Budgeting Process: Planning for Short-Term Success

1. BUS106 Lecture #6 Chapter 9 Presented by Dr Greg Laing Prepared by Nicola Beatson

2. Strategic planning and budgetingcontinued • Budgeting is a process that focuses on the short term, commonly one year, and results in the production of budgets that set the financial framework for that period • Budgets operationalise strategic plans and allow operational areas to understand how their area contributes to the entity’s strategic objectives Prepared by Nicola Beatson

3. Budgets • Entities engage in a planning process that requires involvement in a budgeting process • Part of the formal planning process relates to an entity’s operational plans, including short term goals and targets • Performance management involves setting targets in other than just financial terms e.g., improving customer service, corporate governance, management techniques, and human resource management Prepared by Nicola Beatson

4. Budgets continued • A budget is the quantitative expression of an entity’s plans • Budgeting can assist in decision making by: • putting into operation longer term plans • Assessing the feasibility of strategic plans • setting targets for managers • identifying resource constraints in budget period • identifying periods of expected cash shortages and excess cash holdings • assisting with short-term planning decisions, such as capacity utilisation Prepared by Nicola Beatson

5. Budgets continued • providing profit forecasts and other financial data to the capital markets • forecasting data such as sales or fees, which commonly set the level of activity for the budget period • helping determine required inventory levels and purchasing requirements for raw materials • planning labour and other inputs • determining the ability of the entity to meet financing commitments Prepared by Nicola Beatson

6. The budgeting process • Consideration of past performance • Assessment of expected trading and operating conditions • Preparation of initial budget estimates • Adjustment to estimates based on communication with, and feedback from, managers • Preparation of budgeted reports and sub-budgets • Monitoring of actual performance against the budget over the budget period • Making any necessary adjustments to the budget during the budget period Prepared by Nicola Beatson

7. The budgeting process continued Prepared by Nicola Beatson

8. Types of budgets • Sales (or fees) budget • Operating (expenses) budget • Production and inventory budgets • Purchases budget • Manufacturing overhead budget • Budgeted income statement • Cash budget • Budgeted balance sheet • Capital budgets • Program budget Prepared by Nicola Beatson

9. Applicable budgets for sample entities Prepared by Nicola Beatson

10. Master budget • A master budget is a set of interrelated budgets for a future period which provides a framework for viewing relevant budgets of an entity • To enable the budget to be used as a control tool to monitor the entity’s achievement of its plans, classification of items included in the master budget needs to mirror the entity’s chart of accounts • Because budgets are based on forecasts about the future, complete accuracy is impossible and variances will inevitably arise Prepared by Nicola Beatson

11. Master budget continued Prepared by Nicola Beatson

12. Master budget continued • Stages in the preparation of a master budget • Determine the expected level of activity for the coming budgeting period • Developing the sales budget • Developing the production budget • manufacturers only • Developing the materials budget • manufacturers only Prepared by Nicola Beatson

13. Master budget continued • Stages in the preparation of a master budget • Developing the purchases budget • Retailers and manufacturers only • Developing the labour budget • service providers do this after the sales budget • Developing the operating expenses budget • See illustrative examples 9.1-9.10 in your textbook Prepared by Nicola Beatson

14. The cash budget • The cash budget is a statement of expected future cash receipts and payments • It assists decision making by: • documenting timing of all cash receipts and payments • helping to identify periods of expected cash shortages and surpluses • identifying suitable times for purchase of non-current assets Prepared by Nicola Beatson

15. The cash budget continued • assisting with planning and use of borrowed funds • providing a framework for ‘what if’ analysis • For an entity that provides goods or services on credit, one of the main tasks in the preparation of a cash budget is calculating the cash receipts from the credit sales or fees generated • This is commonly shown in a schedule of receipts from debtors/accounts receivable Prepared by Nicola Beatson

16. Prepare a schedule of receipts Prepared by Nicola Beatson

17. Prepare the cash budget Prepared by Nicola Beatson

18. Budgets: planning and control • The preparation of the cash budget is an important part of the planning process • It can then be used for monitoring cash performance, also known as the control process Prepared by Nicola Beatson

19. Budgets: planning and control continued • A cash budget prepared on a month-by-month basis is much more useful for planning and control than one prepared on a quarterly or yearly basis • As each month passes, actual cash numbers can be compared to the budget numbers, with the difference between the two known as a variance Prepared by Nicola Beatson

20. Variances • A favourable variance (‘F’) will occur when actual revenues are larger than budgeted, or actual costs are lower than budgeted. • An unfavourable variance (‘U’) will arise when the actual revenue is less than budgeted, or actual costs are greater than budgeted Prepared by Nicola Beatson

21. Variance report (example) Prepared by Nicola Beatson

22. Improving cash flow • Cash inflow may be increased by: • improving the collections of cash from debtors • seeking ways to improve sales or fees • reducing unnecessary stock levels • arranging external finance • providing an extra capital contribution from the owners, or considering a change in ownership structure • selling excess non-current assets Prepared by Nicola Beatson

23. Improving cash flow continued • Cash outflow may be reduced by: • cutting expenses by identifying areas of waste, duplication or inefficiency • making use of creditors’ terms • keeping inventory levels to only what is required, as excess inventory ties up cash and often adds to storage and handling costs • deferring capital expenditures • Reducing carbon footprint Prepared by Nicola Beatson

24. Behavioural aspects of budgeting • Like all decision-making processes, budgeting is affected by human behaviour, attitudes and assumptions • These are seen in the management styles adopted in the budget process Prepared by Nicola Beatson

25. Behavioural aspects of budgetingcontinued • In an authoritarian style of budgeting, • senior management simply sets the targets and the budget for unit managers • unit managers have little say in the targets that are set Prepared by Nicola Beatson

26. Behavioural aspects of budgetingcontinued • a participative style of budgeting • targets and budgets are arrived at by a process of discussion and negotiation between senior management and unit managers • unit managers are seen to have had a say in the setting of targets and the budget Prepared by Nicola Beatson

27. Behavioural aspects of budgetingcontinued • The behavioural aspects of budgeting are also seen in the attempts by some line managers to: • overstate planned expenditure or understate planned revenue or receipts • include some margin for error in case targets are not met • manipulate information so that their performance is presented in the best possible light Prepared by Nicola Beatson

28. Example from Lecture 5 continuedSales & Production Budgets

29. Materials Budgets

30. Labour Budget

31. Additional Information

32. Manufacturing Budget

33. Additional Information

34. Cash Receipts Budget

35. Cash Payments Budget

36. Summary • Strategic planning influences shorter term aspects of the budgetary planning process • A master budget may be viewed as a set of interrelated budgets for a future period • A master budget is commonly classified into a set of operating budgets and financial budgets • The behavioural aspects of budgeting relate to the human involvement in decision making Prepared by Nicola Beatson