Unit 8

1. Unit 8 Budgetary Planning - The Budget Process

2. A budget is • ‘quantitative expression of a plan for a defined period of time’. • A budget as defined by CIMA Official Terminology.

3. The role of Budgeting • The main objective of budgeting is to provide a formal quantitative and authoritative statement of the firms plans expressed in monetary terms. • It acts as a blueprint for a business to follow in future periods.

4. The master budget • The plan of action selected is termed the master budget for the period. • A projected profit and loss account. • A projected balance sheet. • A projected cash budget.

5. Budgetary planning • ‘ the establishment of objectives, and the formulation, evaluation and selection of the policies, strategies, tactics and action required to achieve them'. • Planning as defined by CIMA Official Terminology • In general, budgetary planning is divided into: • Strategic planning • Short-term planning.

6. Decision Set business objectives  Identify potential strategies Long Term Planning Process Decision Evaluate and select strategies Implement strategies Compare actual results with plan Control Process Investigate variances and take corrective action Framework for planning, decision-making and control

7. The budgetary process • Communicate details of budget policy and guidelines • Identify limiting factors • Preparation of sales budget • First draft preparation of department budgets • Budget negotiation • Co-ordination and review of budgets • Final acceptance of budget

8. Administration of the budget process • Any budget process should have the following administrative supports • A budget committee • A budget manual • Accounting staff for support

9. A budget committee • A budget committeeshould consist of senior management who are responsible for the major functions of the organisation. • Generally the committee will appoint a budget officer (normally an accountant) who co-ordinates the individual budgets into the master budget. • Each business segment submits a budget and each member of the budget committee see the other budgets submitted and the overall effect in the master budget. • The final budgets are agreed. • The budget committee also sets the guidelines for the preparation of individual budgets and the procedures for negotiating and agreeing budgets.

10. A budget manual • A budget manualoutlines the objectives, rules, regulations and procedures involved in the budgetary process. It is generally prepared by the company accountant and could include timetables regarding the process, highlighting important dates as well as the persons responsible for the various budgets to be submitted.

11. Advantages • A budget gives a firm direction. It forces management to set and prioritise goals which act as a blueprint for the future. • Budgeting compels management to plan and focus on the future. • Budgets provide management with a basis on which to measure subsequent performance. • The budgeting process encourages communication within the organisation. • The budgetary process plays a strong role in the co-ordination of activities and goal congruence. • The budgetary process provides a basis for responsibility accounting.. • Control within an organisation is facilitated by the regular, systematic monitoring and reporting of activities and comparing with the budget. • The preparation of a master budget facilitates better cash and working capital management. • Because of the ‘exception principle’, managers time can be saved and attention directed to areas of most concern.

12. Problems or difficulties • Some organisations may find it difficult to forecast sales with any degree of accuracy. • It may be difficult for management to estimate the availability of resources for the year ahead. • Currency fluctuations and inflation may make it difficult to estimate future price levels for materials, expenses and wages. • Badly handled budgetary systems that fail to consider the human aspects involved may dilute the morale of a workforce. • Managers are often made accountable for budget variances that may be caused by factors outside their control. • Budget slack, the intentional overstating of expenses, may prevent an organisation from producing accurate budgets and can affect the overall cost competitiveness of an organisation. • For many organisations, budgets are developed around existing organisational structures which may be inappropriate for current conditions and organisational development. • A budget and planning process that is too rigid may hinder the creativity and flexibility in an organisation.

13. Approaches to budget implementation • There are two main approaches to budget implementation • A top-down (imposed) approach • A bottom-up (participative) approach

14. Top-down approach • ‘a budgeting process where budget allowances are set without permitting ultimate budget holders the opportunity to participate in the process’. • Top-down approach to budgeting as defined byCIMA Official Terminology.

15. Top-down approach • When a top-down (imposed) approach is adopted, senior management prepare a budget with little or no input from operating personnel. The budget is then imposed on employees who have to work to the budget figures. This imposed approach can be effective in newly formed or small organisations during economic hardship when precise co-ordination is required, or when operational managers lack budgeting skills.

16. Advantages Senior managers should be aware of the total resources of the organisation. Budgets should be in line with strategic plans. Co-ordination should be enhanced. The approach is quicker and less costly in the short-term.. Disadvantages Imposed approach may result in staff dissatisfaction and poor morale. Can contribute to a lack of team spirit. Limited acceptance of budget by staff which can contribute to poor performance. Budget process may be seen as a punitive device. Unachievable budgets may be set. Lower-level management initiative is stifled. Top-down approach

17. Bottom-up approach • ‘a budgeting process where all budget holders have the opportunity to participate in setting their own budgets’. • Bottom-up approach to budgeting as defined by CIMA Official Terminology.

18. Bottom-up approach • Where a bottom-up (participative) approach is adopted, budgets are developed by lower-level managers who then submit and agree their budgets with their superiors. This approach can be effective in very large organisations or where operational managers have strong budgeting skills.

19. Advantages Budget information comes from those who know at an operational level. Knowledge used in the process is spread throughout the organisation and should improve the quality and accuracy of budget data. Morale and motivation may be improved as participation levels increase. In general, the likelihood of acceptance of the budget is increased. Generally budgets can be more realistic. Disadvantages The approach is more time consuming. Changes often made by senior managers can cause motivation issues. Lower level managers may be unqualified to participate. Budgetary slack may be introduced. The budget process may be forced to start earlier, therefore more uncertainty exists regarding budget forecasts. Bottom-up approach

20. Motivational aspects of budgets Performance and motivation may be improved: • When the process involves a bottom-up approach to target setting, management at all levels are involved or have their say in the target setting process. • Where targets are set that are demanding but achievable. • Where the work environment is more relaxed and factors such as staff motivation are considered to be as important as achieving set targets. • Where targets are not achieved, a caring non-personal and non-critical approach is taken. • Where managers are not held responsible for costs and revenues that they are not in a position to control. Thus the existence of responsibility accounting, where departmental managers are only responsible for costs and revenues generated within their control.

21. Motivational aspects of budgets Performance and motivation may be hindered: • Where the process of target setting is a top-down approach with management deciding targets for their subordinates. • Where unrealistic targets are set resulting in an idealistic budget rather than an attainable or realistic budget. • Where the expectation in the work environment is that targets must be met above all other things. In this instance managers will introduce 'slack' into the target setting process to ensure the target is achieved. • Where a critical approach is taken when targets are not achieved.

22. Budgeting and Responsibility Accounting • Budgeting works best where a clear organisation structure exists. This occurs where an organisations structure is an arrangement of lines of responsibility where each manager within the organisation is responsible for a part or segment of the organisation • There are four major types of responsibility centres: • Cost centres • Revenue centres • Profit centres • Investment centres

23. A cost centre • This is where the manager is responsible for costs only. An example would include the maintenance or cleaning department of a hotel which only deals with costs and expenditure and thus would be a cost centre.

24. A revenue centre • This is where managers are only responsible for the revenues earned. An example would include the sales reservations of a hotel or leisure centre.

25. A profit centre • This is where the manager is responsible for both the revenues and costs of a section or segment of the organisation. An example would include a leisure centre as part of a chain or a retail outlet as part of a chain of outlets or a restaurant within a hotel. Here the budget represents both revenues and costs.

26. An investment centre • This is where a manager is responsible for investments as well as revenues and costs. The regional manager of a retail chain would for example, be responsible for not just how each of the outlets have performed from a profit (revenues less costs) perspective, but for the level and quality of the investment and the level of return on investment achieved within the region.

27. Responsibility accounting • Responsibility accounting measures actual results with budgeted for every responsibility centre and ultimately helps to trace costs and revenues to the person who has the most knowledge of, and who is responsible for, those costs and revenues. Budgets coupled with responsibility accounting, provide a focus for managers when interpreting variances. Variances, whether positive or negative, should prompt questions and subsequent investigation, not blame. Thus responsibility accounting identifies a person who can properly explain a variance.