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Basics of Budgeting
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BUDGETING
Definition : A budget is a quantified expression of the intentions of the management and operates in a fashion that enables attainment of orgainsational goals.
Elements of a Budget
1. It is a comprehensive and co-ordinated plan.
2. It is expressed in financial and physical terms.
3. It is a plan for the company’s operations and resources.
4. It is a future plan for a specified period.
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MAJOR OBJECTIVES OF BUDGETING
1. To state the company’s goals.
2. To communicate expectations to all concerned.
3. To provide detailed plan of action for reducing uncertainty.
4. To co-ordinate activities and efforts in such a way so as to maximise resources.
5. Measure for controlling performance.
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TYPES OF BUDGETS
Comprehensive Budgeting involves the preparation of a Master
Budget. The three important components of Master Budget are:
i) Operational / Functional Budgets
ii) Financial Budgets
iii) Capital Budgets
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ESSENTIALS OF BUDGETING
1. Senior management support
2. Clear and realistic goals
3. Assignment of authority and responsibility
4. Creation of responsibility centres
5. Adaptation of accounting system
6. Full participation
7. Effective communication
8. Budget education
9. Flexibility
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Budgeting As a Tool of Management Planning and Control• Communication• Coordination• Performance Evaluation• Motivation
Fundamental Concepts & Techniques Used for Budgetary Control
• Cost benefit analysis including the social cost benefit analysis.
• Contingency approach
• Responsibility accounting based on the technique of variance analysis
• Value analysis for services, systems, cost incurrence etc.
• Application of mathematical models such as PERT, CPM,Transportation & Assignment models, L.P. & Simplex Models, Scrutiny Analysis etc.
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bBudgeting Process – A Structured Approach
Formation of Multipurpose Budget Team Definition of Vision/Mission/Objectives Exhaustive analysis of :
- Competitive Environment- Economic Environment- Political Environment- Business SWOT- New Product Strategies- Corporate Strategic Initiatives e.g.., New/ Restructured
Alliances at Industry and Company level
Continued …
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• Agree on Volumes and Price Realisations
• Work on related linkages (at various companies, various business etc. viz., Manufacturing, Logistics, etc.)
• First pass preparation of Income/Capital Employed Statements
• Budget Package Finalisation
Continued …
Continued …
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Volumes and Price Realisation determination
• Territywise/Productwise Volume and NRV determination (Net Realisable Value).
• Inputs on Brand Pricing,Product Positioning , Past Product Performance Analysis, Proposed Product Lines from Marketing and Technology Teams.
• Deliberations on the above done by the Budget Team to determine Volumes and Prices Regionwise
Continued …
Continued …
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• Zero base build up, other than Fixed Commitments
• Projected Business Growth
• Determination of Sales Regions/ Territories
• Manpower Requirement
• New Product Launches
• Proposed Brand Plans
Continued …
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Manufacturing Budget Preparation
CapacityVolumes
Inventory
Production PlanImport Plan
Operations Cost
Variable
Fixed
Labour
Utilities
Standard Cost of Goods Sold
Fixation of RM/PM Costs
Continued …
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Logistics Cost Plan
Determined by the Production Plan, Import Plan and Despatch Plan
Continued …
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FUNCTIONAL / OPERATIONAL BUDGETS
1. Sales budget
2. Production / Operations
3. Material Consumption
4. Purchase
5. Labour
6. Overheads
7. Marketing and Selling
8. Administration and Finance
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Sales Budgets : sales being primary source of cash practically all the enterprise planning regarding capital additions needed, the production level, manpower requirements, inventories required, material purchases etc. depend upon the sales volumes.
Thus the usefulness of almost all the rest of the budgets depend upon the accuracy & reliability of the sales estimates, much of the expertise for the forecasting of it is with Marketing Staff of the firm .
Operating Budgets : Provide the profit Budget for the Co. as a whole as well as its segments by consolidation of the several budgets comprising the operational budgets. Sales Budget is one of the operating Budgets.
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Following factors affect the sales budget figuresGeneral Industry & economic conditions
a) Product Mixb) Territories & /or other segments of businessc) Pricing decisions (in turn depends upon the demand, cost recovery &
profit margins)d) New Products/Existing Productse) Seasonal saleabilityf) Sensitivity to technological advancementg) Competitor’s Strategies h) Types of consumers (classes /masses) i) Govt. Policies. j) The quantity and value of past salesk) Market research and salesmen’s estimates
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STEPSa) Sales forecast by productb) Product mix : taking into consideration the
manufacturing capacity and profitability of product lines.
c) By product type; area and mix which management believes it could sell to achieve company objectives.
d) Customer profile Products TotalSales Budget A BBudgeted Sales Units (i) Budgeted Sales Price Rs./unitBudgeted Sales Revenue Rs.
70,00055
38,50,000
80,00040
32,00,000
1,50,000
70,50,000Above illustration shows that the budget targets of both types physical & financial are required.
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AN OVERVIEW OF BUDGETING PROCESSA PLAN OF OPERATIONS Management’s Goals and Objectives for the year
Formalised in
THE ANNUAL PROFIT PLAN
Wherein Mgmt. Specifies
THE OVERALL INCOME OBJECTIVEDetailed in
SALES BUDGETin Qty/Territory/ Product and Time
Period
OTHER INCOME BUDGETInterest Income / Royalty etc.
Less
THE OVERALL COST & EXPENSE OBJECTIVE detailed in
DISTRIBUTION EXP. BUDGET
By Territory
ADMIN. EXP. BUDGET
By Department
OTHER EXP. BUDGET
Interest Exp. Etc.
PRODUCTION BUDGET
Unites to be produced
All the below are prepared for pre decided time period involved
[PURCHASE BUDGET][DIRECT LABOUR BUDGET]
[FACTORY O/H BUDGET]
The Entire PLAN OF OPERTIONS is finally reflected in
THE FINANCIAL BUDGET Composed of
THE BUDGETED B/SASSETS/ LIABILITIES
OWNER’S EQUITY
SUPPORTING SUB-BUDGETS, CASH BUDGET,
INVENTORY BUDGET, CAPITAL EXP. BUDGET,
OTHERS
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TABLE SHOWING VAROUS FACETS OF A BUDGET PROGRAM Name of Budget
What it shows
Prepared by
Based upon Classification by
1) Sales Budget
2) Production Budget
3) Production Cost Budget
4) Materials & Stores
5) Labour Budget
6) Production Over Heads
Estimated sales of products
Estimated Quantity of Production
Cost of Production
Quantity & Value of Materials needed for (2)
Labour Hours and Cost needed for (2)
Estimated Over Heads expenses for (2)
Sales Manager
Production Manager
Production Manager
Production Manager & Costing Department
Production Manager & Costing Department Production Manager & Costing Department
Historical Analysis Business Conditions Salesman's Report Market Analysis, Special ConditionsSales Budget, Production Capacity, Stock Requirements
Production Budget
Production Budget and Stocks on hand
Production Budget
Production Budget and fixed expenses
Product Territory Customers,Salesmen, Period
Product, Department, Period
Product /Department, Period & Elements of Costs
Item wise (Major)
Category/Skill wise
Expense Wise Department Wise
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FLOW CHART OF BUDGETARY CONTROL
Specification of organisational objectives and identification of key factors
Sales Budget
Operations Budget
Budget for Prime Cost & Overhead
Budget for Sell. & Dist. Cost
Cap. Expend.Budget
Cash Budget
AdministrativeCash Budget
Master Budget
Acc. & Resp., Var. analysis Managerial Action
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Summary of Steps in Budgetary Control
1) SWOT analysis for deciding objectives2) Preparing a budget statement3) Recording the actual performance4) Periodic comparisons between the budgeted and actual performance,
& finding out the favourable and unfavourable variances5) Finding out the causes grouping these variances 6) Basis the cause grouping these variances as “controllable” and
“uncontrollable”7) Deciding the quantum of reward or penalty for the individual or the
teams for the variances8) Revising the standards to suit the cyclic – environmental and
uncontrollable changes in conditions.9) Go through the steps 2 to 7 again10) Thus the process of budgetary control has to be continuous, flexible
and unbiased
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ADVANTAGES OF BUDGETING1. Forced planning.
2. Co-ordinated operations.
3. Performance evaluation & control.
4. Effective communication.
5. Optimum resource utilisation.
6. Productivity improvement.
7. Profit mindedness.
8. Efficiency.
9. Cost control.
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LIMITATION IN USING THE BUDGETING SYSTEM
1. Management judgement.
2. Continuous adaptation.
3. Implementation.
4. Management complacency.
5. Unnecessary detailing.
6. Goal conflict.
7. Evaluation system.
8. Unrealistic targets.
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PROFIT PLANNING AND CONTROL Consider the following data:
EXHIBIT I
Sales Rs.SalesVariables Cost Contribution MarginFixed CostOperating ProfitFinancing Costs (@10%)NPBTI.T. @ 50%NPATOwners FundsBorrowed fundsCapital Employed
10,00,0006,00,0004,00,0001,00,0003,00,00050,0002,50,0001,25,0001,25,0005,00,0005,00,00010,00,000
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EXHIBIT II
[A] OPERATING MANAGEMENT PERFORMANCE: (A) =(a) x (b) x(c) = 75% x 40% x 100% = 30%
= 40%(a) P/V Ratio = Contribution MarginSales
= 75%(b) Margin of Safety Ratio =Contribution Margin
Operating Profit
(c) Turnover Ratio = = 100%Capital Employed
Sales
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B] FINANCIAL MANAGEMENT PERFORMANCE:
(B) = (d) x (e) = 41% x 200% = 82%
(d) NPAT .
OPERATING PROFIT = 41%
(e) Capital Employed Owner’s Funds
= 200%
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[C] OVERALL MANAGEMENT PERFORMANCE:
(A) =(B) = 30% x 82% = Approx 25%EXHIBIT III
BREAK EVEN ANALYSIS
A 75% Margin of safety indicates if sales fell by 75%, losses will start (as shown hereunder)
Sales (reduced by 75%) 2,50,000
Variable Costs @60% 1,50,000
Contribution Margin 1,00,000
Fixed Costs 1,00,000
PROFIT ZERO .
Thus the sales level of Rs. 2,50,000 is the “NO PROFIT – NO LOSS” point or the BEP which is also defined as:
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It is defined in units as under:
BEP = Fixed Costs x Sales Unit Contribution Margin
BEP = Fixed Costs x Sales Sales – Variable Costs
=Fixed Cost
P V Ratio
BEP =1,00,000 X 10,00,000
4,00,000= 2,50,000
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EXHIBIT IV
SENSITIVITY ANALYSIS FOR PROFIT PLANNING BASIS BEP
In the existing situation Operating Profit is planed @30% on capital employed.
With the help of BEP Analysis we can now check its sensitivity to various factors as under:
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1. What should be the sales level to increase the OP to 40% level?
BEP = Fixed Costs + Desired Profit PV Ratio
1,00,000 + 4,00,00040%
= 12,50,000=
Computation of operating profit at new sales level:
Sales 12,50,000
Variable Costs (60% of Sales) 7,50,000
Contribution Margin (40% of Sales) 5,00,000
Fixed Costs 1,00,000
Operating Profit 4,00,000
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BEP = Fixed Costs + Desired Profit PV Ratio
1,00,000 + 4,00,000
PV Ratio=10,00,000=
5,00,00010,00,000
=PV Ratio= 50%=Contribution Margin
Sales=
2. What should be the variable costs level to increase the OP to 40% level?
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Computation of Operating Profit at new variable costs level:-
Sales 10,00,000
Variable Costs 5,00,000
Contribution Margin@ 50% 5,00,000
Fixed Costs 1,00,000
Operating Profit 4,00,000
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BEP = Fixed Costs + Desired Profit
PV Ratio
Fixed Cost + 4,00,000
40%=10,00,000=
4,00,000 = Fixed Costs + 4,00,000
Fixed Costs = Zero
3. What should be the fixed costs level to increase the OP to 40% level?
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Computation of Operating Profit at New Fixed Costs Level:
Sales 10,00,000
Variable Costs 6,00,000
Contribution Margin 4,00,000
Fixed Costs Zero .
Operating Profit 4,00,000
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VARIOUS STYLES OF BUDGETING
1. Flexible Budgeting
2. Zero Base Budgeting
3. Activity Based Costing
4. Balanced Score Card
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Flexible Budgeting It is a budget which by recognizing the difference between fixed, semi fixed and variable costs, is designed to change in relation to the level of activity attained. It is a budget prepared for a range and is also known as variable budget or a sliding scale budget
Steps in flexible budgeting:1. Deciding the range of activity2. Determine cost behaviour patterns3. Selecting the activity levels to prepare budgets at those levels4. Prepare budget at each activity level
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Zero Base Budgeting
ZBB is a method of budgeting whereby all activities are
revalued each time a budget is formulated and every item of
expenditure in the budget is fully justified. That is, ZBB
involves starting from scratch or zero
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Implementation of ZBB involves the following :
1. Each activity of the organisation is identified and called a decision package
2. Each decision package must be justified
3. If justified the minimum cost to sustain each decision package is determined
4. Alternatives for decision packages are evaluated
5. Managers rank their decision package in order of priority for resource allocation
6. Resources are allocated to the package
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ADVANTAGES OF ZBB
1. Allocation of resources by need and benefit
2. Identifies and eliminates wastages and obsolete operations
3. Best possible methods of performing jobs is ensured
4. Increased staff involvement which may lead to improved motivation and greater interest in job
5. It increases communication and co-ordination within the organisation
6. Managers become more aware of cost inputs which help in identifying priorities
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DISADVANTAGES OF ZBB
1. Substantial Cost & time involved in preparing a large number of decision packages
2. Managers could develop fear and feel threatened by ZBB
3. Ranking of packages could result in departmental conflict
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Measurement-Performance-SuccessMeasurement-Performance-Success
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Activity Based Costing•In Activity based costing (ABC) costs are first traced to activities and then to products •It is a system which focuses on activities performed to produce products •Activities become the focal point of cost accumulation
ABC involves two primary stages:
- Tracing costs to activities
- Tracing activities to products
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TRADITIONAL COSTING
OverheadCost
P1
P2
P3
PRODUCT
Stage 1 : Overheads assigned Stage 2 : Overheads assigned to to cost centres/ pools. products using cost
driver rate.
Process / Job 1
Process / Job 2
Process / Job 3
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ACTIVITY BASED COSTING
OverheadCost
PRODUCT
Stage 1 : Overheads assigned Stage 2 : Overheads assigned to cost centres / pools. to products using
cost driver rate.
Activity 1
Activity 2
Activity 3
Activity 4
Activity 5
P1
P2
P3
P4
P5
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COST DRIVERS IN ABC
1. Number of receiving orders 2. Number of purchase orders 3. Number of dispatch orders 4. Number of units 5. Amount of labour cost involved 6. Number of material handling man hours 7. Number of direct labour hours 8. Number of vendors/ suppliers 9. Number of set up hours10. Number of employees11. Number of labour transactions
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ACTIVITY BASED MGMT [ABM]Meaning :• It is the use of activity based costing
information to manage costs, by improving operations and eliminating non-value-added costs
• ABC allows an understanding what activities cause costs
• ABM involves managing these activities to reduce costs
• It focuses on ‘Work’ and not ‘Worker’• It is a management information tool
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ABM TECHNIQUES
• Activity Analysis
• Analysis of value-added & non-value added costs
• Activity based budgeting & variance analysis
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ANALYSIS OF VALUE-ADDED & NON VALUE-ADDED COSTS
The objective is to eliminate non value Added activities
Engineering study of processes and benchmarking are important tools in identifying non value-added costs
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ANALYSIS OF VALUE-ADDED COSTS
Value-added activities are necessary activities that cannot be eliminated without deterioration of
product quality performance or perceived value Value-added activities contribute to customer
value & satisfaction or satisfy an organization need
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Traditional Amt. ABC Amt.
Salaries 100.00 Clean door 40.00Equipment 80.00 Paint door 75.00Supplies 20.00 Inspect door 75.00Overhead 45.00 Send door to assembly 55.00 Total 245.00 Total 245.00
ABC vs. Traditional CostingExample in a Car Mfg. Org.
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CUSTOMER PROFITABILITY ANALYSIS
Customer profitability analysis uses activity-based costing to determine the
activitiescostsprofit associated with serving particular
customers
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LIMITATION OF FINANCIAL MEASUREMENT
OF A BUSINESS PERFORMANCE
Less supportive of long term investments with no short term returns
•Leads to under-investment in intangible assets – product and process innovation, employee skills, customer satisfaction – where short term returns are difficult to measure
•Over investment in assets that can be easily valued, such as through mergers and acquisitions
•Allows companies with very strong asset bases (such as in natural resources, strong consumer brands) to operate inefficiently as long as short term results are satisfactory
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Why Is It So Difficult to Execute Strategy ?Why Is It So Difficult to Execute Strategy ?
Value is Shifting from Tangible to Intangible Assets Value is Shifting from Tangible to Intangible Assets Percentage of market value related to ...Percentage of market value related to ...
Intangible Assets
Tangible Assets
38%
62%
62%
38%
62%
38%
1982 1992 1998
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Is Strategy very Important to Investors?Is Strategy very Important to Investors?
““Strategy has never been more importantStrategy has never been more important””Business WeekBusiness Week
““Less than 10% of strategies Less than 10% of strategies effectively formulated are effectively formulated are effectively executedeffectively executed””
Fortune MagazineFortune Magazine
““In the majority of failures - we In the majority of failures - we estimate 70% - the real problem estimate 70% - the real problem Is nIs n’’t (bad strategy) ….. Itt (bad strategy) ….. It’’s bad s bad
executionexecution””
Fortune MagazineFortune Magazine
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60% of organizations don’t link strategy & budgets
85% of management teams spend less than one hour per month on strategy issues
STRATEGY
Strategic Learning Loop
BALANCED SCORECARD
Translate Strategy to Operational terms
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SUCCESS FACTORS OF INDUSTRIAL AGE & INFORMATION AGE
INDUSTRIAL AGEINDUSTRIAL AGE
• Economies of ScaleEconomies of Scale• Economies of ScopeEconomies of Scope• Technology Technology
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SUCCESS FACTORS OF SUCCESS FACTORS OF INDUSTRIAL AGE & INDUSTRIAL AGE & INFORMATION AGEINFORMATION AGE
INFORMATION AGEINFORMATION AGE
Customer loyalty through customer Customer loyalty through customer relationshipsrelationships
Innovative products and servicesInnovative products and services High quality customized products and High quality customized products and
services at low cost and with short lead services at low cost and with short lead timetime
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SUCCESS FACTORS OF SUCCESS FACTORS OF INDUSTRIAL AGE & INDUSTRIAL AGE & INFORMATION AGEINFORMATION AGEINFORMATION AGEINFORMATION AGE
Employee skills, motivation and Employee skills, motivation and capabilitiescapabilities
Adaptation of Information Adaptation of Information TechnologyTechnology
EVOLUTIONEVOLUTIONTHE PROBLEM-
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Balance Score Card
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Origin
• Developed by Robert Kaplan and David Norton
• Communicate Companies’ Objectives, link them to strategy
• Translates mission and strategy into four perspectives
ROCEROCE
Customer Customer LoyaltyLoyalty
On-time On-time deliverydelivery
Process Process Cycle TimeCycle Time
Process Process QualityQuality
Employee Employee CompetencyCompetency
Cause and Effect RelationshipCause and Effect Relationship
Balance Score CardBalance Score Card
Knowledge, Skills, Systems, and ToolsKnowledge, Skills, Systems, and Tools
Financial Financial ResultsResults
To Build the Strategic Capabilities..To Build the Strategic Capabilities..
Needed to Deliver UniqueNeeded to Deliver UniqueSets of Benefits to Customers...Sets of Benefits to Customers...
To Drive Financial To Drive Financial Success...Success...
And Realize
the Vision
Equip our People...Equip our People...
Internal Internal CapabilitiesCapabilities
Customer Benefits
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The Balance Scorecard Perspectives
• Financial
• Customer
• Internal business processes
• Learning and growth
Vision &Vision &StrategyStrategy
Learning & Learning & growthgrowth
Internal Internal Business Business processprocess
Financial Financial perspectiveperspective
Customer’sCustomer’s
PerspectivePerspective
Balanced Scorecard FrameworkBalanced Scorecard Framework
BALANCED SCORECARD BALANCED SCORECARD GOALS & MEASURESGOALS & MEASURES
Goals MeasuresGoals Measures Goals MeasuresGoals Measures
Goals MeasuresGoals Measures
Goals MeasuresGoals Measures
Financial PerspectivesFinancial Perspectives
Learning & Growth PerspectivesLearning & Growth Perspectives
Customer Customer PerspectivesPerspectives
Internal Process Internal Process PerspectivesPerspectives
Balanced Balanced ScorecardScorecard
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The Balance Scorecard Perspectives
• Financial
• Customer
• Internal business processes
• Learning and growth
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BALANCED SCORECARD BALANCED SCORECARD GOALS & MEASURESGOALS & MEASURES
FINANCIAL PERSPECTIVEFINANCIAL PERSPECTIVEGOALSGOALS MEASURESMEASURES
SurviveSurvive • Cash FlowCash Flow
SucceedSucceed • Sales GrowthSales Growth• Growth in Operational IncomeGrowth in Operational Income
ProsperProsper • ROIROI• EVAEVA
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BALANCED SCORECARD BALANCED SCORECARD GOALS & MEASURESGOALS & MEASURES
CUSTOMER PERSPECTIVECUSTOMER PERSPECTIVEGOALSGOALS MEASURESMEASURES
ResponsiveResponsive SupplySupply
On time deliveryOn time delivery
Preferred Preferred supplier Statussupplier Status
Share of key customers’ purchasesShare of key customers’ purchases
New Product New Product LaunchLaunch Percentage sale from new Percentage sale from new
productsproductsCustomer Customer RelationshipRelationship Customer partnership venturesCustomer partnership ventures
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BALANCED SCORECARD BALANCED SCORECARD GOALS & MEASURESGOALS & MEASURES
INTERNAL PROCESS PERSPECTIVEINTERNAL PROCESS PERSPECTIVE
GOALSGOALS MEASURESMEASURES
Technology Technology UpgradationUpgradation
Technological investmentsTechnological investments
New Product New Product DevelopmentDevelopment
R & D expenditureR & D expenditure
Manufacturing Manufacturing ExcellenceExcellence • Cycle-time reductionCycle-time reduction
Commercialization of R & DCommercialization of R & D
• Improvement in throughputImprovement in throughput
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BALANCED SCORECARD BALANCED SCORECARD GOALS & MEASURESGOALS & MEASURES
INNOVATION & LEARNING PERSPECTIVEINNOVATION & LEARNING PERSPECTIVEGOALSGOALS MEASURESMEASURES
Technological Technological LeadershipLeadership • Internal technology developmentInternal technology development
Manufacturing Manufacturing ImprovementImprovement
• Waste reductionWaste reduction
Time to Time to MarketMarket
Process improvementProcess improvement
Constraint removalConstraint removal
BALANCED SCORECARD STRATEGIC BALANCED SCORECARD STRATEGIC THEMETHEMEELEMENT ELEMENT STRATEGYSTRATEGY TARGETARGE
TTMEASURESMEASURES INITIATIVES INITIATIVES
FINANCIAL FINANCIAL PERSPECTIVEPERSPECTIVE
REVENUE REVENUE GROWTHGROWTH
CUSTOMER CUSTOMER PERSPECTIVEPERSPECTIVE
INNOVATIVE INNOVATIVE PRODUCTSPRODUCTS
INTERNAL INTERNAL PERSPECTIVEPERSPECTIVE
WORLD CLASS WORLD CLASS PRODUCT PRODUCT DEVELOPMENTDEVELOPMENT
INNOVATION INNOVATION & LEARNING & LEARNING PERSPECTIVEPERSPECTIVE
COMPETENCY COMPETENCY BUILDINGBUILDING
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Four perspectives: Are they sufficient?Four perspectives: Are they sufficient?
•Community perspective - Social responsibilityCommunity perspective - Social responsibility
•Suppliers perspectiveSuppliers perspective
Question : Is it vital for success of business unit’s Question : Is it vital for success of business unit’s strategy?strategy?
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Conclusions
• The Balance Score Card is basic tool
• Can be modified & customized according to an Organization's needs
• An important weapon in every manager’s arsenal
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Learning Curves and Non Linear Costs
The learning curve phenomena is based on the concept that costs tend to be non linear.
It is found that the cost of doing most tasks of a repetitive nature decrease as experience at doing these tasks accumulate.
Most experience curves, estimated on actual process, indicate that costs decline 20 to 30 percent each time accumulated experience doubles.
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Factors that lead to this long-run decline in costs include:
1. Labour efficiency.
2. New process and improved methods.
3. Product stadardisation.
4. Scale effect.
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REVENUE MANAGEMENT - TOPLINE Rule I Price then costs
Intuition In high demand times, increase productive capacity. In periods of low demand, reduce capacity and lower headcount
Entropic Event:
Demand fluctuations growing in frequency and intensity
R.M.P. I Address short term fluctuations with price, then capacity planning in long run
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Rule II Value management and marketing value based pricing dominates cost based pricing
When customers dominate – value dominates and they do not care about your costs; you care if cost based price exceeds customer’s valueFind market acceptable price point
Move from cost-based pricing to price-based costingIntuition Set prices to cover costs and provide an acceptable
margin (Cost Based Price: CBP)Entropic Event:
Non-conformist customers determine the price: Marketing provides the choices
R.M.P. II Move from CBP to PBC Monitor market for both Revenue Management (RM)& Cost Management (CM) for Profit Management (PM)
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Rule III Sell to segmented micro-markets and not mass markets
Seek and seize revenue advantage rather than worry about cost disadvantage
Faster-Better-Cheaper mantra
What is this customer willing to pay for this product at this point in time
There is no average consumer, thus there can not be an average price
Intuition Price is set to sell the greatest number of units at the highest possible price in the mass markets
Entropic Event:
Consumer individualism and amoeba market shatters the myth of mass market
R.M.P. III
Different segments demand different prices. To maximise revenue with competition, prices must vary to meet the price sensitivity of each market segment
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Rule IV Save your product for your most valuable customers
“First Come, First Served” do not ensure RM or PMMakes relevance only when there is shortageCustomers who are paying less are those who come FirstFavor the most valuable customers
Intuition Sell products and services on a “First Come, First Served” basis
Entropic Event:
Traditional business practices do not satisfy investor demand for revenue growth
R.M.P. IV
Forecast and understand demand at micro-market levels and save products for the most valuable customers through prioritization
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Rule V Decisions should be based on knowledge and not supposition
Data Information Knowledge Profit Adopt a RM program of appropriate size and scopeUnderstand window of opportunity and volatilityUnderstand intentional/unintentional biases and availability of information bias while forecasting
Intuition Assumptions are and can be made about future consumer behaviour based on intuition and personal observation
Entropic Event:
Non-conformist consumers are continuously fragmenting the market and changing buying behaviour
R.M.P. V
Forecast demand at the micro-market level, gain knowledge of subtle changes in consumer behaviour patterns and then optimize on Product/Consumer/ Supply or Demand
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Rule VI Exploit and leverage each product’s value cycle.Maximise value of product in micro-markets over timeAdopt a RM program of appropriate size and scopeGet as much money as possible as soon as possibleEntertainment – Movie business example
Intuition Decisions on product availability and pricing are made based on experience, gut feel, tradition or rule of thumb.
Entropic Event:
Rapidly changing market conditions defy conventional approaches
R.M.P. VI Maximise revenue by understanding the value cycle and optimally timing the availability and price of the product to each micro-market segment.The sales force in the trench should be armed with decision support tools built upon appropriate databases so they can make dynamic decisions at the micro-market level.
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PRICE is VALUE ADD + COSTSPRICE is VALUE ADD + COSTS Philip Kotler has defined Customer Delivered Value as the difference Philip Kotler has defined Customer Delivered Value as the difference
between the Total Customer Value and Total Customer Cost, as between the Total Customer Value and Total Customer Cost, as illustrated here below.illustrated here below.
Customer CostCustomer Cost
Monetary CostMonetary Cost
+ Time Cost+ Time Cost
+ Energy Cost+ Energy Cost
+ Psychic Cost+ Psychic Cost
Total Customer ValueTotal Customer Value
Generic Value Generic Value
+ Service Value+ Service Value
+ Personnel Value+ Personnel Value
+ Image Value + Image Value
minusminus
Price = Customer Delivered ValuePrice = Customer Delivered Value
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Facts Data
Analysis Information
Forecasts Knowledge
Profit Optimization Wisdom
Turn Facts into Profit!
THE CRUX OF BUDGETING