Managing Finance and Budgets

1. Managing Finance and Budgets Lecture 10 Budgets (1)

2. Session 10 – Budgets (1) LEARNING OUTCOMES • To understand the importance and role of budgets in organisations • To know the different types of budgets that might be set in order to Manage Working Capital • To understand some of the issues and processes involved in the setting and monitoring of budgets

3. Budgets - definitions • A budget is defined as a financial plan for the future. “A plan, qualified in money terms, prepared and approved prior to a defined period of time, usually showing planned income to be generated and/or expenditure to be incurred during that period, and the capital to be employed to attain given objectives” (CIMA definition)

4. Budgets - intentions • Clearly, in planning for the future, a budget will contain an element of forecasting, but a budget is not simply a forecast. • A budget will contain financial and other numerical predictions. These are targets, and are ‘statements of intention’ that events will occur as planned in the budget. • This implies an element of control; this in turn means that a budget targets need to be monitored closely and managed effectively.

5. What exactly is a Budget? A budget: • Predicts the contribution to income which will be expected to be generated by each department and each project. • Allocates to each department, project or activity an appropriate share of the of funding in order to enable that income to be generated.

6. What exactly is Budget for? A budget: • enables a business to plan appropriately for the future • Important tool for management agenda-setting and control • sets targets in monetary terms for departments and projects • provides a way of sharing out resources to departments and projects so that they can have continued existence.

7. How are Budgets created? • The budget-setting process is quite complex, and often very time-consuming. • It involves a number of stages, some of which ask the business to question precisely what it is doing, and where it is going – almost at a ‘philosophical' level • Other stages involve detailed calculations of amounts of money and negotiations about who gets what. • A complex budget may take six months to one year to produce.

8. Budget Setting • This is often an annual process linked to a review of long-term plans – Planning & Control • It is an iterative process. Tentative plans are created, which are thrown open to discussion. These discussions then lead to modifications and further discussion, and so on until the budget is set. • Should be participative – all interested parties involved, with the process ‘transparent’. • A combination of top-down(i.e. agenda-setting) and bottom-up (i.e. recognition of needs) approaches is required.

9. The Planning & Control Process 1.Identify business objectives 2. Identify available options 3. Evaluate and select options 4. Prepare detailed plans or budgets 5a.Collect information on performance 5b. Identify and respond to variances 5c. Revise Plans if necessary

10. The Planning & Control Process – a summary Mission, Aims, Objectives Market, Products, Services Sales, Costs, Profits, Returns 1. Identify key objectives Limiting factors: External & internal Environment - market size, production capability, competition 2. Identify available options 3. Evaluate and select options Markets, products, financing, physical resources, human resources 4. Prepare detailed plans or budgets Short-term plans: Sales, Cash, Stock, Labour, Production à Master budget 5.Collect information and control Identify variances and respond as appropriate

11. Types of budget Here are some examples of the different types of budgets that might be employed in a business: • Cash budget • Stock budget • Debtors budget • Creditors budget • Income & Expenditure Budget • Master budget Please note that the examples are illustrative only, and may not be ‘consistent with one another.

12. Overall Format for a Budget • You may have noticed that in the previous examples, almost all the budgets were designed more or less to the same format Budget XJan Feb Mar Apr May Jun Opening Balance 0 20 50 40 30 20 ADD Some Stuff 30 60 50 20 20 50 LESS Other Stuff 10 30 60 30 30 60 Closing Balance 20 50 40 30 20 10 • We might break down the ‘stuff’ into sub-headings, and have separate targets for these, but essentially that is all there is to a budget.

13. What budgets are actually used in practice? • The actual budgets that will be used by different businesses will clearly depend on the business. • High street retailers will normally have little use for a ‘Trade Debtors’ budget, but will be very concerned with a Stock Budget and Trade Creditors, especially (as is generally the case) their business is seasonal. • A manufacturing company such as Jaguar will have a production budget, where the number of vehicles produced will be planned; however this type of budget would be completely pointless for the Cats Protection League, who might a ‘donations and endowments’ budget, which would be equally irrelevant to Jaguar.

14. Sales budget Overheads budget Capital Expenditure budget Direct Labour budget Raw Materials purchases budget Trade Debtors budget Trade Creditors budget Cash budget Trade Creditors budget Raw materials Stock Budget Production Budget The Interrelationship of Budgets

15. Setting Complex Multiple Budgets • Often departments are asked to create ‘spending plans’ (speculative, often optimistic documents, bidding for money and suggesting targets) • Managers will be called to interview to justify these plans, and to negotiate realistic targets. • Out of this process, draft budgets will be created, which will be reviewed and co-ordinated. • Finally the master budget will be created and communicated. • Next week we will examine more closely the budget-setting process, and what is done, and in which order.

16. Five areas of usefulness: Forward planning Co-ordination Motivation Control Authorisation The uses of budgets

17. Budgets - Purpose • Encouraging forward planning and identifying any possible future problems to enable solutions to be implemented in advance • Ensuring co-ordination across the organisation so that all departments are able to fulfil organisational objectives • Motivating managers to improved performance against set benchmarks • Providing a basis for control systems • Providing a basis for a system of authorisation, so that managers know exactly what are the limits to their authority, manage within them.

18. Follow-Up to Lecture 9 - Activities • M & A Chapter 12 pp 355-360, pp360-363, pp 371-376 • You should ensure that you attempt both the MCQs and the ‘fill in the blanks’ questions on the M & A website. Questions like these will be part of the exam. • The Seminar this week will not concern budgets, but will be Test 3 on Ratios & Working Capital, together with a short introduction to the Sample Case Study.