Accounting & Financial Analysis 11 Lecture 3

1. Accounting & Financial Analysis 11 Lecture 3 Budgets

2. What is a Budget ? • A budget is a plan • Developed by management • To achieve a goal • Within a specified time frame

3. What is a Budget ? (2) • It is a financial plan, • prepared and approved prior to a defined period of time, • incorporating the policy to be pursued during that period • for the purpose of attaining a given objective. • A plan is of little value unless it is monitored and controlled. The budget provides a benchmark.

4. Why prepare a budget? • A budget sets a target / goal to be achieved (Sales, costs, profit) • A budget is a plan set by management for the development of the business. • A means to compare actual results on an ongoing basis to the budget (Monitor) • Provides a check on progress towards the desired goal (Measurement) • Indicates departure from the plan at the earliest possible time. (Timeliness) • Facilitates corrective action to get back on track. (Correction) • A budget establishes a benchmark for operational efficiency. (Standard) • Creates teamwork amongst department managers (Participative approach)

5. Why prepare a budget? (2) • Makes management accountable for performance (Ownership) • An effective management tool, shares knowledge amongst all department managers. (Control & enlightened management team) • Feedback mechanism for management. (Feedback) • Highlights fundamental changes within the business and indicates the need for a modification of the future plans. (Trends) • Identifies the need for capital investment in a timely manner. (Capital) • Motivates staff towards efficiency / reward scheme. (Motivation) • Assists in the development of future plans. (Growth) • Identifies trouble spots ahead

6. Disadvantages of preparing a budget • Takes time to prepare. Interrupts operational work. • It is a costly exercise • Future information is difficult to predict and risky. • Could create rivalry amongst managers. Blame on others. • An easy budget encourages complacency. • Demoralises staff if targets are unachievable. • In order to be effective the actual performance requires regular monitoring to the budget plan. • Any departure from budget (variances) require regular analysis and justifications – time consuming

7. Approaches to budget preparation • Authoritative • Consultative • Participative

8. Approaches to budget preparation (2) • Authoritative : This is where top management develops the budget without any consultation with department managers or supervisors. • It is centralised decision making and discourages employee motivation.

9. Approaches to budget preparation (3) • Consultative : Top management develops final budget after consulting with supervisors regarding specific aspects of operations. • (Seeking information only, not encouraging participation)

10. Approaches to budget preparation (4) • Participative : All levels of management actively participating in the development of the budget, and taking ownership for the performance of their department. • In many cases there is a high interdependence of departments and a participative approach is the only way to achieve a consensus.

11. Difficulties when preparing a budget? • Internal • Scarce resources, how to allocate resources over requirements. • Interdependency of departments • Conflict amongst managers • Reluctance to predict future trends • Provide for unforseen circumstances. What can go wrong. • Cash flow requirements • Establish measurement criteria • Restricted timeframe to produce budget.

12. Difficulties when preparing a budget? (2) • External • Change in trends / fashion • Changes in bank rate • Changes in currency exchange rates • Changes in infrastructure, diverting traffic, open new main road. • Development of alternate products. • Government restrictions/sanctions to other countries. (AWB export to Iraq) • Competitors opening new premises close to yours, or giving special discounts. • Boycott by sectors of the public. (Live trade export, boycott of wool products)

13. Process of budget preparation • Establish a budget committee – Participative approach, to involve department managers in the process. • Establish desired company direction, (Policies & Procedures) • Responsibility for co-ordination of budget. • Establish deadline for completion of budget

14. Allocate budget resources • Funds are always in short supply, one of the major scarce resources within any business. • Management will have to decide which of the projects are most beneficial to the business and allocate funds accordingly.

15. Allocate budget resources (2) • The decision is generally reached after the following considerations: • Feasibility study / best return • Department needs / interdependence • Capital or expense replacement • Return on investment • Improved efficiency • Management decision / participative approach • Staff morale • Customer comfort • Market research / competitors / client needs

16. Maintain detailed records of resource allocation • Maintain detailed records of resource allocation in accordance with enterprise control systems • Financial records are developed in a variety of ways (refer session 6 – Historical and Future Predictions). • One of the most common methods is by use of spreadsheets to calculate project revenue and expenses. • These calculations will represent standard expectations and will be used as a benchmark to evaluate actual results

17. Maintain detailed records of resource allocation (2) • Source documents and accounting records relating to expenditure are checked and monitored to ensure that they comply with earlier estimates. • A budget is of little use unless it is monitored and controlled. • The budget is a benchmark for the business activities, it is a management tool used to detect if the business is drifting away from its goals. • Constant monitoring of expenses will ensure accurate allocation as well as economies and best value.

18. Processes required in order to maintain appropriate records of expenditure • Analyse and review source documents. • Check source documents are properly authorised. • Check allocation of expenses to appropriate account heading in the general ledger. • Check debtor’s schedule to estimate receipts in the short term. • Check creditor’s schedule to confirm payments due in short term.

19. Processes required in order to maintain appropriate records of expenditure (2) • Check cash flow to confirm sufficient cash available. • Complete monthly bank reconciliations. • Check Capital budget to see what requires to be purchased in the short term. • Substitute/adjust capital purchases in the event of cash shortage. • Monitor project expenses to stay within budget and detect any blow-outs as early as possible. • Establish variances between actual and budget, notify department manager, and implement corrective action.

20. PRACTICE ACTIVITY! • EXCEL exercise • OR Continue with MYOB postings • OR Do it by manual postings – if you want to look like this