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Role of Budgeting

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Role of Budgeting

  1. 1. qwertyuiopasdfghjklzxcvbnmqwertyuiopasdfghjklzxcvbnmqwertyuiopasdfghjklzxcvbnmqwertyuiopasdfghjklzxcvbnmqwertyuiopasdfghjklzxcvbnm Budgetingqwertyuiopasdfghjklzxcvbnmqwerty “The downturn has rendered budgets agreed last year largely irrelevant”uiopasdfghjklzxcvbnmqwertyuiopasd Jason Cates 14th March 2011fghjklzxcvbnmqwertyuiopasdfghjklzx Word Count 1318cvbnmqwertyuiopasdfghjklzxcvbnmqwertyuiopasdfghjklzxcvbnmqwertyuiopasdfghjklzxcvbnmqwertyuiopasdfghjklzxcvbnmqwertyuiopasdfghjklzxcvbnmqwertyuiopasdfghjklzxcvbnmqwertyuiopasdfghjklzxcvbnmqwertyuiopasdfghjklzxcvbnmqwertyuiopasdfghjklzxcvbnmrtyuiopasdfghjklzxcvbnmqwertyuiopasdfghjklzxcvbnmqwertyuiopasdfghjklzxcvbnmqwertyuiopasdfghjklzxcvbnmqwertyuiopasdfghjklzxcvbnmqwertyuiopasdfghjklzxcvbnmqwertyuiopasdfghjklzxcvbnmqwe
  2. 2. Jason Cates Performance Management Budgeting Contents PageFront Page …………………………………………………………………….………. 1Contents Page ……………………………………………………………..….………. 2Bibliography ……………………………………….……………………..…….…..…. 2Section 1 (Introduction) …………………………………….………………..….……. 3 Purpose of a Budget …………………………………………………………… 3 Budget Parameters ……………………………………………………..…...…. 4Section 2 (Analysis) ………………………………………..…….……………..….….. 5Section 3 (Conclusion) ……………………….……………………………….……….. 8References (Harvard Referencing) ………..………………………………....………… 9 Bibliography BBC News Chartered Institute of Management Accountants Chartered Institute of Public Finance and Accountancy CNBC Economy Watch EDF Energy Energy and Capital Jarman and Bibekar Meredith, G.G. Pyhrr, Peter. A. RWE Scott, J.A 2
  3. 3. Jason Cates Performance Management Budgeting Section 1 – Introduction This Report will analyse to what extent the quote “The downturn has renderedbudgets agreed last year largely irrelevant.” as stated by Jarman and Bibekar, truly reflectsreality. (Jarman and Bibekar, 2009) This will be carried out by defining the purpose and parameters of varies budgetingtechniques. We will then analyse the compatibility of annual and continues-budgets inrelation to operations within the energy industry. This report will then evaluate its findingsand use them to form a comprehensive conclusion.Purpose of a Budget It is generally considered that a budget helps plan and predict future expenditure andcash levels within an organisation. A budget enables better analyse of operations and allowsfor better comparisons between alternative programmes and functions. (Pyhrr, 1973) Theyalso enable organisations to map-out and co-ordinate future operations and can be used as acriterion for evaluation monetary performance. (Scott, 1970) Therefore, allowingorganisations to better calculate where problems are occurring and take corrective action asneeded. Budgets can be carried out over varies time spans with some budgets being carriedout for the period of a single year, but budgets can also be carried out for up to five years.However, long-term budgets have their reliability impaired due to increasing uncertainty asthe time period is increased. (Scott, 1970) 3
  4. 4. Jason Cates Performance Management BudgetingBudget Parameters There is generally considered to be four main types of budgeting. The first of these is“Incremental Budgeting” and can be considered the simplest to carry out. In this case,resources are allocated based upon results from the previous period adjusting for knownissues such as inflation. (Economy Watch, 2011) This budgeting system is considered steadywith changes being clear and visible. However, this system may cause managers to overstatetheir needs in a “use it or lose it” culture. It may also lead to managers becoming wasteful ofresources due to a lack of scrutiny. (Economy Watch, 2011) Zero-Based budgeting includes carrying out budgets from scratch. Managers will berequired to define, develop and rank all their activities and resource requirements in relationto their importance or benefit. This ranking may be through subjective means or cost/benefitanalysis. (Pyhrr, 1973) This system can be considered to lead to more effective resourceallocation due to a higher level of justification being required for resource expenditure.However, this system can be considered time consuming and expensive. (CIPFA, 2007) Priority-based budgeting involves allocating resources in line with organisationalstrategies. This system considers the implications of alterations in a previous budget inrelation to the organisations long-term strategy. This system is generally utilized by not-for-profit organisations that may have difficulty defining and managing their long-term resourcerequirements. (Meredith, 1969) The final budgeting system is defined as rolling or continues-budgeting. This is atechnique where a budget is continuously updated and altered as time progresses, normallyon a monthly basis. (CIMA, 2008) Therefore, this system allows for greater levels offlexibility and incorporates more up-to-date information than annual budgets. As a result, thissystem can help organisations better manage their financial risk and uncertainty and adapt tothe changing economic environment. (CIMA, 2008) 4
  5. 5. Jason Cates Performance Management Budgeting Section 2 - Analysis This report will now analyse the use of budgets in respect to the energy industry,more specifically, comparing nuclear energy to the use of natural gas in energy production. Nuclear power could be considered to operate effectively on an annual budget basisdue to running costs being relatively low and stable. However, energy production usingnatural gas could be considered more suited to a continues-budgeting system. This is due tothe volatility in natural gas prices over recent decades. This includes prices of natural gas inthe last three years ranging from $0.45 to $16.02 per thousand cubic-feet as shown in thegraphs below. (CNBC, 2011) As a result, it may be difficult for energy companies usingnatural gas to predict future changes in gas prices. Therefore, utilising continues-budgets mayallow them to become more adaptable to these fluctuations as they occur. 5
  6. 6. Jason Cates Performance Management Budgeting As stated, if you compare the costs of building and running nuclear and gas poweredstations, their financial requirements are quite different. In relation to nuclear power, the maincosts are those within the building phase as shown in the diagram below. (BBC, 2009) Then,once built, the running costs of energy generation utilising nuclear power are relatively smalland stable in relation to natural gas. This means they can be more easily predicted andbudgeted for in the long-term. Therefore, it may be considered that annual budgets may stillbe effectively utilised in areas such as nuclear power. However, 80% of the total costs inenergy production utilising natural gas is the purchase of the gas itself. (BBC News, 2008)Therefore, any fluctuations in gas prices will have a large impact on the profitability of thistype of energy production. 6
  7. 7. Jason Cates Performance Management Budgeting Therefore, how energy company’s produce their energy will affect to what degreetheir costs may fluctuate from their budgeted values. As a result, a company such as EDFEnergy (the world’s largest generator of nuclear power (EDF Energy, 2011)) will be moreable to predict future costs and activities than companies that utilise natural gas due to greaterstability in fuel prices. This compares to RWE, owner of NPower, which saw 45% of its UKenergy production in 2010 utilising natural gas. (RWE, 2010a) As a result, RWE will bemore susceptible to volatility in natural gas prices. As shown in RWE’s quarterly reports, costof materials in April-June 2010 increase to 68% of revenue compared to 62% a year earlier.(RWE, 2010a) This may be partly due to the increase in natural gas prices during this period.Therefore, it may be concluded that, in this case, utilising a continues-budget would be moresuitable than using an annual budget. This will allow RWE to more effectively budget for andadapt to any changes in gas prices. This will become more appropriate in the future as RWEintends to expand its use of natural gas in UK energy production. (RWE, 2010b) Therefore,it will remain susceptible to these changes for the foreseeable future. As a result, RWE maybenefit more than organisations such as EDF Energy in utilising continues-budgeting. In relation to the quote as stated at the start of this report regarding the relevance ofannual budgets, it can be stated that their relevance largely depends on the organisationsindividual circumstances. This includes the way in which organisations operate and thevolatility of their costs and/or revenues. As a result, some organisations such as RWE willbenefit more from incorporating continues-budgeting than others, in this case, EDF Energy.However, this does not necessarily mean companies like EDF Energy are not subject tobudgeted cost fluctuations. Therefore, a company such as EDF Energy also may benefit fromimplementing continues-budgeting, but merely to a lower extent than RWE. 7
  8. 8. Jason Cates Performance Management Budgeting Section 3 - Conclusion This report concludes that organisations as a whole can benefit from implementingcontinues-budgeting. However, the extent of which organisations can benefit from continues-budgeting depends on their specific operations. Simply, the greater the likelihood of futurecost/revenue volatility, the greater the potential benefit of implementing continues-budgeting. Therefore, the quote “The downturn has rendered budgets agreed last year largelyirrelevant.”, although vague, can be considered relatively accurate. This is due to budgetsprior to 2009 being largely prepared on the assumption of continues economic stability.Therefore, did not anticipate the changes that took place in areas such as consumer spendinghabits or the availability of finance. Utilising continues-budgets may have not protectedcompanies from the downturn, but may have helped them better adapt to the changingeconomic environment as it occurred. This is compared to the use of annual budgets that mayhave not accurately reflected the likely costs/revenues for the specified period. However, asstated, the extent of which this relates to specific organisations largely depends on their ownspecific circumstances during this period. 8
  9. 9. Jason Cates Performance Management Budgeting References – Harvard ReferencingBBC News (2008) Q&A: The costs of nuclear energy. Available at:http://news.bbc.co.uk/1/hi/business/7180539.stm [Accessed: 7 March, 2011].BBC News (2010) Guide to UK Nuclear Power. Available at:http://news.bbc.co.uk/1/shared/spl/hi/guides/456900/456932/html/nn4page1.stm [Accessed: 7March, 2011].Chartered Institute of Management Accountants (2008) Budgeting. [Online] Available at:http://www.cimaglobal.com/Documents/ImportedDocuments/cig_tg_budgeting_mar08.pdf[Accessed: 7 March, 2011].Chartered Institute of Public Finance and Accountancy (2007) Zero Based Budgeting.[Online] Available at:http://www.cipfa.org.uk/pt/download/zero_based_budgeting_briefing.pdf [Accessed: 7March, 2011].CNBC (2011) Noyagold Resources Inc. Available at:http://data.cnbc.com/quotes/NG/J1/tab/2 [Accessed: 7 March, 2011].Economy Watch (2011) Incremental Budgets. Available at:http://www.economywatch.com/budget/types/incremental.html [Accessed: 7 March, 2011].EDF Energy (2011) Nuclear Power. Available at: http://www.edfenergy.com/about-us/energy-generation/nuclear.shtml [Accessed: 7 March, 2011].Energy and Capital (2010) Natural Gas Prices: What No One Else Has Caught… Yet.Available at: http://www.energyandcapital.com/articles/natural-gas-prices/1240 [Accessed: 7March, 2011].Jarman, N. and Bibekar, S. “New era budgeting”, ACCA Accounting and Business, July2009, pp 46-47.Meredith, G.G. (1969) Capital Investment Decisions. 1st edn. Brisbane: Harper and Row. 9
  10. 10. Jason Cates Performance Management BudgetingPyhrr, Peter. A. (1973) Zero Based Budgeting. 1st edn. New York: John Wiley and Sons, Inc.RWE (2010a) Interim Reports and Annual Reports. Available at:http://www.RWE.com/web/cms/en/110822/RWE/investor-relations/financial-reports/[Accessed: 7 March, 2011].RWE (2010b) Annual Report. [Online] Available at:http://www.RWE.com/web/cms/mediablob/en/543512/data/110822/4/RWE/investor-relations/financial-reports/Annual-report-2010-PDF-Download-.pdf [Accessed: 7 March,2011].Scott, J.A. (1970) Budgetary Control and Standard Costs. 6th edn. Bath: Pitman Publishing. 10

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