Ch1 Budgeting - Big Picture Flashcards
Four steps for a meaningful budget
- Identify constraints, potential issues, and areas of uncertainty
- Gather information
- Make future predictions
- Implement the budget and gather feedback
Essential roles of budgets
- predict financial consequenses of plans
- compare resource requirements with available resources
- allocate constrained resources to the most profitable uses
- communicate the orginization’s financial and operating objectives
- assign resonsibility and establish control
(long-term budgets: requesting financing / preparing a business valuation)
Issues in budget preparation
- Budget time frame
- dependent on type of budget and purpose
* capital budget: long-term life time of the investment
* operating budget: annual, quarterly, monthly, or weekly
* rolling budget: aka continuous budget, or rolling forecasts; updated monthly and extended through next 12-16 months - Budgets as performance measures
- Budget manipulation: budgetary slack
underestimating revenue / overestimating expenses
Budget methods
- Traditional budgeting: undamentally flawed but fast and cost efficient
- Static and flexible budgeting: based on planned level of sales and production and not adjusted for acutal changes - used for high-level analysis and communicating to external stakeholders who don’t require additional detailes
Flexible budgets provides more depth into a company’s activities for better cost control when actual units or activity levels differ from plan
- Priority budgeting: allocate resources based on strategic plan
- Top-down and participative budgeting
paticipative budgeting:
- increased cooperation
- more accurate budgets
- greater motivation to achieve budgets
- budget manipulation - Zero-based budgeting
- perpetuated budgetary slack if using prior budgeted amount as starting point
- budgeted items not referenced to prior budgets, but based on analyses of marketing strategy, demand for products or services, competition etc.
- costly and time-consuming, so used only occasionally or for new projects - Activity-based budgeting
- budget cost per unit of activity based on demand
- develop budget by function/product/service
- more accurate budgets than tranditional budgeting
Continuing role of budgets
Opponents:
- ineffective and outmoded and unneccessarily disrupt operations
- ignore key non-financial aspects of performance, discourage innovation and reduce motivation
Proponents:
- used appropriately, a viable and effctive management tool
- provide valuable insights into the consequences of operations plans
- create a natural basis for assigning responsibility and accountability,
- and provide useful relevant information for evaluationing results
Terminology
- plan: set of intended actions and expected results
- forecast: future-oriented financial information prepared using assumptions and judgments regarding probable economic conditions
- budget: financial plan or estimate, expressed in quantitative terms, to predict the most likely financial consequences of a course of action
- pro forma: financial statements that anticipate the results of a planned transaction to present the entity’s future financial situation
- projection: future-oriented financial information prepared using assumptions and judgments regarding probable economic conditions only with a hypothesis in mind
Two main roles of a management accountant in budgeting
- Planning: setting objectives and preparing bugets to achieve the objectives
- Control: regularly compare the budget to actual results
- identify opportunities to improve organizational performance
- assign accountability for performance failures and rewards for performance success
Strategic planning process
- Short-term plans (operational)
- Short-term bugets
- Master operational budget
- Project budgeting (one year or less)
- Long-term plans (strategic)
- Long-term budgets
- Capital budgeting
- Two- to ten- year strategic budgets
Types of budgets
- Master budget
- Operating budget
- Financing budget
- Cash budget (or forecast)
- Budgeted financial statements - Specific budget
- Project budget
- Capital / Investment budget
Decision framework (budgeting process)
- Four steps
- Identify constraints, potential issues, and areas of uncertainty
- prioritize - Gather information
- internal: management information system
- external: economic forecast, political trends, social media, and industry-driven data - Make future predictions
- realistic
- based on justifiable information - Implement the budget and gather feedback
- following up with variances
- taking corrective action
Rolling budgets
aka - continuous budgets or rolling financial forecasts
Updated every month or quarter and typically extend through the next 12 to 16 months
Reflect more current information about economic circumstancs (resource prices and customer demand)
Budget participants
Managers who control the costs and revenues of the organization
- Bottom-up approach: managers prepare their own budget and reviewed by senior management and combined to form the overall organizational budget
- they can build in significant slack to ensure profitability targests are easily met
- Top-down approach: senior managers imposes a budget on the managers and departments under its control
- drafted and approved by management
- presented to BOD / oversight body (budget committee) - final approval
- presented to shareholders at annual general meeting (to ask questions on the direction of the organization)
- drafted and approved by management
Budget components
- recursive (update)
- recycling / redeveloping
Situations when budgets require recycling and redeveloping
- initial budget unacceptable, e.g. a deficit or lower ROI and senior managers demand a more aggressive one
- initial budget generates a production plan requiring acquisition of capital equipment or skilled labour that cannot be accommodated in the time available
- unforeseen circumstance (product failure or competitor’s initiative) requiring major reworking of the planned budget
