Budgeting and Forecasting

Budgeting:
Objectives are the things you are trying to achieve
Strategies are methods you use to achieve the objectives
Measures are quantitative or qualitative metrics used to assess how well the strategies work
Targets are the desired level of measures you want to achieve. Targets should be quantifiable and time-
based.

The master budget consists of operating, cash, and capital expenditure budgets. When combined, these
budgets generate a budgeted income stmt, balance sheet and CF stmt.
We always start with sales budget.
Operating budgets: revenue, COGS, expenses for the various budget centers
Capital budgets: requests for large assets which create major demands on an entity’s cash flow

Cash budgets: an estimation of the cash inflows and outflows for a specific period of time
Used to assess whether the entity has sufficient cash to fulfill regular operations.
Identifies whether too much cash is being left in unproductive capacities.
Manufacturing company example:
EX sales budget
We wanna grow revenue by 10% next year. The increase in sale may be a combination of increases in
sales as well as increases in volume.

A budget center is a group within an organization that prepares the actual budget. It is up to the
organization’s decision on how the group is organized or who are designated.

Participative budgeting: when employees and managers work from the bottom up to recommend
targets to the executives. The level of manager involvement is most likely the highest of the three
approaches.

Negotiated budgeting: Budgeting approach where executive outline targets they wish to achieve while
sharing responsibility with managers and employees on budget preparation.

Imposed budgeting: A top-down approach where executives set goals and impose budget targets for
activity and costs which managers should follow. Managers have a low level of involvement in the
budgeting process.

Incremental budgeting: take numbers from last year and either grow or shrink them by a certain
percentage. It is simple method that looks at what was spent last year and then adds or subtracts a
percentage.last year’s acutal figures+x% Basis for this year’s budget. However, it is likely to perpetuate
inefficiencies, likely to result in budgetary slack, likely to ignore external drivers of activity and
performance.

Value proposition budgeting: has to be made for every line item on the income statement：
Why is this amount included in my budget?
Does the item create value for customers, staff, or other stakeholders? Does the value of this item
outweigh its cost? If not, is there another reason why this cost is justified.

Zero-based budgeting: last year numbers are completely ignored, and everything is built from the
bottom-up and this was beginning from the scratch.:
All department budgets are zero. Managers are required to build their budgets from the group up,
justifying every penny they wish to spend. It is most effective when there is an urgent need for cost
containment. However, it is best suited for discretionary costs (not essential operating costs), extremely
time consuming, most effective when only used occasionally.

Activity-based budgeting: This is an output target. That’s for example, revenue, or some volume of
production. The activities are determined that are required to support those goals and from the
activities the costs are determined to support those activities.
Inputs are determined by outputs not the other way around. Avoid starting by assessing the resources
you have and trying to assess what is achievable.
Output/Input: The activities I need to undertake to achieve my business aim.
The cost expectation of delivering these activities.

Analyzing costs into fixed and variable highlights factors affecting the level and volatility of profits:
Sales-variable labor costs (overtime, casual, temps)=gross contribution
- Fixed labor costs ( full time staff salaries)
= Net Profit
What is the breakeven point=fixed costs/contribution margin?
Breakeven point is the amount of sales required to recover fixed costs.
What is the margin of safety=((sale-breakeven sales)/sales*100%)
Margin of safety is the amount that sales can decline while still breaking even

Cost Model: sales volume 10k sales price/unit=$10 variable cost/unit=$5

Fixed costs=25K
Revenue100k-variable costs 50
=contribution margin=50k-fixed cost=25k=net earnings

Ex: Breakeven revenue =fixed cots/CM*Rev=25k/50k*100k=50k

Margin of safety=(Sales-Breakeven)/sales=50%

Cost control matrix:

Start your cost analysis with the budget items with the highest cost priority

Technique Use Math Involved Data needed

Moving Repeated forecasts Minimum level Historic data
averages
Simple linear Comparing one independent Statistical Knowledge A sample of relevant
 regression with one dependent variable required observations
Multiple linear Compare more than one Statistical knowledge A sample of relevant
regression independent variable with one required observations
dependent variable

The longer the period used to calculate moving average, the smoother the forecast would be.

A line regression: there’s just a correlation or actual causality between variables. The other thing to
remember is that a regression

Multiple linear regression: when 2 or more independent variables are required for a prediction the
analysis is referred to as multiple linear regression.
Excel-Data Analysis-Regression

Coefficients Standard Error t Stat P-value

Intercept 187.3296 252.2822 0.7425 0.4767
Promotion 6.3925 1.201 5.3228 0.0005
Advertising -0.3193 0.9338 0.3419 0.7403

Promotion
cost $100 Revenue
Advertising
cost $275

The formula of this regression is revenue=Intercept+ promotion coefficient* promotion cost+

Advertising coefficient*advertising cost
Revenue=187.3296+6.3925*100-0.3193*275=739

PEST analysis: How the trend impact budget

 Political forecasting: legislation; taxation;regulations;gov/bus relations/new competition
 Economic: Economic cycle; interest rates; consumer ;gov spending; busi investment;exchange
rates
 Social: Demographics;lifestyles;attitudes;needs and desires
 Technological forecasting: leading edge developments;own R&D;competitor’s R&D
The opportunities would be reasons why perhaps growth will be higher or costs will be lower
The threat would be revenue might actually decline or costs might rise significantly

Budget performance with variance analysis:

Objectives: Outline how variances are used to monitor and control a business
Calculate variances and interpret results
Build a variance dashboard report
Variance: The difference between budgeted/expected cost and actual cost; and similarly for revenue.
Variance Analysis: The process of examining in detail each variance between actual and budgeted/
expected costs to determine the reason why budgeted results were not met( material costs too high,
sales prices too low, etc.)

Investigating a variance
Total labor variance=84k=labor price variance42k (F)+ labor hours variance126K(U)

What could be some of the possible causes?

Labor price variance (F): Use of junior vs senior works; use of workers commanding lower hourly rates;
use of unskilled workers paid lower rates.
Labor quantity variance(U): Poor supervision;improperly trained workers;machine breakdowns;use of
unskilled workers; use of more workers

Apply Excel Functions: Goal seek and solver tool in Excel

Understand how to design a robust budgeting process:

Operating budgets: -income statement.Cash budgets; capital expenditures bugets

Assessment
Questions

Correct Answer
Partially Correct
Incorrect Answer

1
Budgets must link ________ to objectives, so budgeting is a tactical implementation of the
________.
Your Answer
Strategies, business plan
Correct Answer
Strategies, business plan
Explanation

Budgets must link strategies to objectives, so budgeting is a tactical implementation of the

business plan.

2
Identify which of the following is NOT a good way for managers to use a budget.
Your Answer
Managers can use budgets alone to estimate how well they perform over a period of time
Correct Answer
Managers can use budgets alone to estimate how well they perform over a period of time
Explanation

Budgets are not the sole determinants of how well managers perform over a period of
time. They should be used in conjunction with other quantitative and qualitative metrics to
evaluate the performance of managers and employees.
 3
Which of the following is the best key performance indicator (KPI) for measuring customer
satisfaction?
Your Answer
Customer retention rate
Correct Answer
Customer retention rate
Explanation

Revenue increase and increase in sales price without losing customers is not directly tied to
customer satisfaction, while employee feedback on customer satisfaction could be
manipulated to benefit the employee, therefore customer retention rate is the best
measure of customer satisfaction.

4
Which of the following components is not necessary to have in every master budget?
Your Answer
Direct material purchases budget
Correct Answer
Direct material purchases budget
Explanation

The operating budget and financial budget are the two parts required in a complete
budget.

The cash budget is part of financial budget and is also required.

The direct materials budget is only required for manufacturing companies; for retail and
services company, they do not need to purchase any direct material.

5
Which of the following describes the correct budgeting process?
Your Answer
Planning & communication – Establish objectives & targets – Develop a detailed budget –
Review & approval – Implementation and management
Correct Answer
Planning & communication – Establish objectives & targets – Develop a detailed budget –
Review & approval – Implementation and management
Explanation

The budgeting process is: Planning & communication – Establish objectives & targets –
Develop a detailed budget – Review & approval – Implementation and management
 6
In a bottom-up approach, managers should have a ________ level of controllability and a
________ level of involvement in budget setting.
Your Answer
High, high
Correct Answer
High, high
Explanation

In a bottom-up approach, the manager needs control over the situation to have incentives
to improve the operating process. Having the manager take part in the budget-making
process creates a sense of involvement and shared responsibility, not just something
imposed by the top managers.

7
Identify which trait below about incremental budgeting is FALSE.
Your Answer
Inputs or activities are determined by the budgeted outputs
Correct Answer
Inputs or activities are determined by the budgeted outputs
Explanation

"Inputs or activities are determined by the budgeted outputs" This describes activity-based
budgeting, not incremental budgeting.

8
What is the main argument of "Beyond Budgeting"?
Your Answer
Firms today need to be more flexible and responsive to deal with unpredictable change,
hyper competition and increasingly fickle customers
Correct Answer
Firms today need to be more flexible and responsive to deal with unpredictable change,
hyper competition and increasingly fickle customers
Explanation

Although there are 12 principles to beyond budgeting, they are completely new principles,
not ones added to the traditional principles.

Although CEO of General Electric states that budgets should never have existed, "Beyond
Budgeting" still argues that budgets should be made more flexible instead, not eliminated.
"Beyond Budgeting" entails a shift from a performance emphasis on numbers to one based
on people and institutional arrangements, and have nothing to do with operating and cash
budget.

9
Out of the four different types of costs, how would you classify overhead costs? (Hint:
Overhead costs are unavoidable costs a company must spend to produce any amount of
outputs up to a certain level. There’s usually a threshold where the outputs exceed the
maximum capacity which requires additional spending for every extra unit of outputs.)
Your Answer
Semi-variable cost
Correct Answer
Semi-variable cost
Explanation

Overhead costs usually contains fixed costs such as manager salary and rent, but it also
contains some variable costs such as electricity and utilities, therefore it is a semi-variable
cost.

10
What does variable cost with economies of scale mean?
Your Answer
The higher the volume of output, the less it costs to produce one extra unit
Correct Answer
The higher the volume of output, the less it costs to produce one extra unit
Explanation

When there is a variable cost with economies of scale, the cost and volume is in a quadratic
relationship, not linear. Although the total costs increase when you increase in production,
the individual cost per unit decreases.

11
Identify which of the following is NOT an advantage of performing multiple regression.
Your Answer
It is easy to use and audit
Correct Answer
It is easy to use and audit
Explanation

To be able to read and understand the regression report, one is required to have some
level of understanding in statistics. Also, having to find the function in excel and learning
how to use it impedes some people from using this tool.
 12
Using the PEST analysis, which of the following should a company like Apple Inc. worry
about the most?
Your Answer
Political forecasting and trends
Correct Answer
Technological forecasting and trends
Explanation

Because Apple is a technological company, it should worry about technological forecasting

and trends the most compared to all other factors.

13
Identify the cause of an unfavorable variance in profit.
Your Answer
Actual material cost is higher than budget
Correct Answer
Actual material cost is higher than budget
Explanation

If material costs are higher than budgeted, it increases expenses and decreases profit.

If labor costs are lower than budgeted, it decreases expenses and increases profit.

If sales volume is higher than budgeted, it increases revenue and increases profit.

If sales price is higher than budgeted, it increases revenue and increases profit.

14
Using the information given in the table below, identify whether the sales volume variance
and price variance are favorable or unfavorable.

Your Answer
Unfavorable, favorable
Correct Answer
Unfavorable, favorable
Explanation

The actual sales volume is lower than the budget, therefore the volume variance is
unfavorable; the actual sales price is higher than budget, therefore the price variance is
favorable.

15
Based on the information provided, calculate the revenue variance percentage and
determine whether it is favorable or unfavorable.

Your Answer
16.67% favorable
Correct Answer
16.67% favorable
Explanation

The budgeted revenue is calculated by 40,000 x 15 = 600,000.

The actual revenue is calculated by 35,000 x 20 = 700,000.

The variance is calculated by (700,000 - 600,000) / 600,000 = 16.67%.

The actual revenue is higher than budget, meaning that the variance is favorable.

16
Identify which of the following is not a goal of the variance dashboard.
Your Answer
A detailed written report
Correct Answer
A detailed written report
Explanation
A dashboard should be a visual report. It should be light on words and use graphics to
convey the information.

17
To find out the value of the assumptions that are needed to hit a certain budget target, you
would use ______; to optimize an output, you would use ______.
Your Answer
Solver, goal seek
Correct Answer
Goal seek, solver
Explanation

You would use goal seek and solver, because pivot table is used to perform analysis on the
data, while consolidate is to summarize data from separate sheets onto one sheet.

18
Which of the following is NOT an advantage to link workbooks?
Your Answer
The links will update themselves when the file name changes
Correct Answer
The links will update themselves when the file name changes
Explanation

One of the major disadvantage to linked workbooks is that once the file name changes,
links will not automatically update, so when using linked workbooks, it is important to
check on an ongoing basis that the links are correctly referencing the appropriate files.

19
Please open the attached Excel file. 

Budgeting & Forecasting Assessment-Questions.xlsx

Use simple linear regression to estimate the relationship between promotion and revenue for
ABC Company. What will the revenue be when the promotion cost is 150?
Your Answer
$1059.51
Correct Answer
$1059.51
Explanation

The equation generated from the simple linear regression is Y = 6.2716 X + 118.77.
Revenue = 6.2716 x 150 + 118.77

See the attached Excel file for details:

Budgeting & Forecasting Assessment-Answers.xlsx

20
Use the same Excel data in the previous question and run a multiple regression to estimate
the relationship between promotion, advertising (independent variables) and revenue
(dependent variable). Calculate the revenue if the promotion cost is $150 and the
advertising cost is $250.
Your Answer
1060.83
Correct Answer
1060.83
Explanation

The formula generated from the multiple regression is Revenue = Intercept + Promotion
Coefficients * Promotion Cost + Advertising Coefficients * Advertising Cost = 1060.83 See
the details of the multiple regression in the Excel file from the previous question.