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Slide 12.2 Once the objectives of the business have been determined, the various options that can fulfil these objectives must be considered and evaluated in order to derive a strategic plan. The budget is a short-term financial plan for the business that is prepared within the framework of the strategic plan. Control can be exercised through the comparison of budgeted and actual performance. Where a significant divergence emerges, some form of corrective action should be taken. If the budget figures prove to be based on incorrect assumptions about the future, it might be necessary to revise the budget. Figure 12.1 The planning and control process
Slide 12.3 The first budget to be established is usually the sales budget. The expected level of sales normally defines the overall level of activity for the business, and the other budgets will be drawn up in accordance with this. Thus, the sales budget will largely define the finished stock requirements, and from this we can define the production requirements and so on. The figure shows the interrelationship of budgets for a manufacturing business. Figure 12.2 The interrelationship of various budgets
Slide 12.4 Budgets are seen as having five main benefits to the business. Figure 12.3 Benefits of budgeting
Slide 12.5 There is a sequence of events in the preparation of the budgets. Once the budgets are prepared, they are communicated to all interested parties and, over time, actual performance is monitored in relation to the targets set out in the budgets. Figure 12.4 Steps in the budget-setting process
Slide 12.6 Figure 12.5 Source: Reproduced from Figure 16 on p. 22 of Chittenden et al. (see reference 2 at the end of the chapter).
Slide 12.7a Example 12.1 Vierra Popova Ltd is a wholesale business. The budgeted profit and loss accounts (income statements) for each of the next six months are as follows: Jan Feb Mar Apr May June £000 £000 £000 £000 £000 £000 Sales revenue 525555605553 Cost of goods sold 30 31 31 35 31 32 Salaries and wages 10 10 10 10 10 10 Electricity 5 5 4 3 3 3 Depreciation 3 3 3 3 3 3 Other overheads 2 2 2 2 2 2 Total expenses 505150534950 Net profit 2 4 5 7 6 3
Slide 12.7b Example 12.1 continued The business allows all of its customers one month’s credit (this means, for example, that cash from January sales will be received in February). Sales revenue during December totalled £60,000. The business plans to maintain stocks (inventories) at their existing level until some time in March, when they are to be reduced by £5,000. Stocks will remain at this lower level indefinitely.
Slide 12.7c Example 12.1 continued Stock purchases are made on one month’s credit. December purchases totalled £30,000. Salaries, wages and ‘other overheads’ are paid in the month concerned. Electricity is paid quarterly in arrears in March and June. The business plans to buy and pay for a new delivery van in March. This will cost a total of £15,000, but an existing van will be traded in for £4,000 as part of the deal. The business expects to have £12,000 in cash at the beginning of January.
Slide 12.7d Example 12.1 continued The cash budget for the six months ending in June will look as follows: Jan Feb Mar Apr May June £000 £000 £000 £000 £000 £000 Receipts Debtors (note 1, Slide 12.7e) 605255556055 Payments Creditors (note 2, Slide 12.7e) 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 424268384752 Cash surplus 18 10 (13) 17 13 3 Opening balance (note 3, Slide 12.7e) 12 30 40 27 44 57 Closing balance 30 40 27 44 57 60
Slide 12.7e Example 12.1 continued Notes 1 The cash receipts from trade debtors (receivables) lag a month behind sales because customers are given a month in which to pay for their purchases. So, December sales will be paid for in January and so on. 2 In most months, the purchases of stock will equal the cost of goods sold. This is because the business maintains a constant level of stock. For stock to remain constant at the end of each month, the business must replace exactly the amount that has been used. During March, however, the business plans to reduce its stock by £5,000. This means that stock purchases will be lower than stock usage in that month. The payments for stock purchases lag a month behind purchases because the business expects to be allowed a month to pay for what it buys. 3 Each month’s cash balance is the previous month’s figure plus the cash surplus (or minus the cash deficit) for the current month. The balance at the start of January is £12,000 according to the information provided earlier. 4 Depreciation does not give rise to a cash payment. In the context of profit measurement (in the profit and loss account), depreciation is a very important aspect. Here, however, we are only interested in cash.
Slide 12.8a Example 12.2 To illustrate some of the other budgets, we shall continue to use the example of Vierra Popova Ltd that we considered in Example 12.1, (Slides 12.7a – 12.7e). To the information given there, we need to add the fact that the stock balance at 1 January was £30,000. Show the debtors (receivables), creditors (payables) and stock (inventory) budgets for the six months.
Slide 12.8b Example 12.2 continued Solution Debtors (receivables) budget This would normally show the planned amount owing from credit sales to the business at the beginning and at the end of each month, the planned total sales revenue for each month, and the planned total cash receipts from debtors. The layout would be something like the following: Jan Feb Mar Apr May June £000 £000 £000 £000 £000 £000 Opening balance 60 52 55 55 60 55 Add Sales revenue 52 55 55 60 55 53 112 107 110 115 115 108 Less Cash receipts 60 52 55 55 60 55 Closing balance 52 55 55 60 55 53 The opening and closing balances represent the amount that the business plans to be owed (in total) by debtors at the beginning and end of the month, respectively.
Slide 12.8c Example 12.2 continued Creditors (payables) budget Typically this shows the planned amount owed to suppliers by the business at the beginning and at the end of each month, the planned purchases for each month, and the planned total cash payments to creditors. The layout would be something like the following: Jan Feb Mar Apr May June £000 £000 £000 £000 £000 £000 Opening balance 30 30 31 26 35 31 Add Purchases 303126353132 60 61 57 61 66 63 Less Cash Payment 303031263531 Closing balance 30 31 26 35 31 32 The opening and closing balances represent the amount planned to be owed (in total) by the business to creditors, at the beginning and end of the month respectively.
Slide 12.8d Example 12.2 continued Stock (inventory) budget This would normally show the planned amount of stock to be held by the business at the beginning and at the end of each month, the planned total stock purchases for each month, and the planned total monthly stock usage. The layout would be something like the following: Jan Feb Mar Apr May June £000 £000 £000 £000 £000 £000 Opening balance 30 30 30 25 25 25 Add Purchases 303126353132 60 61 56 60 56 57 Less Stock used 303131353132 Closing balance 30 30 25 25 25 25 The opening and closing balances represent the amount of stock, at cost, planned to be held by the business at the beginning and end of the month respectively.
Slide 12.8e Example 12.2 continued Stock (inventory) budget A raw materials stock budget, for a manufacturing business, would follow a similar pattern, with the ‘stock usage’ being the cost of the stock put into production. A finished stock budget for a manufacturer would also be similar to the above, except that ‘stock manufactured’ would replace ‘purchases’. A manufacturing business would normally prepare both a raw materials stock budget and a finished stock budget. The stock budget will normally be expressed in financial terms, but may also be expressed in physical terms (for example, kg or metres) for individual stock items.
Slide 12.9a The traditional model is based on the use of fixed targets, which determine the future actions of managers. The ‘beyond budgeting’ model, on the other hand, is based on the use of stretch targets that can be adapted. The traditional hierarchical management structure is replaced by a network structure. Figure 12.6 Traditional versus ‘beyond budgeting’ planning model Source: www.bbrt.org.
Slide 12.9b The traditional model is based on the use of fixed targets, which determine the future actions of managers. The ‘beyond budgeting’ model, on the other hand, is based on the use of stretch targets that can be adapted. The traditional hierarchical management structure is replaced by a network structure. Figure 12.6 Continued Source: www.bbrt.org.
Slide 12.10a Summary • The main points of this chapter may be summarised as follows: • Budget = a short-term financial plan • Budgets are the short-term means of working towards the business’s objectives. • They are usually prepared for a one-year period with sub-periods of a month. • There is usually a separate budget for each key area.
Slide 12.10b Summary continued • Uses of budgets • They: • promote forward thinking; • help co-ordinate the various aspects of the business; • motivate performance; • provide the basis of a system of control; • provide a system of authorisation.
Slide 12.10c Summary continued • The budget setting process • Establish who will take responsibility. • Communicate guidelines. • Identify key factors. • Prepare budget for key factor area. • Prepare draft budgets for all other areas. • Review and co-ordinate. • Prepare master budgets (profit and loss account (income statement) and balance sheet). • Communicate the budgets to interested parties. • Monitor performance relative to budget.
Slide 12.10d Summary continued • Preparing budgets • There is no standard style – practicality and usefulness are the key issues. • They are usually prepared in columnar form, with a column for each month (or similarly short period). • Each budget must link (co-ordinate) with others.
Slide 12.10e Summary continued • Criticisms of budgets • Cannot deal with rapid change. • Focus on short-term financial targets, rather than value creation. • Encourage a ‘top-down’ management style. • Time-consuming. • Based around traditional business functions and do not cross boundaries. • Encourage incremental thinking (last year’s figure plus x per cent). • Protect rather than lower costs. • Promote ‘sharp’ practice among managers. • Budgeting is very widely practised despite the criticisms.
