial process that permits a more accurate economic evaluation of candidate projects than the simple payback and cost-benefit ratio methods. Present worth analysis considers the effect of time with respect to investment potential and equipment life.

The capital cost of a project constructed today can be thought of as being paid for in today's dollars. Those dollars have an alternative investment potential that is foregone when they are committed to the project. The interest rate at which the funds could be invested reflects a concept called the time value of money.

The time value of money should be taken into account whenever leaving it out could distort the data being used for budget justifications. When the time periods are relatively short and interest rates are relatively low, the distortions caused by ignoring the time value of money will usually be minor. However, long time periods and high interest rates introduce significant financial effects, and ignoring the time value of money can result in comparing apples to oranges.

A multiplier called the present worth factor is used to relate future money flows to todayhs expenditures. The period of time over which this is done is usually the useful life of the equipment or facility being considered. In this way, the time value of money is brought into consideration when comparing projects having different equipment life expectancies and occurrences of costs.

When there is only one future amount to be considered, the formula to calculate the present worth factor is present worth factor = 1/(1 + 1).sup.n where i = interest rate (time value of money expressed as a decimal n = number of interest earning periods (years)

When there are multiple future dollar amounts that are uniform in size and occur at regular periodic intervals, you could make numerous calculations using the previous formula. However, there is a better way. It involves making only one calculation using a formula that is only a little more complicated. This second formula is present worth factor = (1 + 1).sup.n - 1/i(1 + 1).sup.n

Fortunately, a manager really does not need to worry about making calculations using these formulas because there are numerous published tables that list the present worth factors for a wide range of interest rates and terms of years. For example, Volume IV of the Protection of Assets Manual (POA) provides this information in Figures 35-10 (single amounts) and 35-11 (equal annual amounts).

An example of pertinent single amounts data from figure 35-10 of the POA Manual is

Similarly, an example of equal annual amounts data from Figure 35-11 of the POA Manual is

Continuing with the access control and CCTV system example, find the present worth of the 10-year series of equal annual amounts of $100,000/year savings using an interest rate of 10 percent (0.10). The approach is as follows.

First find the present worth factor for 10 years of savings when the interest rate is 10 percent. present worth factor = (1 + 0.10).sup.10 - 1/0.10(1 + 0.10).sup.10 present worth factor = 2.5937 - 1/0.10(2.5937) = 6.145

Using the POA Manual, the same factor can be seen in Figure 35-11 on page 35-50 in the row labeled "10 years" under the column labeled "10 percent." Therefore, the present worth of 10 years of saving $100,000 per year in guard costs will be present worth = 6.145 X $100,000 = $614,500

Taking into account the initial $250,000 investment in the access control and CCTV system, the present worth of the net overall savings would be present worth of future guard cost savings $614,500 present worth of access control and CCTV system investment (250,000) present worth of the net savings $364,500

Note that the present worth of the access control and CCTV system reflects a present worth facto of 1.0. That is because the $250,000 is considered to be an expenditure that would occur in the present and no discounting is involved.

On the other hand, consider what would happen if the security system of this example would require an investment of not $250,000 but $700,000. There would be no net savings. Instead, there would be a net loss of $85,500. present worth of future guard cost savings $614,500 present worth of access control and CCTV system investment (700,000) present worth of the net loss -$85,500

This illustrates a useful aspect of present worth analysis, one that helps you avoid giving too much credit to future savings. It would have been tempting to compare the original investment of $700,000 to a total savings of $1,000,000 ($100,000 per year for 10 years) for an apparent savings of $300,000. The fallacy, of course, would be that such an analysis ignores the time value of money.

Rate of return. Another financial approach you could use to evaluate the attractiveness of a proposed security systems investment is to consider the expected future savings benefits in view of the initial investment needed to obtain those benefits. This approach is to determine the rate of return that reflects the annual savings resulting from the investment. It is called rate-of-return analysis.

Rate-of-return analysis uses the same formulas and tables that are used for present worth analysis. However, unlike the three previous techniques with which you can calculate an answer directly, rate-of-return analysis usually requires that you use a trial-and-error approach to find the answer. This is because the interest rate for which you watt to solve is usually not exactly one of the values printed in the tables.

To perform a rate-of-return analysis, begin by using one of the present worth factor tables described previously. The pertinent data from Figure 35-11 of the POA Manual appear as follows:

Look in the row corresponding to the number of years associated with the project. In this example, use the data in the row for a 10-year project life.

Next, read across that row u ntil you find the exact present worth factor that equals the ratio of the investment required for the security system to the amount of the future annual guard cost savings. In this example, the value of the ratio is 2.500. target present worth factor = $250,000/$100,000/year = 2.500

If that exact present worth factor is not listed on that row of the table, find the two factors that bracket the factor and then interpolate between them. Use straight-line interpolation between the bracketing factors to find the appropriate interest rate value.

Finally, look at the top of the table to find the interest rate that corresponds to the present worth factor you located on the year's row corresponding to the project's assumed life. That interest rate is the rate of return associated with your proposed budget item.

Again, consider the example of a proposed investment in an access control and CCTV system. The goal is to find the 10-year interest rate that represents the present worth factor that multiplied by the $100,000 annual savings equals the $250,000 investment.

Since 2.500 is not an exact factor shown on this line of the table, interpolate between 2.715 and 2.414 to find the appropriate value for the rate of return this project would generate. i = 0.35 + 2.715 - 2.500/2.715 - 2.414 X (0.40 - 0.35) i = 0.35 + 0.215/0.301 X (0.05) = 0.38 (or 38%)

Thus, the rate of return associated with the proposed project would be 38 percent based on the data given. In the case of an actual project you would want to include additional cost and savings items such as operating and maintenance costs and tax savings based on depreciation. Doing so would probably increase the accuracy of the analysis, but the simplified example considered here presents the basic approach to rate-of-return analysis.

WHEN YOU COMPETE FOR CORPORATE dollars in the budgeting process, it is advisable to play the game using the best tools possible. You will be most successful if you present your project's financial information using the language and techniques of the financial community.

It is your responsibility to put the best face possible on the projects you proposed to management for funding. When it comes to projects that depend on financial justification, it will make sense to present your data in financial terms. That is because the decision makers will usually be judging your project against others using financial criteria. The advantages of doing your project may not be intuitively obvious to someone outside of your work area.

You should select one or more of the financial justification tools described in this article to make your presentation. Which one, or ones, will depend on the nature of the project, the type of data available, and the manner in which your management prefers that you present requests.

If all the budget requests for your company are presented in terms of simple payback, then make sure you give that number. Sometimes it will make sense to present all four -- especially if you are not sure how the requests are compared. The easier you make it for the decision makers to make a favorable decision on your project, the greater the potential your project will be approved.

Continuing the example used throughout this article, the project can be represented in the following ways:

* simple payback period = 2.5 years

* cost-benefit ratio = 1 cost to every 4 benefits

* present worth analysis = $365,500 (In present-worth dollars, the savings realized by doing the project over not doing it.)

* rate of return = 38% (the return on your investment in the access control and CCTV system is equivalent to getting 38 percent interest over the 10 years.)

In this particular example, the figures for the rate of return seem to speak most loudly. An axiom from the world of advertising applies to your budget requests as well: The sizzle sells the steak!
COPYRIGHT 1989 American Society for Industrial Security
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1989 Gale, Cengage Learning. All rights reserved.

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Title Annotation:presenting budget requests
Author:Persson, Erland A.; Chandler, Lorna L.
Publication:Security Management
Date:May 1, 1989
Words:3099
Previous Article:Essential expert expectations.
Next Article:Budgetspeak.
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