Presentation on theme: "Budgetary Planning – Preparation of the Master Budget"— Presentation transcript:
1Budgetary Planning – Preparation of the Master Budget Chapter 9Budgetary Planning –Preparation of the Master Budget
2Fixed budget‘budget set prior to the control period and not subsequently changed in response to changes in activity, costs, or revenues.’Fixed Budget as defined by CIMA Official Terminology
3The fixed/master budget The fixed or master budget sets out the plans for the business for the next accounting period based on various assumptions of sales and sales growth, inflation (in particular labour inflation), interest rates, taxation and capital expenditure. This master budget is known as the fixed budget as it is based on these fixed assumptions of trading performance and financial outlook. Its chief role is at the planning stage, in setting the overall direction or plan for the business
4The master budget Operating Budgets Capital Budgets Cash Flow Budget Sales revenueCost of salesPayroll and related expensesOther department expensesFixed expensesCashFlowBudgetCapital BudgetsCapital expenditureStocks (related to purchases)Debtors (related to sales)Creditors (related to purchases)P&L account (Income statement)Balance sheetCash flowMaster Budget
5The master budget statements Profit and LossAccountBalance SheetCash BudgetA projected profit and loss account (income statement) includes all the revenues and expenses anticipated for the budget month under review.A projected balance sheet is a statement of the expected position of an entity at the end of the budget month. It contains the expected monetary value of assets, liabilities and capital at the end of the budget month.Cash budgets are prepared in order to ensure that there will be sufficient cash in hand to cope adequately with budgeted activities. They must contain every type of cash inflow (money received) and every type of cash outflow (money paid).
6Example 9.1: The effect of sales in the master budget
7Example 9.1: The effect of sales in the master budget
810% of €100,000 sold in month 3 not received. Profit and loss extract (months 1 to 3)Sales revenue€280,000€80,000 + €100,000 + €100,000Cash Budget – Cash inflowsMonth 1Month 2Month 3Cash sales (90%)€72,000€90,000Credit sales (10%)______€8,000€10,000Total sales receipts€98,000€100,000Balance sheet extract as at end month 3Current AssetsDebtors €10,00010% of €80,000 sold in month 1.10% of €100,000 sold in month 2.10% of €100,000 sold in month 3 not received.
9Example 9.2: The effect of purchases and stock in the master budget
10Profit and loss extract for (months 1 to 3) € Opening stock €Opening stockPurchases (€50,000 x 3)150,000Closing stock(20,000)Cost of goods sold130,000Cash Budget - cash outflowsMonth 1Month 2Month 3Purchases€50,000Month 1 purchases are paid for in month 2.Balance Sheet extract as at end month 3Current assets €Stock20,000Current liabilitiesCreditors50,000Month 2 purchases are paid for in month 3.Month 3 purchases are unpaid (due to be paid in month 4).
11Other differences between P&L and cash budget The purchase cost or sales proceeds of fixed assets.Proceeds from the issue of sharesCash flows from the procurement or repayment of loansDepreciation of fixed assets
12Forecasting‘A prediction of future events and their quantification for planning purposes’A forecast as defined by CIMA Official TerminologyThree essential elements are required before one can begin to prepare projected financial statements.Forecast of sales.Forecast of costs / expenditure.Forecast of the required investment in net assets to achieve these sales.
13Forecasting - factors influencing sales Past sales volume and mixLevel of competitionQuality of the product or serviceConsumer behaviourStrength of the brand nameState of the economyPlanned advertising expenditurePolitical and industrial outlookPricing policyLocal activities and eventsCapacitySeasonalityAdvance bookingsDemand analysis
15Forecasting – balance sheet items Debtors: Debtors tend to increase as sales increase.Stock levels: More stock is required to meet increased demand.Cash: More cash is required to meet increased costs associated with the increase in sales.Creditors: More credit is required from suppliers as purchases increase in line with sales.Accrued expenses: More accrued expenses occur as a result of increased overheads.Bank overdraft: A bank overdraft is frequently used to bridge any financing gaps caused by increases in activity.Fixed assets: As the business expands new fixed assets are required. (Note that fixed assets will not increase as sales increase, but only as the business reaches capacity and requires expansion). Hence there is a long-term relationship between sales and the fixed assets requirement.Long-term finance: As fixed assets expand, one will also expect long-term finance in the form of equity and more likely long-term debt to increase.
16Other forecasting issues Taxation and rate of corporation tax.Variable interest rates on borrowings.The rate of inflation.The policies and commitments of the business.Capital expenditureFinancing methodsDividend payouts
23Projected financial statements and decision-making Is the projected profit satisfactory in relation to the risks involved and the required return on capital? If not, what can be done to improve this?Are sales and individual expense items at a satisfactory level?How adequate are the projected cash flows of the business and can they be improved?Should management consider additional financing?What type of financing is required, long, medium or short-term financing?What type of financial instruments are appropriate, debt or equity?Will there be surplus funds and if so, what plans have the company as regards investing these funds?Is the business overly financed through debt?How liquid is the business?Is the financial position at the end of the period acceptable?
24Alternative approaches to budget preparation Incremental budgetingZero-based budgetingActivity based budgetingRolling budgets
25Incremental budgeting ‘Method of budgeting based on the previous budget or on actual results, adjusting for known changes and inflation’Incremental budgeting as defined by CIMA Official TerminologyThis is where the current budget and actual figures act as the starting point or base for the new budget.The major disadvantage of this is that the major part of the expense (the base) does not change and.
26Zero-based Budgeting Zero-based Budgeting ‘Method of budgeting that requires all costs to be specifically justified by the benefits expected’ CIMA official terminologyAdvantagesFosters a questioning attitude to all revenues and costs.Focuses attention on value for money concept.Should minimise waste and result in more efficient allocation of resources.DisadvantagesCosting and time consuming approch
27Activity based budgeting ‘Method of budgeting based on an activity framework and utilising cost driver data in the budget setting and variance feedback processes’Activity based budgeting as defined by CIMA Official TerminologyABB is an extension of the zero-based budgeting approach and goes into far greater detail in identifying value and non-value activities. It can be more effective than zero-based and incremental budgeting because:It avoids slack that is often included in the incremental approach.ABB focuses attention on each activity, highlighting those that do not add value.
28Rolling budgets‘Budget continuously updated by adding a further accounting period (month or quarter) when the earliest accounting period has expired’Rolling budgets as defined by CIMA Official TerminologyA rolling budget is a twelve month budget which is prepared several times each year (say once each quarter).The purpose of a rolling budget is to give management the chance to revise its plans, but more importantly, to make more accurate forecasts and plans for the next few months.
29Rolling budgets Advantages Disadvantages Budgets are reassessed regularly and thus should be more realistic and accurate.Because rolling budgets are revised regularly, uncertainty is reduced.Planning and control is based on a recent updated plan.The budget is continuous and will always extend a number of months ahead.DisadvantagesRolling budgets are time consuming and expensive as a number of budgets must be produced during the year.The volume of work required with each reassessment of the budget can be off-putting for managers.Each revised budget may require revision of standards or stock valuations which is time consuming.