Certainly! Let’s break down your question into clear steps, with explanations and a structured answer. We’ll use a hypothetical example for clarity, as the questions are about *how* to analyze a business unit using zero-based budgeting (ZBB) and related financial metrics. --- ## 1. **What is Zero-Based Budgeting (ZBB)?** **Definition:** Zero-Based Budgeting is a method where each business unit or department starts from a "zero base" every budget period. Instead of adjusting last year's budget, every expense must be justified as if it were new. **Purpose:** - To allocate resources efficiently - To eliminate unnecessary expenses - To ensure alignment with company strategy --- ## 2. **Applying ZBB to Each Business Unit** Suppose a company has three business units (A, B, C). For each, ZBB requires: - Listing all activities and their costs from scratch - Justifying each cost/expense - Requesting capital based on actual needs, not historical spending --- ## 3. **Questions to Answer for Each Business Unit** Let’s walk through the analysis for a single business unit (the same logic applies to others). ### **a) What Capital Does It Require?** - **Capital required** is the total investment needed for operations. - Includes fixed assets (plant, equipment) - Working capital (inventory, receivables, cash buffer) - Start-up or expansion costs **Example:** Business Unit A requires: - $500,000 for equipment - $300,000 for inventory - $200,000 for receivables - $50,000 cash buffer **Total capital required:** $1,050,000 --- ### **b) What Return Does It Make?** - **Return** is typically measured as Net Operating Profit After Tax (NOPAT) or EBIT (Earnings Before Interest & Taxes). - It’s the profit the business unit generates annually. **Example:** Unit A generates annual EBIT of $210,000 --- ### **c) Cash Conversion for Working Days** - **Cash Conversion Cycle (CCC):** How long, in days, it takes to turn investments in inventory and other resources into cash flows from sales. **Formula:** CCC = Days Inventory Outstanding (DIO) + Days Sales Outstanding (DSO) – Days Payables Outstanding (DPO) **Example:** - DIO: 60 days (inventory is held for 60 days) - DSO: 30 days (customers pay in 30 days) - DPO: 40 days (company pays suppliers in 40 days) CCC = 60 + 30 – 40 = **50 days** This means cash is tied up for 50 days before it is recovered. --- ### **d) What is the Annual Return on Capital?** - **Return on Capital Employed (ROCE):** ROCE = EBIT / Capital Employed × 100% **Example:** ROCE = $210,000 / $1,050,000 × 100% = **20%** --- ## **Summary Table for Business Unit A** | Metric | Value | Explanation | |-----------------------|------------|---------------------------------------------| | Capital Required | $1,050,000 | Equipment, inventory, receivables, cash | | Annual Return (EBIT) | $210,000 | Profit generated annually | | Cash Conversion (Days)| 50 days | Time to convert investment to cash | | ROCE | 20% | Annual return on capital employed | --- ## **Step-by-Step Solution (Generalized):** 1. **List all activities and costs from scratch (ZBB)** 2. **Calculate total capital needed** (fixed + working capital) 3. **Estimate annual profit (EBIT)** 4. **Analyze cash conversion cycle** (DIO + DSO – DPO) 5. **Calculate annual return on capital** (EBIT / Capital Employed) --- ## **Final Answer (Template):** > For each business unit under zero-based budgeting: > - **Capital required** is the sum of funds needed for assets and operations, calculated from scratch. > - **Return made** is the annual EBIT or net profit generated. > - **Cash conversion for working days** is the number of days it takes to turn invested capital into cash, calculated as the cash conversion cycle. > - **Annual return on capital** is the EBIT divided by total capital employed, expressed as a percentage. **Example for Business Unit A:** - Capital required: $1,050,000 - Annual return (EBIT): $210,000 - Cash conversion: 50 days - Annual return on capital: 20% --- **Use this analysis for each unit to justify expenditures, allocate resources efficiently, and assess performance under zero-based budgeting.**