Budgeting Flashcards
What is budgeting?
A budget is a quantitative expression of a plan of action prepared in advance of the period it relates to. They st out the costs and revenues that ae expected to be incurred or earned in future periods.
What are the purposes of budgets?
1) Planning
2) Control- when actual results are compared against the budget and action is taken.
3) Coordination- Coordinating parts of the business towards a common goal.
4) Delegation- extra responsibility to managers who may be involved in coordinating the budget making it more realistic.
5) Communication- formal communication channel between junior and senior managers.’
6) Authorisation- authorises certain expenditures for managers.
7) Evaluation- used to evaluate the actions of a manager within the business in terms of cost and revenues.
What is the principal budget factor?
This is the limiting factor that caps the budget. In business terms, this is typically sales.
What are the steps in preparing a budget?
1) Sales forecast budget
2) Production budget
3) Materials usage which leads to material purchases.
4) Overhead budget
5) Labour utilisation budget which leads to labour cost budget.
What is a cash budget?
This is a detailed forecast of when an organisation expects to receive and pay out cash. It ensures that there is sufficient cash available to meet the level of operations planned.
Cash budget considerations
1) Other expenses
2) Capital expenditure
3) Drawings
What to ignore in cash budgets?
1) Accruals
2) Prepayments
3) Depreciation
What should organisations do when they have a cash shortfall?
1) Apply for a bank loan or overdraft
2) Seek credit from suppliers
3) Cut back on staff
4) Reduce withdrawals
5) Allow customers less or no credit
It all depends on whether it is short-term or long-term.
What are settlement discounts?
An incentive for early payment e.g. if they pay earlier they pay less.
What to do when there is a cash surplus?
1) Deposit the money in the bank
2) Invest the money
3) Lend the money while charging interest
Issues with offering credit
Some credit customers will never pay back their debts. This is called bad debt.
What is responsibility accounting?
This is when unit managers are evaluated on items they have control over.
What is a responsibility centre?
A segment of an organization where an individual manager is held responsible for the segment’s performance.
What are the three types of cost centres?
1) Cost centre
2) Investment centre
3) Profit centre
What are some controllable and non-controllable measures of performance?
Controllable- negotiation of price for raw materials.
Non-negotiable- factory rent
What are the approaches to budgeting?
1) Fixed Budget
2) Incremental budget
3) Zero-based budgets
What is a fixed budget?
These do not change.
What is the incremental budget?
It starts with the previous year’s budget/ actual results and adds/subtracts an incremental amount to cover inflation and other known changes.
It is suitable for businesses that are stable where costs are not expected to change significantly.
Advantages of incremental budgets
1) Quickest and easier method
2) Suitable for stable businesses.
Disadvantages of incremental budgets
1) Builds on previous inefficiencies.
2) Uneconomic activities may be continued e.g. not outsourcing
3) Managers may spend unnecessarily to get the same budget next year.
What is zero-based budgeting?
Each cost element must be specifically justified as though those activities were taken for the first time.
Advantages of zero-based budgeting
1) Suitable for public sector organisations as they are rigorous.
2) Inefficiencies are dealt with.
3) Increased staff involvement meaning its more accurate.
4) Responds to changes in the business environment.
5) Knowledge and understanding of the cost behaviour patterns of the business will be enhanced.
6) Resources are allocated efficiently and economically.
What are the four stages of ZBB?
1) Managers specify which responsibility centres they are in charge of.
2) Each individual activity is then described as a decision package. This should state the costs and revenue expected from the given activity.
3) Each decision package is evaluated and ranked usually using cost/benefit analysis against other activities.
4) The resources are then allocated to the various packages.
Disadvantages of ZBB
1) Demotivation due to the long time spent on the budgeting process.
2) Ranking can be difficult for different types of activities where benefits are qualitative in nature.
3) Emphasises short-term benefits to the detriment of long-term goals.
What is a top-down budget?
This is set without allowing the ultimate budget holder to have the opportunity to participate in the process.
What is a bottom-up/ participative budget?
Budget holders participate in setting their own budgets.
Advantages of bottom-down
1) More insightful therefore more realistic.
2) More motivation to meet own budgets.
Disadvantages of bottom-up
1) Setting easier targets.
2) Difficult to reach an agreement with many people.
Advantages of top-down
1) Easy and quick to implement.
2) Pushes for growth
3) Sees the bigger picture.
Disadvantages of top-down
1) Lack of insight
2) De-motivates budget holders if too hard.
What does the strategic planning process involve?
A vision statement that clarifies beliefs and governing principles and a mission statement which is more action-oriented.
What is a long-term plan?
It is a statement of targets and activities required.
What is the process for strategic planning, budgeting and control process?
1) Strategic planning process (specification of objectives and strategies.
2) Creation of a long-term plan to implement strategies.
3) Preparation of the annual budget within the context of the long-term plan.
4) Monitor actual results.
5) Respond to deviations from the plan.
