Budgeting Flashcards

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Budget Definition

The budget is the quantitative expression of a plan for a defined period of time. It may include planned sales volumes and revenues, resource quantities, costs and expenses, assets, liabilities and cash flows.

Five Main Budget Benefits

• Promote forward thinking and identification of short-term problems

• Motivate managers to better performance

• Provide a basis for a system of control

• Provide a system of authorisation

• Help co-ordinate the various sections of a business

Planning Definition

A systematic approach to long and short-term
forecasting by which an organisation identifies its
goals and the means of achieving them.

Control

the process of measuring performance and taking
suitable corrective action to implement the
organisation’s aims.

Strategic Management Process

1. Establish mission and obkectives

2. Undertake position analysis

3. Identify and Assess the strategic options

4. Select strategic options and formulate plans

5. Perform, review and control

What is Responsibility Accounting

• Responsibility accounting divides the organisation into budget centres, each of which has a manager who is responsible for its performance.

• The budget is the target against which the performance of the budget centre or the manager is measured

Budgeting Process

1. Budget committee is formed

2. Budget manual is produced

3. Limiting factor is identified

4. Initial budgets are prepared

5. Initial budgets are reviewed and integrated into the complete budget system

6. The master budget is prepared

7. Budgets are reviewed regularly

Traditional/Incremental Budget

A method of preparation of the budget in which last year’s budget is taken as the base. Only those items in traditional budgets need to be justified which are over and above the last year’s budget.

Traditional/Incremental Budgeting Advantages

• Easy to prepare

• Easy to implement

• Bring stability in the functionality of the organisation

• Gives opportunity to consolidate projects into one single larger one

Criticisms of traditional/incremental budgeting

• Constrain responsiveness and flexibility

• Focus on detail loses strategic overview

• Not perceived as value-adding

• Designed for vertical “command and control”

• Encourage “gaming” and perverse behaviour

• Developed and updated too infrequently

• Often based on unsupported assumptions and guesswork

• Reinforce barriers rather than encourage knowledge sharing

• Make people feel undervalued

Budgetary Systems

• Periodic VS Rolling budgets

• Incremental VS Zero Based budgets

• Activity Based budgeting

• Top Down vs Bottom Up

Rolling Budgets Advantages

• Budgets are up to date

• Budgets are relevant to the current environment

Zero-Based Budgeting Definition

Budgeting method where every expense must be justified starting from a “zero
base”. Key Steps: Identify decision units > Build decision packages > Evaluate & rank packages > Allocate resources based on priority

Why ZBB matters?

• Aligns spending with strategy

• Eliminates unnecessary/legacy costs

• Increases transparency & accountability

ZBB Challenges

• Time consuming to implement

• Requires strong data and stakeholder commitment

Incremental budgeting advantages

• Easy to understand

• Quick to implement

• Straightforward to explain

Incremental budgeting disadvantages

• Errors may be carried forward

• Can reduce innovation

• No requirement to justify spending each year

ZBB advantages

• Full Review of all items

• Questions accepted beliefs

• Justification of all activities

• Actively involves operational managers

• Establishes clear links between budgets and the organisation’s objectives

ZBB Disadvantages

• Induces organisational conflicts

• Time-consuming and therefore expensive

• May be difficult to identify suitable activities

• Uncertainty about costs and resources of options

Activity-Basedd Budgeting

Budget output of cost drivers > Determine the necessary activities > Determine the resources required for the budget period

ABB Stages

1. Estimate the production and sales volume by individual products and customers

2. Estimate the demand for organizational activity

3. Determine the resources required to perform said activity

4. Estimate for each resource the quantity that must be supplied to meet demand

5. Take action to adjust resource capacity to match projected supply

ABB Advantages

• Budgets based on cost drivers should more accurately reflect cause of costs

• Enables focus on overhead and support costs.

ABB Disadvantages

• Costing system needs to match (ABC must be used)

• Time-consuming, and therefore costly

• May require cultural change internally

Bottom-Up Budgeting

• An imposed/top-down budget is a budget which is set without permitting the ultimate budget holder to have the opportunity to participate in the process

• Bottom up is a budget system in which all holders are given the opportunity to participate in setting their own budgets

Participative budget advantages

• Increased motivation

• Should contain better info

• Increases managerial understanding and commitment

• Better communication

• Senior managers can concentrate on strategy

Participative budget disadvantages

• Loss of control

• Inexperienced managers

• Budgets not in line with objectives

• Budget preparation slower and disputable

• Budgetary slack

• Certain environments may interfere

Factors affecting Participation

• Personality

• Work environment

• Organisational structure

• Managers’ outlook

• Percieved difficulty of job

Budgetary Behaviours

1. Budgets do not motivate unless accepted as personal tasks

2. Up to the point of non-acceptance, the more demanding the budget, the better the results

3. Over-demanding budgets produce negative attitudes; “demanding but attainable” budget are seen as positive incentives

4. A two-way communication process makes acceptance of budget targets easier

Abandoning budgets

• Focus on external benchmarks

• Incentives and targets separated from budgets

• Orientation towards competitive advantage and strategy

• Develop consistent IT systems

• Improved forecasting models

• Emphasis on managing future results, not explaining the past

Private sector budgets

• Planning document

• Changing the budget is simple as it is usually for internal use

• A means for achieving profitability

Public sector budgets

• Government budgets are planning AND legal documents

• Often Lengthy and difficult legal procedures apply

• Incorporates political mandates and objectives

• Unlike companies, many PSOs publish their performance against their budget after the year ends

Why budget?

• Restriction of spending

• Ensuring planned services are delivered

• Monitoring performance