Budgeting Flashcards
Introduction
Improvement of performance can be done
1. setting KPIS and targets
2. setting of budgets which helps with exercising control
Questions will involve
1. Evaluate existing budget or system whether it is appropriate
2. Suggest better alternative systems to the one currently being used
Types
1. Incremental
2. ZBB
3. Rolling
Purposes of budgeting -PRIME
1. Planning - looking to the future. This may be difficult as it requires
estimation and may involve factors outside your control
2. Responsibility - target, controllability, accountability, rewards and
consequences
- A budget is a target so will aid accountability, the outcomes
need to be controllable.
- How difficult is the target and what are the rewards for staying
within budget. what are consequences of not meeting the target
3. Integration - This involves co-ordination of departments if sales
budget to sell 200 units, production must also budget to make
200 units
4. Motivation - can be a motivator or a demotivation depending on
how achievable targets are
5. Evaluation - Budget forms basis for variance analysis. Budget
needs to be flexed before analysis
Participation in budget setting - Types of budget, levels
There are two expected scenarios
1. When employees are invited to participate but shouldn’t have
2. when they weren’t invited to participate but they should have
Types
1. Top down budgeting - senior MGT dictate the budget- this leads to
unrealistic targets, its always based on the strategy. Autocratic
2. Bottom up - employees set their own targets - This could
introduce budgetary slack and is quite rare in practice
3. Participated budgeting - three stage process where snr MGT
provide framework and overall guideline results but employee
produces first draft which is the challenged and eventually
agreed
Levels of participation needed
1 . Acquisition of new business - participation will be high so new
mgt can gradually understand the new business
2. simple business with low grade staff - participation will be low as
staff lack expertise.
3. Environment change and strategic change - Low, strategic change
is best forced from the top
4. History of budgetary slack - low, this needs to be reversed by Top
down
5. Budgets are ignored - High as participation needs to be introduced
to get employee buy in. this will improve motivation
Methods of budgeting - Introduction, Incremental
We need to be able to
Describe and understand the budgeting system in order to
1. Evaluate the method - positive and negative points, weigh them
and give an opinion
2. Indicate whether it is suitable in the current circumstances
Incremental Budgeting -
Suitability
1. Good in a stable business environment
2. Poor if history of gaming or abuse or errors
3. suitable for contracted costs, rent costs for existing buildings,
stationery, low inflation environment
4. not suitable for R&D, marketing, volatile product range, project budgeting
Positives
1. Quick and easy
2. Easy to understand
3. popular amongst non finance people
Negatives
1. Errors re-budgeted, budgetary slack carried over
2. use it or lose it gaming can occur
3. Tendency to budget for costs not needed because they were
needed last year.
Methods of budgeting - ZBB - suitability, positive, negatives
An approach which requires budget to be built without reference to the past spend but to be built from scratch. looing over things with a fresh pair of eyes
A few assumptions are needed
1. Structure
2. staffing levels
3. Wage rates
4. hours worked
5. Bonuses
General structure
1. Agree area for budget - it wouldn’t be for the whole business -
R&D, marketing
2. General estimate for cost ,provide justification and benefits. A
decision package.
3. Budgets are challenged by senior managers ( cost v benefit
analysed to see if justified) and resources allocated.
Issues to consider
1. Estimation techniques will be needed e.g. sector norms
2. Third party involvement to provide quotes or estimates (there
might be a bias so might be underrated as they will not cover
extra costs when it is an estimate)
3. Compare with other departments
4 . Resource constraints
5. Experience and judgement is needed
Suitability
1. Dynamic environment
2. A new project or department
3. structural change
4. significant incremental costs e.g. training, maintenance
5. unreliable historical costs
6. High level of waste
Positives
1. Forces you to understand business model
2. Removes waste
Negatives
1. Likely to result in underbudgeting for costs - missing costs and
under estimation is common
2. Complicated to do
3. Time consuming
4. Can become a competitive process
Rolling budgeting - suitability, positive, negatives
Anew quarter is added as the old quarter expires, consequently business is always 12 months ahead and if new information comes to light all future budgets must be amended to reflect this
Suitability
1. Dynamic environment
2. Fast moving business
3. an emerging market
4. factors outside your control
Positives
1. Budget always seen as fair
2. Reflects quickly changing environments - popular with financiers
Negatives
1. Very time consuming
2. No commitment to budgetary control just change the budget.
3. No action taken to fix underlying problem - just change the
budget
Beyond budgeting - suitability, positive, negatives
It suggests many traditional budgeting approaches are flawed, it is a cultural shift rather than a way of budgeting
Flaws of budgeting
1. Takes too much time
2. Lacks focus on external factors on direct competition
3. Encourages staff to game the system
4. offers poor control, merely a way to berate managers based on
what happened. .
5. Limits flexibility to respond to change particularly in an
environment of
- shorter lifecycles
- rapidly changing technology
- The need to repurpose resources quickly
- The need to repurpose quickly
- New competitors emerging to disrupt market.
6. Too much focus on financial control
7. Budgets are constrains to quality, which is vital as standards rise
What is beyond budgeting - DRAFT
1. Devolved strategic process - Give divisional managers more power
to go with their responsibility, Head office will challenge
assumption but divisional managers understand their SBU as they
are closest to its should be free to make strategic changes.
2. Aspirational targets - divisional managers are asked to think Big
and ambitiously, crucially this targets are not used to assess
subsequent performance as this could make them risk averse
3. Relative performance focus - The emphasis is on performance
against the competition using relative measures, rewards will also
be driven by this focus, beat the competition and get rewarded
Snr mgr.’s Rewards are for personal work and group results
4. Terrific resource mgt - Any resource supplied centrally should be
at market value not cheaper (businesses must live in the real
world more more expensive ( profit manipulation through transfer
pricing. Head office should support in tomes of rapid change
open sharing of access to IT systems
5. Flexible control methods - Strict budgeting techniques are
replaced by
- Increased use of non financial targets - quality, waste,
productivity, down time
- Rolling budgeting techniques to reflect current conditions as
some form of budgetary control is important
- Greater focus on trend of costs whilst recognising changing
scene
Problems and issues with Beyond budgeting
1. Traditional power structures will be disrupted so change will be
resisted by those in power
2. Control is being sacrificed for flexibility and trust. Divisional
managers must make good decisions
3. If all divisions decide to expand, this could lead to cashflow issues
4. Divisional managers will need to be updated by recruitment and
training
5. Business could become disjointed and apart from each other
Gaming of performance management systems
All systems are subject to abuse and accountants putting stems in place need to be aware of this and also how to spot it.
Misrepresentation - deliberate fudging of numbers either by changing input data or by creatively reporting results
Misinterpretation - data often tells the story but not why, WHY can be judgemental and often easy to misinterpret
Short termism - myopia
making decisions which only benefit the business in the short term but can disastrous long term consequences e.g. discretionary cost reduction, less on marketing, training and R&D.
Fixation - excessive focus on a particular measure regardless of other possibly undesirable consequences
sub optimisation - when employees achieve targets early then decide not too exceed it too much so the future targets are not increased
Ossification is when a flexible idea becomes rigid and inflexible. They get set in their ways and refuse to change.
Budget padding - Because budgets are reduced, managers pad initial budget.
Indicators of gaming
1. Constant favourable variances
2. When reductions to budget is accepted easily, we should normally
expect push back
3. Managers attempt to conceal explanations or are vague when
questioned.
4. Reduction in discretionary costs
5. complaints around quality
6. Implausible explanations
Action to be taken
1. Vary the performance system used - once people become familiar
they will try to game it
2. Use a balance set of targets - financial and non financial, short
and long term. balance score or building block would help
3. Reward excess performance rather than merely rewarding trigger
point success
4. Stress a culture of trust and honesty
