6.

Budgets

Trefor McElroy
September/October 2017

Voettekst van presentatie

LEARNING OUTCOMES
You should be able to:

Define a budget and show how budgets, strategic

objectives and strategic plans are related

Explain the budgeting process and the interlinking

of the various budgets within the business

Indicate the uses of budgeting (including

limitations) and construct various budgets,
including the cash budget, from relevant data

Show how flexing the budget can be used to

exercise control over the business
• To implement long term strategic plans
Needbudgets
• Detailed for Budgets
prepared for next 12 months

• 2 phases:
– Planning
– Control

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The planning and Establish mission and objectives
control process
Undertake a position analysis

Identify and assess strategic options

Select strategic options and formulate long-

term (strategic) plans

Prepare budgets

Perform and collect information on actual

performance

Identify variances between planned

(budgeted) and actual performance

Respond to variances and exercise control

Revise plans (and budgets) if necessary

What is the purpose of control?

• Control enables managers to evaluate performance by comparing

actual performance with budgeted performance.
What is the purpose of control?
• There are three major reasons why there is variance, i.e. why actual
performance is different from budgeted performance:

1. External explanation:
• Business conditions have changed.
2. Internal explanations:
• There have been problems in the planning
process; or
• There have been problems in the
implementation process.
Variance analysis

1. Is the variance significant?

2. Is it likely to be repeated?
3. Can it be explained and understood?
4. Is it controllable?
Fixed and flexible budgets

For control purposes (variance analysis), flex

the original budget to the actual activity.

Variances can be investigated regularly (e.g

monthly) based on past spending patterns.

Rolling budget –
– prepared on a continual basis so always have 12
months budget ahead
Relationship between the budgeted and actual profit

Budgeted profit

plus

All favourable variances

minus

All adverse variances

equals

Actual profit
 Flexible budgets
A more valid comparison can be made between the budget
(using the flexed figures) and the actual results.
Original Flexed budget Actual
budget
Output (production 1,000 units 900 units 900 units
and sales)
£ £ £
Sales revenue 100,000 90,000 92,000
Direct materials (40,000) (36,000) (36,900)
Direct labour (20,000) (18,000) (17,500)
Fixed overheads (20,000) (20,000) (20,700)
Operating profit 20,000 16,000 16,900
Budgeting

“An important tool for effective short-term

planning and control”

Possible approaches
1. Incremental
2. Zero-base
 Approaches

• Incremental –
– Add a percentage to last year’s budget
– Builds in any previous inefficiencies (budgetary slack)
– But quick and simple to prepare

• Zero Based -
– Start with zero value and justify all expenditure
– Time consuming & expensive

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What is the budgeting process?

• Budgets are established annually.

• There are two approaches:
– Bottom-up, where the information flows from the lower-level to
the top managers.
– Top-down, where the information flows from the top to the lower-
level managers.

Very often, companies use a combination of these

two approaches.
Communication

Whatever approach is used, communication is

vital in the budgeting process.
 Behavioural aspects of budgetary control

The existence of budgets generally tends to improve

performance

Demanding, yet achievable, budget targets tend to

motivate better than less demanding targets

Unrealistically demanding targets tend to have the

adverse effect on managers’ performance

The participation of managers in setting their targets

tends to improve motivation and performance
 The five main benefits of budgets to a business

Promote forward
Help coordination
thinking and and communication
identification of Budgets between the various
short-term sections of the
problems business

Motivate managers
to better Provide a basis Provide a
performance and for a system of system of
assists control authorisation
performance
evaluation
• Income statement, balance sheet & Cash budget
Master
• Cash budget Budgets
– shows expected cash flows in detail

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 What are the typical budgets? (2)

Sales budget

Production budget

Operating Direct material cost Direct manufacturing Manufacturing overhead

Budgets budget labor cost budget costs budget

Cost of sales budget

R&D costs budget Marketing costs budget Distribution costs budget

Budgeted income
statement

Financial Capital expenditures Budgeted balance sheet Budgeted cash flow

Budgets budget statement
 The interrelationship of operating budgets

Trade Trade
Cash
receivables payables
budget
budget budget

Capital Direct Raw

Sales Overheads materials
expenditure labour
budget budget purchases
budget budget
budget

Finished Raw materials

Production
inventories inventories
budget
budget budget
 The vertical relationship between a business’s sales budgets

Overall sales budget

Sales budget Sales budget Sales budget Sales budget

North region South region East region West region
 An example of a budget – the cash budget
Jan Feb Mar Apr May June

£000 £000 £000 £000 £000 £000

Receipts

Receivables 60 52 55 55 60 55

Payments

Payables 30 30 31 26 35 31

Salaries and wages 10 10 10 10 10 10

Electricity 14 9

Other overheads 2 2 2 2 2 2

Van purchase 11

Total payments 42 42 68 38 47 52

Cash surplus 18 10 (13) 17 13 3

Opening balance 12 30 40 27 44 57
Cash balance 30 40 27 44 57 60
 An example of a trade receivables budget

Jan Feb Mar Apr May June

£000 £000 £000 £000 £000 £000

Opening balance 60 52 55 55 60 55

Sales revenue 52 55 55 60 55 53

Cash receipts (60) (52) (55) (55) (60) (55)

Closing balance 52 55 55 60 55 53
 An example of a trade payables budget

Jan Feb Mar Apr May June

£000 £000 £000 £000 £000 £000

Opening balance 30 30 31 26 35 31

Purchases 30 31 26 35 31 32

Cash payment (30) (30) (31) (26) (35) (31)

Closing balance 30 31 26 35 31 32
 An example of an inventories budget

Jan Feb Mar Apr May June

£000 £000 £000 £000 £000 £000

Opening balance 30 30 30 25 25 25

Purchases 30 31 26 35 31 32

Inventories used (30) (31) (31) (35) (31) (32)

Closing balance 30 30 25 25 25 25
• Jane Ashton:
• Cashbalance
Bank budgetat-1Example
June £25,000
• Budgeted sales:
– May £65,000
– June £95,000
– July £105,000
– August £125,000
• 70% in the month of sales, 25% in the month following

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Example ….

• Budgeted purchases:
– June £65,000
– July £80,000
– August £55,000
• Wages: £8,000 per month paid monthly
• Overheads: £17,000 per month (including
£4,000 depreciation ) paid monthly
• Tax: £15,000 paid in July
• Loan Repayment: £7,500 paid in July

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Cash Budget Template
June July August
£ £ £
Receipts
Cash sales (70%)
Credit sales (25%)
Total receipts

Payments
Purchases
Wages
Overheads
Tax
Loan repayment
Total payments

Net cash flow

Opening balance
Closing balance

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• Sales:
• Receipts
Cash sales for June = 70% of June’s sales (£95,000)
• Credit sales for June = 25% of May’s sales (£65,000)
• Use the same approach for July and August

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Cash Budget for 3 months to 31 August

June July August

£ £ £
Receipts
Cash sales (70%) 66,500
Credit sales (25%) 16,250
Total receipts 82,750

Payments
Purchases
Wages
Overheads
Tax
Loan repayment
Total payments

Net cash flow

Opening balance
Closing balance

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• Use the information as given
Payments
• Note: Overheads include depreciation
• Depreciation is not a cash flow - exclude

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• Net cash flow = Total receipts minus total payments
• Finally
Opening balance = bank balance at 1 June
• Closing balance = net cash flow plus opening balance
• Closing balance = opening balance for the next month

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 Making budgetary control effective

A serious attitude taken to the system

Clear demarcation between areas of managerial

responsibility

Budget targets that are challenging yet

achievable
Established data collection, analysis and
reporting routines

Reports aimed at individual managers

Fairly short reporting periods

Timely variance reports

Action being taken to get operations back

under control
Criticisms of budgeting

1. Time-consuming and expensive

2. Too inflexible and prevent a fast response
3. Protect rather than reduce costs (i.e builds in inefficiencies)
4. Stifle product and strategy innovation
5. Focus on sales targets rather than customer satisfaction
6. “Game playing” can cause waste, misallocation of resources , and
reduce motivation
Summary

1. Budgets are useful tools for both planning and control

2. Variances can be calculated and investigated
3. Budget comparisons help control