Budgeting Flashcards
Business Plan
- The business plan is a key document for the internal management of the organization
- Provides basis for evaluation/control
- Helps with obtaining financing from external resources
9 steps in a business plan
- Owner’s visions: Decides to go into business
- Site Analysis: Choose site and do market research
- Layout design: Choose product/service
- Preliminary Budget: Forecast sales revenue
- Business Structure: Production, marketing, HR plan
- Financing Alternatives: Debt/Equity finance options
- Preliminary ProForma: 2-5 year forecast of all financial statements
- Discussion Package: Qualitative feasibility analysis
- Financing Plan
ProForma
A future looking set of financial statements based on estimates
Budget
A budget is a plan expressed in monetary terms that covers a future time period (typically a year)
Provides a plan expressed in quantitative terms
Master Budget
A MASTER BUDGET is a summary of all phases of a company’s plans/goals
It is a network consisting of many separate budgets that are interdependent.
Culminates into pro-forma statement of net income and cashflow statement
Reasons for budgeting
Budgets provide the ability to:
Compels management to think about the future
Clearly defines areas of responsibility
Provides a basis for performance appraisals through variance analysis
Improves allocation of scarce resources
Advantages of Budgeting
Provides managers a way to formalize their planning efforts
Provides definite goals and objectives that serve as benchmarks for evaluating subsequent performance (motivates mgrs. to achieve targets)
Uncovers potential bottlenecks before they occur
Coordinates the activities of the organization to ensure the plans and objectives are consistent with the broad goals of the entire organization
Allocates resources in line with strategic goals
Provides a means to control activities
Responsibility Centres
A responsibility center is defined as any functional unit headed by a manager who is responsible for the activities of that unit.
Revenue Center
Expense Center
Profit Center
Investment Center
Revenue Center
Outputs measured in $ terms but not directly compared to input costs
Expense Center
Units where inputs are measured in $ but outputs are not
Profit Center
Performance is measured by the difference between revenues and expenditures
Investment Center
Outputs compared with assets employed in producing them (ROI)
Eight steps in the budgeting process
- Business objectives: define and communicate the objectives for the year
- External analysis: Forecast economic and industry conditions, including competition
- Sales budget: Develop detailed sales budgets by market, geographic territories, major customers, and product groups
- Production budget: Prepare production budget (materials, labour, and overhead) by responsibility centre to satisfy the sales forecast and maintain agreed levels of inventory
- Non-production budget: Prepare by cost centre
- Capital expenditure budget: Prepare capital expenditure budget
- Cash budget: Prepare cash forecasts and identify financing requirements
- Master budget: Prepare master budget and budgeting statement of cash flows and obtain approval of profitability and financing targets
Sales Budget
A sales budget is a detailed schedule showing the expected sales for the coming periods.
Key to the entire budgeting process
All other parts of the master budget are dependent on the sales budget in some way
If the sales budget is inaccurate, the rest of the budgeting process will be a waste of time
Sales Forecasting
In order to develop a sales budget, consider the following in the forecast:
- Past experience with sales volumes
- Prospective pricing policy
- Unfilled order backlogs
- Market research studies
- General economic and industry conditions
- Consumer income, employment rate
- Advertising and promotion techniques
- 4 P’s
Production Budget
After the sales budget is prepared, the production requirements for the forthcoming budget period can be determined and organized in the form of production budget.
Sufficient goods must be available to meet sales projections and provide the desired ending inventory
Production needs = budgeted sales + desired EI – BI
What do you do if the production requirements exceed your capacity?
If the production requirements exceed capacity, consider the following options:
Subcontract the work
Plan for overtime
Introduce shift work
Purchase/lease additional machinery
Direct Materials Budget
Reports the values of direct materials that will be used during the year
Direct Labour Budget
A forecast of the direct labour hours required to produce each unit
Manufacturing Overhead Budget (MF OH)
Often based on previous year’s costs, adjusted for changes in cost rates.
Includes indirect labour, indirect materials and supplies, utility costs, plant maintenance, depreciation
Capital Budget
The capital budget covers the acquisition of land, building, and items of capital equipment.
How are Capital Expenses (CapEx) different from Operating Expenses (OpEx)
Purpose: CapEx are assets purchased with a useful life greater than a year; OpEx are costs to run a business
When Paid: CapEx are paid in one lump sum; OpEx are reoccuring expenses
When accounted for: CapEx are accounted for over a 3-10 year life span as the asset depreciates; OpEx are accounted for in the current month or year
Listed as: CapEx are property or equipment; OpEx are operating cost
Tax treatment: CapEx deducted overtime as the asset depreciates; OpEx are deducted in the current year
Cash Budget
The cash budget shows the impact of cash flow, under the following sections: Receipts Disbursements Excess/Deficiency (balance) Financing section Ending cash balance
Budgeting Challenges
Accuracy in predictions
Motivational problems
Limiting Nature of Budget
Negative Reputation of Budgeting
Accuracy in predictions
Predicting volumes and sales are only estimates based on historical performance and future outcomes
Motivational problems
When a budget is developed to control and monitor performance, managers may be inclined to develop budgets that are easy to achieve to avoid the risk of facing a poor performance review (agency problem)
Limiting Nature of Budgets
Can constrain/limit innovation when encourage to keep costs at a specific level; may not take actions that could be beneficial for the company
Must have complete acceptance/support of management to be successful
Negative Reputation of Budgeting
Often viewed by employees as a necessary evil and a restrictive tool.
Methods of budgeting
Top-down Bottom up Zero-based budgeting Line-item Program budgets Performance budgets Activity-based budgets Incremental budgets
Top-down
Budget prepared by mgmt. and imposed on lower levels of org.
Bottom up
Supervisors/middle mgrs. prepare budgets and forward them up for review and approval.
Zero-based budgeting
Each activity starts from a budget of zero and must build their budgets accordingly.
Line-item
Each expenditure has a line included in the budget and a system to track it (does not show true costs of service programs or production)
Program budgets
Delineates all the costs associated with doing a project/program (common for grant applications)
Performance budgets
Similar to program budgets except they are tied to data that includes performance (i.e. customers served)
Activity-based budgets
Allocates costs to products or services according to how much of the resources of the firm they consume
Incremental budgets
Takes previous year’s budget as a base and adds/subtracts a percentage to determine new amount.
Types of Budgetary Control
Goal Setting Planning Planning using a Budget Manual Planning by Budgeting Profit Budget Monitoring/Variance Analysis Auditing Expenditures and Results
Goal Setting
Set goals for your budget
Recurring operational goals
Strategic goals
Goals communicate to managers what your business must achieve in the coming year.
Planning
Control the level of spending using budgeting plans.
Short-term budgets
Long-term budgets
Planning using a Budget Manual
All of your budget procedures and policies belong in one manual
Details who is responsible for various budget functions, such as approving expenditures, scheduling accounts receivable, collecting overdue bills, paying bills, making deposits and creating invoices
Shows how work flows through your budgeting department. For example, indicate how a department manager fills out an expenditure request, who it goes to in the budget center, all of the approvals needed and who sends it back to the department head.
Planning by Budgeting Profit
Choose your budget method
Example: Choose zero-based budgeting
Income must match expenditures
If you do not include profit as an expenditure, you will have the tendency to spend all of your income on materials, supplies, overhead and payroll. By using zero-based budgeting with an expense built in for profits, you place an emphasis on success rather than mere survival.
Budget Monitoring/Variance Analysis
Compare what the department actually spends with what the department budget called for.
Determine the reasons for budget overruns, and consider reducing the budget for departments that consistently spend less than their budgets indicated they would need.
Auditing Expenditures and Results
It is not sufficient to determine if each program area spends according to its budgeted levels.
Audit the expenditures in different budget lines, such as supplies, and identify instances of waste
Study the results achieved based on how a manager spent his budget over the last year
Measure the performance against the overall budget policy
