Budgeting faces several challenges: (1) estimating an uncertain future, (2) gaining buy-in from budget holders, and (3) responding to unplanned changes. To overcome these, companies use flexible budgets, involve stakeholders, and regularly update budgets. Effective budgeting requires open communication and adapting to new information.

1. BUDGETING AND BUDGETARY CONTROL

2. Introduction Strategic Financial Planning is a formal process for establishing financial goals and objectives over the long run. It involves developing a mission statement that captures why the organization exists and plans for how the organization will thrive in the future. 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.

3. Outline Meaning of Budget Characteristics of Budgets Types of Budgets The Budgeting Process Approaches to Budgeting Budgetary Control Importance of Budgeting

4. Meaning of Budget When plans are quantified and monetized, they become budgets. 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)

5. Meaning of Budget (contd) A budget shows the following: Planned revenues and expenditures. Plans for assets and liabilities. Estimates for cash receipts and payments.

6. Characteristics of Budget From the above definitions, the following characteristics of budget are discernable. Financial/quantitative – the plans are converted to figures with monetary values. Prior to a time period – relies on forecast, estimate, etc. Fraught with uncertainty.

7. Xteristics of Budget (contd) Policy to be pursued – Business decisions and activities Defined period – usually 1 year (short-term) or 2-5 years (medium-term) or above 5years (long-term). Objective – The overall purpose is to achieve organizational goals.

8. Types of Budget Functional budgets – budget for various departments and functions of the organization such as sales, production, admin, etc. Master budget – summary of all functional budgets including projected Income statement and Balance Sheet. Cash budget – a budget of cash inflows and outflows.

9. Types of Budget (contd) Capital budget – a budget for investments that require huge capital outlay over a long period of time. Government budget – a budget for government revenue and expenditure Miscellaneous budget – a budget for special events e.g. Trade fair, R&D, Sales Promo, etc.

10. The Budgeting Process We will assume that the process of preparing budget is sequential. In reality, the process is not as straightforward. Due to series of discussion, arguments and information flow, some steps may be repeated.

11. Determine budget policies and guidelines. Consider the overall corporate objectives Consider past results and performance Consider internal strengths and weaknesses Consider external opportunities and threats Select a budget period (length of time the budget will cover) and a control period (time interval for reviews).

12. Set up a Budget Committee. Comprises of various functional heads of the company. The committee meets regularly to administer the budgeting process. The Management Accountant is the anchor man or ‘Budget officer’ who provides technical assistance and relevant information.

13. Set up a Budget Committee (contd). Duties of the committee include: Communicate budget policies and guidelines – pre budget meetings and strategy sessions are organized to enlighten and sensitize employees. Identify budget centres – these are divisions that need to be allocated resources to enable them perform their functions. They prepare their budgets.

14. Budget ctee (cont) Establish time table for budgeting process. Produce Budget Manual - contains the purpose of, procedure for and responsibility of the people involved in budgeting. Identify limiting factors – constraints that limit planned activities of the organization. Coordinate forecasts and harmonize budgets Monitor implementation

15. Prepare assumptions and forecasts. Use of statistical and mathematical techniques (Regression, moving averages, trend analysis, sensitivity analysis and simulation) Qualitative factors are also considered ( Natural intelligence, historical analogy, market survey, Delphi method). Data inputs must be appropriate for the intended forecast. Cost/benefit of forecasting technique should be considered

16. Produce functional and subsidiary budgets. Departmental heads will submit their projections to the Budget committee. Committee compares all functional budgets for feasibility and practicability. Amendments are recommended and effected Committee approves

17. Produce the Master Budget. The committee consolidates all the budgets into a Master Budget. Includes projected Profit and Loss account, projected Balance Sheet, and Cash flow statement. Submit Master Budget to top management for review and approval.

18. Obtain approval for the budget. Top management considers consistency of budget with long-term plans (market leadership, customer service, branding, social responsibility). Consistency with short-term plans is also considered (profitability, adequate return on capital, solvency, and liquidity) CEO approves

19. Publish and implement the budget. Budget is circulated to budget holders and departmental heads for implementation. Budget becomes an executive order, empowering lower level managers and demanding performance from them. Top management must provide necessary financial and moral support.

20. Review the Budget Budget is reviewed at regular intervals Changes in environment may necessitate preparation of revised budget.

21. Approaches to Budgeting Fixed budget – remains unchanged regardless of changes in activity level. Flexible budget – adjusts to the achieved level of activity. Continuous budget – a budget prepared and reviewed as economic and environmental conditions change.

22. 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. ZERO BASED BUDGET – A budget built up afresh each period. Not based on historical data.

23. Meaning of Budgetary Control. Budgetary control entails measuring , reporting, analyzing and giving feedback on budget performance. 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 The process is as follows:

24. 1. Identify Variances Record actual results Compare with budget A variance is difference between budgeted levels and actual levels of revenues and costs.

25. 2. Analyze and Investigate variances Positive/ Favorable variance – Better than expected result. Negative/Adverse/Unfavorable variance – A worse than expected result. Analyze size and direction of variance, controllability, permanence.

26. 3. Give Feedback to Operators Periodic Budgetary control reports to budget holders and their supervisors. Top management to also get feedback from staff regarding challenges and suggestions on performance improvement .

27. 4. Take Corrective Action Decide on solutions to adverse variances Budget should be reviewed at regular intervals because changes in environment may necessitate preparation of revised budget.

28. Budgetary Control Report Format Operating Profit Other Costs Staff Costs Admin Expenses Cost of Sales Turnover Action Comments Variance Budget Actual

29. Principles of Good Budgetary Control Managerial responsibilities must be clearly defined Budgets must include plan of action Performance must be monitored against the budget Corrective action must be taken if results differ significantly from the budget Extra budgetary expenses must go through senior management approval Budgetary control must enhance ‘management by exception’.

30. The Importance of Budgeting

31. Communication of corporate objectives. Budget is a formal process of communicating top management expectations (vertically and laterally). Employees become aware of their roles in achievement of overall company objectives.

32. Enhances systematic and logical planning. Ensures that short-term plans are consistent with long-term plans. Managers are compelled to think ahead and anticipate future challenges. Continuous improvement by eliminating non- value adding activities.

33. Coordination Budget ensures goal congruence, promotes teamwork, and eliminates overlapping of activities. Functional activities are harmonized through the Master budget (r/m purchases and production requirements, production and sales volumes, cash inflows and outflows).

34. Clarification of Authority and Responsibility. Managers get to know their limits as authority to commit is established. Departmental heads and individuals take responsibility for achieving their budget.

35. Control Ensures that plans are complied with and deviations are noted and investigated (variance analysis). A company reaps the benefits of central control and at the same time, the benefits of delegation. Serves as a basis for revision of policies.

36. Performance evaluation. Serves as a yardstick for measuring and assessing actual performance. Decisions on promotion, recognition, and punishment are usually based of budget achievement. A manager can do self appraisal.

37. Motivation. Active participation in setting the budget motivates employees towards achieving the budget. Employees are motivated when their personal interests are closely associated with budget.

38. Resource Allocation Scarce resources are optimally allocated to the most profitable areas. This would be in terms of human resource, raw materials, equipments, money, time and all other attributes.

39. Group Discussion Enumerate the challenges encountered in budget preparation and implementation and control. How can these challenges be overcome?