Week 3: Budgeting Flashcards
Key Functions of Management Accounting
Planning, Control and Performance Evaluation
Planning
- Entities need direction
They consist of various divisions which need to work together, by developing plans that are as accurate as possible, the different divisions which need to work together.
By developing accurate plans different divisions are able to ensure their performance doesn’t hinder other divisions. I.e Strategic plan
Control
- Implementation of the plan
Management needs to keep their finger on the pulse and ensure that all employees are playing part according to the plan that they are accountable for heir decisions and actions
Performance Evaluation
Can be performed on different levels. One could evaluate the performance of a business, a division or even an employee.
If an employee has contributed positively to the execution of the plan and have created value - They will rank favorably in their performance evaluation and may receive a bonus.
Bonuses are offered as incentives to encourage employees to act in accordance with the plan and to align their interests with those of shareholders. Information of PE is taken into account when developing budgets for following periods
What is a budget?
A budget is a forecast of activity, incomes, expenses, or cash flows over a future specified period.
- Planning tool but helpful for maintaining control and PE
—> They set a standard in which employees can be held against
Purposes of a budget?
- Plan revenues, expenses and cash flows
- Evaluate performance against the budget and adjust expectation of future performance
- Provision of incentives/bonuses - linked to evaluation of performance
- Force management to reflect on the future - can they develop realistic projections?
- Allow efficient and effective allocation of funds to different business units/divisions
- Vital for start-up businesses as a road map. Think about your product, costs and availability of finance.
- Important for government/public sector operations and non-profit companies that rely on grant funding
Types of budgets
Master budget - All lower level budgets aggregated to produce budgeted financial statements, a cash budget and a financing plan
Operational budgets
- Sales budget - budgeted sales
- Cost/expenses budget - budgeted operating costs
Financial budgets
- Cash budget - A budget and all cash inflows and outflows for the period, including the initial bank balance at the end of the period. Prepared on a cash basis
- Capital spending budget - Budgeted expenditure on capital
- Forecasted Financial Statements
Historical budgeting vs Zero Based budgeting
Historical - Previous budget form previous period is used as a starting point for the new budget. Adjustments are made to account for expected changes in prices and activity levels in order to develop new budget.
Zero-Based - The budget is created from scratch - the starting point is Zero. If there was a budget for the prior period, it is not considered when preparing the new budget. Each item added to the budget will be based off a planned activity or project for the following period. More time consuming but can Crete better direction and clarity in an organization.
Top down vs Bottom up budgeting
Top-down - starts at the highest level of the entity and works downwards. The top of the entity determines the appropriate financial allowance for departments and imposes a budget on he lower layers
+ Saves Time for lower management (respond rather than create)
+ One budget created at one time instead of combining several departments.
- Those who are not involved in day to day may not be aware of particular expenses
- Decreased motivation of lower management, not involved but expected to implement
Bottom up - Starts at the lowest level of an entity and works upwards based on the need of the business. Decided by lower management and then presented to top management for approval.
+ Lower management creates the budget based on the needs of their department (Know the department best) = increased motivation
+ Top management can concentrate more on the overall strategy of the organization, and dont have to focus on each department.
- May not be in line with overall stately and objectives as they set budget on only the departments needs and not take account the whole entity
What is Participative budgeting?
Budget holders having the opportunity to participate in setting their own budget
Budgetary slack
Managers set targets too east to achieve
What is a cash budget
Predicting what is going to come in the future and how much cash will come and go and whether the business is going to have net inflow of cash or a new outflow of cash
What must be prepared before a cash budget?
A sales budget
Production budget
Expenses budget
Because cash flows follow activities. Before one can estimate the cash inflows from customers. It’s necessary to know how many sales are forested for the period and how soon the business expects to collect cash from sales
Steps taken before preparing a cash budget
1) Establish the time frame - Weekly, Monthly, Quarterly, Annually
2) Cash receipts from sales and other income should be determined
3) Cash payments from acquiring inventory and operating expenses should established
4) Cash payments and receipts not reflected on the statement of comprehensive income must be included
5) Calculate the overall net cash inflows/outflows
6) Add or deduct the net cash flows to/from the opening cash balance to determine the expected amount of cash on hand at the end of the year.
