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Manage Budgets and Forecasts

Week 1 – Chapter 1BUDGETING BASICS

FNSACC503AManage Budgets and Forecasts

By the end of this lesson, you will be able to…

1. Define and discuss some key budgeting terms2. Discuss the benefits & limitations of budgeting3. Prepare a simple budget

Overview1. What is a budget?2. What is a budget used for?3. Organisational planning The planning cycle4. Budgets their Benefits + Limitations5. Budget preparation6. Approaches to budgeting7. Types of budgets8. Budget classification9. Master budgets10.Example: Simple budget preparation

QuickBRAINSTORMING

Activity

What do you already know about budgeting?

What is a budget?A BUDGET is:•a written statement•of management’s strategic plans for achieving the organisation's key objectives•expressed in financial terms

What is a budget?Put simply, a BUDGET is an itemised forecast of money coming in and money going out for a specified period of time for either a specific activity, department, product or the organisation as a whole.

What is a budget used for?Budgets help the leadership team of an organisation to CO-ORDINATE and CONTROLkey activities across the organisation, enabling the goals of the organisation to be reached.

Specifically, they help management with the:1. Planning2. Organising3. Motivating4. Controllingaspects of their role.

Organisational planningPLANNING is defined as: -- the set of actions taken-- to formulate the scope and direction-- of future activities and operations.

Organisational planning Long term plans: span 5 to 10 years

(more strategic in nature)

Medium term plans: span 1 to 5 yearse.g. new product releases, equipment upgrades etc.

Short term plans: span up to 1 year(quite detailed; deal with day-to-day operations of the business)

Budgeting is: an integral part of the planning process. used to support management decision

making in relation to allocation of scarce resources to facilitate goal achievement.

Organisational planningExample : Airline CompanyIn the short-term, the allocation of plane size and crew numbers

requires a detailed analysis of destinations and expected activity to ensure that resources are utilised efficiently.

In the medium-term, the company will have to consider adding some new destinations to their current offering and discontinue operations to low volume (low profit) destinations to grow business operations and remain competitive.

In the long-term, the company will have to plan for major capital expenditures in relation to replacing and adding airplanes to the fleet. The increase / decrease in capacity will be based on expectations and forecasts of market trends and market share as it relates to the company.

The planning cyclePERFORMANCE REPORTPERFORMANCE REPORTBUDGETBUDGET

Comparison of ACTUAL results to BUDGET VARIANCEComparison of ACTUAL results to BUDGET VARIANCE

The planning cycle(ref. diagram on previous slide)

1. Plans, including budgets are prepared.2. Action is taken to implement these plans.3. Performance is measured by comparing actual

results to the budget.4. Differences or variances are analysed so that

corrective action can be taken.5. If necessary, plans are reviewed and assessed.

Benefits of budgets1. Forces management to do some planning.2. Provides realistic performance targets (if done

properly involving the appropriate personnel).3. Basis for controlling what happens within the

organisation.4. Helps co-ordinate the activities of the various

departments that make up the business.5. Promotes communication – managers exchange

information on ideas, business goals etc.6. Motivational tool – if appropriate staff are involved

in the budget-setting process

Limitations of budgets1. Only estimates, not statements of facts.2. Costly and time-consuming.3. No substitute for sound management

practices.4. Need to be amended if circumstances change.5. Preparation does not guarantee success.6. Aspects of people’s behaviour may undermine

the value of the process (CHAPTER 11).

Budget preparationThe organisation’s leadership team has to work

out:1.Where are we now? (i.e. analyse the organisation’s

internal environment as well as the external & remote environment within which the organisation operates)

2.Where do we want to go? (decide upon the organisation’s short-, medium- and long-term goals)

3.How are we going to get there? (put together a workable strategic planning; budgeting is an integral part of this planning process)

Budget preparationRelevant factors must be considered when preparing

a budget, for example:Past sales levels and trendsEconomic trends

(e.g. changes in interest rates, exchange rates & tax rates; ‘boom’ & ‘bust’ business cycles)The likely action of competitorsMarket research studiesPossible government actions (e.g. child care rebate)

Budget preparation

Allow enough time to prepare the budget.

Involve appropriate staff.

Approaches to budgeting

Approach used depends on the SIZE and STRUCTURE of the firm and the type of ENVIRONMENT in which it operates.

e.g. organisations planning a change of focus or strategy cannot rely on established budgeting processes & procedures – they may need to be a bit more creative.

Approaches to budgetingStandard approach:

historical figures (actual or budget) are used and adjusted for any likely future events – not recommended as past inefficiencies may be perpetuated and funds may not be allocated to activities designed to meet the organisation’s objectives.

Zero-based budgeting: the initial figures for each activity are set to zero. To receive funding, each activity must be justified in terms of how it meets the organisation’s objectives. The dollar figure attached to that activity is then based on the resources needed to make that activity happen.

Types of budgets Revenue budgets: (LESSON 2)

Provide estimates of the income of an organisation from the sale of goods and/or provision of services for a specific period of time.

Operating budgets: (LESSON 3)Provide an estimate of the activities that will affect net profit including purchases, COGS and operating expenses

Budgeted financial statements: (LESSON 5)Show the estimated results and projected financial position of a business and include the budgeted income statement, balance sheet and cash flow statement.

Budget classification1. PERIOD budget:developed for a specific period of time e.g. a quarter.

2. ROLLING (CONTINUOUS) budget: continually updated so that it always reflect plans for the same length of time e.g. 12 months. This is done by periodically adding a new time period to the forecast and dropping off the equivalent period just completed.

Budget classification3. STATIC (fixed) budget:prepared for one level of planned activity e.g. a particular level of sales, say, $75,000.

4. FLEXIBLE budget:a series of budgets that show how costs vary at different levels of activity within which the organisation may operate (CHAPTER 10).

See example on next slide - The Simms Card Co.

Flexible budgetse.g. The Simms Card CompanyThe Simms Card Company manufactures inexpensive greeting cards, which are sold in packs of ten (10) at discount stores. The Simms Card Company has prepared its budgets on the assumption that it will sell 200,000 packs of cards during the year.

How could the company’s performance be accurately assessed if 190,000 packs of cards were sold instead?

Flexible budgetse.g. The Simms Card Company (STATIC)

BUDGET ACTUAL VAR. F / U

Sales 200,000 190,000 10,000 ULess: Variable costs* 20,000 18,000 2,000 F

Contribution margin 180,000 172,000 8,000 U

Less: Fixed costs 10,000 10,000 - -

Net profit 170,000 162,000 8,000 U

* Budgeted for at 10c per sales dollar

Flexible budgetse.g. The Simms Card Company (FLEXIBLE)

BUDGET(level 1)

BUDGET (level 2)

BUDGET (level 3)

Sales 190,000 200,000 210,000

Less: Variable costs* 19,000 20,000 21,000

Contribution margin 171,000 180,000 189,000

Less: Fixed costs 10,000 10,000 10,000

Net profit 161,000 170,000 179,000

* Budgeted for at 10c per sales dollar

Cost Classification(FIXED vs. VARIABLE costs)

FIXED COSTS do not vary (in the short run) with changing levels of activity.The cost per unit decreases as activity increases. This relationship is constant within the relevant range of activity.e.g. factory rent

Fixed Costs

Cost Classification(FIXED vs. VARIABLE costs)

VARIABLE COSTS in total vary (in the short run) with changing levels of activity.Remain the same per unit over the relevant range. e.g. labour costs

Variable Costs

Flexible budgetse.g. The Simms Card Company (FLEXIBLE)

BUDGET ACTUAL VAR. F / U

Sales 190,000 190,000 - -Less: Variable costs* 19,000 18,000 1,000 F

Contribution margin 171,000 172,000 1,000 F

Less: Fixed costs 10,000 10,000 - -

Net profit 161,000 162,000 1,000 F

* Budgeted for at 10c per sales dollar

Master budgets a combination of all the budgets of an organisation. reflects the integrated plans and expected financial

results of all operations and departments of the organisation.

* Starting point sales / revenue budget* Other budgets are then prepared in line with the required

level of sales.

MASTER BUDGETS (chapter 1 : budgeting fundamentals)

Budget income statementMERCHANDISING PROFESSIONAL SERVICES*

Sales Fees income Sales

Purchases >> COGS Professional and support labour costse.g. dentist + dentalassistant * direct labour

>> COGSMarketing expenses Marketing expensesAdmin. expenses Admin. expenses Admin. expensesFinancial expenses Financial expenses

Cash budget Capital expenditure budget

Budgeted balance sheet* sells expertise and knowledge

MANUFACTURINGBudget income statement

Marketing expenses

Financial expenses

Production + Ending Inventories

* direct materials (usage + purchases)

* factory overhead

Example 1 : Simple budgetTurner Home Building Products manufactures bricks and tiles. Their Brisbane branch has to prepare its budgets for the coming year and they will bepresented to head office for approval. The Admin. department’s actual figuresfor last financial year ended June 30 were as follows:

Item $Salaries 323,400Stationery 14,000Telephone 15,120Electricity 15,850Rates 7,780Depreciation 12,600Total 388,750

After carefully considering all relevant factors, it was estimated that the

following changes are likely to occur for the next financial year: Salaries are expected to increase by 5% Due to a new online facility installed by Turner, stationery is

expected to decrease by 10% Tarrif increases will mean that electricity will increase by 6% Rates will increase by 8% Telephone and depreciation should remain the same

Required:Prepare next year’s budget for the Admin.department of Turner’s Brisbane branch.

Solution : Example 1Turner Home Building Products : Brisbane Branch : Admin. Dept

Budget for year ended 30 June 2013

Item Last year actuals

Budget workings

Budget for next year

Salaries $323,400 X 1.05 $339,570Stationery $14,000 X 0.9 $12,600Telephone $15,120 $15,120Electricity $15,850 X 1.06 $16,801Rates $7,780 X 1.08 $8,402Depreciation $12,600 $12,600Total $388,750 $405,093

Example 2 : Simple budgetThe personnel department of Avnet Industries had the following actual results

for last year:

Required: Prepare next year’s budget for the personnel dept. of Avnet Industries.

Item Actuals30 June X0

Salaries $215,600Stationery $4,930Telephone $9,800Electricity $10,750Office rent $25,200Depreciation $8,400Total $274,680

It is estimated that next year’s budget will reflect the following changes:* Salaries will increase by 5%* Stationery costs will increase by 3%* Telephone usage is expected to decline by 4%* Electricity costs are expected to rise by 1.5%* A change of location means that office rent should decrease by 5%* Depreciation – it is anticipated that furniture costing $5,600 will be disposed of at the beginning of the financial year and immediately replaced with new furniture costing $7,000. The rate of depreciation is 10% p.a. on cost.

Solution : Example 2Avnet Industries : Personnel Dept.

Budget for year ended 30 June 20X1

Item Actuals30 June X0

Budget workings

Budget30 June X1

Salaries $215,600 X 1.05 $226,380Stationery $4,930 X 1.03 $5,078Telephone $9,800 X 0.96 $9,408Electricity $10,750 X 1.015 $10,911Office rent $25,200 X 0.95 $23,940Depreciation $8,400 -$560 + $700 $8,540Total $274,680 $284,257

How to work out the depreciation amount of $8,540

Information provided:

Depreciation: It is anticipated that furniture costing $5,600 will be disposed of at the beginning of the financial year and immediately replaced with new furniture costing $7,000. The rate of depreciation is 10% per annum on cost.

Depreciation method: Straight-line depreciation.

We are not told what the opening balance for ACCUMULATED DEPRECIATION is.

How to work out the depreciation amount of $8,540

This week’s homework Get a copy of the textbook Read chapter 1 Budgeting Basics Complete homework questions (chapter 1)

(ref. STUDENT ONLINE STUDY GUIDE)

You are now ready to start the next lesson on:

Chapter 3

Sales and RevenueBudgets