Chapter 10: Budgeting Flashcards
What is a budget?
Quantitative plan for a specific time period
Normally financial and prepared for one year
Benchmarks vs actual (variance analysis)
What is the purpose of budgeting
planning
control
communication
co-ordination
evaluation
motivation
authorisation
delegation
What is planning
forward looking
management don’t rely on ad hoc/ poorly co-ordinated planning
What is control
actual results vs budget with appropriate action taken
What is communication
budget is a formal communication channel
Juniors to seniors can converse
What is co-ordination
all areas work towards a common corporate goal
What is evaluation
each manager has responsibility for its own areas
Budget can evaluate actions of a manager within the business in terms of cost & revenue they have control for
What is motivation
budget used as a target for managers to aim for
Reward for operating within/ under budgeted expenditure
What is authorisation
Formal method of authorising manager’s expenditure, hiring staff, pursuit of plans within the budget
What is delegation
Managers can be involved in setting the budget
extra responsibility can motivate managers
Can set more realistic targets
How do budgets link to performance management
benchmarks (variance analysis) & corrective measures
Detailed sales target, staffing plans, production, cash investment and borrowing, capital expenditure
Give managers pre-approval for spending- anticipate & avoid disastrous outcomes
What is strategic planning
LT
Whole organisation
Defines resource requirements
e.g develop new products for customers
What is tactical planning
Medium term
Department/ divisional level
Specifies how to use resources
e.g train staff on a product
What is operational planning
ST- detailed
where most budgeting activities are
e.g budget set to include advertising, sales forecast, labour & material
Impact of operational leads onto tactical and strategical success
Flexible to meet changing need of business
What do budgets in manufacturing usually include?
sales, production, materials usage, materials purchases & labour utilisation
capital expenditure, cash budgets all pulled together for a master budget
What are the 3 management styles used by Hopwood?
1) Budget constrained style
2) Profit conscious style
3) non- accounting style
What are the performance evaluation and behavioural aspects of budget constrained style (Hopwood)
Performance Evaluation:
Manager evaluated on ability to achieve budget in ST or criticised for poor results
Behavioural aspects:
Job related pressure
ST decision making at expense of LT goals - poor working relations with colleagues
manipulated of data
What are the performance evaluation and behavioural aspects of profit conscious style (Hopwood)
Performance Evaluation:
Manager evaluated on ability to reduce costs & increase profit in LT
Manager can exceed budget limit ST if it benefits LT
Behavioural aspects:
Less job related pressure
Better working relations with colleagues
Less data manipulation
What are the performance evaluation and behavioural aspects of Non-accounting style (Hopwood)
Performance evaluation:
Manager evaluated on non-accounting performance indicator e.g quality & customer satisfaction
Behavioural aspects:
Similar to profit conscious style bu less concern for accounting info
Requires stringent monitoring of performance against budget
What is an expectation
budget set at current achievable levels
Unlikely to motivate to improveMay give more accurate forecasts for resource planning, control & performance evaluation
What is an aspiration
Budget set at a level exceeding level currently achieved
motivate managers to improve if it’s seen as attainable
Can result in adverse variance if too difficult
What are the different approaches to budgeting
*Top down vs bottom up budgeting
* Incremental budgeting
* Zero-based budgeting (ZBB)
* Rolling budgets
* Activity-based budgeting
* Feed-forward control.
What is imposed style (top down) budgeting
budget allowance set without permitting the ultimate budget holder to participate in the budgeting process
What are the advantages of imposed style budgeting
1) Involving managers in setting budgets= time consuming
2) Managers may not have skill/ motivation to participate usefully in process
3) Senior managers= better verall view of the company & resources - better placed to create a budget using scarce resources
4) Seniors aware of LT strategic objectives- prepare in line
5) Budget holders can build budgetary slack/ bias into budget - make them easier to achieve and look better on them
6) imposed by seniors = more objective, fresher perspective
7) If participation isn’t genuine - budgets are drastically changed by seniors= dissatisfaction –> demotivate staff
What are participative budgets?
All budget budget holders are given the opportunity t participate in setting their own budgets
What are the advantages of participative budgets
1) Morale of management is improved- managers feel listened to & valued
2) managers are more likely to accept plans & achieve targets
3) lower level managers = more detailed knowledge of their particular part of business - more realistic
4) Frees up senior time
What are the motivational & co-operational behaviours?
These behaviours are needed for incentive - if not satisfied managers will be cautious & conservative
No incentive to achieve favourable variances
Need to be able to distinguish controllable from uncontrollable costs
Personal goals and usually linked to organisational goals - goal congruence
reliance on budgetary control systems doesn’t always result in goal congruence
How can there be a successful/ unsuccessful budget?
1) Budget is used as a pressure device - if viewed as a stick to beat people with= it will be sabotaged
2) budgeting process & control exercises induce competition between departments & execs. Managers may try to meet budget that aren’t in best interest of business as a whole
What is the purpose of budgetary control
induce managers to behave to the best advantage of the company
Compliance to budget enforced by negative & positive sanctions
What happens with adverse variances in budgetary control
implies poor performance by managers
If they can’t be correct or explain the adverse variances= negative sanctions
e.g no salary increase/ demoted
What could positive inducements be?
incentive to avoid adverse variances
performance-related salary bonus, promotion, new company car etc
Careful that it doesn’t skew performance
What is the view of budgets as a pot of cash
Some managers spend it through fear of reduced budget next year - can make their job more difficult or lose status in the organisation
Could mean that they use a stricter budget for the first 11 months to build a bugger (low quality/ cut backs) and splash out at the end - seen a lot in Gov departments
How do budget negotiations work
Budget can be initiated by departmental managers and corrected from a convo with the budget officer
What does padding the budget or budgetary slack mean?
incentive to negotiate a budget difficult to achieve
A manager exagerates the costs required to achieve objectives
1) if a manager does it = control exercise is damaged. Comparing actuals vs budget = meaningless so manager can include inefficiencies in operation if they want
2) successful managers= hard negotiators –> infighting in management
3) time & energy spent on admin procedures
What can influence accounting policies
apportioning costs and how they’re apportioned
this position creates scope & incentive for managers to argue over accounting policies
If managers perceive a department’s performance is below budget they may try to charge them elsewhere
What is a conservative approached management style
immediate impact of a new business venture is likely to rise in capital & operating costs and adversely impact current period profit
Benefits felt LT
manager may perceive as below budget performance and turn it down
How can budget constrained managers act
relying on reading financial reports
can lead to unsatisfactory corporate culture based on hierarchies & social divisions
Can favour projects that benefit budgets
choose project with little uncertainty are easy to incorporate
those with high uncertainties are attractive if there’s some high returns & low cost exit routes - difficult to incorporate into budgets
what are the main findigs from budget studies e.g Hofstede and Stedry
1) loose budgets are poor motivators
2) as budgets are tightened up to a certain point they become motivational
3) beyond that point a very tight budget ceases to be motivational
what are incremental budgets
starts with the previous period’s budget / actual results and adds/ subtracts an incremental amount to cover inflation
good for stable businesses - good cost control and limited discretionary costs
Advantages of incremental
budgets
1) quick & easy method
2) good for a stable organisation & historic figures are acceptable - only increment needs adjusting
3) managers not demotivated by targets changing regularly
Disadvantages of incremental
budgets
1) includes prev probs & inefficiencies
2) uneconomic activities coul be continued e. make inhouse when cheaper to outsource
3) managers may spend unnecessarily to use their budget so they get the same or larger next year
what is zero based budgeting
each cost element is justified- without approval the budgeted allowance is zero
what is zero based budgeting good for
1) Allocating resources in area where spend is discretionary i.e non essential e.g R&D, advertising & training
2) public sector orgs e.g local auth
What are the 4 stages in implementation of zero based budgeting
1) Managers should specify for their area the activities that can be individually evaluated
2) Individual activities are described in a decision package which states cost & revenues from the activity
3) Evaluate each decision package & rank using cost/ benefit analysis
4) Resources are allocated to various packages
Advantages of zero based budgeting
1) Inefficient/ obsolate operations identified & discontinued
2) increased staff involvement - more work & info required to complete budget
3) Responds to changed in business enviro
4) Knowledge & understanding of cost behaviour patterns = enhanced
5) Resources allocated efficiently & economically
Disadvantages of zero based budgeting
1) emphasises ST benefits detrimental to LT goals
2) Budgeting process = too rigid & org may not be able to react to unforeseen opps / threats
3) management skills required may not be present
4) managers feel demotivated - a lot of time spent on process
5) ranking is difficult for different types of activities or where benefit are qualitative
What is a decision package (Peter Pyhrr)?
doc that identifies & describes a specific activity so seniors can:
1) evaluate & rank against other activities competing for limited resources
2) decide whether to approve or disprove it
a) analyse cost of activity (costs can be built up from 0 base but costing info can be obtained from historical records or last years budget)
b) states activity purpose
c) identifies alternative methods of same purpose
d) assess consequence of no activity/ performing activity at different level
e) establishes measures of performance for activity
What 2 types of packages of Pyhrr identify?
1) Mutually exclusive package: contain different methods of the same objective
2) Incremental package: divide the activity into different levels. Base package = min effort & cost for activity. Other packages = incremental & benefits when added to the package
When can ZBB be used in the public sector
Use incremental budgeting every year. 3-5 years use ZBB for a major change
or use ZBB for only some departments for essential costs e.g heating & lighting
What is a rolling budget?
kept continuously up to date by adding another accounting period when the earliest accounting period has expired (e.g month/ quarter)
Remaining budget is reforecast and add on the new period
When are rolling budgets suitable
if accurate forecasts can’t be made (e.g fast moving environment) or if an area of business needs tight control
What are advantage of rolling budgets
1) Planning & control based on more accurate budgets
2) Reduce uncertainty - concentrate on ST
3) always a budget that extends to the future (normally 12 months)
4) management reasses budget regularly & produce up to date budgets
What are the disadvantages of rolling budgets
1) costly & time consuming > incremental budgets
2) can demotivate employees if they feel they spend a large proportion of time budgeting or targets constantly change
3) danger that budget is the same as last budget (+/- a bit)
4) increase in budgeting work = less control of actual results
5) issues with version control - each month FY number changes
6) confusion in meetings over whic numbers the business is working towards -detract from key issues
What is activity based budgeting (ABB) ?
based on activity framework & utilising cost driver data in the budget setting & variance feedback processes
Preparing budgets using OH costs from activity based costing methodology
What are the advantages of Activity based budgeting?
1) draws attention to ‘OH activities’ - large proportion of total operating costs
2) recognises that activities drive costs- control the drivers= better managed & understood
3) useful info in total quality management (TQM) environment- relates cost of activity to level of service provided
4) quite accurate
What are the disadvantages of ABB?
1) time-consuming & admin heavy to establish key activities & their drivers
2) difficult to identify clear individual responsibilities for activities
3) in ST many OH costs aren’t controllable & don’t directly vary with volume of activity for cost driver. Only cost variances to report= fixed OH expenditure variances
4) If the area of work involves price of raw materials = fluctuates –> needs reworking
What is an activity-based budget matrix
identifies activities in each column and the resources required to carry out activites in each row
What are sustaining costs
e.g keeping records & supervision - not attributed to cost drivers - doesn’t reflect their true cost behaviour = inappropriate budgets being set
Treated as fixed costs
What is feedback control
measurement of differences between planned outputs & actual outputs achieved - modification of subsequent action and/ or plans to achieve future required results
Feedback control cycle
Compare budget vs activity
Explain variance
either/or revise budget or corrective action and repeat
What is positive feedback
Feedback taken to reinforce a deviation from standard
Inputs/ processes not altered
What is negative feedback?
feedback taken to reverse a deviation from standard
amending inputs/ processes to system reverts to a steady state
e.g machine reset over time back to its original setting
What is single loop feedback
control to regulate the output of a system
Connecting a strategy for action to a result
e.g if result is different to what’s expected we observe results, take on feedback and try different approach to achieve targets
Don’t change targets
What is double loop feedback?
When a business is able, having attempted to achieve a target various times, to modify the target/ budget in light of experience or possibly reject target
What is a feedforward control system
compares budgeted results vs forecast and the differences trigger control action
If forecast is bad- control action is taken before actual results come through
What factors determine how suitable a budgetary system is?
1) type & size of organisation
2) type of industry
3) type of product& product range
4) culture of organisation
What sources of information can be used for budgeting
1) prev year actual results
2) internal sources e.g managers knowledge about state of repair of non-current assets , staff training needs, LT requirements of individual customers
3) estimates of cost of new products using methods e.g work study techniques & technical estimates
4) statistical techniques to help forecast sales
5) model e.g EOQ to forecast optimal inventory levels
6) external sources of info e.g suppliers price list, estimates of inflation, fx movements, strategic analysis of eco enviro
What is the pestel model
Political change
economic change
social change
technological change
legal change
other factors
What is political change
Change in Gov policy e.g fiscal policy can affect demand for an org’s products and/or cost in providing them
Change affect LT and ST planning - why planning is a continuous process
What is social change?
changes in social responsibilities & people’s attitudes affect organisations
Some social changes now recognised by law and can affect plans
What are economic changes
demands on people’s income can become more focused e.g from boom to recession
Money spent on necessity not luxury
Lack of saving deters investment - plans have to be modified if they’re to be realistic
can be local, national or international and include global factors e.g banking crisis & ongoing impact on world economies
What are technological changes
plans made on certain equipment available
older methods become more inefficient
decisions are taken to update operations
so budgets are no longer relevant
Need to draw up revised plans
What are legal changes
plans based on current legal framework
Known changes are factored in over time
Old info can become redundant
e.g Gov banning fast food ads between kids tv shows
What are other factos
competitive factors e.g activities of rivals
Stakeholders factors e.g increased pressure from trade unions to initiate change
Impacts of changes in a budgetary system
Time- consuming
improve planning, control & decision making
What issues should be considered before changing a budgetary system?
1) Are staff suitably trained to implement it successfully
2) Changing the system take up management time- could be used for strategy?
3) All staff trained in the system & understand procedure to be followed in changing to new approach. Lack of participation & understanding builds resistance to change
4) Costs of the system change evaluated against benefits. Benefits can be difficult to quantify - rigourous investment appraisal may be difficult to prepare
What factors can contribute to uncertainty in budgets?
Recession
changes to supplier prices
changes in external environment when a company has no control
What changes in the external environment affect budgets?
1) Social/ political unrest affects productivity (e.g industrial action)/ natural disasters
2) Unexpected machine breakdown - fall behind production schedules
3) customer demand different to forecast E.g major customer goes into liquidation can have an impact on that business too
4) Workforce performing less than expected e.g demotivated/ illness or better than thought
5) Competitors strengthen/ emerge- take some business away or their position may weaken leading to increased business
6) tech advances = products/ services are out dated and less desirable
7) increase price of materials - global commodity prices changes
8) inflation and IR movement - price changes
What techniques can be used to deal with uncertainty in budgets?
1) flexible budgets
2 ) rolling budgets
3) sensitivity analysis
4) simulation
What are spreadsheets?
Computer packages that store data in a matrix with cells
Help with budgeting
What are the advantages of spreadsheets?
1) can include large volumes of information
2) If a figure is amended all formulae update themselves - useful for sensitivity analysis
3) Results can be printed or distributed electronically/ quick & easy
4) Can represent results graphically
What are the disadvantages of spreadsheets
1) time consuming to develop. Benefits must be greater than cost to develop & maintain
2) Data can be accidentally changed/ deleted without user being aware
3) errors in design = invalid output. Due to complexity errors may be difficult to locate
4) Data used subject to high degree of uncertainty.
5) security issues e.g risk of unauthorised access/ loss of data
6) Version control issues
7) Educate staff to use them= time consuming
Characteristics of a modern economic environment (lean/ virtual businesses)
fast changing
flexible manufacturing
short product life cycle
products/ services highly customised
Own minimal traditional assets but can assemble resources to meet customer demand- flexible & quick to explot opportunities
What is beyond budgeting
practices intending to replace management models. Core concept is moving from a business model based on centralised hierarchies to devolved networks
CIMA- the idea that companies need to move beyond budgeting because of the flaws. Take on rolling forecasts, market-related targets
What are the 6 principles of beyond budgeting?
1) Structure has clear principles & boundaries - no doubts over responsibilities
2) Managers given goals & targets based on relative success- based on KPI
3) Managers given high degree of freedom for decisions- TQM & business process reengineering. BB= flat
4) Decision responsibility with front line teams - TQM and Business Process redesign (BPR) - aim of continuous improvement
5) Front line teams responsible for relationships with customers, businesses & suppliers - direct communication consistent with SCM concept
6) info support systems should be transparent & ethical
Benefits of beyond budgeting
1) faster response time - flexible org allows managers to react quickly
2) Better innovation - where performance is based on team & business unit results- adopts new innovations e.g working methods/ apps
3) lower costs- resources used effectively rather than entitlement. Better awareness of purpose
4) Improved customer & supplier loyalty- increased front line teams = deepen relationships
