Welcome to: FNSACC503A Manage Budgets and Forecasts
Week 1 – Chapter 1 BUDGETING BASICS FNSACC503A Manage Budgets and Forecasts
By the end of this lesson, you will be able to… 1. Define and discuss some key budgeting terms 2. Discuss the benefits & limitations of budgeting 3. Prepare a simple budget
Overview 1. What is a budget? 2. What is a budget used for? 3. Organisational planning The planning cycle 4. Budgets their Benefits + Limitations 5. Budget preparation 6. Approaches to budgeting 7. Types of budgets 8. Budget classification 9. Master budgets 10. Example: Simple budget preparation
Quick BRAINSTORMING Activity What do you already know about budgeting?
What is a budget? A BUDGET is: • a written statement • of management ’ s strategic plans for achieving the organisation's key objectives • expressed in financial terms
What is a budget? Put simply, a BUDGET is an itemised forecast of money coming in and money going out for a specified period of time for either a specific activity, department, product or the organisation as a whole.
What is a budget used for? Budgets help the leadership team of an organisation to CO-ORDINATE and CONTROL key activities across the organisation, enabling the goals of the organisation to be reached. Specifically, they help management with the: 1. Planning 2. Organising 3. Motivating 4. Controlling aspects of their role.
Organisational planning PLANNING is defined as: -- the set of actions taken -- to formulate the scope and direction -- of future activities and operations.
Organisational planning Long term plans : span 5 to 10 years (more strategic in nature) Medium term plans : span 1 to 5 years e.g. new product releases, equipment upgrades etc. Short term plans : span up to 1 year (quite detailed; deal with day-to-day operations of the business) Budgeting is : an integral part of the planning process . used to support management decision making in relation to allocation of scarce resources to facilitate goal achievement.
Organisational planning Example : Airline Company In the short-term , the allocation of plane size and crew numbers requires a detailed analysis of destinations and expected activity to ensure that resources are utilised efficiently. In the medium-term , the company will have to consider adding some new destinations to their current offering and discontinue operations to low volume (low profit) destinations to grow business operations and remain competitive. In the long-term , the company will have to plan for major capital expenditures in relation to replacing and adding airplanes to the fleet. The increase / decrease in capacity will be based on expectations and forecasts of market trends and market share as it relates to the company.
The planning cycle BUDGET BUDGET PERFORMANCE REPORT PERFORMANCE REPORT Comparison of ACTUAL results to BUDGET VARIANCE Comparison of ACTUAL results to BUDGET VARIANCE
The planning cycle (ref. diagram on previous slide) 1. Plans, including budgets are prepared. 2. Action is taken to implement these plans. 3. Performance is measured by comparing actual results to the budget. 4. Differences or variances are analysed so that corrective action can be taken. 5. If necessary, plans are reviewed and assessed.
Benefits of budgets Forces management to do some planning. 1. Provides realistic performance targets (if done 2. properly involving the appropriate personnel). Basis for controlling what happens within the 3. organisation. Helps co-ordinate the activities of the various 4. departments that make up the business. Promotes communication – managers exchange 5. information on ideas, business goals etc. Motivational tool – if appropriate staff are involved 6. in the budget-setting process
Limitations of budgets Only estimates, not statements of facts. 1. Costly and time-consuming. 2. No substitute for sound management 3. practices. Need to be amended if circumstances change. 4. Preparation does not guarantee success. 5. Aspects of people ’ s behaviour may undermine 6. the value of the process (CHAPTER 11).
Budget preparation The organisation’s leadership team has to work out: 1. Where are we now? (i.e. analyse the organisation’s internal environment as well as the external & remote environment within which the organisation operates) 2. Where do we want to go? (decide upon the organisation’s short-, medium- and long-term goals) 3. How are we going to get there? (put together a workable strategic planning; budgeting is an integral part of this planning process)
Budget preparation Relevant factors must be considered when preparing a budget, for example: Past sales levels and trends Economic trends (e.g. changes in interest rates, exchange rates & tax rates; ‘boom’ & ‘bust’ business cycles) The likely action of competitors Market research studies Possible government actions (e.g. child care rebate)
Budget preparation Allow enough time to prepare the budget. Involve appropriate staff.
Approaches to budgeting Approach used depends on the SIZE and STRUCTURE of the firm and the type of ENVIRONMENT in which it operates. e.g. organisations planning a change of focus or strategy cannot rely on established budgeting processes & procedures – they may need to be a bit more creative.
Approaches to budgeting Standard approach : historical figures (actual or budget) are used and adjusted for any likely future events – not recommended as past inefficiencies may be perpetuated and funds may not be allocated to activities designed to meet the organisation’s objectives. Zero-based budgeting : the initial figures for each activity are set to zero. To receive funding, each activity must be justified in terms of how it meets the organisation’s objectives. The dollar figure attached to that activity is then based on the resources needed to make that activity happen.
Types of budgets Revenue budgets : (LESSON 2) Provide estimates of the income of an organisation from the sale of goods and/or provision of services for a specific period of time. Operating budgets : (LESSON 3) Provide an estimate of the activities that will affect net profit including purchases, COGS and operating expenses Budgeted financial statements : (LESSON 5) Show the estimated results and projected financial position of a business and include the budgeted income statement, balance sheet and cash flow statement .
Budget classification 1. PERIOD budget: developed for a specific period of time e.g. a quarter. 2. ROLLING (CONTINUOUS) budget: continually updated so that it always reflect plans for the same length of time e.g. 12 months. This is done by periodically adding a new time period to the forecast and dropping off the equivalent period just completed.
Budget classification 3. STATIC (fixed) budget: prepared for one level of planned activity e.g. a particular level of sales, say, $75,000. 4. FLEXIBLE budget: a series of budgets that show how costs vary at different levels of activity within which the organisation may operate (CHAPTER 10). See example on next slide - The Simms Card Co.
Flexible budgets e.g. The Simms Card Company The Simms Card Company manufactures inexpensive greeting cards, which are sold in packs of ten (10) at discount stores. The Simms Card Company has prepared its budgets on the assumption that it will sell 200,000 packs of cards during the year. How could the company’s performance be accurately assessed if 190,000 packs of cards were sold instead?
Flexible budgets e.g. The Simms Card Company (STATIC) BUDGET ACTUAL VAR. F / U Sales 200,000 190,000 10,000 U Less: Variable costs* 20,000 18,000 2,000 F Contribution margin 180,000 172,000 8,000 U Less: Fixed costs 10,000 10,000 - - Net profit 170,000 162,000 8,000 U * Budgeted for at 10c per sales dollar
Flexible budgets e.g. The Simms Card Company (FLEXIBLE) BUDGET BUDGET BUDGET (level 1) (level 2) (level 3) Sales 190,000 200,000 210,000 Less: Variable costs* 19,000 20,000 21,000 Contribution margin 171,000 180,000 189,000 Less: Fixed costs 10,000 10,000 10,000 Net profit 161,000 170,000 179,000 * Budgeted for at 10c per sales dollar
Cost Classification (FIXED vs. VARIABLE costs) FIXED COSTS do not vary (in the short run) with changing levels of activity. The cost per unit decreases as activity increases. This relationship is constant within the relevant range of activity. e.g. factory rent
Fixed Costs
Cost Classification (FIXED vs. VARIABLE costs) VARIABLE COSTS in total vary (in the short run) with changing levels of activity. Remain the same per unit over the relevant range. e.g. labour costs
Variable Costs
Flexible budgets e.g. The Simms Card Company (FLEXIBLE) BUDGET ACTUAL VAR. F / U Sales 190,000 190,000 - - Less: Variable costs* 19,000 18,000 1,000 F Contribution margin 171,000 172,000 1,000 F Less: Fixed costs 10,000 10,000 - - Net profit 161,000 162,000 1,000 F * Budgeted for at 10c per sales dollar
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