Chapter 6: Budgeting Flashcards
Definition of budget:
A budget can be seen as a short term business plan, typically for a year and expressed in financial terms.
Usually have sub periods for month and separate budget for each key area
Role of a budget:
to convert strategic plans into actionable blue prints for the immediate future
Budgets essential for exercising control
define precise target such as cash receipts and payments, sales volume and revenues etc.
How is it linked to strategic plan?
Helps with step 4 - select strategic options and formulate plans. Foundation of the ‘pyramid of purpose’
Who’s in charge of budgets?
Managers have responsibility, accountants should play some role but not dominate the process
What is it helpful to identify before drawing up budgets?
limiting factors
Budgets are forward or backward looking?
forward
two types of budget
Periodic budget
Rolling budget - done each month, encourages full forward looking behaviour, but costly, only 9% north American businesses use them
Why are Budgets helpful? (5 reasons and a note)
- promotes forward thinking and short term problem identification
- help cordination between various of the business ie. stopping repeat purchases
- Motivation - manager tasks in line with business objective
- Basis for system of CONTROL compare plans and outcomes and allows for management by exception
- provides authority to spend, but correct ammount
Note - sometimes these reasons clash so must prioritise the uses
9 steps of budget setting process
- establish responsibility for process
- communicate guidelines to relevant managers
- identify limiting factor
- prepare budget for area of limiting factor
- prepare draft budget for other areas (top down or bottom up, top down more popular)
- review and coordinate budget
- prepare master budget
- communicate budget to all interested parties
- monitor performance relative to budget
two types of budget setting
incremental (60% used according to CIMA)
Zero based
Info on zero based budgeting
- philosophy that all spending must be jsutified,
- starts at zero, must provide good reason for funding
- encourages managers to question approaches
- subordinates may feel threatened
- becoming more relevant, and could be used once every three/four years
Most important budget and few points
Cash budget
- cash budget reflects business more comprehensively than any other statement as cash is key
- internal use, so no set formula, but usually broken into sub periods, in columnar form, payments and receipts of cash identified, surplus of cash identified each month, running cash balance identified
Activity Based Budgeting
identify limiting factor then the activites necessary to reach budgeted sales target
each cost centre will have own budget based on cost drivers
more direct link between costs and outputs, should provide more accurate budget and better understanding of resources
How does ABC budgeting improve control?
- more accurate budget motivates managers
- managers have direct control over cost drivers
7 Criticisms of Budgeting
- cannot deal with fast changing environment, quickly out of date
- too much focus on short term targets
- reinforce command and control, power at top
- time consuming for managers
- focus on business functions, not consumers
- protects costs, not lowers (hockey stick)
- promotes ‘sharp’ practices - building in slack
