Budgeting 1 (LECTURE 7)

Question 1

BUDGETING

Answer 1

The implementation of the long-term plan for the year ahead through the development of detailed financial plans.

A budget is a financial plan covering the whole enterprise over a specific period of time and accounts for all the enterprise’s resources. It aims to allocate those resources in the most beneficial manner.

Question 2

BUDGET

Answer 2

A financial plan for implementing management decisions.

Question 3

CASH BUDGET

Answer 3

A budget that aims to ensure that sufficient cash is available at all times to meet the level of operations that are outlines in all other budgets.

Objective is to identify potential cash shortfalls and also large cash surpluses. Then do something.

Needs frequent reviews, wise to do it on a weekly basis for about 6-8 week time horizons. Use some element of SENSITIVITY ANALYSIS.

Revise frequently.

Question 4

CONTINUOUS BUDGETING / ROLLING BUDGET

Answer 4

An approach to budgeting in which the annual budget is broken down into months for the first three months and into quarters for the rest of the year, with a new quarter being added as each quarter ends.

Question 5

CONTROL PROCESS

Answer 5

The process of comparing actual and planned outcomes, and responding to any deviations from the plan.

Question 6

CORPORATE OBJECTIVES

Answer 6

Specific, measurable statements, often expressed in financial terms, of what the organisation as a whole wishes to achieve.

Question 7

DISCRETIONARY COSTS

Answer 7

Costs such as advertising and research where management has some discretion as to the amount it will budget.

Question 8

FEEDBACK LOOPS

Answer 8

Parts of a control system that allow for review and corrective action to ensure that actual outcomes conform with planned outcomes.

Question 9

INCREMENTAL BUDGETING

Answer 9

An approach to budgeting in which existing operations and the current budgeted allowance for existing activities are taken as the starting point for preparing the next annual budget and are then adjusted for anticipated changes.

Question 10

LONG-TERM PLAN / STRATEGIC PLAN

Answer 10

A top-level plan that sets out the objectives that an organisation’s future activities will be directed towards.

Question 11

MANAGEMENT BY EXCEPTION

Answer 11

A system in which a manager’s attention and effort can be concentrated on significant deviations from the expected results.

Question 12

MASTER BUDGET

Answer 12

A document that brings together and summarises all lower level budgets and which consists of a budgeted profit and loss account, a balance sheet and cash flow statement.

Question 13

MISSION

Answer 13

A statement that provides in very general terms of what the organisation does to achieve its vision, its broad purpose and reason its existence, the nature of the business(es) it is in and the customers it seeks to serve and satisfy.

Question 14

UNIT OBJECTIVES

Answer 14

Specific, measurable statements, often expressed in financial terms, of what individual units within an organisation wish to achieve.

Question 15

STRATEGY

Answer 15

The courses of action that must be taken to achieve an organisation’s overall objectives.

Question 16

VISION STATEMENT

Answer 16

A statement that clarifies the beliefs and governing principles of an organisation, what it wants to be in the future or how it wants the world in which it operates to be.

Question 17

ZERO-BASED BUDGETING

Answer 17

An approach to budgeting in which projected expenditure for existing activities starts from base zero rather than last year’s budget, forcing managers to justify all budget expenditure.

Good at cutting excess costs.

Encourages questioning attitude.

Seen in public and private sector.

Expensive and time consuming.

Requires a high level of negotiating skills.

Question 18

TOP DOWN BUDGET

Answer 18

Dictatorial style; common in the smaller business; discourages initiative, and depends on the top manager’s skill.

Question 19

BOTTOM UP BUDGET

Answer 19

Recommended - allows initiative and responsibility to be shared. Facilitates participatory attitude.

Question 20

Why produce budgets?

Answer 20

• Planning
• Co-ordination
• Communication
• Motivation
• Control
• Evaluation
• Delegation
• Authorisation

Question 21

CO-ORDINATION

Answer 21

In a large, divisionalised, departmentalised organisation, it is essential to co-ordinate activities for the benefit of the organisation as a whole.

There needs to be a system for ensuring everyone sticks to the aim of the firm.

Budgets demand discussion between departments to work in the firm’s best interests.

Question 22

COMMUNICATION

Answer 22

Takes place in several ways.
Top management uses the budget to communicate its strategic objectives for the budget period.

At more junior levels, individual managers will clearly have to interface with more senior managers to negotiate and agree budget targets and allocations.

A wider aspect of communication is that the budget is often the only time in which individual departmental managers talk to other managers outside their own department.

Question 23

MOTIVATION

Answer 23

A good budget should motivate staff to perform well.

People perform better if they have a target to aim at. The target must be ATTAINABLE.

Risk of complacency or despondency.

The benefit of a target is increased where people have a say in the setting of targets.

A good way of improving motivation is to let somebody set their own target (within limits). This will be reviewed by an individual’s line manager to ensure it is in keeping within the firm’s overall objectives and that it is sufficiently challenging.

Question 24

CONTROL

Answer 24

The budget is an integral part of a business’ control system.

Managers can use the budget to trace what belongs to an organisation and the use to which it is put.

Budgets allow management by exception.

Question 25

EVALUATION

Answer 25

Establishing a target allows us to compare actual performance with the budget. A manger's performance can then be evaluated according to how well they did compared to the budget. If the managers prove themselves competent at handling a junior role, they may be rewarded with promotion.

Question 26

THE BUDGET COMMITTEE

Answer 26

Most businesses appoint one. They oversee the budget planning process and ratify individual functional budgets, e.g. production function, sales function, marketing function, etc. Appoint a budget officer; normally senior accounting personnel.

Question 27

ACCOUNTING STAFF

Answer 27

Essentially a technical, advisory and supporting role. They DO NOT prepare the budget.

Question 28

BUDGET MANUAL

Answer 28

Internal document, prepared by budget officer, incorporates key objectives, procedures, personnel, timetables, etc.

Question 29

Classical approach to budgeting.

Answer 29

1) Communication (typically via the budget manual). 2) Identification of the key limiting factor. 3) Preparation of the INITIAL budget. 4) Initial preparation of functional budgets. 5) Negotiation of budgets. 6) Co-ordination and review of budgets. 7) Final acceptance. 8) Ongoing review of budget in place.

Question 30

THE KEY LIMITING FACTOR / BUDGET FACTOR

Answer 30

The single issue which is going to be most responsible for limiting the activity of the firm. In most sales profit-seeking businesses this will be SALES. But could be materials, or labour, or machine capacity, or government quota.

Question 31

THE FIRST BUDGET

Answer 31

The key factor budget is prepared first. Sales is the most commonplace. Difficulty due to external variables such as customer demand, competitor activity and general economic conditions. Should originate at the most junior level of management. Details of preparation method in budget manual. Incremental approaches are common.

Question 32

What is the general structure of the budget?

Answer 32

``` Sales Budget Production Budget Materials Usage Budget Materials Purchase Budget Labour Budget ```

Question 33

NEGOTIATION

Answer 33

Review of the budget should reduce the risk of BUDGET SLACK. A balance should be taken; arrogance on the part of senior management may be repaid with poorer performance and ultimately high job turnover, which simply benefits competitors. A participative approach does not mean that junior managers get what they want. targets must be challenging but realistic.

Question 34

CO-ORDINATION AND REVIEW

Answer 34

The budget officer should keep a careful watch that budgets are co-ordinated with each other to avoid wastage and delay. As budgets progress up the functional ladder, less attention is paid to small details. Top managers are more interested in global totals.

Question 35

FINAL ACCEPTANCE

Answer 35

The MASTER BUDGET is the ultimate output. For board level ratification. Budgeted Statement of Comprehensive Income, budgeted Statement of Financial Position, budgeted Statement of Cash Flows. Cash budget also incorporated with this. Global totals; different informational needs - top directors concerned with strategy.

Question 36

ONGOING REVIEW

Answer 36

Comparisons between the budget and the actual are made and sent to individual managers, who are asked to comment on the differences. It may be necessary to FLEX the budget to reflect actual level of output.

Question 37

Describe the process of cash budgeting.

Answer 37

-Flows should be divided by inflows and outflows, and split into components. Components may be split down into smaller categories. Forecasts often have items in them with different levels of certainty. There will be certain flows, those that are forecastable to some extent and those that are less predictable. The cash manager will need to identify sources of information for the forecast. These may include: - Last years actual cash flows - Sale projections - Purchase projections - Accounts payable and receivable data - Investment plans including acquisition

Question 38

How can cash deficits sometimes be resolved?

Answer 38

By altering the timing of payments and receipts. - Bringing receipts forward - Delaying payments

Question 39

Headings for cash budget. (example)

Answer 39

``` Month Cash Sales Credit Sales Share Issue TOTAL INFLOW ``` ``` Payments to suppliers Wages Other Expenses Tax Fixed Asset Purchase Loan Repayment Overdraft Interest TOTAL OUTFLOW NET CASH FLOW Balance at start of month Balance at end of month ```

Question 40

Cash vs. profit

Answer 40

Both are vital but their importance varies according to the time scale. There is not much point raising cash unless it is going to be used to generate profit.

Question 41

OBSOLESCENCE

Answer 41

A key issue in budgeting for 12 months. Leads to a lack of respect for the budget, even to completely ignoring it. Can be obviated by the continuous/rolling budget.

Question 42

Procedure of zero-based budgeting.

Answer 42

1) Define decision packages. 2) Evaluate and rank all alternative packages. 3) Implement the chosen package- any funds remaining can then be devoted to alternative programmes.

Question 43

Advantage of incremental budgets.

Answer 43

Still useful where the environment is stable. Cheaper, due to speed and simplicity. Information already available. Easy to understand by non-financial managers.

Question 44

Disadvantage of incremental budgets.

Answer 44

Builds on wasteful wasteful practices of prior years. Encourages spending up to the budget limit (poor behaviour). Ignores cost drivers. Unsuitable in dynamic environments. Encourages budget slack.

Question 45

BUDGETARY SLACK

Answer 45

Is the deliberate under-estimation of budgeted revenue or over-estimation of budgeted expenses. Standard solutions include; staff rotation, ZBB, higher targets, non financial performance measures.

Question 46

HUMAN BEHAVIOUR

Answer 46

Weakest link in the budget process.

Question 47

PASSING BUDGET ALLOCATIONS

Answer 47

Refers to a situation where a manager tries to pass on costs from their department onto other departments. Objective is to keep costs down in their department. difficult to cure, but justifies the existence of clear lines of demarcation.

Question 48

BUDGET CONSTRAINED STYLE

Answer 48

Refers to a situation where little or nothing gets done unless it's in the budget. So it can lead to ignoring other, essential aspects of business, such as delivery times, quality, innovation etc.

Question 49

What variances should managers be accountable for?

Answer 49

OPERATIONAL VARIANCES

Question 50

FLEXIBLE BUDGETING

Answer 50

Incorporate a range of budget totals, based on differing levels of activity.

Question 51

Cash Budget Format

Answer 51

``` Month INCOME Sales Grant (e.g.) Investment proceeds (e.g.) ``` ``` EXPENDITURE Materials Labour Fixed Overheads Machinery ``` Opening Balance Balance for Month Closing Balance

Question 52

Flexible Budget Format

Answer 52

Activity Level Labour Hours Production ``` Sales income Labour Materials Supervisor Salaries Fixed Overhead Total Expenditure Profit ```

Question 53

Functional Budget Format

Answer 53

SALES BUDGET (volume and value) Sales Volume Sales Price (£) Sales Value ``` PRODUCTION BUDGET (volume) Sales Requirement Closing Inventory Finished Goods Requirement Less; Opening Inventory Production Requirement ``` ``` RAW MATERIALS BUDGET Production Requirement Raw materials needed Raw materials price/kg Raw materials expense (£) ``` LABOUR BUDGET Production requirement Labour hours x labour rate Labour cost (£)