Budgeting Flashcards
What is a budget?
A written plan that quantifies the transactions for the upcoming period. It is important for:
-planning
-coordinating
-motivating & evaluating employees
Additionally it is important for for decision making and decision control functions
Why is a budget important for company XYZ?
-Coordinate actions among departments
-Planned actions help to achieve overall organizational goal
-Decision rights for employees
-Investment centres get access to capital decisions
-Employees might be held responsible against the defined budgets
What are the advantages of a bottom-up approach?
-Local agents have better information over the real local circumstances
-Quicker decision making process which is often required when it comes to crucial decisions
-Depends on information asymmetry between top management and division
What are the drawbacks of a bottom-up approach?
-Division managers might use these crucial information to their own benefit and give biased information to top management
How do you evaluate whether to take a top-down or bottom-up approach?
-Basically based on information assymetry
-Stable environment more likely to use top-down approach
-Rapidly changing environment more appropriate to use bottom-up approach
What is budgetary slack?
The difference between what is actually possible and what is set as a target (sandbagging)
What are the consequences of budgetary slack?
It can harm the planning of an organization and hereby lead to high cost due to planning failures
What is resource allocation?
As soon as managers want to compete for scarce resources, managers do not want to misrepresent their productivity as they want to make sure that they get enough resources to operate their division
What is low horizontal information asymmetry?
Peers can observe the performance or behaviour of an individual agent, which creates pressure amongst each other that should reduce the tendency for building budgetary slack
What’s the impact of resource allocation and horizontal information asymmetry on small companies?
Resource allocation should be of lower importance, since it is not common for a small company to have scarce resources. Big companies with multiple product lines would be more likely to face that issue
Social comparison on the other hand is an issue that often exists especially in small countries.
How do you calculate ROA?
Net Operating Profit After Tax (NOPAT) / Total Assets
How do you calculate RI?
Net Operating Profit After Tax (NOPAT) - WACC x Total Assets
How do ROA and RI affect investments when implemented?
When moving to ROA and RI, investment are likely to decrease, because the benchmark of choosing investments moves from the cost of debt (net income) to the current/previous ROA (WACC) and the latter is higher than the former
