Budgeting

Question 1

Business Plan

Answer 1

• The business plan is a key document for the internal management of the organization
• Provides basis for evaluation/control
• Helps with obtaining financing from external resources

Question 2

9 steps in a business plan

Answer 2

1. Owner’s visions: Decides to go into business
2. Site Analysis: Choose site and do market research
3. Layout design: Choose product/service
4. Preliminary Budget: Forecast sales revenue
5. Business Structure: Production, marketing, HR plan
6. Financing Alternatives: Debt/Equity finance options
7. Preliminary ProForma: 2-5 year forecast of all financial statements
8. Discussion Package: Qualitative feasibility analysis
9. Financing Plan

Question 3

ProForma

Answer 3

A future looking set of financial statements based on estimates

Question 4

Budget

Answer 4

A budget is a plan expressed in monetary terms that covers a future time period (typically a year)

Provides a plan expressed in quantitative terms

Question 5

Master Budget

Answer 5

A MASTER BUDGET is a summary of all phases of a company’s plans/goals

It is a network consisting of many separate budgets that are interdependent.

Culminates into pro-forma statement of net income and cashflow statement

Question 6

Reasons for budgeting

Answer 6

Budgets provide the ability to:

Compels management to think about the future

Clearly defines areas of responsibility

Provides a basis for performance appraisals through variance analysis

Improves allocation of scarce resources

Question 7

Advantages of Budgeting

Answer 7

Provides managers a way to formalize their planning efforts

Provides definite goals and objectives that serve as benchmarks for evaluating subsequent performance (motivates mgrs. to achieve targets)

Uncovers potential bottlenecks before they occur

Coordinates the activities of the organization to ensure the plans and objectives are consistent with the broad goals of the entire organization

Allocates resources in line with strategic goals

Provides a means to control activities

Question 8

Responsibility Centres

Answer 8

A responsibility center is defined as any functional unit headed by a manager who is responsible for the activities of that unit.

Revenue Center
Expense Center
Profit Center
Investment Center

Question 9

Revenue Center

Answer 9

Outputs measured in $ terms but not directly compared to input costs

Question 10

Expense Center

Answer 10

Units where inputs are measured in $ but outputs are not

Question 11

Profit Center

Answer 11

Performance is measured by the difference between revenues and expenditures

Question 12

Investment Center

Answer 12

Outputs compared with assets employed in producing them (ROI)

Question 13

Eight steps in the budgeting process

Answer 13

1. Business objectives: define and communicate the objectives for the year
2. External analysis: Forecast economic and industry conditions, including competition
3. Sales budget: Develop detailed sales budgets by market, geographic territories, major customers, and product groups
4. Production budget: Prepare production budget (materials, labour, and overhead) by responsibility centre to satisfy the sales forecast and maintain agreed levels of inventory
5. Non-production budget: Prepare by cost centre
6. Capital expenditure budget: Prepare capital expenditure budget
7. Cash budget: Prepare cash forecasts and identify financing requirements
8. Master budget: Prepare master budget and budgeting statement of cash flows and obtain approval of profitability and financing targets

Question 14

Sales Budget

Answer 14

A sales budget is a detailed schedule showing the expected sales for the coming periods.

Key to the entire budgeting process

All other parts of the master budget are dependent on the sales budget in some way

If the sales budget is inaccurate, the rest of the budgeting process will be a waste of time

Question 15

Sales Forecasting

Answer 15

In order to develop a sales budget, consider the following in the forecast:

• Past experience with sales volumes
• Prospective pricing policy
• Unfilled order backlogs
• Market research studies
• General economic and industry conditions
• Consumer income, employment rate
• Advertising and promotion techniques
• 4 P’s

Question 16

Production Budget

Answer 16

After the sales budget is prepared, the production requirements for the forthcoming budget period can be determined and organized in the form of production budget.

Sufficient goods must be available to meet sales projections and provide the desired ending inventory

Production needs = budgeted sales + desired EI – BI

Question 17

What do you do if the production requirements exceed your capacity?

Answer 17

If the production requirements exceed capacity, consider the following options:

Subcontract the work
Plan for overtime
Introduce shift work
Purchase/lease additional machinery

Question 18

Direct Materials Budget

Answer 18

Reports the values of direct materials that will be used during the year

Question 19

Direct Labour Budget

Answer 19

A forecast of the direct labour hours required to produce each unit

Question 20

Manufacturing Overhead Budget (MF OH)

Answer 20

Often based on previous year’s costs, adjusted for changes in cost rates.
Includes indirect labour, indirect materials and supplies, utility costs, plant maintenance, depreciation

Question 21

Capital Budget

Answer 21

The capital budget covers the acquisition of land, building, and items of capital equipment.

Question 22

How are Capital Expenses (CapEx) different from Operating Expenses (OpEx)

Answer 22

Purpose: CapEx are assets purchased with a useful life greater than a year; OpEx are costs to run a business

When Paid: CapEx are paid in one lump sum; OpEx are reoccuring expenses

When accounted for: CapEx are accounted for over a 3-10 year life span as the asset depreciates; OpEx are accounted for in the current month or year

Listed as: CapEx are property or equipment; OpEx are operating cost

Tax treatment: CapEx deducted overtime as the asset depreciates; OpEx are deducted in the current year

Question 23

Cash Budget

Answer 23

The cash budget shows the impact of cash flow, under the following sections:
Receipts
Disbursements
Excess/Deficiency (balance)
Financing section
Ending cash balance

Question 24

Budgeting Challenges

Answer 24

Accuracy in predictions
Motivational problems
Limiting Nature of Budget
Negative Reputation of Budgeting

Question 25

Accuracy in predictions

Answer 25

Predicting volumes and sales are only estimates based on historical performance and future outcomes

Question 26

Motivational problems

Answer 26

When a budget is developed to control and monitor performance, managers may be inclined to develop budgets that are easy to achieve to avoid the risk of facing a poor performance review (agency problem)

Question 27

Limiting Nature of Budgets

Answer 27

Can constrain/limit innovation when encourage to keep costs at a specific level; may not take actions that could be beneficial for the company Must have complete acceptance/support of management to be successful

Question 28

Negative Reputation of Budgeting

Answer 28

Often viewed by employees as a necessary evil and a restrictive tool.

Question 29

Methods of budgeting

Answer 29

``` Top-down Bottom up Zero-based budgeting Line-item Program budgets Performance budgets Activity-based budgets Incremental budgets ```

Question 30

Top-down

Answer 30

Budget prepared by mgmt. and imposed on lower levels of org.

Question 31

Bottom up

Answer 31

Supervisors/middle mgrs. prepare budgets and forward them up for review and approval.

Question 32

Zero-based budgeting

Answer 32

Each activity starts from a budget of zero and must build their budgets accordingly.

Question 33

Line-item

Answer 33

Each expenditure has a line included in the budget and a system to track it (does not show true costs of service programs or production)

Question 34

Program budgets

Answer 34

Delineates all the costs associated with doing a project/program (common for grant applications)

Question 35

Performance budgets

Answer 35

Similar to program budgets except they are tied to data that includes performance (i.e. customers served)

Question 36

Activity-based budgets

Answer 36

Allocates costs to products or services according to how much of the resources of the firm they consume

Question 37

Incremental budgets

Answer 37

Takes previous year’s budget as a base and adds/subtracts a percentage to determine new amount.

Question 38

Types of Budgetary Control

Answer 38

``` Goal Setting Planning Planning using a Budget Manual Planning by Budgeting Profit Budget Monitoring/Variance Analysis Auditing Expenditures and Results ```

Question 39

Goal Setting

Answer 39

Set goals for your budget Recurring operational goals Strategic goals Goals communicate to managers what your business must achieve in the coming year.  

Question 40

Planning

Answer 40

Control the level of spending using budgeting plans. Short-term budgets Long-term budgets

Question 41

Planning using a Budget Manual

Answer 41

All of your budget procedures and policies belong in one manual Details who is responsible for various budget functions, such as approving expenditures, scheduling accounts receivable, collecting overdue bills, paying bills, making deposits and creating invoices Shows how work flows through your budgeting department. For example, indicate how a department manager fills out an expenditure request, who it goes to in the budget center, all of the approvals needed and who sends it back to the department head.

Question 42

Planning by Budgeting Profit

Answer 42

# Choose your budget method Example: Choose zero-based budgeting Income must match expenditures If you do not include profit as an expenditure, you will have the tendency to spend all of your income on materials, supplies, overhead and payroll. By using zero-based budgeting with an expense built in for profits, you place an emphasis on success rather than mere survival.

Question 43

Budget Monitoring/Variance Analysis

Answer 43

Compare what the department actually spends with what the department budget called for. Determine the reasons for budget overruns, and consider reducing the budget for departments that consistently spend less than their budgets indicated they would need.

Question 44

Auditing Expenditures and Results

Answer 44

It is not sufficient to determine if each program area spends according to its budgeted levels. Audit the expenditures in different budget lines, such as supplies, and identify instances of waste Study the results achieved based on how a manager spent his budget over the last year Measure the performance against the overall budget policy