Chapter 7 - Preparing budgets Flashcards
What are the purposes of budgets?
- Planning
- Control and evaluation
- Co-ordination
- Communication
- Motivation
- Authorisation
What are some advantages of budgeting?
- Actions and goals aligned
- Forces management to consider future
- Better prepared for change
- Improve decisions
What are some disadvantages of budgeting?
- Time consuming
- Subjective
- Create conflicts
- Encourages short-termism
- Deters innovation
What are the difficulties of budgeting for global companies?
- Currency
- Legal framework
- Customer tastes
- Competitor actions
- Political climate
What is the principal budget factor?
Key resource is in short supply and affects planning decisions
What is a sales budget?
How many units can be sold
What is a production budget?
How many units must be produced to meet budgeted sales
How is the production budget calculated?
Sales budget
Closing inventory finished
(opening inventory)
What are raw materials, labour and overheads budgets based on?
Production budget
What 2 parts make up the raw materials budget?
- Materials purchases
- Material required in production
How is the materials purchases budget calculated?
Materials required
Wastage
Total material requirement
Closing inv raw mat
(Opening inv raw mat)
How is total production calculated?
Sales budget
Closing inv finished
(Opening inv finished)
Good production required
Faulty production
How is direct labour calculated when variable?
Production budget x direct labour cost per unit
What is the overhead budget based on?
Budgeted overhead absorption rates
What is included as part of non-production budgets?
Selling and distro costs
How is the master budget summerised?
Budgeted:
- P/L
- Cash budget
- SOFP
What is a cash forecast?
Estimate of cash receipts and payments for a future period under existing conditions
What is the purpose of a cash budget?
- Plan for cash deficits and surpluses
- Compare with actual spending
- Assess and integrate operating budgets
Why do cash receipts and payments differ from sales and COS in the P/L?
- Not all cash receipts/payments affect P/L
- Not all items in P/L are cash
- Timing differences
- Irrecoverable debts never received in cash
What are the steps to prepare a cash budget?
- Layout
- Fill in simple figures
- Work out complex figs
- Calc closing cash bal
What will a cash budget layout typically include?
- Clear distinction between cash receipts and payments
- Net cash flow for each period
- Closing cash balance for each period
What are the simple figures that are filled in?
- Wages and salaries
- FOH expenses
- Dividends
- Purchase of NCA
What are the more complex figures?
Info on sales and purchases:
- Timing must be found from credit periods
- VOH may require info about production levels
- Purchases may require calcs based on production schedules and inv balances
What are some examples that need to be considered when interpreting a cash budget?
- Balance at period end
- Is there sufficient finance
- Best time to make discretionary expenditure
- Plan for dealing with surpluses
- Key causes of deficits
What is sensitivity analysis?
Revising the budget on the basis of a series of varied assumptions
One assumption can be changed at a time
What does a stress test do?
Examine how a budget would perform/function under severe/unexpected pressure
What re some of the sources of business stress?
- sudden economic changes
- cybersecurity attacks
- Loss of a major customer
- Foreign exchange rate risk
- Industrial action
What are some of the purposes of stress testing?
- Quantify risks
- Warning signs for stress events
- Tailored software
What are some sources of budget data regarding sakes?
- General economic data
- Public announcements
- Historical sale trends
- Market research
- business unit consultation
How is big data useful?
Can be analysed to provide insights that lead to better informed decisions
What are sources of big data?
- Media
- Internet
- Machine generated
- Databases
What are the benefits of big data?
- Competitive advantage
- Drives innovation
- Improves productivity
How can big data help stress testing?
- Identify stress events
- Quantify effect of stress events
- Test validity of assumptions
- Identify correlation
- Create/identify warning signs
How can the 4 V’s cause issues?
- Volume - not all data relevant
- Variety - no consistency in how big data is presented
- Velocity - software plays critical role
- Veracity - increased risk of inaccuracies
What are the problems in performing big data analytics?
- Data freely available and can be used by others
- Requires significant investment
- Distorted by outliers
What is a periodic budget?
Shows costs and revenues one period at a time
What is a rolling budget?
Budget that is continuously updated
Why may companies use a rolling budget?
- Accurate forecasts cannot be made
- Areas of business that need tight control
What are the advantages of rolling budgets?
- Reduce uncertainty in budgeting
- Used for cash management
- Force managers to continuously look forward
- More realistic in a changing environment
What are the disadvantages of a rolling budget?
- Time consuming
- Difficult to communicate frequent changes
What is incremental budgeting?
Take previous year’s budget and add on % to allow for inflation and cost increases
What are the advantages of incremental budgeting?
- Simple
- Low cost
- Quick to administer
- Suitable in stable environments
- Practical
What are the disadvantages of incremental budgeting?
- Backward looking, unsuited to changing environments
- Assumes all current activities are continued
- Encourages over-spending
- Unchallenging targets
- Consideration not given
How can the problems of incremental budgeting be solved?
By using Zero based budgeting (ZBB)
What is ZBB?
- All activities are re-evaluated each time a budget is formulated
- Assumes function doesn’t exist and is at 0 cost
What is ZBB suitable for?
- Allocating resources in areas where spend is discretionary
- Public sector organisations
- New functions
What is the 4 step process for implementing ZBB?
- Determine activities that are to be used as the object of decision packages
- Request managers to prepare alternative decision packages
- Rank packages in order of contribution
- Fund decision packages based on ranking
What are the 2 types of decision packages?
- Mutually exclusive
- Incremental
What is a mutually exclusive decision package?
Different methods of meeting same objective
What is an incremental decision package?
Divides activity into different levels of service/support needed to carry out activity
What are the advantages of ZBB?
- Creates organisational environment where change is accepted
- Better focus on goals
- Forces managers to examine activities
- Establishes measure of performance for each decision package
- Gets managers involved in the budgeting process
What are the disadvantages of ZBB?
- Time consuming
- Temptation to concentrate of short-term cost saving
- Requires budgeting skills
- Ranking process can be hard
- Rigid
What is Activity based budgeting (ABB)?
Budgeting based on an activity framework utilising cost driver data
What is the basic approach of ABB?
- Identify cost drivers
- Calc cost driver rate
What are the advantages of ABB?
- Draws attention to costs of overhead activities
- Recognises that activities drive cost
- Provides info for TQM
What are the disadvantages of ABB?
- Expensive
- Relies on ABC
What is beyond budgeting?
Companies moving away from traditional budgeting techniques
When are beyond budgeting approaches most commonly used?
Organisations that face regular environmental changes or where continuous improvement is critical
What are some common features of beyond budgeting?
- Use of rolling budgets
- Wide range of performance measures
- Targets set on benchmarks observed externally
- Greater focus on future
- Innovation encouraged and rewarded
- Budgets set locally
What are the advantages of beyond budgeting?
- Continuous planning
- Targets more challenging
- More Innovative
- Managers involved in decision making
- Decisions taken quicker
- Creates info systems
What are the disadvantages of beyond budgeting?
- Planning more complicated
- Effort reduced when trying to achieve unrealistic benchmarks
- Organisational goals less clear
- More accurate and up to date info required
How is total available labour hours calculated to incorporate idle time?
Hours/% of hours worked excluding idle time
What category of overhead is rent?
Admin
Is a royalty a direct cost?
Yes, not included in overhead budget
