Topic 6 Performance measurement budgeting Flashcards
What is a budget
A detailed plan (in financial and non-financial terms) of
management activities for a certain time period – normally a 12-month period. The budget essentially reflects the short-term goals of the primary decision-makers.
What is a budget linked to
Linked to the organisation’s long-term strategic plans and
goals. The strategic plan usually identifies:
• How product value is to be created;
• The external factors- social, environmental, technological.
Why budgeting is important
The budget is one of the most important means of
communication and coordination. The budget is an essential tool for planning,
organising and controlling activities.
Whom are budgets provided to
Budgets are usually provided to those people within the organisation who have
responsibility (and are held to account) for the resources (e.g., labour, materials, cash)
used in undertaking particular activities. This might be, for example, the marketing
manager (for meeting sales goals), the purchasing manager (for purchasing the correct amount and quality of supplies at certain prices) or the IT manager (for supplying
services and hardware to various activities). Each of these managers will have goals for
their activity area that link to the overall goal of the organisation.
Budgets and planning - Setting goals
The budget is also a way of indicating to people
those factors that are considered important. Changing organisational goals will usually be reflected in budget changes. Budget goals may also act as a form of motivation for
those who are held responsible for its delivery and achievement.
Budgets and organising - allocating resources and responsibility
When setting budgets, resources need to be allocated to the different activity areas. The manager is responsible for the efficient and effective use of resources. Rewards for managers may be attached to meeting their budget goals.
Budgets and controlling - measuring performance
Comparing actual results with budgets (the differences
are called variances). Provides a basis for evaluation of the performance of
organisation. This can be linked to formal incentives, such as cash rewards, promotions, awards or profit sharing.
The Master (Annual) Budget
The master budget is a comprehensive set of budgets
that cover all aspects of a firm’s activities. The master budget consists of several interdependent
budgets
Operating budgets
Financial budgets
Operating budgets
Operating budgets include the sales budget and the various
cost budgets
Financial budgets
Financial budgets consist of the budget statement of
financial performance, the budgeted statement of financial position, the cash budgets
Sales budget
A detailed summary of the estimated sales units and revenues from the organisation’s products for the budgeted year. Its based on the sales forecast, which involves estimating which products will be sold and in what quantities. Sales forecasting is a critical step in the budgeting process and market research is often used.
Factors to consider when forecasting sales include
Internal factors: e.g. past sales levels; new products planned;
External factors: e.g. general economic trends, specific
industry trends.
Cost budgets for manufacturing firms
• A production budget, which has cost budgets for direct
materials, direct labour and overheads.
• Budgets for marketing, general and administrative expenses.
Cost budgets for retailers and wholesalers
- A purchasing budget, will be used to determine the quantity and cost of goods purchased for resale.
- Budgets for marketing, general and administrative expenses.
The financial budgets
Cash budget
Budgeted income statement
Budgeted balance sheet
Sales budget format
Business Sales Budget for the year ending
Expected sales units
Selling price
Total Sales revenue
Photo 1
Production budget format
Business Production Budget for the year ending
Expected sales (units)
Add: Desired ending inventory
Less: Beginning inventory
Required production units
Photo 2
Material budget format
Business Material Budget for the year ending
Units to be produced Material cost per unit Cost of material required for production Target ending materials inventory Total material required Less: Beginning materials inventory Total cost of materials purchases
Photo 3
Labour Budget format
Business Labour Budget for the year ending
Units to be produced Labour time per unit Total required labour hours Labour cost per hour Total labour cost
Photo 4
Overhead budget format
Photo 5
Selling and administrative expenses budget format
Photo 6
Cash budget format
BUSINESS
CASH BUDGET
FOR THE TWO MONTHS ENDED
Beginning cash balance Add: Receipts etc Total Available Cash Less: Disbursements etc Excess (deficiency) of available cash over disbursements Financing Borrowings Repayments Ending Cash balance
Photo 7
Behavioural aspects of budgeting
Budgets affect virtually all people in an organisation:
• Those who prepare the budget;
• Those who use the budget for decision making; and
• Those whose performance is evaluated using the
budget.
3 approaches to budgeting
Participative budgeting
Top-down budgeting
Bottom-up budgeting
Participative budgeting
managers at all levels develop
their budgets.
Top-down budgeting
senior managers impose budget targets.
Bottom-up budgeting
lower managerial and operations levels play an active part in budget setting
Budget as a means of communication
The budget is one of the most important means of communication within an organisation and is essential for planning, organising and controlling activities. For example, to measure performance of an activity, a specific goal/objective must be clearly established in the first instance and resources organised and allocated to allow the goals in that
activity area to be achieved.
Budgeting and the coordination of activities
As budgets for different activities are constructed, the different activity areas of the
organisation are required to communicate and plan the coordination of activities, e.g.,
marketing, purchasing and production need to align activities to ensure that a product of value to the customer is provided on time and at the quality required. The finance department must ensure it has sufficient cash to allow these activities to be undertaken. You might notice here some similarities to the idea of a “value-chain”.
Budgeting is a way of indicating to people
those factors that are considered important. Changing goals will usually be reflected in budget changes.
Budgeting as a source of feedback
Budgets are also an important source of “feedback” which occurs when planned
performance is compared with actual performance. Differences are examined and
corrective action taken if needed; to ensure goals will be achieved. Budget comparisons
with actual performance, and the related feedback, also provide an account to those held responsible for the activities on how they and their activity area have performed.
Type of information included in a budget
The type of information included in a budget can include both financial (e.g., sales revenue - $) and non-financial (e.g., number of product returns) and is influenced by the particular goals for that activity area (e.g., marketing or production targets).
Production budget
A production budget includes cost budgets for direct materials, direct labour and
overheads. Direct materials are those physical resources used to manufacture a product,
e.g. wood used for creating a desk is considered a direct material. Direct Labour is the
cost of the human resources such as labourers who work to create the product, e.g., the
payment for the cabinet maker who constructs the desk but excludes costs of managers
and sales people. These costs that relate only to the manufacturing process are
described as direct. Overheads are the other resources used in the production process
such as cost of electricity or heating for the factory.
Budgets for marketing, general and administrative expenses
General and administrative
expenses include resources used for activities other than the manufacturing process, e.g.
advertising costs, payments to managers and accountants, repayment of interest on
loans.
The cash budget
Expected cash receipts and planned cash payments. The timing of all cash movements is important to identify cash shortages and cash surpluses.
Budgeted statement of financial performance (profit and loss)
Shows expected
revenues and planned expenses for the budget period.
Budgeted statement of financial position (balance sheet)
Expected assets and liabilities
at the end of budget period.
Budget admin
In large organisations, formal processes are often used to collect data and prepare the
budget. Budget administration is often the responsibility of the senior accounting managers. A budget manual may be developed to communicate who is responsible for providing
various types of information, when the information is required and what form is it to take. A budget committee is often appointed to advise the accountants during the preparation
of the budget.
Advantages of participative budgeting
Participative budgeting generally encourages coordination and communication between
managers and a greater understanding and appreciation of the wider organisation. It may
also lead to more accurate budget estimates, as those close to the operations have the best knowledge of the likely sales or costs in their area and this approach provides a greater level of motivation for people to work toward budget goals.
Budget acceptance is generally more likely when:
- Targets are developed with employee participation
- Targets are considered achievable
- There is frequent feedback on performance
- Employees are held responsible for activities that are within their control
- Achievement of targets is accompanied by rewards that are valued
- Budgets must be set at a level that provides challenges and stretch, but not too difficult.
