Chapter 2: Introduction to budgeting Flashcards
Purposes of budgeting - PRIME
Planning - forces managers to look at the future and to set out detailed plans that will allow them to achieve targets in each department
Responsibility - a budget identifies who is responsible for achieving targets within the budget for each cost centre. Manager in charge of the budget is the budget holder
Integration - assist good communication and co-ordination between departments
Motivation - help motivate staff by setting targets for them to achieve - effective when linking bonuses
Evaluation and control - allow evaluation of actual results to the budgets - process in known as control and will allow management to improve the performance of the business in the future
Budgeting process
- Establish budget period (how long)
- Issue budget manual to staff who will be involved in setting the budgets
Can contain:
Objectives
Organisational structure
Administrative details
Procedures such as standard spreadsheet templates to complete
-Appoint budget committee
Group of managers and staff who will co-ordinate the process of preparation and admin (oversea budget preparation)
-Identify the budget coordinator (usually an accountant, head up process and ensure that everyone else completes their tasks in time)
-Each budget holder will draw up budget for their department
Budget accountant
responsible for production and issue of budget
They will monitor actual amount spent compared to budget on a regular basis and report to finance director, will prepare reports and anaylsis to enable senior management to make their decisions
Budget accountabilities
Senior managers will be responsible for preparing and providing information to enable the preparation of the operations budget
manager of each department or division will be accountable for their performance and the achievement of their budget, approval of budget by manager will mean the manager has accepted the budget and will now be held accountable for it
Budget cycle (or budgetary control system)
Budget cycle uses budget to assess the actual performance of the business and then takes appropriate actions to bring the actual performance in line with the budget
- Set Objectives - for example market share
- Budgets - preparing budgets in line with objectives - done at start of year in ‘planning’ stage
- Operating - Operate during year working to achieve targets set within budget
- Comparison - compare actual analysis with budgets in a process called ‘control’- variance analysis
Impacts of budget - motivation
increasing staff motivation
Improve staff motivation:
-create challenging targets
-be achievable
-act as effective targets for meaningful reward schemes
-Focus on items that managers have influence over
Participation in the budgetary process:
Top down budgeting
adv
disadv
Senior level management setting the budget with little or no involvement of lower level of staff. Budgets passed down to lower level staff who are expected to achieve them - enforcement budgeting
adv
-ensure best use of resources
-operational managers may lack skills or experience to set budgets
-Gives senior managers greater control
-better grasp of the big picture and overall corporate objectives
Disadv
-Senior managers may lack local knowledge so many budgets may lack relevance to the conditions faced
-targets may be unrealistic or unachievable
-poor use of senior managers time as they should be focusing on strategic considerations
-De-motivating staff if impossible targets imposed on them
Participation in the budgetary process:
Bottom-up budgeting
adv
disadv
Each department sets its own budget by identifying what they think they can achieve. Passed up through hierarchy for senior managers to review and agree
adv
-operational managers are likely to have better local knowledge so should set more meaningful budgets
-local managers will have better understanding of what is possible to achieve
-frees up senior managers time
-More motivating staff
-lower level managers more involvement in determining the future direction of the business which will help them build their skills
disadv
-can be very time consuming as many managers in many different departments will need to be involved
-Operational managers may lack the skills leading to poor budgets
- too many conflicting views
-targets may be too easy to achieve (budgetary slack)
-Budgets may lack consistency across different departments (one department try to cut costs, one department try to focus on maintaining quality)
Negotiated budgeting
Budgets are agreed between different levels of management.
This might involve department managers producing a first draft of budget which senior managers review and amend (will probs make more challenging to remove any possible slack) then pass back to departments
Types of budgetary systems - incremental budgeting
adv
disadv
Calculated by taking current year budget and adjusting for changes such as anticipated inflation and market growth
adv
-budget is stable and changes are gradual
-System is relatively simple to operate and easy to understand
-Co-ordination between department budgets is easier to achieve as their budgets will change at same rate
disadv
-Assumes activities and methods will continue in the same way from year to year. Some highly innovative businesses may radically ater what they do between on year and next
-No incentive to cut costs as in budget assumes everything will increase each year - if there is budgetary slack built into budget for one year it will automatically be put back into the budget for the following year
-Encourages departments to spend full amount of their cost budgets rather trying to save money - lead to inefficiency and waste of money in business
Types of budgetary systems - Zero based budgeting
adv
disadv
Budget that starts at zero every year and it takes nothing for granted - requires managers to justify every item of expenditure even if accepted in previous year. Opposite to incremental budget approach
adv
-More efficient allocation of resources - should eliminate budgetary slack
-Drives managers to find cost-effective ways to improve operations and identifies opportunities for saving money
-increases staff motivation by providing greater involvement and responsibility in decision-making
disadv
-V time consuming
-managers may be demotivated at being forced to justify every detail
-more challenging to undertake as necessary to train managers to be able to perform it, ZBB needs to be understood by many managers at various levels or cannot be successfully implented
-More difficult to administer the process and may affect communication because more managers are involved
Types of budgetary systems - Rolling budgets
adv
disadv
Amending the budget each month to account for developing circumstances in the marketplace
Always have a 12 month planning time horizon
adv
-Times of uncertainty around resource price and demand levels producing regular revisions to the budget will result in more up-to-date budgetary information
-Ensure that we have always considered a lengthy time horizon so there should be no unexpected suprises
-Encourages staff to be continually looking at changing internal and external variables and being aware of the impact
disadv
-involves much time and effort as we can end up performing budgeting on a monthly basis rather than once a year
-Continually changing the budgets can lead to de motivation of staff as they dont know what they are aiming for
-At the end of the year it can be unclear which series of budgets we are going to compare actual performance too, esp staff bonus calculations
Types of budgetary systems - Activity based budgets
adv
disadv
Initially to identify the causes of costs within the functions of the organisation - rather than assuming costs are on a functional basis(admin department can control all admin costs)
identify activities that actually drives costs - these are called cost drivers
adv
-Focuses management attention on the true drivers behind costs within an organisation which will give us far more chance of controlling the costs and thus improving profits
-Budgets are likely to be more accurate bcause we consider activities which lead to costs increasing
-More efficient improvement programs to be implemented because it considers the whole of a cost generating activity
disadv
-Time-consuming and resource intense as work will need to be done to identify a cost driver for every separate element of a cost (cost pools)
-Concept is not easily understood by managers - difficult to gain widespread staff support and may require considerable investment in training
Types of budgetary systems - Priority based budgeting
Modification of Zero-based budgeting
Focuses on an organisational priorities and allocates growth and savings in the budgets accordingly
on-going review of activities provided by departments and requires a statement of:
-objectivies/purposes of the activity
-targets/standards the activity is trying to achieve
-different levels at which the activity could operate
classed as essential/highly desirable/beneficial
Types of budgetary systems - Contingency based budgets
adv
disadv
deal with unexpected financial problems that arise suddenly.
It incorporates risk factors into the budget so the organisation can be prepared for uncertainty
adv
-Additional resources are set aside and therefore readily available should they be requried, enables better management of risk, providing a buffer for future uncertainties such as price fluctuations
-performance appraisal - managers will be appraised based on a fairer, achievable budget should initial uncertainities play out
disadv
-Budgetary slack - additional budgetary slack built into the budget to allow for overspend and therefore is encouraged to spend everything budgeted for
-straining resources - the business has to have enough resources to provide for contingency/back up plan and this may put a strain on the business resources and prevent other opportunities being undertaken
