Budgeting SEMESTER 1 : FINANCIAL PLANNING AND CONTROL CA BUSINESS SCHOOL POSTGRADUATE DIPLOMA IN BUSINESS AND FINANCE

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1 CA BUSINESS SCHOOL POSTGRADUATE DIPLOMA IN BUSINESS AND FINANCE SEMESTER 1 : FINANCIAL PLANNING AND CONTROL Budgeting M B G Wimalarathna [FCA, FCMA, MCIM, FMAAT, MCPM][MBA PIM/USJ]

2 Introduction A budget is a formal plan of actions (operational) expressed in monetary terms for a given future period of time. What you are going to do tomorrow? How you can quantified them? How you can basically achieve those? Simply, a budget is a quantitative expression and presentation of entity s future plans. The word quantitative essentially refers both financial and non-financial data/information. But in most circumstances, the budget even includes qualitative information. Most of the entities tend to prepare a corporate budget for next 12 months which usually refers forthcoming financial year. But in order to reap more benefits and have more control, it is recommended to compile the budget by considering shorter period of time as much as possible due to risk of uncertainty. More the time laps, hire the risk (in general)

3 Introduction In general, the budget works as planning and controlling tool within the organization once compiled. Most importantly, the budget provides essential guidance and direct all employees towards achieving set targets/goals. Once the budget compiled, it shall urge managers (employees) to be more proactive in their routine duties. This also a very crucial feature of the budget since it assist identify the problems/issues in advance and find the possible solutions accordingly (proactive). Key roles of the budget among many. Assist planning and controlling scares resources Communicates plans/actions to key management and all employees Motivate people (managers) to strive to achieve goals Evaluate the performance and take prompt actions Create good culture in which people are accountable for what they do

4 Introduction Nature, size and types of the budget is solely depend on the industry as well as the nature/size of the business operation of the particular organization. In common, every organization attempts to compile budgeted cash flow statements at minimum. Following are also quite popular in business world. Revenue budget Expenditure budget Production budget Capital budget Marketing budget Project budget Sales budget (sometimes same as revenue budget) Labor force budget

5 Introduction In addition to above, following are some of the principles/practices we used/observed within the overall scope of the budget. Fixed/Static budget The budget which prepared based on the target level of output. Hence, fixed budget prepares with the assumption of target revenue/output can be measured in certain. If actual output differ from what has budgeted, the variance will be calculated. Use of fixed budget in practice is very limited. Flexible budget Unlike in fixed budget, flexible budget shall basically be taken into consider the fluctuations of expenditures and revenues over the period and do necessary adjustments accordingly. Flexible budget gives quite very updated information and useful for decision making.

6 Introduction Traditional/ conventional/ historic budget Changes to the data in the budget do very carefully by analyzing their tendency to be fluctuated over the period. Amendments shall only be for the data which could expect dramatic variances. Zero-based budget In contrast to historic budget, zero-based budget shall amend all the data regardless their tendency to be fluctuated and begins the process of compiling budget as do first time. Computerized budget Like many other areas/aspects in the business, budget also had an enormous impact from IT/MIS. As such, most of the organizations practice to compile their budget and evaluate the results through computerized software (system). This mostly enhance the efficiency as well as the effectiveness of the concept of budget to a greater extent (but more care is required).

7 Importance of Compiling a Budget A budget is a mere document for most of the organization which just prepares and documents as part of the job of the finance manager. I must re-iterate that the compilation of budget can theoretically be a duty of the finance manager but it should be a contribution of all the people within the company. An entity must essentially link its (annual) budget with corporate strategic plan (business plan) in order to reap the real benefits. Understand the importance of working towards achieving vision and mission of the organization. In simple term, if you are not, you do not have a future. CSP is a common tool which essentially communicates such level of importance messages among all the people within the company and the budget is the vehicle through which an organization compiled its CSP. Now, established the relationship/link and understand the importance of budget. At minimum, an entity prepares a budgeted financial statements based on the current (audited) financial information. Most of the other budgets are directly linked with routine operations (activities) including sales/marketing.

8 Budget Cycle Budget cycle basically denotes the important aspect of overall budget process in an organization. Once the budget has been compiled, it shall be used as a control tool/mechanism to monitor actual results with the budgeted/ expectations and investigate the reasons for differences and also evaluate and reward the performance. Budget cycle brings many positive attributes to the organization. Re-assess the vision and core competencies Evaluate and reward performance Reconsider long term strategies & apply Investigate the difference between actual and budget Develop operating plans Monitor actual results compared to budget Translate strategies/operating plans into master budget

9 Use of Budget As discussed in above, it revealed that most of the organizations tend to prepare their budget simply for the sake of preparation as part of annual documentation. You must remember and recall in every minute that the budget is a very vital/useful document and even effective budget can turnaround your company. How your budget basically assist you in routine decision making? Putting into operation the longer term plans link with strategies Setting targets/goals for the managers through which whole staff Utilization of capacity (properly) at maximum level. Enhance performance of the activities/divisions/employees. Planning raw materials & other service requirements. Planning and effective utilization of labor force. Efficient/effective usage of all scares resources. Planning and determining future financial commitments Provide inputs to the long term plans/csp/vision & Mission. Control mechanism/tool.

10 Three wheels of planning Successful budgeting helps strengthening the interrelationship between most important three aspects of the business: profit cash return on investment as depicted through following model. Cash Tr. Debtors Cash wheel Inventory Sales Op. Expenses Profit wheel Investments Profit Assets Utilization ROE wheel Equity ROE

11 Process of Compiling a Budget Compilation of budget involves series of steps in which one activity/process essentially link to the other. Consideration of past Performance (A) Assessment of expected trading & operation results (B) Audited Financial Statements Macro economic factors Initial budget preparation (C) Production capacity Expected Market(s) * based on experience Adjustment (1) Line Managers (D) Adjustment (2) As per F above (G) Monitoring Actual Vs Budgeted (F) Final Budget (E) Sub Budget * based on actual * during budget period * formal

12 Diversities of Budgets Different types of budgets will be prepared by the entity and diversities of them including formats is solely depend on the nature of the entity s operational activities. Sales/Revenue Expenses Purchase/Production Sales Fee Functional Sectional R/m Services Manufacturing Budgeted Income Statement. Budgeted Balance Sheet. Cash Budget. Capital Budget. Apart from the above (common) budgets, some entities tend to prepare a program budget based on the availability and involvement of programs (local/foreign) (general training/marketing/promotional).

13 Diversities of Budgets Manufacturer Service (Hotel) Professional Service (Law firm) Government Department Sales budget Sales budget Fees budget Fees budget (rare) Production budget N/A N/A N/A DM budget DM budget (rare) DM budget (rare) DM budget (rare) DL budget DL budget DL budget DL budget MNF OH budget N/A N/A N/A NMNF OH budget N/A N/A N/A Expenses budget Expenses budget Expenses budget Expenses budget Departmental budget Departmental budget Departmental budget Departmental budget Cash budget Cash budget Cash budget Cash budget Budgeted I/St. Budgeted I/St. Budgeted I/St. Budgeted I/St. (rare) Budgeted B/S Budgeted B/S Budgeted B/S Budgeted B/S (rare) Program budget -rare Program budget Program budget Program budget

14 Master Budget A Master Budget is a summary of entire budgets (discussed in above) prepared within the entity for a particular period. Generally, Master Budget divided in to two (02) parts. Operational Budget Sales (quantity and monetary) Operational expenditures Financial Budget Income Statement Balance Sheet Cash Capital Budget Variance: Difference between actual and forecasted (budgeted) figures/data/results. Why it is important? Budget Variance Favorable Unfavorable (need holistic analysis)

15 Cash Budget A cash budget is the most common & popular budgetary statement prepare by entities which depicts future cash inflows and outflows coupled with the end results of net cash balance. Cash budget is essentially helps in decision making as follows. Determined cash receipts & payments time. Identify cash shortage Sources of Finance. Identify cash surplus Sources of Investment. Identify suitable time to make long term investments and purchase of NCA. Determined how to use borrowed funds. Provide framework for what if analysis. Note: Cash Budget is generally prepare on a monthly basis and it should be treated as an effective control tool of an entity. (need care)

16 Use of Cash Budget You must get maximum use of cash budget rather than mere prepares it. Amidst many use, cash budget essentially assist to improve the cash position of an entity as follows; Enhance cash revenue (new market/new product/expansion/diversification) Expedite/enhance collection from debtors (many ways) Reduce unnecessary cash investment in stocks/inventory (many) Sale of idle assets (still can have an impact over entity s image) Seek low cost sources of finance (debt as opposed to equity) Control operational & maintenance expenditures (not cut) Defer capital expenditures (will have an impact in the long run) Maximum utilization of creditors support (ethically)

17 Behavioural Aspects of Budgeting Behavioral aspects refers human behaviors with respect to the preparation/presentation of budget and evaluation of the results of such budgets. Management styles Authoritarian Participative Some insights: Over state expenditures - under state revenue Reserve for margin of error (snow balling effect)(mostly, in participative) Manipulate information to show efficiency/performance Unnecessary use of budget funds (program budget)