Budgeting 1 (LECTURE 7) Flashcards
BUDGETING
The implementation of the long-term plan for the year ahead through the development of detailed financial plans.
A budget is a financial plan covering the whole enterprise over a specific period of time and accounts for all the enterprise’s resources. It aims to allocate those resources in the most beneficial manner.
BUDGET
A financial plan for implementing management decisions.
CASH BUDGET
A budget that aims to ensure that sufficient cash is available at all times to meet the level of operations that are outlines in all other budgets.
Objective is to identify potential cash shortfalls and also large cash surpluses. Then do something.
Needs frequent reviews, wise to do it on a weekly basis for about 6-8 week time horizons. Use some element of SENSITIVITY ANALYSIS.
Revise frequently.
CONTINUOUS BUDGETING / ROLLING BUDGET
An approach to budgeting in which the annual budget is broken down into months for the first three months and into quarters for the rest of the year, with a new quarter being added as each quarter ends.
CONTROL PROCESS
The process of comparing actual and planned outcomes, and responding to any deviations from the plan.
CORPORATE OBJECTIVES
Specific, measurable statements, often expressed in financial terms, of what the organisation as a whole wishes to achieve.
DISCRETIONARY COSTS
Costs such as advertising and research where management has some discretion as to the amount it will budget.
FEEDBACK LOOPS
Parts of a control system that allow for review and corrective action to ensure that actual outcomes conform with planned outcomes.
INCREMENTAL BUDGETING
An approach to budgeting in which existing operations and the current budgeted allowance for existing activities are taken as the starting point for preparing the next annual budget and are then adjusted for anticipated changes.
LONG-TERM PLAN / STRATEGIC PLAN
A top-level plan that sets out the objectives that an organisation’s future activities will be directed towards.
MANAGEMENT BY EXCEPTION
A system in which a manager’s attention and effort can be concentrated on significant deviations from the expected results.
MASTER BUDGET
A document that brings together and summarises all lower level budgets and which consists of a budgeted profit and loss account, a balance sheet and cash flow statement.
MISSION
A statement that provides in very general terms of what the organisation does to achieve its vision, its broad purpose and reason its existence, the nature of the business(es) it is in and the customers it seeks to serve and satisfy.
UNIT OBJECTIVES
Specific, measurable statements, often expressed in financial terms, of what individual units within an organisation wish to achieve.
STRATEGY
The courses of action that must be taken to achieve an organisation’s overall objectives.
VISION STATEMENT
A statement that clarifies the beliefs and governing principles of an organisation, what it wants to be in the future or how it wants the world in which it operates to be.
ZERO-BASED BUDGETING
An approach to budgeting in which projected expenditure for existing activities starts from base zero rather than last year’s budget, forcing managers to justify all budget expenditure.
Good at cutting excess costs.
Encourages questioning attitude.
Seen in public and private sector.
Expensive and time consuming.
Requires a high level of negotiating skills.
TOP DOWN BUDGET
Dictatorial style; common in the smaller business; discourages initiative, and depends on the top manager’s skill.
BOTTOM UP BUDGET
Recommended - allows initiative and responsibility to be shared. Facilitates participatory attitude.
Why produce budgets?
- Planning
- Co-ordination
- Communication
- Motivation
- Control
- Evaluation
- Delegation
- Authorisation
CO-ORDINATION
In a large, divisionalised, departmentalised organisation, it is essential to co-ordinate activities for the benefit of the organisation as a whole.
There needs to be a system for ensuring everyone sticks to the aim of the firm.
Budgets demand discussion between departments to work in the firm’s best interests.
COMMUNICATION
Takes place in several ways.
Top management uses the budget to communicate its strategic objectives for the budget period.
At more junior levels, individual managers will clearly have to interface with more senior managers to negotiate and agree budget targets and allocations.
A wider aspect of communication is that the budget is often the only time in which individual departmental managers talk to other managers outside their own department.
MOTIVATION
A good budget should motivate staff to perform well.
People perform better if they have a target to aim at. The target must be ATTAINABLE.
Risk of complacency or despondency.
The benefit of a target is increased where people have a say in the setting of targets.
A good way of improving motivation is to let somebody set their own target (within limits). This will be reviewed by an individual’s line manager to ensure it is in keeping within the firm’s overall objectives and that it is sufficiently challenging.
CONTROL
The budget is an integral part of a business’ control system.
Managers can use the budget to trace what belongs to an organisation and the use to which it is put.
Budgets allow management by exception.
EVALUATION
Establishing a target allows us to compare actual performance with the budget.
A manger’s performance can then be evaluated according to how well they did compared to the budget.
If the managers prove themselves competent at handling a junior role, they may be rewarded with promotion.
THE BUDGET COMMITTEE
Most businesses appoint one.
They oversee the budget planning process and ratify individual functional budgets, e.g. production function, sales function, marketing function, etc.
Appoint a budget officer; normally senior accounting personnel.
ACCOUNTING STAFF
Essentially a technical, advisory and supporting role. They DO NOT prepare the budget.
BUDGET MANUAL
Internal document, prepared by budget officer, incorporates key objectives, procedures, personnel, timetables, etc.
Classical approach to budgeting.
1) Communication (typically via the budget manual).
2) Identification of the key limiting factor.
3) Preparation of the INITIAL budget.
4) Initial preparation of functional budgets.
5) Negotiation of budgets.
6) Co-ordination and review of budgets.
7) Final acceptance.
8) Ongoing review of budget in place.
THE KEY LIMITING FACTOR / BUDGET FACTOR
The single issue which is going to be most responsible for limiting the activity of the firm.
In most sales profit-seeking businesses this will be SALES.
But could be materials, or labour, or machine capacity, or government quota.
THE FIRST BUDGET
The key factor budget is prepared first.
Sales is the most commonplace.
Difficulty due to external variables such as customer demand, competitor activity and general economic conditions.
Should originate at the most junior level of management.
Details of preparation method in budget manual.
Incremental approaches are common.
What is the general structure of the budget?
Sales Budget Production Budget Materials Usage Budget Materials Purchase Budget Labour Budget
NEGOTIATION
Review of the budget should reduce the risk of BUDGET SLACK.
A balance should be taken; arrogance on the part of senior management may be repaid with poorer performance and ultimately high job turnover, which simply benefits competitors.
A participative approach does not mean that junior managers get what they want.
targets must be challenging but realistic.
CO-ORDINATION AND REVIEW
The budget officer should keep a careful watch that budgets are co-ordinated with each other to avoid wastage and delay.
As budgets progress up the functional ladder, less attention is paid to small details. Top managers are more interested in global totals.
FINAL ACCEPTANCE
The MASTER BUDGET is the ultimate output. For board level ratification.
Budgeted Statement of Comprehensive Income, budgeted Statement of Financial Position, budgeted Statement of Cash Flows.
Cash budget also incorporated with this.
Global totals; different informational needs - top directors concerned with strategy.
ONGOING REVIEW
Comparisons between the budget and the actual are made and sent to individual managers, who are asked to comment on the differences.
It may be necessary to FLEX the budget to reflect actual level of output.
Describe the process of cash budgeting.
-Flows should be divided by inflows and outflows, and split into components. Components may be split down into smaller categories.
Forecasts often have items in them with different levels of certainty. There will be certain flows, those that are forecastable to some extent and those that are less predictable.
The cash manager will need to identify sources of information for the forecast. These may include:
- Last years actual cash flows
- Sale projections
- Purchase projections
- Accounts payable and receivable data
- Investment plans including acquisition
How can cash deficits sometimes be resolved?
By altering the timing of payments and receipts.
- Bringing receipts forward
- Delaying payments
Headings for cash budget. (example)
Month Cash Sales Credit Sales Share Issue TOTAL INFLOW
Payments to suppliers Wages Other Expenses Tax Fixed Asset Purchase Loan Repayment Overdraft Interest TOTAL OUTFLOW NET CASH FLOW Balance at start of month Balance at end of month
Cash vs. profit
Both are vital but their importance varies according to the time scale.
There is not much point raising cash unless it is going to be used to generate profit.
OBSOLESCENCE
A key issue in budgeting for 12 months.
Leads to a lack of respect for the budget, even to completely ignoring it.
Can be obviated by the continuous/rolling budget.
Procedure of zero-based budgeting.
1) Define decision packages.
2) Evaluate and rank all alternative packages.
3) Implement the chosen package- any funds remaining can then be devoted to alternative programmes.
Advantage of incremental budgets.
Still useful where the environment is stable.
Cheaper, due to speed and simplicity.
Information already available.
Easy to understand by non-financial managers.
Disadvantage of incremental budgets.
Builds on wasteful wasteful practices of prior years.
Encourages spending up to the budget limit (poor behaviour).
Ignores cost drivers.
Unsuitable in dynamic environments.
Encourages budget slack.
BUDGETARY SLACK
Is the deliberate under-estimation of budgeted revenue or over-estimation of budgeted expenses.
Standard solutions include; staff rotation, ZBB, higher targets, non financial performance measures.
HUMAN BEHAVIOUR
Weakest link in the budget process.
PASSING BUDGET ALLOCATIONS
Refers to a situation where a manager tries to pass on costs from their department onto other departments.
Objective is to keep costs down in their department.
difficult to cure, but justifies the existence of clear lines of demarcation.
BUDGET CONSTRAINED STYLE
Refers to a situation where little or nothing gets done unless it’s in the budget.
So it can lead to ignoring other, essential aspects of business, such as delivery times, quality, innovation etc.
What variances should managers be accountable for?
OPERATIONAL VARIANCES
FLEXIBLE BUDGETING
Incorporate a range of budget totals, based on differing levels of activity.
Cash Budget Format
Month INCOME Sales Grant (e.g.) Investment proceeds (e.g.)
EXPENDITURE Materials Labour Fixed Overheads Machinery
Opening Balance
Balance for Month
Closing Balance
Flexible Budget Format
Activity Level
Labour Hours
Production
Sales income Labour Materials Supervisor Salaries Fixed Overhead Total Expenditure Profit
Functional Budget Format
SALES BUDGET (volume and value)
Sales Volume
Sales Price (£)
Sales Value
PRODUCTION BUDGET (volume) Sales Requirement Closing Inventory Finished Goods Requirement Less; Opening Inventory Production Requirement
RAW MATERIALS BUDGET Production Requirement Raw materials needed Raw materials price/kg Raw materials expense (£)
LABOUR BUDGET
Production requirement
Labour hours x labour rate
Labour cost (£)