Topic 3 - Budgeting and Forecasting Flashcards
Why do organisations prepare budgets? ACRONYM 5
Planning, Responsibility, Integration and coordination (goal congruence), Motivation, Evaluation and control (PRIME)
Define goal congruence
To achieve the best outcomes, individual goals should align with organisational goals. This is known as goal congruence, when the goals or objectives of different individuals, departments or levels within an organisation are aligned, typically toward a larger common goal
PRIME ACRONYM
Planning, Responsibility, Integration and coordination, Motivation, Evaluation and control (PRIME)
What is a budget?
A quantified plan of action detailing what an organization intends should happen in the future.
What is a forecast?
A prediction of what is likely to happen in the future given a certain set of circumstances.
What is the budget committee?
The budget committee is the co-ordinating body in the preparation and administration of budgets.
Who makes up the budget committee?
It is usually headed up by the managing director (as chairman), who is assisted by a budget officer – usually the finance director or another accountant. Every part of the organisation should be represented on the committee.
What are the functions of a budget committee? 6 CATCPM
Co-ordination, Approval, Timetabling, Provision of information, Communication, Monitoring of actual and budgeted results to assess the effectiveness of the budgeting process.
What is the usual period covered by a budget?
One year, often divided into 12 monthly or 13 four-week control periods.
What is a budget manual?
A collection of instructions governing budget responsibilities, procedures, forms, and records.
What is contained within the budget manual? 5
A budget manual may contain the following:
• An explanation of the objectives of the budgetary process
• Organisational structures
• An outline of the principal budgets and the relationship between them
• Administrative details of budget preparation
• Procedural matters
Which of the following is not one of the main purposes of a budget?
A To compel planning
B To communicate targets to the managers responsible for achieving the budget
C To inform shareholders of performance in meeting targets
D To establish a system of control by comparing budgeted and actual results
C To inform shareholders of performance in meeting targets
What is the principal budget factor?
The factor that limits an organization’s activities, usually sales demand.
What else might be the principal budget factor for a business? 4
Capacity e.g. machines
Material availability
Supply chain is slow moving
Labour shortage / limited Labour hours
What does a master budget include?
A consolidation of all subsidiary budgets, including income statement, balance sheet, and cash budget.
Is a master budget fixed? What is the purpose of a master budget?
The master budget relies on a particular set of assumptions. It is not designed to change and could therefore be said to be fixed. The major purpose of a fixed budget lies in its use at the planning stage, when it seeks to define the broad objectives of the organisation.
Which budget is usually prepared first?
Sales budget.
Order of budget preparation 4
TOPLINE SUMMARY
A Sales Budget (units/value)
B Production budget (units)
Labour budget (hours/value)
Overheads budget (value)
C Material USAGE budget (kg/litres etc)
D Material PURCHASE budget (kg/litres/value)
DETAILED BREAKDOWN
A Sales Budget (units/value)
A.1 Consider op/cli inv (finished goods)
Sales - how much do we think we can sell
Cl inv - what do we want to end the year with
LESS Open inv
EQUALS Production required
A.2 Losses incurred/damaged goods
B Production budget (units) - How much will production cost?
Units produced x kg per unit from cost card
Labour budget (hours/value)
Overheads budget (value)
C Material USAGE budget (kg/litres etc)
C.1 Consider op/cli inv (raw materials)
Production usage
Cl inv
LESS Open inv
EQUALS Materials required
C.2 Losses incurred
D Material PURCHASE budget (kg/litres/value) - Think about discounts
If a company has no production resource limitations, in which order would the following budgets be prepared?
1 Material usage budget 2 Sales budget 3 Material purchase budget 4 Finished good inventory budget 5 Production budget 6 Material inventory budget
A 5,4,1,6,3,2
B 2,4,5,1,6,3
C 2,4,5,1,3,6
D 2,5,4,1,6,3
B 2,4,5,1,6,3
When preparing the master budget, which of the following tasks would normally be carried out first?
* A Calculate the overhead absorption rate
* B Establish the organisation’s long-term objectives
* C Identify the principal budget factor
* D Prepare the sales budget
B Establish the organisation’s long-term objectives
What does the budget period usually cover? A) One month B) One year C) Three years D) Five years
B: One year
Which of the following is a key function of the budget committee? A) Setting sales prices B) Conducting audits C) Preparing financial statements D) Monitoring actual and budgeted results
D: Monitoring actual and budgeted results
Which of these is an example of a principal budget factor? A) Sales demand B) Overhead cost C) Administrative expenses D) Marketing budget
A: Sales demand
What is the main assumption of forecasting using historical data? A) The past provides guidance to the future B) The budget is fixed C) Costs remain constant D) Sales will always increase
A: The past provides guidance to the future
What is a functional/departmental budget?
Functional/departmental budgets include budgets for sales, production, purchases, labour and administration.
What is sensitivity analysis?
A technique used to assess the impact of changes in assumptions on budgeted outcomes.
A sensitivity analysis (sometimes called a ‘what if?’ analysis) might be performed to show the effect of changes such as these.
What is the High-Low Method used for?
The high-low method is a technique for analysing the fixed and variable cost elements of a semi-variable cost and thus predicting the cost to be incurred at any activity level within the relevant range.
What are the steps of the High-Low Method?
- Pick high/low activity levels - The difference between the total costs of these two periods will be the total variable cost of the difference in activity levels.
- Calculate variable cost per unit
- Calculate fixed costs
- Use y = a + bx to predict the cost for a given activity level.
Linear Graph formula
y = a + bx
- y is the dependent variable
- a is a constant
- b is a constant
- x is the independent variable
Semi Variable Graph formula
TC (dependent var)
This can be adapted to express a relationship between costs in the form TC = FC + (VC/unit √ó output) where:
* TC is the dependent variable
* FC is a constant
* VC/unit is a constant
* Output is the independent variable
Which method is commonly used to separate fixed and variable costs?
A) Break-even analysis
B) High-low method
C) Marginal costing
D) Sensitivity analysis
B: High-low method
What is a disadvantage of the high-low method?
A major disadvantage of the high-low method is that it takes account of only two sets of data, which may not be representative of all the data available.
What is Linear Regression Analysis?
Linear regression analysis is a statistical technique for establishing a straight line equation to represent a set of data.
Which statistical technique is superior to the High-Low Method for cost estimation?
Linear Regression Analysis.
Why is Linear Regression Analysis considered superior to the High-Low Method?
It takes into account all sets of recorded data, providing a more accurate estimate.
What is an issue of the linear regression analysis and high-low method?
A further issue with the use of both the high-low method and linear regression analysis is
that the quality or reliability of the linear equation derived will depend upon the correlation between the variables.
What is correlation in data analysis?
Correlation is the degree to which one variable is related to another, ie the degree of interdependence between the variables.
What are the types of correlation?
Positive correlation: As one variable increases, so does the other.
Negative correlation: As one variable increases, the other decreases.
What does the coefficient of correlation (r) indicate?
“The coefficient of correlation, r
The degree of correlation between two variables can be measured using the coefficient of correlation, r.
r has a value between –1 (perfect negative correlation) and +1 (perfect positive correlation).
If r = 0 then the variables are uncorrelated.”
What does a coefficient of correlation (r) of 0 mean?
The variables are uncorrelated.
What is the coefficient of determination (r²)?
The coefficient of determination, r2, is a measure of the proportion of the change in one variable that can be explained by variations in the value of the other variable.
Between 0 and 1
Scenario question. The coefficient of correlation, r, between vehicle maintenance costs and vehicle running hours has been calculated to be 0.96.
What does this degree of correlation indicate?
The coefficient of correlation, r, between vehicle maintenance costs and vehicle running hours has been calculated to be 0.96.
What does this degree of correlation indicate?
r = +0.96
r2 = +0.9216
92.16% of the change in y (cost) can be explained by the change in x (output). 7.84% can be explained by other factors.
What is a time series?
Time series: A time series is a series of observations recorded over time. Any pattern found in the data is assumed to continue into the future and a forecast is produced. There are four components of a time series: trend, seasonal variations, cyclical variations and random variations.
Which components make up a time series?
- Trend
- Seasonal variations
- Cyclical variations
- Random variations.
What is a trend?
Trend: The trend is the long-term underlying movement in the data.
What is a seasonal variation?
Seasonal variation: Seasonal variations are short-term patterns that occur during different periods such as rush hour during the day, weekdays during the week, or warmer months of the year.
What is a cyclical variation?
Cyclical variations: Cyclical variations are medium to long-term patterns such as economic booms and recessions. In practice they are difficult to predict and model.
What is a random variation?
Random variations: Random variations are the product of randomness and so cannot be predicted.
What is the purpose of a moving average in time series analysis?
A moving average removes seasonal variations to forecast long-term trends. A moving average is an average of the data of a fixed number of periods. The aim
of calculating moving averages is to remove the effect of seasonal variations, for use in forecasting long-term trends.
What are the two models used for estimating seasonal variations?
Seasonal variations can be estimated using:
* The additive model TS = T + SV or
* The multiplicative model TS = T √ó SV
Where TS = actual time series, T = trend, SV = seasonal variation.
If the trend is increasing or decreasing over time, the multiplicative model produces more accurate forecasts than the additive model. This is because, if the trend is increasing or decreasing, seasonal variations are likely to be increasing or decreasing too. The additive model simply adds an unchanging figure to the trend figures.
When looking at seasonal variations when determing to use the additive vs muliplicative model what factors determine this?
If the trend is increasing or decreasing over time, the multiplicative model produces more accurate forecasts than the additive model. This is because, if the trend is increasing or decreasing, seasonal variations are likely to be increasing or decreasing too. The additive model simply adds an unchanging figure to the trend figures.
What are the assumptions of time series analysis? 3
- Past trends will continue in the future
- A linear trend relationship exists
- Seasonal variations are constant or proportional to the trend line.
Why are cyclical and random variations not modelled?
Cyclical variations are difficult to predict and random variations are impossible to predict. They are therefore excluded from the models
What are data outliers?
Data outliers are observations that are abnormal and can therefore significantly distort the results. Sometimes outliers are removed from the data set before applying forecasting techniques.
What are Big Data characteristics? 3
High volume, high velocity, high variety of data used for identifying trends.
What is Big Data management?
Big Data management relates to the storage and administration of large volumes of data in all forms.
What is Big Data analytics?
Big Data analytics are used to analyse the data to identify relationships, patterns and other correlations in order to improve profitability.
What is Data mining?
Data mining is the process of sorting through data to identify patterns and relationships between different items.
What are sources of Big Data?
Sources of Big Data include website traffic, online trends, customer feedback, promotions, responses to emails and online promotions and adverts, microeconomic factors specific to the business’s industry.
What are the benefits of Big Data? 2
- Forecasting demand
- Identifying customer preferences.
What are common problems with Big Data? 4
- Privacy concerns
- Security issues
- Incorrect data
- Lack of forecasting tools and skilled analysts.
What is Artificial intelligence (AI)?
Artificial intelligence (AI) is the use of computers to do tasks which are thought to require human intelligence eg learning, knowing, sensing, reasoning, creating things and generating and understanding language.
What is Machine learning?
Machine learning is a field within AI where computers learn to do things rather than follow pre-programmed rules. Predictions improve as more data is analysed and the forecasting formula is refined.
Why should users of information produced by data analytics take steps to ensure the analysis is reliable? 1 And what are instances where data bias can take place? 3
1 This helps you to demonstrate professional scepticism
3 • There may be bias inherent in the data that is analysed. This may be intentional or unintentional.
• The data may have been intentionally manipulated during the analysis process.
• The data may have been analysed accurately, but the presentation of the data, or the conclusions drawn from it may be flawed or may have been designed to mislead the users.
Omitted variable
A variable is excluded from the data model and therefore the cause of a change in one variable is incorrectly attributed to another variable in the model eg a change in sales volume
Cognitive
This relates to human perception and includes bias depending on how data is presented (eg infographics or the order of presentation, known as the ‘framing effect’) and ‘anchoring’ (eg being influenced by the first piece of information offered or ‘stuck’ on last year’s numbers) eg budgeting
Confirmation
This occurs when people see data that confirms their beliefs and they ignore (consciously or sub-consciously) data that disagrees with their beliefs eg new product/market research
Survivorship
This is the tendency towards studying successful outcomes while excluding unsuccessful outcomes eg if only repeat customers are asked to participate in a survey
Why does data presented graphically also requires professional scepticism? 2
Data presented graphically also requires professional scepticism. Bias can appear in charts and infographics, either deliberately or through misunderstanding.
Bias can occur by:
• Manipulating axes on a graph or bar chart.
• Omitting some data.
What is Imposed or top-down budgeting?
Imposed or top-down budgeting is where top management prepare a budget with little or no input from operating personnel, which is then imposed upon the employees who have to work to the budgeted figures.
What are the situations when imposed budgets are effective? 4
The situations when imposed budgets are effective:
• In newly-formed organisations
• In very small businesses
• During periods of economic hardship
• When operational managers lack budgeting skills
What are the advantages of top-down budgeting? 3
- Enhances coordination and strategic objectives
- Uses senior management experience effectively
- Reduces time spent on budgeting.
What are the disadvantages of top-down budgeting? 3
- Can lead to dissatisfaction and low morale
- Budgets may be unrealistic or unachievable
- Limits acceptance of organizational goals.
What is participative or bottom-up budgeting?
Participative or bottom-up budgeting is where budgets are developed by lower-level managers who then submit the budgets to their superiors. The budgets are based on the lower-level managers’ perceptions of what is achievable and the associated resources.
What are the advantages of bottom-up budgeting? 3
- Increased commitment to objectives
- Based on up-to-date information
- Improves morale and motivation.
What are the disadvantages of bottom-up budgeting? 3
- Time-consuming negotiations required
- Managers may introduce budget slack (overstating costs or understating revenues)
- Senior management changes may cause dissatisfaction.
What is the difference between imposed (top-down) and participative (bottom-up) budgeting?
Top-down: Budgets are prepared by senior management with little input from employees.
Bottom-up: Lower-level managers develop budgets and submit them to their superiors.
What is budget slack?
The practice of overestimating expenses and or underestimating the project revenues when prepping a budget statement for the rest of the financial period. Makes budget more flexible by eliminating slack, the company can make more precise financial predictions and aspire better organisational decisions.
Might be due to
Uncertainty
Information asymmetry (person preparing budget doesn’t know enough about specific team)
Managers get rewards so they set it lower
What is incremental budgeting?
A traditional approach where the forthcoming year’s budget is based on the current year’s results modified for changes in activity levels and prices. Incremental budgeting is a reasonable approach if the current operations are as effective, efficient and economic as they can be.
What are the advantages of incremental budgeting? 1
- Easy to prepare.
What are the disadvantages of incremental budgeting? 2
- Inefficient
- Budgetary slack is protected and carried forward.
What is zero-based budgeting (ZBB)?
A budgeting approach where each budget should be prepared from zero, and every item of expenditure must be justified separately to be included in the budget.
What are the advantages of zero-based budgeting? 3
- Obsolete or inefficient operations can be identified and removed.
- Results in a more efficient allocation of resources.
- Particularly useful for discretionary costs like marketing and training.
What are the disadvantages of zero-based budgeting? 3
- Time-consuming
- Expensive
- May emphasize short-term benefits over long-term goals.
What is a rolling budget?
A budget that extends by an extra period as the current period ends, instead of preparing an annual budget.
They are particularly useful when an organisation is facing a period of uncertainty so that it is difficult to prepare accurate plans and budgets.
Instead of preparing a periodic budget annually for the full budget period, budgets would be prepared, say, every one, two or three months (four, six, or even twelve budgets each year). Each of these budgets would plan for the next twelve months so that the current budget is extended by an extra period as the current period ends – hence the name rolling budgets.
Why is a rolling budget useful if a company is facing a period of uncertainty?
They are particularly useful when an organisation is facing a period of uncertainty so that it is difficult to prepare accurate plans and budgets.
How is a rolling budget prepared?
Instead of preparing a periodic budget annually for the full budget period, budgets would be prepared, say, every one, two or three months (four, six, or even twelve budgets each year). Each of these budgets would plan for the next twelve months so that the current budget is extended by an extra period as the current period ends – hence the name rolling budgets.
What are the advantages of rolling budgets? 3
- The budget is more realistic and certain.
- Planning and control are based on a more recent plan.
- Managers are forced to reassess the budget regularly.
What are the disadvantages of rolling budgets? 2
- Involves more time, effort, and money in budget preparation.
- May demotivate managers if they cannot see the benefit of regular revisions.
What is Beyond Budgeting?
A budgeting approach that suggests budgets should be more adaptive and agile, rather than rigid and fixed.
What are the leadership principles in Beyond Budgeting?
- Purpose – Engage and inspire people around bold and noble causes.
- Values – Govern through shared values and sound judgment.
- Transparency – Make information open for self-regulation, innovation, and learning.
- Organisation – Cultivate a strong sense of belonging in accountable teams.
- Autonomy – Trust people with freedom to act.
- Customers – Connect everyone’s work with customer needs.
What are the management processes in Beyond Budgeting?
- Rhythm – Organize management processes dynamically.
- Targets – Set directional, ambitious, and relative goals.
- Plans and forecasts – Use unbiased, flexible planning.
- Resource allocation – Foster a cost-conscious mindset.
- Performance evaluation – Evaluate holistically with feedback for learning.
- Rewards – Reward shared success rather than fixed performance contracts.
