Budgeting and budgetary control


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Budgeting and budgetary control

  2. 2. Introduction <ul><li>Strategic Financial Planning is a formal process for establishing financial goals and objectives over the long run. </li></ul><ul><li>It involves developing a mission statement that captures why the organization exists and plans for how the organization will thrive in the future. </li></ul><ul><li>Finally, strategic plans are implemented by developing an Operating or Action Plan. Within this Operating Plan, is a complete set of financial plans or budgets. </li></ul>
  3. 3. Outline <ul><li>Meaning of Budget </li></ul><ul><li>Characteristics of Budgets </li></ul><ul><li>Types of Budgets </li></ul><ul><li>The Budgeting Process </li></ul><ul><li>Approaches to Budgeting </li></ul><ul><li>Budgetary Control </li></ul><ul><li>Importance of Budgeting </li></ul>
  4. 4. Meaning of Budget <ul><li>When plans are quantified and monetized, they become budgets. </li></ul><ul><li>Budget is ‘a financial and/or quantitative interpretation, prior to a defined period of time, of a policy to be pursued for that period to attain a given objective’. (CIMA) </li></ul>
  5. 5. Meaning of Budget (contd) <ul><li>A budget shows the following: </li></ul><ul><li>Planned revenues and expenditures. </li></ul><ul><li>Plans for assets and liabilities. </li></ul><ul><li>Estimates for cash receipts and payments. </li></ul>
  6. 6. Characteristics of Budget <ul><li>From the above definitions, the following characteristics of budget are discernable. </li></ul><ul><li>Financial/quantitative – the plans are converted to figures with monetary values. </li></ul><ul><li>Prior to a time period – relies on forecast, estimate, etc. Fraught with uncertainty. </li></ul>
  7. 7. Xteristics of Budget (contd) <ul><li>Policy to be pursued – Business decisions and activities </li></ul><ul><li>Defined period – usually 1 year (short-term) or 2-5 years (medium-term) or above 5years (long-term). </li></ul><ul><li>Objective – The overall purpose is to achieve organizational goals. </li></ul>
  8. 8. Types of Budget <ul><li>Functional budgets – budget for various departments and functions of the organization such as sales, production, admin, etc. </li></ul><ul><li>Master budget – summary of all functional budgets including projected Income statement and Balance Sheet. </li></ul><ul><li>Cash budget – a budget of cash inflows and outflows. </li></ul>
  9. 9. Types of Budget (contd) <ul><li>Capital budget – a budget for investments that require huge capital outlay over a long period of time. </li></ul><ul><li>Government budget – a budget for government revenue and expenditure </li></ul><ul><li>Miscellaneous budget – a budget for special events e.g. Trade fair, R&D, Sales Promo, etc. </li></ul>
  10. 10. The Budgeting Process <ul><li>We will assume that the process of preparing budget is sequential. </li></ul><ul><li>In reality, the process is not as straightforward. </li></ul><ul><li>Due to series of discussion, arguments and information flow, some steps may be repeated. </li></ul>
  11. 11. Determine budget policies and guidelines. <ul><li>Consider the overall corporate objectives </li></ul><ul><li>Consider past results and performance </li></ul><ul><li>Consider internal strengths and weaknesses </li></ul><ul><li>Consider external opportunities and threats </li></ul><ul><li>Select a budget period (length of time the budget will cover) and a control period (time interval for reviews). </li></ul>
  12. 12. Set up a Budget Committee. <ul><li>Comprises of various functional heads of the company. </li></ul><ul><li>The committee meets regularly to administer the budgeting process. </li></ul><ul><li>The Management Accountant is the anchor man or ‘Budget officer’ who provides technical assistance and relevant information. </li></ul>
  13. 13. Set up a Budget Committee (contd). <ul><li>Duties of the committee include: </li></ul><ul><li>Communicate budget policies and guidelines – pre budget meetings and strategy sessions are organized to enlighten and sensitize employees. </li></ul><ul><li>Identify budget centres – these are divisions that need to be allocated resources to enable them perform their functions. They prepare their budgets. </li></ul>
  14. 14. Budget ctee (cont) <ul><li>Establish time table for budgeting process. </li></ul><ul><li>Produce Budget Manual - contains the purpose of, procedure for and responsibility of the people involved in budgeting. </li></ul><ul><li>Identify limiting factors – constraints that limit planned activities of the organization. </li></ul><ul><li>Coordinate forecasts and harmonize budgets </li></ul><ul><li>Monitor implementation </li></ul>
  15. 15. Prepare assumptions and forecasts. <ul><li>Use of statistical and mathematical techniques (Regression, moving averages, trend analysis, sensitivity analysis and simulation) </li></ul><ul><li>Qualitative factors are also considered ( Natural intelligence, historical analogy, market survey, Delphi method). </li></ul><ul><li>Data inputs must be appropriate for the intended forecast. </li></ul><ul><li>Cost/benefit of forecasting technique should be considered </li></ul>
  16. 16. Produce functional and subsidiary budgets. <ul><li>Departmental heads will submit their projections to the Budget committee. </li></ul><ul><li>Committee compares all functional budgets for feasibility and practicability. </li></ul><ul><li>Amendments are recommended and effected </li></ul><ul><li>Committee approves </li></ul>
  17. 17. Produce the Master Budget. <ul><li>The committee consolidates all the budgets into a Master Budget. </li></ul><ul><li>Includes projected Profit and Loss account, projected Balance Sheet, and Cash flow statement. </li></ul><ul><li>Submit Master Budget to top management for review and approval. </li></ul>
  18. 18. Obtain approval for the budget. <ul><li>Top management considers consistency of budget with long-term plans (market leadership, customer service, branding, social responsibility). </li></ul><ul><li>Consistency with short-term plans is also considered (profitability, adequate return on capital, solvency, and liquidity) </li></ul><ul><li>CEO approves </li></ul>
  19. 19. Publish and implement the budget. <ul><li>Budget is circulated to budget holders and departmental heads for implementation. </li></ul><ul><li>Budget becomes an executive order, empowering lower level managers and demanding performance from them. </li></ul><ul><li>Top management must provide necessary financial and moral support. </li></ul>
  20. 20. Review the Budget <ul><li>Budget is reviewed at regular intervals </li></ul><ul><li>Changes in environment may necessitate preparation of revised budget. </li></ul>
  21. 21. Approaches to Budgeting <ul><li>Fixed budget – remains unchanged regardless of changes in activity level. </li></ul><ul><li>Flexible budget – adjusts to the achieved level of activity. </li></ul><ul><li>Continuous budget – a budget prepared and reviewed as economic and environmental conditions change. </li></ul>
  22. 22. <ul><li>Incremental budget – A budget prepared on the basis of a previous period’s budget or actual performance with incremental amounts added for the new budget period. </li></ul><ul><li>ZERO BASED BUDGET – A budget built up afresh each period. Not based on historical data. </li></ul>
  23. 23. Meaning of Budgetary Control. <ul><li>Budgetary control entails measuring , reporting, analyzing and giving feedback on budget performance. </li></ul><ul><li>Technically, it is defined as ‘ The establishment of budgets relating to the responsibilities of executive to the requirement of a policy and the continuous comparison of actual with budgeted results either to secure by individual action, the objective of that policy or to provide a basis for its revision’. CIMA </li></ul><ul><li>The process is as follows: </li></ul>
  24. 24. 1. Identify Variances <ul><li>Record actual results </li></ul><ul><li>Compare with budget </li></ul><ul><li>A variance is difference between budgeted levels and actual levels of revenues and costs. </li></ul>
  25. 25. 2. Analyze and Investigate variances <ul><li>Positive/ Favorable variance – Better than expected result. </li></ul><ul><li>Negative/Adverse/Unfavorable variance – A worse than expected result. </li></ul><ul><li>Analyze size and direction of variance, controllability, permanence. </li></ul>
  26. 26. 3. Give Feedback to Operators <ul><li>Periodic Budgetary control reports to budget holders and their supervisors. </li></ul><ul><li>Top management to also get feedback from staff regarding challenges and suggestions on performance improvement . </li></ul>
  27. 27. 4. Take Corrective Action <ul><li>Decide on solutions to adverse variances </li></ul><ul><li>Budget should be reviewed at regular intervals because changes in environment may necessitate preparation of revised budget. </li></ul>
  28. 28. Budgetary Control Report Format Operating Profit Other Costs Staff Costs Admin Expenses Cost of Sales Turnover Action Comments Variance Budget Actual
  29. 29. Principles of Good Budgetary Control <ul><li>Managerial responsibilities must be clearly defined </li></ul><ul><li>Budgets must include plan of action </li></ul><ul><li>Performance must be monitored against the budget </li></ul><ul><li>Corrective action must be taken if results differ significantly from the budget </li></ul><ul><li>Extra budgetary expenses must go through senior management approval </li></ul><ul><li>Budgetary control must enhance ‘management by exception’. </li></ul>
  30. 30. The Importance of Budgeting
  31. 31. Communication of corporate objectives. <ul><li>Budget is a formal process of communicating top management expectations (vertically and laterally). </li></ul><ul><li>Employees become aware of their roles in achievement of overall company objectives. </li></ul>
  32. 32. Enhances systematic and logical planning. <ul><li>Ensures that short-term plans are consistent with long-term plans. </li></ul><ul><li>Managers are compelled to think ahead and anticipate future challenges. </li></ul><ul><li>Continuous improvement by eliminating non- value adding activities. </li></ul>
  33. 33. Coordination <ul><li>Budget ensures goal congruence, promotes teamwork, and eliminates overlapping of activities. </li></ul><ul><li>Functional activities are harmonized through the Master budget (r/m purchases and production requirements, production and sales volumes, cash inflows and outflows). </li></ul>
  34. 34. Clarification of Authority and Responsibility. <ul><li>Managers get to know their limits as authority to commit is established. </li></ul><ul><li>Departmental heads and individuals take responsibility for achieving their budget. </li></ul>
  35. 35. Control <ul><li>Ensures that plans are complied with and deviations are noted and investigated (variance analysis). </li></ul><ul><li>A company reaps the benefits of central control and at the same time, the benefits of delegation. </li></ul><ul><li>Serves as a basis for revision of policies. </li></ul>
  36. 36. Performance evaluation. <ul><li>Serves as a yardstick for measuring and assessing actual performance. </li></ul><ul><li>Decisions on promotion, recognition, and punishment are usually based of budget achievement. </li></ul><ul><li>A manager can do self appraisal. </li></ul>
  37. 37. Motivation. <ul><li>Active participation in setting the budget motivates employees towards achieving the budget. </li></ul><ul><li>Employees are motivated when their personal interests are closely associated with budget. </li></ul>
  38. 38. Resource Allocation <ul><li>Scarce resources are optimally allocated to the most profitable areas. </li></ul><ul><li>This would be in terms of human resource, raw materials, equipments, money, time and all other attributes. </li></ul>
  39. 39. Group Discussion <ul><li>Enumerate the challenges encountered in budget preparation and implementation and control. </li></ul><ul><li>How can these challenges be overcome? </li></ul>