Prepare and monitor basic operating and financial budgets

1. Prepare and monitor basic operating and financial budgets BS508 Accounting Principles

2. QUOTE Budget: A mathematical confirmation of your suspicions. • A.A. Latimer

3. Budget Definition 1: • A budget is a detailedplan in writing (usually expressed in monetary terms) that outlines the expected financial consequences of management’s strategies for achieving the organisation’s key objectives for the coming period.

4. Budget Definition 2: • A budget is a financial document that expresses a future plan or expectation contributing to the operation or control of an organisation (e.g. expressing the expected future cash flows or setting out the expected sales quantities or revenues for a future period).

5. Why Budget ? • to be able to PLAN(eg. resource requirements, so that you have them when you need them) and • to be able to CONTROL (ie. monitor how you’re going, to ensure that you stay on-track to achieve your plans) • Budgeting is a necessary element in the process of management

6. Planning & Controlling • PLAN ingè via a MASTER BUDGET (static) • CONTROL ingè via a FLEXIBLE BUDGET (dynamic) MASTER BUDGET • A set of interrelated budgets representing a comprehensive plan of action for a specified time period. • Basically, the master budget is a combination of all the individual budgets in an organisation, including the operating and financial budgets.

7. Master Budget for Stylistic Furniture

8. Advantages of Budgets • Budgeting forces management to plan ahead. • Realistic performance targets are set against which actual performance can be compared. • Budgeting assists all segments of the organisation to work towards the same goals. • Budgeting contributes to better communication through the exchange of financial information between departments. • Budgeting improves motivation by providing goals to be aimed for.

9. Limitations of Budgeting • B are unable to provide up-to-dateinformation in a fast-changing environment. • B focus too much on short-term financial targets rather than value-adding activities. • B limit innovation by lower level managers • B is too focussed on the functions rather than the processes of the business. • B encourages incremental thinking, i.e. adding a percentage to last year’s figures, rather than strategic planning. • Budgets can encourage using up the whole budgeted amount, irrespective of need.

10. What is Budget Slack? • Budgets may be set in such a way that they are useless as either a control tool or a motivator. A manager who sets a budget that is known to be achievable without stretching (this is known as budget slack) has gone through the motions of budgeting but has not entered into the spirit of setting achievable but challenging targets. • On the other hand, unrealistically high targets act as a disincentive for staff and may produce resentment and reduce motivation. (SMART goals)

11. Types of Budgets • Individual budgets that make up the master budget are often classified as revenue budget, operating budgets or financial budgets. • Revenue budgets set out the estimates of the income of the firm (e.g. sales, fees and other income). • Operating budgets set out the estimates of the costs associated with different aspects of the operations of the firm (e.g. purchases budget, cost of goods sold budget, selling expenses budget, administration expenses budget and financial expenses budget). • Financial budgets set out the estimates of financing activities and the expected summary results for the coming period (e.g. cash budget, income statement budget, balance sheet budget and capital expenditure budget)

12. The Process of Budgeting& the Interrelationships of Budgets • Market Research/Trend Analysis/Demand Forecasting • Operating Budgets • Capital Exp Budgets • P & L Statement Budgets • Cash Flow Budgets • Balance Sheet Budgets

13. Operating Budgets • Revenues (Sales) Budget • Production Budget • Materials Purchases Budget • Direct Labour Budget • Manufacturing Overhead Budget • Non-Manufacturing Costs (Operating) Budgets BUDGETED INCOME (P&L) STATEMENT

16. Operating Budgets • Illustrative Example: • Brentware Ltd (a manufacturer of clay pots)

20. Purchases Budget Exercise • Jesse idol’s DVD sales business • Jesse expects to sell 7000 DVDs in October and 7800 in November. • Jesse requires that the physical stock on hand at the end of each months (i.e. closing inventory) equals 25% of the sales expected for the next month. • Jesse buys the DVDs for $15 each and sells them for $30 each. • Create the Purchases Budget for October.

21. Jesse idol’s Purchases Budget • Cost/unit $50 + (100% mark-up)$50 = $100 SP • Projected Sales for July 5,600 units • August 6,200 units • Opening Stock: 1 July 1400 (25% of July Sales) • Closing Stock : 31 July 1550 (25% of Aug Sales) • a) Purchases for July: 5600 + 1550 – 1400 = 5750 units x $50 = $287,500

22. Jesse idol’s Purchases Budget • Sales 560,000 • Less COS: • Open Inv. 70,000 (1400 x $50) • + Purchases 287,500 • Clos Inv (77,500) 280,000 Gross Profit $280,000

23. Variances • A Variance is the difference between a budgetedamount and the actual amount • Budgeted amounts may be based on: • past costs (but considering future changed conditions &/or past inefficiencies) • expected costs • best practice • “standards” (a combination of expected conditions & best practices)

24. Budgets • Static Budget– is the original budget based on the original planned level of output (ie. the master budget level)- used for resource planning purposes • Flexible Budget– is the static budget restated for the actual level of output achieved • used for analysis, after the ‘actuals’ have occurred,► for performance evaluation purposes • enables a proper comparison of “apples with apples” • A simple example of this concept:Assume you are the Functions Catering Manager at a large hotel → see next slide

26. Variance Analysis Budget (plan) Actuals Variances (for evaluation of performance) Prices Prices Price Variances X X Quantities Quantities Qty Variances Variances Costs Costs

27. For example: your petrol budget for next week

28. Formulas • to calculate variances: Price Variance = price diff. x actual qty Qty Variance = qty. diff. x budgeted price

29. Exercise • LampaLtd manufactures lamps. It has set up the following standards per finished unit for direct materials and direct labour: