1. 1 Budgeting & Control Week 8

2. 2 The nature of budgeting Budget is a detailed plan, expressed in quantitative terms, that specifies how resources will be acquired and used during a specified period of time Purposes: Planning Facilitating communication & coordination Allocating resources Controlling profit & operations Evaluating performance & providing incentives

3. 3 Budget organisation Budgeting is a financial information system which exists to: help managers reach their goals and discharge their responsibilities make managers fairly accountable for their performance Budgeting should be relevant, accurate, and prompt in reporting any performance problems and assisting with explaining their cause

4. 4 Budget organisation Budget centres can be defined in terms of cost and revenue responsibility Budget centres may consist of Cost centres Revenue centres Profit centres Investment centres

5. 5 Budget Centres Cost Centres Cost centres are responsible for control of costs alone eg Service departments provide services to other departments do not produce final good or service sold externally include maintenance, computer services, R&D

6. 6 Budget Centres Revenue Centres Revenue centres are responsible for revenues alone eg Sales division However, there would usually be some costs which must be included in how well or how poorly the segment is doing

7. 7 Budget Centres Profit Centres Profit centres combine both revenues and costs Local managers assessed by both revenues and costs Especially useful in people-intensive service organisations

8. 8 Budget Centres Investment Centres Investment centres create revenue incur costs and use assets eg manufacturing divisions also some service businesses (eg. hospitals, computer service bureaux)

9. 9 Budget cycle and administration The budget cycle involves many factors: objectives success factors sales/revenue budget operating activities budgets negotiation of budget targets coordination and review acceptance and communication continuous monitoring

10. 10 Flexible budgeting Static budgets are prepared for a single, planned level of activity. Performance evaluation is difficult when actual activity differs from the planned level of activity. With a flexible budget you can Estimate costs at different activity levels Compare actual outcomes to expectations when output levels are known

11. 11 Flexible budgeting To flex a budget for different activity levels, we need to 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

12. 12 Flexible budgeting Advantages Flexible budgets show revenues and expenses that should have occurred at the actual level of activity Flexible budgets may be prepared for any activity level in the relevant range Flexible budgets reveal variances due to good cost control or lack of cost control Flexible budgets

13. 13 Budget techniques Flexible budgets A simple example.. Output (units) 90 120 £ £ Revenue9001,200 Variable costs450 600 Variable overheads 90 120 Fixed overheads300 300 Total costs8401,020 Profit 60 180

14. 14 Preparing the flexible budget From this we can see that certain costs clearly vary with levels of output. Obviously fixed costs dont. By calculating the relationship between variable costs and output (as output drives the budget) We can calculate expected costs/revenues for any output level

15. 15 Preparing the flexible budget Clearly the relationships are (at a given level) Revenue £900/90 = £10 per unit Variable costs £450/90 = £5 per unit Variable overheads £90/90 = £1 per unit

16. 16 Preparing the flexible budget Output (units)135 Revenue135 X £10 =1,350 Variable costs135 X £5 = 675 Variable overheads135 X £1= 135 Fixed overheads £300 300 Total costs1,110 Profit 240

17. 17 But what if there are semi- variable costs? There may be instances when the relationship between outputs and inputs is not clear Some costs may be part fixed and part variable High-Low technique

18. 18 High-Low method difference Output90 12030 £ £ £ Revenue9001,200300 Variable costs450 600150 Variable overheads435 480 45 Total costs8851,080 Profit 15 120

19. 19 High-Low method Compare costs/revenues at 2 levels of output Divide cost/revenue change by change in output For Revenue and variable costs £10 & £5 relationship still holds Overheads are semi-variable Therefore change can only be attributed to variable element

20. 20 High-Low method Therefore change = 45/30 = £1.50 per unit At output 90 units Variable element = 90 X £1.50 = 135 So Fixed element = 435 – 135 = 300 To confirm, at 120 units of output Variable element = 120 X £1.50 = 180 So Fixed element = 480 – 180 = 300

21. 21 Budget at different output level At (say) 100 units of output budget = Revenue (100 X £10)£1,000 Variable costs (100 X £5)£ 500 Overheads (£300 + 100 X £1.50) £ 450 Total costs£ 950 Profit£ 50

22. 22 Budgets and behaviour Authoritarian Approach Worker is beast of burden Management role to instruct worker exactly how to perform tasks Top-down authority Usually causes resistance to develop Top-down budgets (imposed) Budgets used to force employees to meet expectations of top management Often causes dysfunctional behaviour

23. 23 Budgets and behaviour Budgetary Slack Developed by subordinate managers and workers to provide protection underestimate revenues overestimate expenses deceive management about task time However.. slack budget may lead to better performance that tight budget provides a hedge against uncertainty confidence in meeting budget

24. 24 Budgets and behaviour Participative Budgeting Allows individuals responsible for performance under budget to participate in establishment of budget Managers (all levels) and workers should be in accord with goals of firm Goal congruence is key objective Humans are highly diverse Behaviour influenced by many factors

25. 25 Budgets and behaviour Advantages of Participative Budgeting Motivates by providing challenge and sense of responsibility Creates higher morale because of positive employee attitudes towards firm Increases likelihood of goal congruence Brings greater satisfaction and self-esteem through job enlargement Better plan: combined knowledge Awareness of how particular fn fits into total operational picture Increases interdepartmental cooperation Junior management made more aware of the future

26. 26 Budgets and behaviour Disadvantages of Participative Budgeting Involves both process & content Process only benefits firm if content is in line with goals Budgetary slack may be included Interaction between aspiration levels and actual performance depends on tightness of budget nature of task level of actual performance personality of individual involved