Budgeting Flashcards
What are the purposes of budgeting?
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
What are the difficulties in budgeting global companies?
Currency
Legal framework
Customer tastes and competitor actions
Where can information be sourced from for budgeting?
General economic data Public announcements Historic sales trends Market research Business unit consultation Big data – volume, variety,velocity
What is the sales budget and how is it calculated?
Sales Budget This must take into account: economic situation trends seasonal variations customer profile
Sales Budget = selling price x quantity sold
What is the production budget and how is it calculated?
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
What is the cost of sales budget and how is it calculated?
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
What are cash budgets?
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
What are the steps in preparing a budget?
Budget aims Identify the principal budget factor Prepare the sales budget Prepare all other functional budgets Consolidate master budgets Negotiation Review Acceptance
What are the alternative approaches to budgeting?
Rolling budgets Incremental budgets Zero based budgets Activity based budgets Periodic budgets
What are rolling budgets?
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
What are the advantages of a rolling budget?
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
What are the disadvantages of a rolling budget?
Preparing new budgets regularly is time-consuming
Can be difficult to communicate frequent budget changes
What are incremental budgets?
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
What are the advantages of incremental budgets?
Simple low-cost budgeting system
If business is stable the budgets may be sufficient
Some items of cost lend themselves to this approach
What are the disadvantages of incremental budgets?
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
What are zero based budgets?
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
What are the benefits of zero based budgets?
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
What are the disadvantages of zero based budgets?
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
What are activity based budgets?
A method of budgeting which uses cost driver information to analyse data
May involve preparing an activity matrix
What are the advantages of activity based budgets?
Draws attention to overhead ‘activities’
useful for monitoring and controlling overheads
Identifies controllable costs
Useful in TQM
What are the disadvantages of activity based budgets?
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?
What are periodic budgets?
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
What is the What if analysis?
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%?
