Budgeting Process and Budget Model

Question 1

Time horizons (picture)

Answer 1

Question 2

Strategic planning process

What should top management do?
What is it important (3)?
What should the master plan consider?
What is the annual budget created within?
Strategic planning begin?
Hierarchy of objectives (3)

Answer 2

• Top management should normally have a vision of where the organisation is going in the next 5-10 years.
• Knowing how to realise the vision is important and management must know how to:
  • Make the plans to get there
  • Use the plans in keeping the organisation on track
• The organisation’s strategic plan (master plan) should consider the longer term objectives and policies to achieve goals
• The annual budget is created within the context of the overall strategic plan
• Strategic planning begins with the specification of objectives towards which future operations should be directed.
• A hierarchy of objectives: mission of an organization, corporate objective and unit objectives.

Question 3

Long-term planning process (4) Annual budgeting process (3)

Answer 3

1. Identify the objectives of the organization.
2. Identify potential strategies.
3. Evaluate alternative strategic options.
4. Select course of action.
5. Preparation of the annual budget within the context of the long-term plan.
6. Monitor actual results.
7. Respond to divergencies from plan.

Question 4

Budget

Budget is concerned with?
Because…budgets are…?
Budget are a…?
Whereas…?

Answer 4

• Budget is concerned with the implementation of the long-term plan for the year ahead.
• Because of the shorter planning horizon, budgets are more precise and detailed.
• Budgets are a clear indication of what is expected to be achieved during the budget period,
• whereas long-term plans represent the broad directions that top management intend to follow.

Question 5

Budget

What is a budget?
What does it provide?
Planning is achieved by means of…whereas…?

Answer 5

• A quantitative statement, for a defined period of time, which may include planned revenues, expenses, assets, liabilities and cash flows.
• A budget provides a focus for the organisation, aids the co-ordination of activities, and facilitates control.
• Planning is achieved by means of a fixed master budget, whereas control is generally exercised through the comparison of actual costs with a flexible budget.
  CIMA

Question 6

Functions of Budgets (6)

Answer 6

• planning - annual operations
• control - by having a plan to compare to
• performance evaluation - managers’ performance
• Coordinating activities of all budget centres
• motivation
• communication - of policies and targets by every manager for that part of the plan

Question 7

Budget period

What is the conventional approach?
What is the budget divided into?

What is an alternative approach?
What does a rolling budget ensure?
What is important to have and why?

Answer 7

• The conventional approach is that once per year the manager of each budget centre prepares a detailed budget for one year.
• The budget is divided into either 12 months or 13 four-weekly periods for control purpose.
• An alternative approach is for the annual budget to be broken down by months for the first 3 months, and by quarters for the remaining 9 month. The quarterly budgets are then developed on a monthly basis as the year proceeds.
• Rolling budget ensures a 12-month budget is always available by adding a quarter in the future as the quarter just ended is dropped.
• Irrespective of whether the budget is prepared on an annual or continuous basis, it is important that monthly or four weekly budgets are normally used for control purposes.

Question 8

Budget committee

Composition?
Major task?

A …to…?

Answer 8

Composition:

• high-level executives who represent the major segments of the business.

Major task:

• ensure budgets are realistically established, and coordinated satisfactorily.

A budget officer is appointed to cooridinate the individual budgets into a budget for the whole organization.

Question 9

Budgeting Process

10 steps

Answer 9

1. Identify the budgeting period (usually a year divided into quarters or monthly).
2. Budgets may be continuous (rolling forward by one month when one actual month elapses so that there is always 12 months of budget data).
3. Communicating expectations to managers, and managers should be fully involved.
4. Determine the limiting factor for the organisation, (usually sales).
5. Sales budget will depend on the sales forecast. The sales forecast will consider the economy, industry factors, market competition, market issues and other factors likely to influence demand.
6. Initial preparation of various budgets
7. Negotiation of budgets
8. Coordination and review of budgets
9. Final acceptance of the budgets
10. Budget review

Question 10

Limiting factors

What are they?
What is essential
The factor..?
For each factor management must consider whether: (2)
Limiting factor examples
.

Answer 10

• Any factor which restricts demand, the volume of production, or any other resource and so limits the activity of the organisation is described as a limiting factor.
• It is essential to identify the limiting factors early because these may determine the starting point for budget preparation.
• The factor that cannot be overcome is known as the “principal budget factor ”

For each factor management must consider whether:

• it is possible to overcome the limitation or
• the limitation has to be accepted because its outside the control of the organisation

Usually the limiting factor is the level of sales, however there could be a shortage of materials, equipment, skilled labour or cash.

Question 11

Budgeting

Other budgets will include: (6)

Answer 11

Other budgets will include:

• Production budget
• Materials purchase budget
• Direct labour budget
• MOH budget
• Cash budget (critical as can provide warning of potential cash flow problems arising in the course of the year).
• Finally, budgeted income statement and balance sheet, cash flow statement

Question 12

Key stages in budget preparation (5)

Answer 12

1. Determine the budget period:

• Decide the timeframe the budget will cover—whether it’s monthly, quarterly, or annually.

2. Identify the limiting factor:

• Pinpoint the constraints that might affect budget outcomes, such as limited resources, market conditions, or production capacity.

3. Prepare the functional budgets:

• Create detailed budgets for individual departments or functions, like sales, production, and marketing.

4. Prepare the master budget:

• Combine all the functional budgets into a comprehensive summary that reflects the organization’s overall financial plan.

5. Obtain approval:

• Submit the finalized budgets to the budget committee or management for review and official approval.

Question 13

Functional budgets

What does it mean?
Examples (5)

Answer 13

Each budget produced serves some particular purpose and is known as a functional budget

1. Sales Budget:

• Focuses on quantities, prices, and values of products or services to project revenue.

2. Production Budget:

• Includes information on production quantities, costs, stock levels, and how the plant’s capacity is utilized.

3. Purchasing Budget:

• Deals with procurement planning to ensure materials and supplies are available when needed.

4. Direct Labour Budget:

• Outlines labor costs and workforce requirements based on production needs.

5. Administrative Expenses Budget:

• Covers overheads related to administrative functions, such as office costs and management expenses.

Question 14

Budgeting Process

• After budget preparation, the budgets must be ___________ and agreed upon by ____ _______________
• Process of _____________ resulting in _______ ________________
• Budgets are never ___________ __ ________ and must be constantly _____________ for ____________ _________

Answer 14

• After budget preparation, the budgets must be reviewed and agreed upon by top management
• Process of negotiation resulting in final agreement
• Budgets are never carved in stone and must be constantly reviewed for potential changes

Question 15

Types of Budgeting (5)

Answer 15

• Incremental Budgeting
• Zero Based Budgeting
• Planned Programme Budgeting Systems
• Rolling Budgets
• Activity Based Budgeting

Question 16

Benefits of Budgeting (6)

Answer 16

• A vehicle for communication of plans
• The process forces managers to think ahead and draw up formal plans
• The process acts as a means of allocating organisational resources
• Highlights the potential problem areas
• Coordinates and integrates the activities of the whole organisation
• Serves as a benchmark for evaluating performance

Question 17

Limitations of Budgeting (9)

Answer 17

• In today’s fast paced environment budgeting is sometimes not the best tool. Some companies are instead using rolling forecasts and KPI’s (key performance indicators)
• Changes to the organisation’s circumstances are often not updated quickly enough
• Encourages rigid planning and incremental thinking
• Time consuming to construct
• Produces inadequate variance reports leaving ‘how’ and ‘why’ questions unanswered
• Focuses too much on short term and ignores shareholder value drivers
• Meets only the lower targets, doesn’t try and improve them
• Behavioural implications such as spending up to budget level in order to protect next years budget
• Achieving the budget becomes the focus even though it may not be desirable