Be aware of different approaches to the budgeting process
Know how to prepare an operating budget
Understand how budgets and variances are used to control operations
Understand the role of the balanced scorecard in linking strategy and control
Ch 6: Budgeting and Budgetary Control: When the organization’s plan for the future is expressed in dollars it is called a budget. A budget may be: part of the organizational planning process; a standard against which the organization is controlled; a target, at which the organization is aiming. Budgets may be prepared: incrementally (previous year + % increase) “ zero based” (a fundamental rethinking every year) based on previous year, but with challenges to the major assumptions
Exhibit 6.1: The Master Budget: Sales forecast/budget changes in receivables changes in finished goods inventory Production budget changes in raw material inventory changes in payables Other expense budgets BUDGETED INCOME STATEMENT CASH BUDGET CAPITAL BUDGET BUDGETED BALANCE SHEET
Sales Forecasting: The budget normally starts with a sales forecast because sales is usually the “limiting factor”. A sales forecast may be prepared by: professional forecasters (e.g. econometricians); sales/marketing staff; a committee of informed personnel. Useful information in preparing a sales forecast includes: past data and trends; macro-economic factors; knowledge of customer preferences; knowledge of technological change; knowledge of competitors’ plans.
Production Forecasting: In a “just-in-time” environment production exactly equals sales. Inventory of finished product allows sales and production are uncoupled, and may be different amounts, enabling smoothing of cyclical demand (e.g Christmas cards). production – increase of inventory + decrease of inventory = sales Labour forecasting: This is generally a function of production plans and labour needs in non-production areas.
Cash Forecasting: Cash forecasting is critical to organizational survival. Opening cash balance + Total cash received = Total cash available Total cash received: Cash collections from sales (Sales +/- changes in receivables) + Other cash receipts: (share issues, loans, sale of plant assets)
Cash payments: To suppliers for goods purchased (cost of goods sold +/- changes in inventory and accounts payable) To employees for labour costs To other expenses Interest & dividends Major plant asset purchases Cash available – cash payments = closing cash balance
Cash Budgeting: The cash budget reveals that over the year the cash increases from $200,000 to $320,000. However there is a cash crisis between May and August, with cash deficit rising to as much as $746,000. If you are unaware that there will be a cash crisis you will be totally unprepared to deal with it. If you are aware you can take steps to deal with it: Possible solutions: Delay payment for the new plant until the fall; Sell short-term investments in the spring; Get a short-term bank loan from May to August. Note this is a temporary problem, so it needs a temporary solution: raising a long-term loan or issuing new shares would not be appropriate, as these are long-term solutions.
The budget will be used to control operations.
Once the budget is “agreed” it represents a social contract between the parties:
The budget is accepted by the operatives as being achievable;
The budget is accepted by management as meeting their needs.
Comparison of budget with the actual results will reveal the extent to which it has, or has not, been achieved.
Deviations from budget should be investigated:
To reveal the responsibility area where the problem arose;
The Balanced Scorecard: Budgetary control focuses on the financial results of the organization. If the organizational strategy can be expressed solely in financial terms, then that is acceptable. Most organizations have strategies that are wider in scope, so a more comprehensive approach to planning and control is necessary. The balanced scorecard is a way of envisioning strategy and measuring progress towards its achievement. The four sections commonly used are: financial perspective; customer perspective; internal business perspective; learning & growth perspective. This articulates and communicates a balanced approach to strategic management.
Carberry Hotels: Balanced Scorecard: September 2002 : Objective Measure Target Actual Financial perspective: Shareholder value Return on investment 15.0% 15.6% Share price growth 5.0% 6.0% Customer perspective: Quantity Occupancy rates 90.0% 93.2% Quality Room rack-rate growth 4.0% 0.0% Customer satisfaction 9/10 9.3/10 Written complaints nil nil Internal business perspective: Cleanliness Random checks 10/10 10/10 Restaurant Menu changes 5 6 Accessibility Wheelchair access 98.0% 98.0% Learning & growth perspective: Staff training Training hours 100 75 Market segments New segments targeted 2 1 Product development New facilities 1 0