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Budgeting in the Private Sector: A Changing Perspective CPD Seminar

Explore the purpose and benefits of budgeting in the private sector, as well as the risks, techniques, and principles involved. Learn about forecasting methods, sales budgets, production budgets, cash budgets, and the importance of cost and resource management.

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Budgeting in the Private Sector: A Changing Perspective CPD Seminar

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  1. BUDGETING IN THE PRIVATE SECTOR

  2. BUDGETING IN PRIVATE SECTORA Changing Perspective CPD Seminar – Commerce & Industry AUGUST 2019 BUDGETING IN PRIVATE SECTOR

  3. BUDGETING & FINANCIAL REPORTING BUDGETING IN PRIVATE SECTOR

  4. BUDGETING Budgeting is a planning tool used by management to quantify the action plans of the organisation – financial plan Budgeting is a is a tool used by management to allocate resources to achieve the goals of the organisation in the most effective and efficient manner BUDGETING IN PRIVATE SECTOR

  5. BUDGETING – STANDARD CONCEPT PURPOSE OF BUDGETING: • Vehicle for financial forecasting • Resource planning & allocation • Vehicle for forecasting • Co-ordinating & control activities of business • Communication of management’s goals • Addressing operational conflict BUDGETING IN PRIVATE SECTOR

  6. PURPOSE OF BUDGETING • Purpose of Budgeting: • Resource planning – allocation of resources to achieve goals economically and efficiently • Financial planning – financial forecasting and activities • Financial control – control over the costs for the activities of the business • Communication – facilitate the organisation wide communication of the strategies & goals • Motivating staff – motivation for staff to achieve performance levels (agreed KPI) • Conflict resolution – facilitate resolving conflict between departments and groups in the organisation BUDGETING IN PRIVATE SECTOR

  7. REASONS FOR BUDGETING • Reasons for Budgeting: • Control – control the implementation of budget and activities • Allocation of resource – facilitate the allocation of resources as the budget is adjusted • Monitoring – tracking the progress towards achieving goals • Evaluation – evaluate performance of staff and departments • Risk management – facilitate the mismanagement of resources and wasteful expenses BUDGETING IN PRIVATE SECTOR

  8. BUDGETING IN PRIVATE SECTOR

  9. BENEFITS OF BUDGETING BUDGETING IN PRIVATE SECTOR

  10. RISKS OF BUDGETING BUDGETING IN PRIVATE SECTOR

  11. BUDGETING TECHNIQUES BUDGETING IN PRIVATE SECTOR

  12. BUDGET FAILURES • Reasons Budgets Fail • Lack of clear purpose of budgets – performance measure vs strategies planning • Unrealistic expectations – lack of detailed planning in setting budgetary goals • Improper communication – lack of information about the budgetary process and the budgets • Improper metrics – lack of proper monitoring and evaluation processes • Top-down cost allocation – cost are allocated with negotiations or agreement • Fixed budget – budgets are viewed as cast in stone and cannot be changed (agility of budgets) BUDGETING IN PRIVATE SECTOR

  13. EFFECTIVE BUDGETING BUDGETING IN PRIVATE SECTOR

  14. PRINCIPLES OF GOAL SETTING BUDGETING IN PRIVATE SECTOR

  15. FORECASTING METHODS BUDGETING IN PRIVATE SECTOR

  16. Sales Budget OPERATING BUDGET O Production Budget p B e u Manufacturing overheads Budget Direct materials Budget Direct labour Budget r d a g t e i Selling & Administrative expense Budget t n g Budgeted income statement Financial Budget Capital Expenditure Budget Balance sheet Budget Cash Budget BUDGETING IN PRIVATE SECTOR

  17. SALES BUDGET BUDGETING IN PRIVATE SECTOR

  18. INVENTORY BUDGET • Inventory Budget: • Inventory budgets should be based on the inventory management strategy of the organisation • Inventory budgets is driven by the sales strategy of the organisation • Inventory budget must account for the risk associated with the warehouse management Inventory Budget - units: Sales volume budget XXX Add: Closing inventory plan XXX Add: Inventory shrinkage/loss XXX XXX Less: Opening inventory XXX Inventory requirement XXX BUDGETING IN PRIVATE SECTOR

  19. PRODUCTION BUDGET • Production Budget: • The production budget is based on the costs associated with the manufacturing process (variable and fixed costs) • The production consists of a resource requirements budget as well as a cost budget • Materials and labour cost budgets must take into account the normal wastages occurring during the production process BUDGETING IN PRIVATE SECTOR

  20. CASH BUDGET BUDGETING IN PRIVATE SECTOR

  21. CASH BUDGET • Cash Budget: • Conversion of operating and capital expenditure budgets to a periodic cash flow plan • Excludes all non-cash transactions such as depreciation, bad debts and accruals • Transactions are inclusive of VAT and the payment of VAT is treated as a separate • Cash flows from customers and suppliers is based on the payment terms BUDGETING IN PRIVATE SECTOR

  22. RELEVANT COSTING BUDGETING IN PRIVATE SECTOR

  23. RESOURCE MANAGEMENT BUDGETING IN PRIVATE SECTOR

  24. BUSINESS INFORMATION Information is the sixth business resource Information must be directly relevant to the decision-making process BUDGETING IN PRIVATE SECTOR

  25. NEED FOR COST INFORMATION To be information literate, a person must be able to recognize when information is needed and have the ability to locate, evaluate, and use effectively the needed information. • Purchasing new equipment • Replacing existing equipment • Introducing new products • Taking special orders • Make vs buy decisions • Product pricing decisions • Allocation of scarce resources BUDGETING IN PRIVATE SECTOR

  26. DECISION-MAKING TURMOIL Sunk cost: Cost already incurred and does not affect the business decision Relevant cost: Future cost and cash flow affecting business decision Avoidable cost: Cost which will not be incurred if discontinued Opportunity costs: Value of benefit sacrifice for choosing an alternative option BUDGETING IN PRIVATE SECTOR

  27. IDENTIFYING RELEVANT COSTS • Any cost that is a future cost or cash flow • Any cost that differs among alternatives and will influence the outcome, • Future costs and future revenues that differ among decision alternatives. • Compare to indicate how they differ under each alternative. • Sunk costs are never relevant • Any cost that is avoidable, and BUDGETING IN PRIVATE SECTOR

  28. DISCUSSION 1 Which cash flows should be taken into consider when making a decision? • An entity acquired inventory at a cost of R300 per unit, but can replace it at a cost of R320. • An entity acquired machinery at a cost of SR900,000, the carrying amount is R400,000. In order to improve the efficiency of the machinery it should be repaired and overhauled at a cost of R75,000. BUDGETING IN PRIVATE SECTOR

  29. DISCUSSION 1 • Decision-making criteria: Decisions are made about the future and thus be based on future cash flows. • Discussion: • When the inventory is sold the entity should have sufficient cash to replace the goods sold, thus the future purchase price of the goods is important to the decision-making process. • The machinery has already been acquired and thus that does not affect the decision. The decision is about improving the efficiency of the machinery and thus the repair costs of R75,000 is the most important factor. BUDGETING IN PRIVATE SECTOR

  30. PRACTICE EXERCISE 1 BUDGETING IN PRIVATE SECTOR

  31. PRACTICE EXERCISE 1 Revenue Not relevant income: same for both alternatives Direct materials Not relevant costs: same for both alternatives Conversion costs Relevant costs: costs differ for the alternatives Selling & distribution expenses Not relevant costs: same for both alternatives Quality assurance costs Relevant costs: costs differ for the alternatives Depreciation Not relevant costs: not future cash flow or cost Maintenance costs Relevant costs: costs differ for the alternatives Salvage of Machine B [replaced] Relevant income: only received if machine is replaced Cost of Machine A Relevant cost: only incurred if machine is purchased BUDGETING IN PRIVATE SECTOR

  32. PRACTICE EXERCISE 1 BUDGETING IN PRIVATE SECTOR

  33. SUNK COSTS BUDGETING IN PRIVATE SECTOR

  34. SUNK COSTS • Business and ethical dilemma: • Traditional recognition of accounting information: Although the book value of an old item has no economic significance (i.e. not relevant), the accounting treatment of past costs may make it difficult for managers to regard them as irrelevant. • Accounting treatment of de-recognised assets: The possibility of recording an accounting loss may place managers in a dilemma. Fearing the loss will lead to superiors questioning his/her judgment, a manager might prefer to use the old item, as opposed to replacing it and be forced to record a loss. • Conflict of accounting and management accounting principles: Cumulative effect of many such decisions will be harmful to the long-run economic health of the organisation. BUDGETING IN PRIVATE SECTOR

  35. AVOIDABLE COSTS • Avoidable costs: An avoidable cost is a cost that can be eliminated, in full or in part, as a result of choosing on alternative over another. All costs are considered avoidable, except: • sunk costs, and • Costs that are the same for each alternative. BUDGETING IN PRIVATE SECTOR

  36. DEPRECIATION & SALVAGE VALUE • Depreciation: Depreciation is the allocation of the cost of the asset and does not represent a future cash flow. Depreciation is not a relevant cost as it relates to a sunk cost. • Salvage value: The salvage value represents a future cash inflows from the disposal of assets is a relevant cash inflow. Similarly, any salvage value at the end of the useful life of the assets will also be relevant. A loss on disposal may have a favorable tax impact if the loss can be offset against taxable gains or taxable income – tax consequence is a relevant cost. BUDGETING IN PRIVATE SECTOR

  37. SUMMARY • Under relevance costing, only costs and revenues that differ under each alternative should be considered. BUDGETING IN PRIVATE SECTOR

  38. UTILISATION OF RESOURCES BUDGETING IN PRIVATE SECTOR

  39. MANAGING RESOURCE CONSTRAINTS • Produce only what can be sold • At the bottleneck itself: • Improve the process • Add overtime or another shift • Hire new/additional workers • Acquire more machines • Sub-contract production • Eliminate waste • Streamline production process BUDGETING IN PRIVATE SECTOR

  40. RELEVANT COST OF MATERIALS Relevant cost = current replacement cost Relevant cost = current resale value Relevant cost = opportunity cost BUDGETING IN PRIVATE SECTOR

  41. DISCUSSION 2 What is the cost of the direct materials? • An entity engaged in a manufacturing process received a request to provide materials to a sub-contractor. The reason for the request was that there was a shortage of materials in the market. • An entity was offered to operate as a contractor for services that a major entity intends to outsource. The materials used in rendering the services are scarce and the entity may have to curtail its services to its existing customers. BUDGETING IN PRIVATE SECTOR

  42. DISCUSSION 2 • Relevant cost criteria – materials: Relevant cost for material represents the future cash flow or costs likely to be incurred which is affected by the use of such materials. • Discussion: • The entity should only provide the material to the sub-contractor which is considered profitable, i.e. the entity must be in a position that will break even in future. As there is a temporary shortage of materials, the entity needs to take into consideration the that to replace the materials for future use the price may increase. The relevant cost represent by the replacement cost of the materials. BUDGETING IN PRIVATE SECTOR

  43. DISCUSSION 2 • Discussion: • The entity should only provide the material to the sub-contractor which is considered profitable, i.e. the entity must be in a position that will break even in future. As the materials are scarce, the entity needs to take into consideration the opportunity cost of not having the materials when required in future. The opportunity cost will be measured by the contribution lost as a result of not being able to produce the goods in future as a result of the non-availability of materials. The relevant cost of the material is represented by the opportunity costs. BUDGETING IN PRIVATE SECTOR

  44. PRACTICE EXERCISE 2 BUDGETING IN PRIVATE SECTOR

  45. PRACTICE EXERCISE 2 BUDGETING IN PRIVATE SECTOR

  46. RELEVANT COST OF LABOUR BUDGETING IN PRIVATE SECTOR

  47. DISCUSSION 3 • Relevant cost criteria – labour Relevant cost for labour represents the future cash flow or costs likely to be incurred which is affected by the use of such labour. • Discussion • Skilled labour is directly associated with the manufacturing process and is considered to be a variable cost. The relevant cost of the skilled labour will depend if there is spare capacity. If the skilled labour is fully utilised, the additional labour capacity will be required. The relevant cost of the additional capacity required will be the cost of hiring additional staff [market rate] or the cost of working overtime [current labour cost plus overtime rate]. If there is unused/spare labour capacity, the relevant cost will be zero provided the labour cost is not paid by unit of output. BUDGETING IN PRIVATE SECTOR

  48. DISCUSSION 3 What is the cost of labour? • An entity received a special request from its major customer to double its supply of goods. The manufacture of the goods require a high proportion of skilled labour. • An entity received a request to increase its output for a period of three months due to the damage caused to one the premises of its competitors. The labour costs involved in the production process consist of both production labour force and supervisor. BUDGETING IN PRIVATE SECTOR

  49. DISCUSSION 3 • Discussion • The relevant cost of the direct labour cost will depend if there is spare capacity as discussed in (a). The supervisor’s cost is a fixed labour cost and is not affected by the level of production. Thus the relevant cost for the supervisor is zero provided there are no additional cost incurred such as incentive schemes on output etc. Fixed cost is not measured in term of the capacity or production level. BUDGETING IN PRIVATE SECTOR

  50. PRACTICE EXERCISE 3 BUDGETING IN PRIVATE SECTOR

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