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Basics of Budgeting

Basics of Budgeting. BUDGETING Definition : A budget is a quantified expression of the intentions of the management and operates in a fashion that enables attainment of orgainsational goals. Elements of a Budget 1. It is a comprehensive and co-ordinated plan.

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Basics of Budgeting

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  1. Basics of Budgeting

  2. BUDGETING Definition : A budget is a quantified expression of the intentions of the management and operates in a fashion that enables attainment of orgainsational goals. Elements of a Budget 1. It is a comprehensive and co-ordinated plan. 2. It is expressed in financial and physical terms. 3. It is a plan for the company’s operations and resources. 4. It is a future plan for a specified period.

  3. MAJOR OBJECTIVES OF BUDGETING 1. To state the company’s goals. 2. To communicate expectations to all concerned. 3. To provide detailed plan of action for reducing uncertainty. 4. To co-ordinate activities and efforts in such a way so as to maximise resources. 5. Measure for controlling performance.

  4. TYPES OF BUDGETS Comprehensive Budgeting involves the preparation of a Master Budget. The three important components of Master Budget are: i) Operational / Functional Budgets ii) Financial Budgets iii) Capital Budgets

  5. ESSENTIALS OF BUDGETING 1. Senior management support 2. Clear and realistic goals 3. Assignment of authority and responsibility 4. Creation of responsibility centres 5. Adaptation of accounting system 6. Full participation 7. Effective communication 8. Budget education 9. Flexibility

  6. Budgeting As a Tool of Management Planning and Control • Communication • Coordination • Performance Evaluation • Motivation • Fundamental Concepts & Techniques Used for Budgetary Control • Cost benefit analysis including the social cost benefit analysis. • Contingency approach • Responsibility accounting based on the technique of variance analysis • Value analysis for services, systems, cost incurrence etc. • Application of mathematical models such as PERT, CPM,Transportation & Assignment models, L.P. & Simplex Models, Scrutiny Analysis etc.

  7. Budgeting Process – A Structured Approach b • Formation of Multipurpose Budget Team • Definition of Vision/Mission/Objectives • Exhaustive analysis of : • - Competitive Environment • - Economic Environment • - Political Environment • - Business SWOT • - New Product Strategies • - Corporate Strategic Initiatives e.g.., New/ Restructured Alliances at Industry and Company level Continued …

  8. Continued … • Agree on Volumes and Price Realisations • Work on related linkages (at various companies, various business etc. viz., Manufacturing, Logistics, etc.) • First pass preparation of Income/Capital Employed Statements • Budget Package Finalisation Continued …

  9. Continued … • Volumes and Price Realisation determination • Territywise/Productwise Volume and NRV determination (Net Realisable Value). • Inputs on Brand Pricing,Product Positioning , Past Product Performance Analysis, Proposed Product Lines from Marketing and Technology Teams. • Deliberations on the above done by the Budget Team to determine Volumes and Prices Regionwise Continued …

  10. Continued … • Zero base build up, other than Fixed Commitments • Projected Business Growth • Determination of Sales Regions/ Territories • Manpower Requirement • New Product Launches • Proposed Brand Plans

  11. Capacity Inventory Volumes Import Plan Fixation of RM/PM Costs Production Plan Labour Variable Utilities Operations Cost Fixed Standard Cost of Goods Sold Continued … Manufacturing Budget Preparation

  12. Continued … Logistics Cost Plan Determined by the Production Plan, Import Plan and Despatch Plan

  13. FUNCTIONAL / OPERATIONAL BUDGETS 1. Sales budget 2. Production / Operations 3. Material Consumption 4. Purchase 5. Labour 6. Overheads 7. Marketing and Selling 8. Administration and Finance

  14. AN OVERVIEW OF BUDGETING PROCESS A PLAN OF OPERATIONS Management’s Goals and Objectives for the year SUPPORTING SUB-BUDGETS, CASH BUDGET, INVENTORY BUDGET, CAPITAL EXP. BUDGET, OTHERS THE BUDGETED B/S ASSETS/ LIABILITIES OWNER’S EQUITY Formalised in THE ANNUAL PROFIT PLAN THE FINANCIAL BUDGET Composed of Wherein Mgmt. Specifies The Entire PLAN OF OPERTIONS is finally reflected in THE OVERALL INCOME OBJECTIVEDetailed in [PURCHASE BUDGET][DIRECT LABOUR BUDGET][FACTORY O/H BUDGET] SALES BUDGETin Qty/Territory/ Product and Time Period OTHER INCOME BUDGETInterest Income / Royalty etc. All the below are prepared for pre decided time period involved Less THE OVERALL COST & EXPENSE OBJECTIVE detailed in DISTRIBUTION EXP. BUDGETBy Territory ADMIN. EXP. BUDGETBy Department OTHER EXP. BUDGETInterest Exp. Etc. PRODUCTION BUDGETUnites to be produced

  15. TABLE SHOWING VAROUS FACETS OF A BUDGET PROGRAM

  16. FLOW CHART OF BUDGETARY CONTROL Specification of organisational objectives and identification of key factors Sales Budget Operations Budget Budget for Prime Cost & Overhead Budget for Sell. & Dist. Cost Cap. Expend. Budget Cash Budget Administrative Cash Budget Master Budget Acc. & Resp., Var. analysis Managerial Action

  17. Summary of Steps in Budgetary Control • SWOT analysis for deciding objectives • Preparing a budget statement • Recording the actual performance • Periodic comparisons between the budgeted and actual performance, & finding out the favourable and unfavourable variances • Finding out the causes grouping these variances • Basis the cause grouping these variances as “controllable” and “uncontrollable” • Deciding the quantum of reward or penalty for the individual or the teams for the variances • Revising the standards to suit the cyclic – environmental and uncontrollable changes in conditions. • Go through the steps 2 to 7 again • Thus the process of budgetary control has to be continuous, flexible and unbiased

  18. ADVANTAGES OF BUDGETING 1. Forced planning. 2. Co-ordinated operations. 3. Performance evaluation & control. 4. Effective communication. 5. Optimum resource utilisation. 6. Productivity improvement. 7. Profit mindedness. 8. Efficiency. 9. Cost control.

  19. LIMITATION IN USING THE BUDGETING SYSTEM 1. Management judgement. 2. Continuous adaptation. 3. Implementation. 4. Management complacency. 5. Unnecessary detailing. 6. Goal conflict. 7. Evaluation system. 8. Unrealistic targets.

  20. VARIOUS STYLES OF BUDGETING • Flexible Budgeting • Zero Base Budgeting • Activity Based Costing • Balanced Score Card

  21. PROFIT PLANNING AND CONTROL Consider the following data: EXHIBIT I

  22. Contribution Margin (a) P/V Ratio = = 40% Sales Operating Profit • Margin of Safety Ratio = = 75% Contribution Margin Sales (c) Turnover Ratio = = 100% Capital Employed EXHIBIT II [A] OPERATING MANAGEMENT PERFORMANCE: (A) =(a) x (b) x(c) = 75% x 40% x 100% = 30%

  23. (d) NPAT . OPERATING PROFIT = 41% (e) Capital Employed Owner’s Funds = 200% B] FINANCIAL MANAGEMENT PERFORMANCE: (B) = (d) x (e) = 41% x 200% = 82%

  24. [C] OVERALL MANAGEMENT PERFORMANCE: (A) =(B) = 30% x 82% = Approx 25% EXHIBIT III BREAK EVEN ANALYSIS A 75% Margin of safety indicates if sales fell by 75%, losses will start (as shown hereunder) Sales (reduced by 75%) 2,50,000 Variable Costs @60% 1,50,000 Contribution Margin 1,00,000 Fixed Costs 1,00,000 PROFIT ZERO . Thus the sales level of Rs. 2,50,000 is the “NO PROFIT – NO LOSS” point or the BEP which is also defined as:

  25. Fixed Costs x Sales Fixed Cost BEP = = Sales – Variable Costs P V Ratio 1,00,000 X 10,00,000 BEP = = 2,50,000 4,00,000 Fixed Costs x Sales BEP = Unit Contribution Margin It is defined in units as under:

  26. EXHIBIT IV SENSITIVITY ANALYSIS OF OPERATING MANAGEMENT PERFORMANCE BASIS BEP In the existing situation OMP is planed @30% on capital employed. With the help of BEP Analysis we can now check its sensitivity to various factors as under:

  27. Fixed Costs + Desired Profit 1,00,000 + 4,00,000 12,50,000 BEP = = = PV Ratio 40% • What should be the sales level to increase the OMP to 40% level? Computation of operating profit at new sales level: Sales 12,50,000 Variable Costs (60% of Sales) 7,50,000 Contribution Margin (40% of Sales) 5,00,000 Fixed Costs 1,00,000 Operating Profit 4,00,000

  28. Fixed Costs + Desired Profit BEP = PV Ratio 1,00,000 + 4,00,000 = 10,00,000 = PV Ratio 5,00,000 Contribution Margin PV Ratio = = 50% = = 10,00,000 Sales • What should be the variable costs level to increase the OMP to 40% level?

  29. Computation of Operating Profit at new variable costs level:- Sales 10,00,000 Variable Costs 5,00,000 Contribution Margin@ 50% 5,00,000 Fixed Costs 1,00,000 Operating Profit 4,00,000

  30. Fixed Costs + Desired Profit BEP = PV Ratio Fixed Cost + 4,00,000 = 10,00,000 = 40% 3. What should be the fixed costs level to increase the OMP to 40% level? 4,00,000 = Fixed Costs + 4,00,000 Fixed Costs = Zero

  31. Computation of Operating Profit at New Fixed Costs Level: Sales 10,00,000 Variable Costs 6,00,000 Contribution Margin 4,00,000 Fixed Costs Zero . Operating Profit 4,00,000

  32. VARIOUS STYLES OF BUDGETING • Flexible Budgeting • Zero Base Budgeting • Activity Based Costing • Balanced Score Card

  33. Balance Score Card

  34. Developed by Robert Kaplan and David Norton Communicate Companies’ Objectives, link them to strategy Translates mission and strategy into four perspectives Origin

  35. Financial Customer Internal business processes Learning and growth The Balance Scorecard Perspectives

  36. Building a Balanced Score Card • More than a mixture of 15 to 25 financial and non financial measures to reflect the business unit’s strategy by linking outcome and performance measures together. • Core Financial Measures • ROI/Economic value added • Profitability • Revenue growth/mix • Cost reduction productivity

  37. Is strategy implementation improving the bottom line? Shareholder value addition Steps: - improve ROI - reduce cost - increase revenue - manage risks etc. Financial Perspectives

  38. Building a Balanced Score Card …… • Core Customer Measure • Market share • Customer acquisition • Customer retention • Customer profitability • Customer satisfaction

  39. Building a Balanced Score Card …… • Core Learning and Growth Measures • Employee satisfaction • Employee retention • Employee productivity

  40. Identify infrastructure to create long-term growth and improvement 3 principle sources of learning - people - systems - organizational procedures Measurement of employee satisfaction, retention, training & skills Aligning incentives with overall organizational success factors Learning & Growth Perspectives

  41. Identify critical internal processes Help to deliver value propositions to attract and retain customers Satisfy shareholder expectations of excellent financial returns - innovation - operations - post sales service Internal Business Process Perspectives

  42. Are 4 perspectives sufficient? No incorporation of other stakeholders’ interest like suppliers and the community Limitations

  43. The Balance Score Card is basic tool Can be modified & customized according to an Organization's needs An important weapon in every manager’s arsenal Conclusions

  44. Flexible Budgeting It is a budget which by recognizing the difference between fixed, semi fixed and variable costs, is designed to change in relation to the level of activity attained. It is a budget prepared for a range and is also known as variable budget or a sliding scale budget. Steps in flexible budgeting: 1. Deciding the range of activity 2. Determine cost behaviour patterns 3. Selecting the activity levels to prepare budgets at those levels 4. Prepare budget at each activity level

  45. Zero Base Budgeting ZBB is a method of budgeting whereby all activities are revalued each time a budget is formulated and every item of expenditure in the budget is fully justified. That is, ZBB involves starting from scratch or zero.

  46. Implementation of ZBB involves the following : 1. Each activity of the organisation is identified and called a decision package 2. Each decision package must be justified 3. If justified the minimum cost to sustain each decision package is determined 4. Alternatives for decision packages are evaluated 5. Managers rank their decision package in order of priority for resource allocation 6. Resources are allocated to the package

  47. ADVANTAGES OF ZBB 1. Allocation of resources by need and benefit. 2. Identifies and eliminates wastage's and obsolete operations . 3. Best possible methods of performing jobs is ensured. 4. Increased staff involvement which may lead to improved motivation and greater interest in job. 5. It increases communication and co-ordination within the organisation. 6. Managers become more aware of cost inputs which help in identifying priorities.

  48. DISADVANTAGES OF ZBB • 1. Substantial Cost & time involved in preparing a large number of decision packages. • 2. Managers could develop fear and feel threatened by • ZBB. • 3. Ranking of packages could result in departmental • conflict.

  49. Learning Curves and Non Linear Costs The learning curve phenomena is based on the concept that costs tend to be non linear. It is found that the cost of doing most tasks of a repetitive nature decrease as experience at doing these tasks accumulate. Most experience curves, estimated on actual process, indicate that costs decline 20 to 30 percent each time accumulated experience doubles.

  50. Factors that lead to this long-run decline in costs include: 1. Labour efficiency. 2. New process and improved methods. 3. Product stadardisation. 4. Scale effect.

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