6: Budgeting Flashcards
What is budgeting?
A quantitative expression of a plan of action, in advance of the period to which it relates
A financial plan!
Gives an idea of the costs and revenue that are expected to be incurred or earned
What types of budgets are there?
Departmental budgets
Functional budgets
Profit or loss account
Cash budgets
Master budget
What are the 8 purposes of budgeting?
Planning for the future
Controlling costs
Co-ordination
Communication
Motivation
Evaluation
Authorisation
Resource allocation
What is a budget committee?
Responsible for communicating policy guidelines to those who prepare budgets, and for setting/approving budgets
Normally made up of CEO, budget officer, departmental heads
What is a budget manual?
Sets out instructions relating to the preparation and use of budgets
Details of the responsibilities if those involved in the budgeting process, including an organisation chart, list of budget holders
What is the principal budget factor?
The factor that will limit the activity of an organisation in a given period
The budget for that factor must be produced first
Four final steps in budget preparation?
Initial budgets are prepared - budget slack is built in
Initial budgets are reviewed - integrated into the complete budget system
Master budget is prepared - shown to top management for final approval
Comparison between budgets and actual results - variances
What are the steps in budget preparation?
Sales (or Principal Budget Factor!)
Production Budget
- Raw materials
- Labour
- Factory overhead
CoS budget
Selling and dist expenses budget
General and admin budget
Master budget
- P&L
- Cash
- Balance sheet
- capital expenditure budget
How to calculate the sales budget?
Sales volume x selling price
What is the calculation for production budget?
Sales budget
Closing Inventory
(Opening Inventory)
—————————
Good production
Faulty production
—————————
Total production
How to calculate the material usage budget?
Production budget in kg (closing inventory) x standard material usage per unit
How to calculate material purchases budget?
Usage budget
Closing Inventory
(Opening Inventory)
————————
@ Standard cost of materials
————————
Budgeted materials cost
How to determine labour budget?
Total labour hours x labour rate per hour
Answer should be in £
What is the master budget?
The budget into which all subsidiary budgets are consolidated
Profit or loss
Balance sheet
Cash flow
What are the elements of a budgeted balance sheet?
Non-current assets
Current assets
Current liabilities
Net current assets
Net assets
Owner’s capital
What is sensitivity analysis?
Identifiy which budget assumptions have the greatest impact on the budget
And which need to be considered most carefully
What is a cost equation, how is it used, and what one is used most?
Derived from historical cost data
Once a cost equation has been established, can be used to estimate future costs
Same formula as linear functions:
y = a + bx
Break down the equation of a straight line?
Y = a + bx
A - fixed cost per period (intercept)
B - variable cost per unit (gradient)
X - activity level (independent variable)
Y - cost, total and fixed (dependent variable)
What are the two ways of analysing semi-variable costs into their fixed and variable elements?
High-low method
Linear regression
The four steps of calculating the high low method?
- Determine the highest and lowest activity levels and their associated costs
- Find the variable cost per unit
Increase in cost / increase in activity
- Find the fixed cost
One semi-variable cost - (variable cost PU x activity level)
- Calculate any expected costs
Fixed costs + (variable costs PU x activity level)
Disadvantage of the high-low method?
Only takes into account two sets of data, which is not wholly representative
What is linear regression, and what are the ads and dis?
Uses mathematical equations
Superior to high low method because it takes all data sets into account
Ads:
- all data points taken into account
Dis:
- assumes that historical behaviour of data goes into foreseeable future
- predictions only reliable it there is significant correlation
What is correlation, and how is it measured?
Strength of a connection between two variables
Two variables are correlated if a change in one variable brings about a change in another
Measured by drawing a scatter graph and drawing a line of best fit
What are the three outcomes of degrees of correlation?
Perfect - all values would lie on a straight line. Linear relationship
Partial - no exact linear relationship, but variables tend to be associated with other
Uncorrelated - no correlation
Difference between positive and negative correlation?
Positive
- high values with one variable are associated with high variable of the other
- or vice versa
Negative
- high values of one variable associated with low values of other
What is the correlation coefficient?
Alternative to drawing graph to determine if two variables are correlated
Strength of a linear relationship between two variables
-1 perfect negative
0 no correlation
1 perfect positive
What is the coefficient of determination?
Square of correlation coeffecient
How much of the variation in the DEPENDENT variable is ‘explained’ or linked by variation in the independent variable
Closer to 1, stronger the correlation is
Remaining amount in random fluctuations
Two limitations of correlation?
Correlations could be misleading on sample data
- sampling error
- why correlation must be accompanied by a significance test to assess its reliability
Correlation and casualty are not the same thing
- correlation does not imply that one variable causes the other
What is a time series analysis?
Uses moving averages to create a trend line over time
When adjusted for seasonal variations can be used to make predictions for the future
What three kinds of variations needs to be considered in a Time Series Analysis?
Cyclical variations - economic cycles of booms and slumps
Season variation - regular variations around the trend over a fixed time period, usually a year
Residual variations - irregular, random fluctuations
What are three ways to calculate the trend for a time variance analysis?
High low
Linear regression
Moving averages
Trend can be extrapolated once its been found!
How to calculate moving averages?
Used to smooth out the variations
- Choose a correct cycle length
- Calculate the total for the first cycle
- Calculate the average by dividing the total by the no. of periods in the cycle
- Repeat for the next cycle, and so on
How are seasonal variations calculated?
How much the data varies from the trend line
Seasonal variance is the difference between the trend line value and the actual historical value
Trend can be extrapolated and variations can be applied
What are the two methods for calculating seasonal variations?
Additive model:
Trend line value + seasonal variation
Absolute number
Multiplicative model:
Trend line value / seasonal variation x 100
Percentage change
Three limitations of time series analysis?
Assumption that what happening in the past is a reasonable guide to the future
Assumption straight line trend exists
Assumption that seasonable variations are constant
What are the two types of budget in terms of participative?
Top down budget
- set without the budget holder being allowed to participative
- imposed budget, or non-participative
Bottom up budget
- budget holders have the opportunity to participate
- participative budgeting
Advantages of participative budgets?
Increased motivation
Contains better information
Increases managers understanding and committment
Better communication
Senior managers can concentrate on strategy
Disadvantages of participative budgets?
Senior managers resent loss of control
Bad decisions from inexperienced managers
Budgets not in line with objectives
Preparation is slower an disputes can arise
Figures may be subject to bias as they add budget slack
Create create environments that preclude participation
3 extra budget types?
Continuous/rolling budget
- prepared a year ahead and updated regularly by adding a further accounting period
- will always reflect the budget a year in advance
Incremental budget
- uses the previous period’s budget as a starting point, then adds ‘increments’ as it sees necessary
Zero-based budget
- starts the budgeting process from zero because it takes nothing for granted
What is beyond budgeting?
Idea that companies need to move beyond budgeting because of inherent flaws in budgeting
- used in orgs that face enviro changes
- greater use of rolling budgets and non-financial targets
- targets are based on externally-observed benchmarks
- innovation is encouraged and rewarded
- budgets is set locally
- inspire workers though bold and noble causes
