2. 2
LEARNING OUTCOMES
Explain the general principles of budgeting, its functioning and the link between
long-and short term planning,
Illustrate the sequence of successive planning on the basis of partial plans,
Do cost planning for direct costs, variable indirect costs and fixed costs using a
case study on their own,
Draw up a performance budget according to the cost sales style and the
expenditure style of presentation,
Draw up a financing plan according to the direct and indirect method as well as a
budgeted balance sheet in the form of a changing balance sheet on their own,
Calculate forecasts and deviation analyses
Analyze, interpret and evaluate the results of a performance budget and a
budgeted balance sheet .
4. INTRODUCTION
What is a budget?
• A budget is a financial plan that takes into account estimated revenue and
expenses over a certain period of time.
• Re-evaluated periodically
• Three types of budgets: Operating budget; Capital budget; Cash budget.
5. THE ROLE OF BUDGETS
• Meeting the organization’s objectives
• Planning
• Monitoring and controlling
• Co-ordinating
• Evaluating performance
• Improving performance
• Motivating managers
• Management contract
• Communicating
• Providing a basis for authorizing expenditure and delegating responsibility
• Identifying scarce resources
• Allocating resources
• Demonstrating and delivering good corporate governance
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6. Meeting objectives
What the organization’s objectives are?
- The primary objective: seek to maximize returns to their owners (maximize
profit) in the long run.
- The secondary objective: achieving certain levels of market share,
developing new products and developing staff capabilities or new technologies.
===> Budgets should be linked to objectives and strategy
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7. Planning
• The budget can act as a plan to help us to achieve our objectives. In fact, in many
organizations, the budget is often referred to as the annual operating plan.
• A different view and probably a different approach: a budget should be a costed
version of what we are going to do over the year, in fact budget performance with no
variances should perhaps be viewed with some suspicion.
• Producing a costed plan may be easier for some elements of the budget than others.
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8. Monitoring and controlling
• To control costs, income and cash, we need to start with a good plan, against which
we can monitor its performance.
• In most organizations, variances from budget are produced every month with major
variations from budget requiring an explanation. It would be better to focus on a few
key figures that made up most of the budget.
• The managers can monitor other figures that lead expenditure or income
• Major underspends always be monitored and explained just like overspends
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9. Co-ordinating
• The act of putting together budgets helps us to coordinate the activities of different
parts of the organizations.
• The budgets and plans need to fit and work together
• Different departments’ and units’ plans need to make the best use of the
organization’s limited resources (known as the limiting factors)
• All departments need to be consistent in order to drive the organization in the same
direction.
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10. Evaluating performance
• Performance should also be measured in terms other than just the performance
against the budget. Perhaps budgets should be judged in conjunction with other KPIs.
• Managers should be measured on what they control (as the profit in his/her store)
• Often cost and profitability are affected by teams of people working across different
departments and functions.
• Measuring a manager’s performance based upon his/her budget may encourage
managers to negotiate their budgets to make it easier for them to achieve rather than
aiming to maximize the performance of their unit.
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11. Improving performance
• Budgets are sometimes seen as targets to beat to deliver improved performance.
• If the budget is a target it should be set carefully. Too challenging, may be de-
motivated; too easy, no strive to do their best.
• The remedy is to put in some additional measures beyond the budget that include
continuous improvement targets (such as reducing unit costs) or relative performance.
• Performance benchmarking: the kind of indicators to look out for are: market share,
total shareholder returns (TSRs) compared to peer companies, and level of customer
satisfaction compared to peer group companies.
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12. Motivating managers
• Managers may be motivated to perform since they are being judged against a budget.
• A manager’s approach to delegating budgets will be influenced by how he views staff
and perceives how they are motivated.
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13. A management contract
• Ideally, a budget should be seen as a contract between the manager and the
organization
• The contract should cover what the manager will deliver at what cost and this will
negotiated and agreed with the line manager.
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14. Communicating
• A key to effective budgeting must be good communication
• Budgets inform managers and employees of the plans and strategy of the
organization expressed in financial terms.
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15. Providing a basis for authorizing expenditure and delegating
responsibility
• Budgets fail when authority and responsibility are not matched
• Budgets may be delegated through responsibility centres, these are usually called
cost centres or profit centres, a rather term is investment centres.
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16. Identifying scarce resources
• The process of building a budget may help us to identify scarce resources and
resources that need to be managed carefully or increased
• Building a budget for an organization may take much negotiation and result in many
iterations or rounds.
• Budgeting at a strategic level must also consider longer-term capacity planning.
Building too little capacity constrains the organization; building too much leads to
needless extra cost and suboptimal operations.
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18. Demonstrating and delivering good corporate governance
• The budgetary control system is effectively part of the internal control system
within an organization
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19. BUDGETING AND FORECASTING
• Budgets describe what the future is most likely to look like (based upon our plans)
• Forecasts describe what the budget is most likely to look like.
• Forecasts as updates to the annual budget:
When the budget is produced it may require some forecasting to derive some of the figures
“The forecast” is an updated estimate of the outturn or result for the year
A reforecast is normally produced every quarter or every month.
The process of reforecasting encourages managers to rethink how the year’s result is going to
develop, this may enable them to identify problems sooner and become more proactive and less
reactive when managing the budget.
• Rolling forecasts: forecasts can also be produced on a rolling basis beyond the
end of the current financial year. The time period of forecasting depends upon the
company and the industry.
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20. Forecasts, projects and contracts
• Working on a project/contract, you could forecast to its end. This approach might
help you identify problems earlier.
• Reviewing the project just on its performance to date may make you complacent.
• When producing the forecast you need to remember the matrix of impact and
variability described ealier.
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21. Forecasting tools and techniques
• Within the business there are a variety of figures which may be forecasted
including:
Sales
Profit and loss
Cash flow
• The best way to produce a forecast and its required predictive accuracy will depend
upon exactly why the forecast is requied.
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22. Types of Budgets
• The combined budgets generate a budgeted income statement, balance sheet, and
cash flow statement.
• There are 3 types of budgets: Operating budget; Capital budget; Cash budget:
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23. Operating budget
• Revenues and associated expenses in day-to-day operations are budgeted in detail
and are divided into major categories such as revenues, salaries, benefits, and
non-salary expenses.
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24. Capital budget
• Capital budgets are typically requests for purchases of large assets such as
property, equipment, or IT systems that create major demands on an organization’s
cash flow. The purposes of capital budgets are to allocate funds, control risks in
decision-making, and set priorities.
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25. Cash budget
• Cash budgets tie the other two budgets together and take into account the timing of
payments and the timing of receipt of cash from revenues. Cash budgets help
management track and manage the company’s cash flow effectively by assessing
whether additional capital is required, whether the company needs to raise money,
or if there is excess capital..
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27. Budget process
• The budgeting process for most large companies usually begins four to six months
before the start of the financial year, while some may take an entire fiscal year to
complete. Most organizations set budgets and undertake variance analysis on a
monthly basis.
• Starting from the initial planning stage, the company goes through a series of
stages to finally implement the budget. Common processes include communication
within executive management, establishing objectives and targets, developing a
detailed budget, compilation and revision of budget model, budget committee
review, and approval.
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