Budgeting and forecasting Flashcards
What is financial planning?
Financial planning is a continuous process of directing and allocating financial resources and determining how an
organisation will meet its strategic goals and objectives.
What is budgeting?
Budgeting is an outline of a company’s financial plans, normally drawn up for the next full trading year. It is the process of creating a plan, also referred to as a financial budget, to project incomes and outflows for the next full year. It creates a baseline to compare actual results with the expected performance.
budgeting = a plan of what the company wants to achieve
It quantifies the expectations or targets (in terms of revenue, cost allocation, savings and so on) by outlining what a company wants to achieve.
What is financial forecasting?
Financial forecasting is the projection of a company’s future financial outcomes over a longer time period by
examining its historical and current financial data.
A financial budget establishes a picture of a company’s financial health, anticipates its funding requirements and presents a strategy for managing its assets, cash flow, income and expenses. It provides an overview of spending relative to revenues.
Budgets are an important tool to identify, allocate and manage the resources as they are needed.
It also helps in motivating employees by setting the objectives of the company and can be also linked to rewards where targets are met.
Forecasting = a prediction of what will actually be achieved
The company always needs a forecast to reveal the
actual circumstances and numbers that will be achieved
What is the most important budget in a company?
One of the most important budgets is a cash budget. A cash budget sets out the cash inflows and outflows for a
company over a specific period of time to ensure that there is enough cash within the company to operate and avoid
financial embarrassment.
It normally covers the next 12 months; however, it can also cover a short-term period such as a month or a quarter.
Cash budgets are used to control and monitor the actual cash receipts and cash payments against the budgeted figures.
On mapping of receipts and payments, a monthly cash surplus or cash deficit can be identified.
The preparation of this statement gives an early warning of the future cash position. This will help the finance manager
consider the timing of important decisions that will impact cash flows.
What is a Master budget?
The master budget shows how all the budgets work together to project combined incomes and outflows for the
company. Each of these budgets will be controlled by a budget holder, managing a specific section of the company.
Budgeting represents a company’s goals, financial position, profit and cash flows.
Budgets are presented mostly in the form of budgeted financial statements (profit or loss, financial position and cash flows). Detailed budgets include sales forecasts, production forecasts and other estimates that show whether the company is heading in the right direction.
Performance against budgets?
Performance against the budget is monitored and updated on a regular basis, ideally each month. This enables company managers to frequently analyse monthly actual results and forecast revenues and expenses for the remaining months of the year based on their real-time observations of the current market conditions – therefore revising the forecast.
What are the two types of budgets?
There are two types of budgets:
- flexible and
- static.
What is a static budget?
The most common type of budget is a static budget that projects a fixed level of expected input, output and costs. It
remains unchanged irrespective of the changes in volume or activity. The actual results at the end of the budget period
very often vary from the static budgets.
What is a flexible budget?
A flexible budget, also known as variable budget, is one that adjusts with changes in volume or activity.
It allows the budget to be adjusted throughout the year as company conditions change. The change can be due to delay in activity, change in volume or adding new activity.
The budget will include a variable rate per unit of activity instead of one fixed total amount.
A flexible budget is often more useful than a static budget.
For example, a company makes a static budget that has
budgeted the cost of running its machinery at £100,000 per month irrespective of the machine hours used.
However, in a flexible budget, the company can budget the running cost based on the average fixed cost of £34,000 + £6 per machine hour.
In a flexible budget, the values change to reflect changes in activity or output, allowing managers to adjust to the
needs of the business.
The flexible budget offers a better opportunity for planning and controlling than a static budget
Budgetary control?
Budgetary control
Once a budget is prepared, financial managers use budgetary control to control and monitor the actual results against the budgeted figure. The detailed analysis of variance (difference) is conducted to evaluate the performance of the project or budget area.
It allows costs and performance to be reviewed and adjusted where needed.
Controlling the budget is a critical responsibility of the budget holder or the project manager. It helps management to set financial and performance goals (such as sales or spending goals), then evaluate progress by comparing and analysing the actual costs and performance results with the budgeted goals. It allows managers to focus on poorly performing areas and strengthen the favourable ones.
The actual results are then compared with the budgeted performance over the entire period. A key element of budgetary control is providing a revised forecast of financial performance. Lastly, management will work to improve the under-performing areas and develop a plan to fix them in the next period.
What is the key objective of cash management?
The key objective of cash management is to avoid either a surplus or a deficit of cash by ensuring:
- there are adequate cash balances in times of need;
- surplus cash is invested or used to repay the existing debt to maximise the returns for the company; and
- there should not be a situation where there is deficit of cash due to unnecessary shortage of funds.
Cash management is a trade-off between liquidity and costs.
Why is there a need for cash?
Every transaction results in an inflow or outflow of cash. These inflows and outflows may not be synchronised.
Sometimes, the inflows are more than the outflows or vice versa.
The primary motive of holding cash is to maintain
a financial position in situations of certainty as well as uncertainty.
According to Keynes’ general theory of economics
(1936), there are three basic motives for holding cash
- The transaction motive
- The precautionary motive
- The speculative motive:
Explain the three basic motives for holding cash?
- The transaction motive
- The precautionary motive
- The speculative motive:
- The transaction motive:
maintaining enough cash to meet the day-to-day operations such as payments to vendors, petty expenditure and salaries.
Cash is received in the ordinary course of company from debtors (trade receivables) or investments. Often these inflows and outflows do not match, hence cash is required to meet these mismatches.
- The precautionary motive:
holding cash to meet contingencies and unexpected situations, such as providing a safety net for unexpected events.
- The speculative motive:
using cash to take advantage of profitable investment opportunities. For example, holding money will allow cheaper bonds or shares to be bought in the future.
What are the methods for Methods of dealing with cash surpluses and cash deficits?
Cash surplus
An entity has a cash surplus if it has enough money to cover at least a couple of months of overheads in an emergency.
A finance manager has to make the most of such a cash surplus. It can be used to either repay existing debts or to
invest in opportunities which will give returns to the entity.
Repayment of debt is usually the first option preferred by the organisation, as investment in short-term investments may not yield the savings that one may get on repayment of debt.
Cash deficit
When an organisation cannot meet its day-to-day cash expenditure, it experiences a cash deficit.
Cash deficits arise due to unnecessary shortages of funds.
When a situation of a cash deficit arises, the organisation may have to sell its assets, cut down its inventory levels, chase customers for payment or delay payments to employees and suppliers.
Financial markets?
A financial market is a marketplace where the financial wealth or assets (such as stocks or equities, bonds, currencies and derivatives) of individuals, institutions, governments and so on are traded. Trade is often conducted via a middleman called a broker or intermediary.
