Lektion 9 - Budgetting and forecasting Flashcards
Which needs does a budget fullfil?
- Motivation
- Communication
- Coordination
(!) Describe the roles of budgeting
General:
- Express proposed plan for future period quantitative
- Aggregate forecast of all expected transactions
- Aid to coordination & implementation of the plan
- Cover both financial & non-financial aspects of plan
_____________
Planning:
General:
- Planning phase in performance management
Strategic planning:
- Budgets provide feedback on strategic plans effect
Ressource distribution:
- Estimate resource demands of different departments or units to fulfil plans
Coordination:
- Balance all functions in organization
- Uncover potential bottlenecks before they occur
- Goal to make everyone follow the same plan
Examples:
- What to be produced or sold
- Products or services that should be developed
- Marketing campaigns that should be executed
- Organizational changes to be implemented
_____________
Accountability:
General:
- Evaluation phase in performance management
- Managers accountable for their departments budgets
- Purpose of both motivation & monitoring may conflict
Monitoring:
- Superiors checking subordinates stick to budget
- Relation to agency theory
- Deviations should be justified
- Opportunity to learn and react
Motivation:
- Achieved through goal-setting: Reward dont motivate
- Goals set by managers themselves extra motivating
- Rewards usually tied to reaching goals
______________
Process:
General:
- Learning phase in performance management
- Importance of the process exceed budget importance
- Process continue, numbers & circumstances change
- Activities during preparation of budget
Reflection:
- Focus on long term vs. short term urgent matters
- Time is a limited resource
Communication:
- Often more valuable than actual budget
- Top-down: Communication of objectives & priorities
- Bottom-up: Communication of opportunities, resource
needs, constraints, risks etc.
- Lateral: Communication enhances ability to work together toward common objectives
External: Communication with suppliers, customers, banks
________________
Ritual:
General:
- Budget used for other things than MC
- Sociological model of human behavior: Behavior in line with identity considered normal & acceptable by others
Habit:
- Budgeting taking for granted
Legitimacy:
- Budgets highlights professional & efficient managing
- Mostly for show
- Required if stock-listed company
- Shows control
- If a legitimacy role it is important to show political wise figures
Describe the building blocks of a budget
Revenue budget:
- Units sold * Sell price
- Usually based on forecast
- Manager cannot be held responsible
- Most critical and uncertain budget in profit budget
- More certainty if volume is constrained by capacity
- Less certainty if volume depends on marketplace
Influencing factors:
- Effective advertisement
- Good service
- Good quality
- Well-trained salespeople
______________
Budgeted production cost and cost of sales:
- Budget shows standard material and labour cost of planned volume of standard mix of products
- Budgeted costs may differentiate from sales budget: Additions or subtractions from finished goods inventory
- Budgeted cost not necessarily the cost of goods that will be purchased in the budget year
- Control over amount purchased is obtained by detailed ‘’open to buy’’ authorization made during the year rather than amount shown in budget
- Difference between purchase and sales represent additions or decrease in inventory
Production managers job:
- Plans for obtaining quantities of material and labour
- Production schedules to ensure needed resources
_______________
Marketing expenses:
- Expenses incurred to obtain sales
- Considerable amount committed before year begins
- Opening or closing offices
- E.g Hiring & training new personnel, advertising, contracts with medias
- Logistics expenses usually separate from order-getting
Logistic expenses:
- Behave more like production costs
- E.g. Order entry, warehousing, order pricking, transportation, collection of accounts achievable
________________
G&A expenses:
- General and administrative expenses
- Staff units expenses
- Discretionary expenses: Some are engineer expenses
________________
R&D expenses:
- Often specified amount of sales revenue
- Based on long-run average
Approaches:
Focus on total amount: Current spending amount or larger amount to be spent in good times. E.g. Increased revenue or develop chance of significant new products or process
Aggregating spending: Aggregating planned spending on each project plus allowance for likely work to undertake
_________________
Income taxes:
- Not always accounted for: Tax policies at headquarter
_________________
Capital budget:
- Stated approved capital projects
- Lump sum of small projects: no need high-level approval
- Typically prepared separate from operating budget
- Typically prepared by different people
- During year capital expenditures are considered at various levels before finally being approved
- At budget time approved projects are assembled into overall package and examined in total: If exceeding some deleted, reduced in size or deferred while projects remaining there be estimate on cash spent each quarter to the cashflow statement
_________________
Budgeted balance sheet
- Decisions included in operating- and capital budget
- Not a management control device: Yet parts for control
- Operating managers with influence on level of inventory, accounts receivable and accounts payable is held responsible for levels
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Budgeted cash flow statement:
- Inflow and outflow of cash during year
- Treasurer need estimate of cash requirement for intervals to the planning lines of credit and short term borrowing
- Show amount of cash to become retained earnings
- Show amount of cash borrowed from outside sources
- Important for financial planning
(!) Describe the different types of budget preparations in the business process
Top-down budget preparation:
General:
- Top management set budget for lower levels
- Top management has full control over end results
- Often in public service organizations
- Often in organizations with uncertain money spending
Process:
Planning:
- Aggregating figures
- Break down to detailed controlling or budget function
Suggestions:
- 3. Sent to responsible managers
Check:
- Managers check realistic of figures
- Managers accept figures or protest with arguments
Changes:
- Controlling department decide changes included
- Top manager has last word in including changes
Consolidation:
Complete budget:
Advantages:
- Faster
- More control on focus from top management
Disadvantages:
- Participation of LL managers & employees is very low
- Negative effect on motivation
- Less personal commitment and acceptance
- Less understanding of how to perform job
- Less realistic budget figures
- Less effective information exchange
- No benefit of expertise & personal knowledge of LL-managers & employees
____________
Bottom-up budget preparation:
General:
- Lower-level managers and employees participate
- Often in organizations with certain money spending
- Often when managers have the best information
- Especially if an uncertain and dynamic environment
Proces:
Assumptions:
Instructions:
Planning:
Suggestions:
- Assessment by managers based on received budget guidelines
Consolidation:
- Controlling department consolidate figures to a complete budget
Complete budget:
- Controlling department send figure to top management
Advantages:
- Generate more commitment to budget objectives
- More realistic due to information
- Positive effect on managerial motivation
- Greater acceptance of budget goals
- Effective informationsharing: Expertise from LL-manager
Disadvantages:
- Risk of included buffers easier reaching budgets
- May derivate from top managers prediction or ambition
_______
Iterative budget preparation:
- Repeat bottom-up until top management satisfied
- Controlling department often make revision due to time & include negotiation between LL manager & top management
Advantages
- LL-managers is involved
- Figures in line with top management intention
Disadvantages:
- Time consuming
- Risk of budget gaming
- Risk of managers trying to trick one another
- Not always commitment: Potential conflicts in direction
(!) Describe the different types of budget evaluation in the business process
Top down / Tight budget control:
General:
- Reference to mechanistic control
- Strict evaluation
- Outcome often linked to reward or punishment
- Lille acceptance of deviations: Need explanation and plan for preventing it in future
Advantages:
- Increased disciplin
Disadvantages:
- Managers may experience evaluation anxiety
- Risk of more gaming
Implementation:
- Low-cost strategies
- Stable & certain environment
__________________
Bottom up / Loose budgetary control:
General:
- Reference to organic control
- Not always having a budget
- Mutual understand about budget as a ‘‘guess’’
- Educated budget guess based on available info
- Constructive discussion on performance, learning objectives and potential improvements
Advantages
- Managers feel supported and strengthened
- Create willingness to make decisions
- Create willingness to take the initiative
- More creativity
Implikation:
- Differentiation strategy
- Dynamic and uncertain environment
(!) Describe what is meant by gaming and reasons for it to occur
General:
- Behavior with purpose beside improving just control
- Can be based on individual or departments goals
- Shows figures better or worse than actually expected
- Aims to achieve individual instead of corporate goals
- A risk when using budgets as performance measure
- Managers has a relevant information advantage
_________________
Gaming during budget processes:
- Exposure: Showing higher revenues or lower costs
- Hedging: Showing lower revenues and higher costs
_________________
Gaming actions in budget period:
- Accelerate sales at year end
- '’Big bath’’ when budget is not achieved
_________________
Budgetary control:
Tight budgetary control:
- Often higher amount of gaming (especially hedging)
- More difficult to get away with gaming
- More reasons to indulge in gaming
- To avoid deviations and increase image
Loose budgetary control:
- Often lower amount of gaming
- Easier to get away with gaming
- Less reasons to indulge in gaming
_________________
Profitability / Economic situation:
Bad economy:
- Gaming with more positive picture
- Organization may close divisions if negative picture
- Organization may see manager as giving up or lazy
- Top managers more alert of gaming
Good economy:
- Gaming with more negative picture
- Better results than budget creates positive reaction
- If not reaching targets top management unsatisfied
- Top managers less alert of gaming
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Uncertainty:
- Buffer if something bad happens
- Depends on managers risk aversion
- E.g. Future demand
_________________
Reward system:
- Managers creates slack if goals result in reward
_________________
Personality:
Risk-willing manager:
- Likely to use exposure
- Optimistic and ambitious budget
Risk-averse manager:
- Likely to use hedging
- Less ambitious budget
(!) Describe the critics against traditional budgets
Internal gaming:
- Benefits of budgets don’t exceed cost of gaming
Internal myopia:
Sub-optimization:
- Optimize parts instead of whole organization
- Risk due to performance measures
Short term:
- Good figures now vs. long term performance
- Risk due to frequent performance measures
________________
Resource consuming:
- Budgets are time-consuming
- Conflict between simplified budget and budgets involving large parts of organization in the process
________________
Time period:
- Calendar year is not a good time period
- Too long due to environment changes
- 12 month plan in January while 3 month plan in October
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Impossible reliability :
- World changing faster than ever
- 12 month too long for budget planning
- Budget already outdated when budget period starts
- Often useless: Virus- climate- refugee or financial crisis
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Less flexibility
- Hard flexibility & plan change when already planned
- No plans makes more room for different alternatives
- Flexibility important in fast changing world
- Budgets based on habits: Limited innovation
_________________
Inefficiencies:
- Inefficiencies are carried over to next year
Contradicting roles:
- Strength and problem that budget has many roles
- Fulfilling all roles either challenge or impossible
Stretch budget:
- Optimistic budget: Risk of closing, then more than this
- Made to motivate: ‘’Go the extra mile’’
- No realistic forecast
Political budget:
- Aiming at legitimacy
- Conservative budget: No exposing of ourselves
- Does not plan future
- Not motivating
(!) Describe the alternative to budgeting: Rolling forecast
Rolling forecast:
Calendar year:
- Prepared any time during year
- May cover any time period
- Forecasts often overlap: ‘’Rolling’’
Level of detail:
- Often less detailed than traditional budgets
- Focus on KPI´s & the aggregated budget
- Less concerned about individual costs or sales item
Frequency:
- Often only when needed: Changes conditions
- Regular updates on forecast is more like budgets
Commitment:
- Sometime regarded as a commitment just as budgets
- Sometimes just a forecast: No one accountable
- Sometimes partly commitment, partly forecast
Evaluation:
- Evaluation often only if forecast with commitment
- Often just discussion of learnings from outcome
- Risk of evaluation anyway (hidden commitment)
Describe what is meant by performance management
General:
- Used on several levels in a company
- Feedback must be given regularly
- A little better for every loop
- Control practices to ensure planned activities are performed & goals are met
____________
Loop activities:
Planning phase:
- Discussions and decisions
- Often when budgets arrive or before forecasts
- Set goals and targets by performance measures
Examples:
- Development of new product
- Building new production line
- Investment in machinery
- Hiring of people
- Figures
Execution phase:
- Daily operations: Check plan is followed
- Most important phase
Evaluation phase:
- Outcome compared to plan: Deviations analyzed, performance discussed, feedback given
- Appraisal of the job done: Rewards or anxiety
Learning phase:
- Most important phase long term
- Sometimes given less priority
Describe budgetting in a crisis
Increased importance of planning:
Hypothesis:
- Higher risk of failure
- Increased pressure to attain goals
- Increased uncertainty & sensitivity to environment
- More planning, forecasts, communication, coordination
Findings:
- Re-budgeting
- Stronger top-down orientation
- Higher frequency
- Increased scenario analysis & forecasting (Flexibility)
- Deeper variance analysis
_____________
Increased importance of resource allocation:
Hypothesis:
- Reduced funding and financing opportunities
- Risk of liquidity problems
- Stronger liquidity management
- Centralized decision making
- Stricter resource management
Findings:
- Need for more flexibility in resource decisions
- Stricter return requirements and return calculations
- Stronger centralization for spending authorization
______________
Decreased importance of performance evaluation:
Hypothesis:
- Targets become unattainable
- High uncertainty reduce usefulness of target setting
- More subjective performance evaluation
- More emphasis on non-financial measures
Findings:
- Company-wide rewards instead of individual rewards
- Use of, e.g., recent forecasts, results form previous years, non- monetary/qualitative results
Describe the model for interactive use of budgets
General:
- 4x4 matrice
- X-axis = Style of budget: Diagnostic or interactive
- Y-axis = Strategic change: Low or high
____________
Diagnostic:
- Traditional purpose of performance
- Attribution of responsibility for outcomes
- Strategic priorities translated into specific objectives & communicated downwards through financial targets
Interactive:
- Constant challenge of data, assumptions & plans
- Facilitation of organizational learning
- Continual exchange and interactions between top management and lower levels across functions
- Dialogue & debate over variance, adaption & responses
_____________
Quadrants:
Diagnostic + low = Match. Performance highest
Interactive + low = Mismatch. Performance lowest
Diagnostic + high = Mismatch. Performance lowest
Interactive + low = Match. Performance highest
Describe what is meant by a master budget
- Comprehensive, organisation-wide set of budgets
- Embrace impact of operating & financing decisions
- Coordinate all financial projections in individual budgets
(!) Describe the alternative to budgeting: Beyond budgeting round table
Beyond budgeting round table / BBRT:
General:
- Separate target setting, forecasting and resource allocation since they conflict in traditional budgeting
- Despite focus on KPI´s instead of data the three steps makes it even more time consuming
- Top managers may want detailed analysis of deviations from the three plans
- Does not deal with problem of gaming
Performance evaluations based on relative performance contracts with hindsight:
- Budget target based on benchmarked performance:
- Allows adjusting for uncontrollable factors
- Challenging but achievable target increase motivation
- Increase accuracy & perceived fairness of evaluations
- Targets with hindsight are adjusted by incorporating actual operating & economic effects during the period
- Reduce gaming behaviors & motivational problems
Rewards based on subjective performance evaluation with emphasis on group performance:
- Doing the best for firm under current circumstances
- Promotion of teamwork
- Encouragement to engage in strategic initiatives
Performance evaluation using various non-financial measures:
- Better alignment with strategic objectives
Budgets only serve the financial planning needs:
- Budget not used as target for performance evaluation
- Planning will become more accurate and useful, can be adapted to changing circumstances
Radical decentralization of the organization principles:
- Provide a governance framework based on clear principles, values and boundaries
- Create high performance climate based on relative success
- Give people freedom to make local decisions that are consistent with governance principles and the organization’s goals
- Place the responsibility for value-creating decisions on front-line teams
- Make people accountable for customer outcomes
- Support open and ethical information systems that provide “one truth” throughout the organization
- Empower people making decisions aligned with strategic goals
- Resources not budgeted in advance, rather available at short notice
- Shift from results control towards controls based on employee selection, corporate visions and values, codes of conduct, training etc
Relate the topic to the case with a master budget
- Sales budget
- Production budget
- Direct materials budget
- Direct labour budget
- Manufactoring overhead budget
- COGS + Ending finished goods inventory budget
- Selling and administrative expense budget
- Cash budget
- Budgeted income statement
- Balance sheet
Relate the topics to the three cases
Medal Rain:
- Discussion of PC versus investment center
- Discussion of ROI versus EVA
Turnaround:
- Calculate ROI, RI & EVA
- Discuss choose of measure
Setting appropriate target:
- Continuous improvement + benchmarking
