Budgeting

Question 1

What are the purposes of budgeting?

Answer 1

Planning
Management use budgets to:
ensure that plans are consistent with company objectives
quantify the amount of resources needed

Communication
A budget is a formal written document that can be communicated to everyone

Co-ordination
A budget provides the means of co-ordinating the efforts of everyone within the organisation

Motivation
Setting challenging targets and offering reward for achieving them may motivate individuals

Authorisation
When a budget is agreed the managers should be authorised to spend the money and obtain the resources permitted by the budget

Control
Budgeted spending limits provide a control over excess spending.
Feedback can be provided that compares actual results with the budget. Any variances are then investigated

Evaluation
Budgets may be used to measure and evaluate performance by comparing actual results and budget targets

Question 2

What are the difficulties in budgeting global companies?

Answer 2

Currency
Legal framework
Customer tastes and competitor actions

Question 3

Where can information be sourced from for budgeting?

Answer 3

General economic data
Public announcements
Historic sales trends
Market research
Business unit consultation
Big data – volume, variety,velocity

Question 4

What is the sales budget and how is it calculated?

Answer 4

Sales Budget
This must take into account:
economic situation
trends
seasonal variations
customer profile

Sales Budget = selling price x quantity sold

Question 5

What is the production budget and how is it calculated?

Answer 5

Production budget
This calculates how many units of finished goods need to be produced to achieve the budgeted sales.

No of units to be sold			 x
No of units of closing stock     		 x
No of units of opening stock   		(x)
No of units to produce             		 x

Question 6

What is the cost of sales budget and how is it calculated?

Answer 6

Cost of Sales budget
Once the production budget has been prepared then need to prepare mini budgets for the following:

i)Raw materials usage
No of units x amount of raw material needed per unit x
Closing stock of raw materials x
Opening stock of raw materials (x)
Amount of material usage x

ii)Raw material purchase
Amount of material usage x price per unit of raw material

iii)Direct labour hours 
Calculate the number of hours needed to produce the number of units required.
=no of hours per unit x no of units

iv)Direct labour cost
Total hours x rate per hour

v) Machine utilisation
Calculate the number of machine hours needed to produce the number of units required
= no of machine hours x no of units

vi)Overheads
Calculate the level of overheads as appropriate.

vii)Closing stock of raw materials
= no of units x cost per unit

viii)Closing stock of finished goods
= no of units x standard cost per unit

Question 7

What are cash budgets?

Answer 7

Show cash effect of all decisions made in planning process
Can forewarn of potential cash problems - both level of cash and length of time that level will last
Potential problem areas:
Short term deficit
Long term deficit
Short term surplus
Long term surplus

Question 8

What are the steps in preparing a budget?

Answer 8

Budget aims 
Identify the principal budget factor 
Prepare the sales budget 
Prepare all other functional budgets 
Consolidate master budgets
Negotiation  
Review 
Acceptance

Question 9

What are the alternative approaches to budgeting?

Answer 9

Rolling budgets
Incremental budgets
Zero based budgets
Activity based budgets
Periodic budgets

Question 10

What are rolling budgets?

Answer 10

A budget kept continuously up to date by adding another accounting period (e.g. month or quarter) when the earliest accounting period has expired
Useful for keeping tight control
Always have an accurate budget for the next 12 months

Question 11

What are the advantages of a rolling budget?

Answer 11

Reduce uncertainty in budgeting
Can be used for cash management
Force management to look ahead continuously
In times of change comparing actual results with budget will be more meaningful

Question 12

What are the disadvantages of a rolling budget?

Answer 12

Preparing new budgets regularly is time-consuming

Can be difficult to communicate frequent budget changes

Question 13

What are incremental budgets?

Answer 13

This is the most common method of budgeting
It involves adjusting the figures for the last period to reflect the anticipated figures for next period
Start with either the previous period’s budget or actual results and add (or subtract) an incremental amount to cover inflation and other known changes

Question 14

What are the advantages of incremental budgets?

Answer 14

Simple low-cost budgeting system
If business is stable the budgets may be sufficient
Some items of cost lend themselves to this approach

Question 15

What are the disadvantages of incremental budgets?

Answer 15

Assumes all current activities will be maintained at existing level of performance
Backward looking
Deskbound planning process
Performance targets often unchallenging
Not a planning system for cutting out waste and overspending

Question 16

What are zero based budgets?

Answer 16

This involves starting the preparation of the budget from zero each time
Every element of cost and benefit has to be justified as if it were the first time of preparing a budget
The principal behind this technique is to prepare for current future needs, rather than reflect past actions
ZBB is normally found in service industries where costs are more likely to be discretionary

Question 17

What are the benefits of zero based budgets?

Answer 17

Creates an environment where change is accepted
Helps to focus on company objectives and goals
Focuses on the future and not the past
Helps to identify inefficient operations and wasteful spending
Provides framework for optimum utilisation of resources. Useful when some costs are discretionary
Establishes a measure of performance for each decision package
Involves managers in the budgeting process

Question 18

What are the disadvantages of zero based budgets?

Answer 18

Time-consuming exercise
Temptation to concentrate on short-term cost savings at expense of longer-term benefits
Requires skill and expertise which management may not have
Ranking process is difficult especially when qualitative issues are present

Question 19

What are activity based budgets?

Answer 19

A method of budgeting which uses cost driver information to analyse data
May involve preparing an activity matrix

Question 20

What are the advantages of activity based budgets?

Answer 20

Draws attention to overhead ‘activities’
useful for monitoring and controlling overheads
Identifies controllable costs
Useful in TQM

Question 21

What are the disadvantages of activity based budgets?

Answer 21

Time and effort to establish the ABB system
ABB not always appropriate for organisation
Difficulty in identifying responsibility for activities
Are overhead costs controllable in short term?

Question 22

What are periodic budgets?

Answer 22

Budget prepared for typically one year at a time
No alterations once the budget has been set
Suitable for stable businesses where forecasting is easy and where tight control is not necessary

Question 23

What is the What if analysis?

Answer 23

Also known as sensitivity analysis

Looks at what the budgeted results would be if certain assumptions or values in the budget were different
What would be the impact on profit:
If sales volume were 10% higher?
If selling price was £5 lower?
If labour efficiency increased by 10%?