The budgeting process: Planning business activities

Transcription

1 The ing process: Planning business activities 21-2 Objectives Once you have completed this part of the topic, you should be able to: Define and describe s. Identify the steps in preparing a master. Explain the difference between static and flexible s. 1of 25

2 21-3 Objective 1 describe Define and s Additional Reading The following reading is in addition to the reading indicated in the Student Study Pack Pages of Juchau, R., Flanagan, J., Mitchell, G., Tibbits, G., Ingram, R.W., Albright, T.L., Baldwin, B.A., Hill, J., Accounting Information for Decisions, Revised 2nd Edition, 2009, Cengage Learning, Australia. PLANNING 21-5 THE COMPREHENSIVE PLANNING APPROACH INVOLVES THE DEFINITION AND THE DETAILED SPECIFICATION OF THE ORGANISATION S OBJECTIVES THE IDENTIFICATION OF THE COURSES OF ACTION AVAILABLE, WITHIN THE LIMITS IMPOSED BY THE RESOURCES AT THE DISPOSAL OF THE ORGANISATION THE SELECTION AND IMPLEMENTATION OF THE COURSE OF ACTION WHICH MAXIMISES THE ACHIEVEMENT OF THE OBJECTIVES OF THE ORGANISATION 2of 25

3 21-6 Business Goals and Objectives Most people think the entire purpose of business is to make a profit. But profit is no more the purpose of business than eating is the purpose of living. Both are essential, but neither is the point of the exercise. Business survives because it continually creates a better world for itself. Petzinger, The Wall Street Journal (June ) 21-7 Business objectives The planning and the ing process must always address the business objectives of the organisation. Business objectives refer to the desired ends of management They should be: the catalyst for all management decisions the basis for measuring actual accomplishments Business objectives Although most organisations claim to have a singular objective to make a profit, in reality all organisations have a number of objectives of 25

4 21-9 Business objectives Profitability Examples of business objectives Objectives concerned with actual profits to be earned or returns on investment. Growth Objectives related to increased revenue, number of employees or range of products being produced. Market share Objectives expecting an increase in the market share. Social responsibility Employee welfare Objectives recognising that as, a corporate citizen, an organisation should address general societal aims, for example, problems of pollution. Objectives showing concern for employees in their working life and place of work, for example, providing a safe work environment. Quality of product and service provision Objectives requiring that only the best products and services be sold or improved over time. Objectives plus stakeholders Each stakeholder, no matter what their key interest may happen to be, they will have a good reason/s for promoting the ongoing prosperity of the business. Shareholders Directors and management Examples of stakeholders Stakeholder Relation to the business organisation The owners, especially major investors, will want to contribute to the plans of the company. People in senior positions, whether elected or employed, will want to ensure their positions and incomes are considered. Employees Financial institutions Clients Suppliers Whether employers are employed in the short or long term, they will be concerned about security of tenure. As Maslow wrote, security of tenure is on the second rung of the hierarchy of needs. Lenders or potential lenders will want to be aware of the intentions of their client. There is no point in producing or selling to clients who no longer need your product. It is always good to know that your suppliers can continue to provide your requirements as change takes place rather than always needing to catching up Business Goals and Objectives Business Goals must be determined before preparing a Budget Business Goals are the desired outcomes of the business operations E.g. to sell my business for $500,000 in 5 years time E.g. to have a debt free business at the end of 3 years E.g. operate a franchise in every capital city within 5 years NOT to maximise sales, or NOT to retire wealthy NOT to be my own boss or NOT double size in two years Business Goals must be Measurable Clear and concise In writing Attainable 4of 25

5 21-12 Business Goals and Objectives Business Objectives are set to achieve business goals E.g. business goal sell business for $500,000 in five years business objective increase market share by 2% each year leading to $1,000,000 in sales in year five at 15% net profit per year Usually several objectives (outcomes of strategy) to achieve business goal Business Goals and Objectives GOALS The Main AIM(s) The main thing(s) we want to get to The terms Goals and Objectives are often interchanged. It doesn t really matter so long as you have a good view and understanding of what the context is, in which the terms are used Business Goals and Objectives STRATGEY is HOW we get to our aim(s) 5of 25

6 21-15 Business Goals and Objectives OBJECTIVES are the steps along the way Linked to strategy often called: - Critical success factors - Key performance indicators etc Business Goals and Objectives CHECKING RESULTS Monitoring or checking on how we are going along the way. So we can assured that we are on target or so we can do better Business Goals and Objectives Objectives generally relate to various operational functions that fall into the following broad categories Production Marketing Purchasing Personnel Financial Administration and Capacity 6of 25

7 21-18 Managing Operational Functions Business performance is a function of ALL the activities of the TOTAL operation. Business Plan must also consider all the activities i i of the TOTAL operation Effective management of the TOTAL operation requires planning as well as control of EACH operating function Business planning For larger organisations, planning: gives direction reduces the impact of change minimises waste and redundancy sets a basis for control within the organisation Levels of planning Long-term plans Intermediate plans A short-term plan usually cover a period in excess of five years. cover between two and five years. usually covers one year. 7of 25

8 21-21 DEFINITIONS A common understanding of is that it represents a spending allowance. This definition applies in accounting only when the resources are of a special kind DEFINITIONS "In a business enterprise a is the formal statement of a management's goals and objectives expressed in financial terms for a specific future period of time..." DeCoster & Schafer "A Budget is a quantitative expression of a plan of action and an aid to coordination and implementation..." Horngren DEFINITIONS "Budgets state formally - in terms of expected transactions - the decisions of all levels of management about the resources to be acquired, how they are to be used, and what ought to result. Budgets put the details of management plans for operations in money units, so that the results may be projected into expected financial statements." W.J. Vatter 8of 25

9 21-24 Budgeting Budgeting deals with the future It is the process aimed at predicting the level at which any activity of a business organisation will operate in a future time period. Based upon those principles, estimates are made of all the operational items leading to a ed statement of financial performance. The master concludes with the ed statement of financial position at the end of the period. Bear Reasons for Business Planning PLANNING & FORECASTING Formulation of Policies Detailed Planning of Future Action Preparation of Estimates CO-ORDINATION ORDINATION & COMMUNICATION Motivation & Goal Congruence CONTROL Assignment of Responsibility Measurement of Actual Results Comparison of Actual to Expected Diagnosis and Correction The annual : a planning tool The annual (or master ) is a comprehensive set of s that covers all aspects of a firm s activities Consists of several interdependent schedules Financial s Operating s In large organisations: a comprehensive process, formal ing procedures taking several months In smaller organisations: less formal process (cont.) 9of 25

10 The annual : a planning tool (cont.) Budgets are developed for specific time periods Rolling s (or continuous s) are continually updated by periodically adding a new time period, such as a quarter, and dropping the period just completed Budgets will vary in their level of detail, often dependent on the size and complexity of the organisation Strategic plans and assumptions Budgets commence with an understanding of the strategy of the organisation The should support the strategic plans The is based on various assumptions about the competitive environment and the economic environment for the coming year STANDARDS PERFORMANCE BENCHMARKS STANDARD a level of quality which is regarded as normal, adequate, or acceptable serving as a basis of weight, measure, value, comparison, or judgement normal, adequate, acceptable, or average Macquarie Concise Dictionary A STANDARD COST is a pre-determined cost based on normal/expected levels of usage of 25

11 21-30 Setting standards A variety of methods may be used to set cost standards Analysis of historical data Can provide a good basis for predicting future costs May need to be adjusted to reflect expected movements in price levels or technological changes in the product process Must be used with care as changes can make those costs irrelevant and can include inefficiencies of the past (cont.) Setting standards (cont.) Engineering methods The focus is on what the product should cost in the future There is a need to determine how much material should be required and how much direct labour should be used in the production process Time and motion studies may be conducted to determine how long it should take for workers to perform each step in a production process In practice, both historical cost analysis and engineering methods may be used together Participation in standard setting may lead to greater commitment to meeting those standards (cont.) Setting standards (cont.) Practical standards are the minimum attainable costs under normal operating conditions, with allowances made for downtime and wastage May encourage more positive and productive attitudes among employees compared to perfection standards Including allowances for idle time, material wastage or normal spoilage, may encourage inefficiency and waste Some companies build continuous improvements into standards to make them (cont.) more demanding of 25

12 21-33 STANDARD COSTS INDICATE WHAT IT SHOULD COST TO PRODUCE ONE BATCH OR UNIT OF PRODUCT UNDER EFFICIENT OPERATING CONDITIONS ARE SET USING ENGINEERING COST DATA, HISTORICAL COST DATA, TARGET COSTING, AND/OR CONTINUOUS IMPROVEMENT COSTING FLEXIBLE BUDGETS ARE BASED ON STANDARD COSTS STANDARD COSTS Price standards specify how much should be paid for the quantity of the input to be used. Quantity standards specify how much of the input should be used per unit of output. Unit standard cost is the product of these two standards: Standard price Standard Quantity (SP SQ) COMPARISON OF ACTUAL, NORMAL AND STANDARD COSTS DIRECT COSTS ACTUAL COSTING Actual Inputs times Actual Prices NORMAL COSTING Actual Inputs times Actual Prices STANDARD COSTING Standard Inputs allowed for actual output achieved times Standard Prices VARIABLE FACTORY OVERHEAD FIXED FACTORY OVERHEAD Actual Inputs times Actual Overhead Rates Actual Inputs times Actual Overhead Rates Actual Inputs times Budgeted Overhead Rates Actual Inputs times Budgeted Overhead Rates Standard Inputs allowed for actual output achieved times Budgeted Overhead Rates Standard Inputs allowed for actual output achieved times Budgeted Overhead Rates 12 of 25

13 Usage of Standard Costing Systems Cost Management Planning and Control Decision Making and Product Costing Overview of the master A is a detailed plan describing the use of financial and operating resources over a specific period. A master is a collection of related s covering sales, production, purchasing, labour, manufacturing overhead, administrative expenses, and financing activities. Exhibit 1 Components of a master Sales Production Direct materials Direct labour Mfg. overhead Admin. expense Pro forma income statement 13 of 25

14 Exhibit 1 Direct materials Components of a master Direct labour Mfg. overhead Admin. expense Pro forma income statement Capital Pro forma balance sheet Cash Objective 2 in Identify the steps preparing a master. Sales The sales projects revenues from sales of a company s products or services. 14 of 25

15 Exhibit 2 Sales Exhibit 2 Sales schedule of cash receipts Production The production identifies the amount of a product that must be produced to meet a company s needs for sales and inventory. 15 of 25

16 Production Production = Expected sales (in units) + Desired ending inventory (in units) Beginning inventory (in units) Exhibit 3 Production Direct materials The direct materials identifies the amount of materials that will be required to support a company s total production needs. 16 of 25

17 Direct materials From the production Direct materials Units to be produced x raw materials per unit + Desired ending raw materials inventory Beginning raw materials inventory = Raw materials to be purchased Direct materials From the production Q1 Production units Raw materials per unit (kg) x 5 Production requirements (kg) Add desired ending inventory Total needs (kg) Less: Beginning inventory (kg) 700 Total materials to be purchased Q x Materials to purchase ($0,60/kg) $4 740 $9 720 Exhibit 4 Direct materials of 25

18 Exhibit Direct materials schedule of cash disbursements Direct labour The direct labour identifies the labour resources required to meet production needs. Each unit requires 48 minutes of labour to produce (0.8 hours), and costs $7.50 per hour. Direct labour From the production Q1 Total units to produce Hours per unit x 0.80 Ttl Total hours required Labour rate per hour x $7.50 Total labour cost $ of 25

19 Exhibit 5 Direct labour Manufacturing overhead The manufacturing overhead provides a schedule of all costs of production other than direct materials and direct labour. Kirkland applies manufacturing overhead using a rate of $2 per direct labour hour. Fixed overhead per quarter is $ Manufacturing overhead Q1 Total production (units) Hours per unit x 0.80 Total hours required Overhead cost per hour x $2 Budgeted variable overhead $2 240 Budgeted fixed overhead Total ed manufact. overhead $ of 25

20 Exhibit 6 Manufacturing overhead Selling and administrative expense The selling and administrative expense contains a list of anticipated expenses for the period for activities other than manufacturing Exhibit 7 Selling and administrative expense of 25

21 Pro forma ed income statement The pro forma income statement is a key schedule in the master, providing a forecast of profitability for the planning period Exhibit 8 Pro forma ed income statement Objective 3 difference Explain the difference between static and flexible s. 21 of 25

22 21-63 Pro forma flexible income statement A pro forma income statement based on a single level of activity is called a static. When activity levels can vary, a flexible allows the calculation of profit for a range of possible sales activity levels. Flexible ing Central concept If you can tell me what your actual activity was for the period, I will tell you what your costs and revenue should have been. As distinct from what was originally ed for using a different level of anticipated activity Flexible ing Show what costs would have been ed at the actual level of activity. May be prepared for any activity level in the relevant range. Reveal variances due to good cost control or lack of cost control. Improves performance evaluation. 22 of 25

23 21-66 Flexible ing To flex a for different activity levels, we must know how costs behave with changes in activity levels. Total variable costs change in direct proportion to changes in activity. Total fixed costs remain unchanged within the relevant range. Exhibit 9 Pro forma flexible income statement Cash The cash has four major sections: Cash receipts C h d b Cash disbursements Cash excess/deficiency Financing requirements 23 of 25

24 Exhibit 10 Cash Q1 Receipts: Collections on account (Exhibit 2) Less: Disbursements: Direct materials (Exhibit 4) Direct labour (Exhibit 5) Manufacturing overhead (Exhibit 6) Selling and administrative i i (Exhibit 7) Income taxes (Exhibit 8)($7200/4) Equipment purchases Dividends Total disbursements Change in cash (12 250) Cash balance beginning Excess (deficiency) of cash (8 000) Exhibit 10 Cash Pro forma ed balance sheet The pro forma ed balance sheet identifies expected amounts of assets, liabilities and owner s equity at the end of the period. 24 of 25

25 Exhibit 11 Pro forma ed balance sheet Sensitivity analysis in ing Because assumptions can be wrong, it is often desirable to determine how sensitive outcomes are to the assumptions used in developing the. Scenarios investigated include: Most likely case Worst case Best case Exhibit 12 Sensitivity analysis in ing of 25