Chapter 9

Budgeting: profit planning and control

Strategic planning and budgeting systems

Budget - a detailed financial plan summarising the consequences of an organisation’s operating activities for a specified period of time

Strategic planning - the long-term planning usually undertaken by senior managers

Cont.

Strategic planning and budgeting systems

Corporate strategy - decisions about the types of businesses to operate in, which businesses to acquire and divest, and how best to structure and finance the organisation

Business (or competitive) strategy - the way a business competes within its chosen market

Purposes of budgeting

PlanningFacilitating communication and co-ordination Allocating resourcesControlling profit and operationsEvaluating performance and providing

incentives

Responsibility accounting

Holding mangers responsible for the activities and performance of their area of the business

Responsibility centre - a subunit in an organisation where the manager is held accountable for the subunit’s activities

The annual budget: a planning tool

Annual financial budget - a comprehensive set of budgets that cover all aspects of a firm’s activities operating budget financial budget

Rolling (or continuous) budget - budgets that are continually updated by adding a new time period (such as a quarter) and dropping the period just completed

Operating budgets

Sales budget - estimated sales units and revenues from the organisation’s products

Cost budgets - detail the cost of operations needed to support forecast sales demand

Production budget - number of production units to be manufactured to meet sales and satisfy inventory requirements

Cont.

Operating budgets

In retail and wholesale businesses purchases budget - used to determine the

quantity and cost of goods that need to be purchased during the budget year

In service firms develop a set of budgets that show how the

demand for those services will be met

Financial budgetsCash budget - details the expected cash

receipts and planned cash payments for the budget period

Budgeted profit and loss statement - shows the expected revenues and planned expenses of the firm during the budget period

Budgeted balance sheet - outlines the expected financial position of the firm at the end of the budget period

Budget administration

Responsibility of a senior accounting manager who gathers and collates the budget data and prepares the budget

Budget manualBudget committee has responsibility for

determining budget policy reviewing and approving budgets

Behavioural consequences of budgeting

Human reactions to the budgeting process participative budgeting budgetary slack budget difficulty

Participative budgeting

Managers who are held accountable for budget performance help develop their own budget estimates

Top-down budgeting vs bottom-up budgeting Employee empowerment

giving employees authority to develop their own budgets and targets, and manage their own work

Budgetary slack: padding the budget

Padding the budget - underestimating revenues or overestimating costs so that budget targets are easier to achieve

Budgetary slack - the difference between the revenue or cost projection that a person provides and a realistic estimate of that revenue or cost

Cont.

Budgetary slack: padding the budget

Why? performance will look better if you can ‘beat

the budget’ cope with uncertainty compete for limited resources

How to minimise problems? avoid relying on the budget as a negative

evaluative tool provide incentives to achieve budget and

provide accurate projections

Budget difficulty

Optimum performance budget is where the budget provides sufficient challenge and stretch, but is not too difficult

Optimum performance budgets may not be suitable for accurate forecasting

Zero base budgeting

All activities in the organisation are initially set to zero.

Managers must justify each activity in terms of continued usefulness to the business

Program budgeting

Requires various programs undertaken by the enterprise be identified objectives for each program budgets for each program

Control through quantitative and qualitative performance measures that derive from the program

Financial planning models

Use mathematical relationships to allow managers to examine interactions between the various operational, financial and environmental events

Allows ‘what if’ questionsAvailability of personal computers and

spreadsheet software has made financial planning models more easily accessible

Exhibit 9.1

Exhibit 9.11