Budgeting
All businesses need plan for the future. In large businesses such planning, usually known as corporate planning. Planning for the future falls into three time scales:
— long-term: from about three years up to, sometimes, as far as twenty years ahead.
— medium-term: one to three years ahead
— short-term: for next year.
Clearly, planning for these different time scales needs different approaches: the further on in time, the less detailed can be the plans. In the medium and longer term, a business will establish broad corporate objective.
A budget can be defined as a planning and control tool relevant to the management of a business.
The main purposes of budgeting are:
— to assist in the assessment and evaluation of different courses of possible action;
— to create motivation by expressing a proposed plan of action in terms of targets;
—to monitor the effectiveness of performance being accomplished against The budget.
Most budgets are prepared for the forthcoming financial year, and are usually broken down into shorter time periods, commonly monthly.
The end result of the budgeting process is the production of a master budget which takes the form of estimated operating statements (manufacturing account, trading account, and profit and loss account) together with an estimated balance sheet at the end of the budgetary period. However, before the master budget can be produced, a number of subsidiary budgets covering all aspects of the business need to be prepared, e.g. sales, purchases, production, overheads, cash.
A limiting factor is some aspect of the business which prevents further expansion.
The planning of a budget is coordinated by a member of the accounts department. However, managers of individual department are responsible for preparing budgets for their own departments.
An important aspect of budgetary planning is to test for feasibility (выполнимость) before submitting the master budget for the approval of the owner or board of directors.
Once a budget has been approved by the owner or, in the case of a limited company, by the board of directors it becomes the official plan of the business for the period of the budget.
The main aspect with which budgetary control is concerned is in comparing actual results with what was planned to happen in the budget.
Advantages of Budgets Performance targets are established
The process of budgeting establishes targets:
— for the business as a whole — in the form of a master budget
— for section managers — in the form of subsidiary budgets
Planning is beneficial
For a budget to be useful to business, it must be a realistic forecast of what can be achieved. At the same time, the senior management of the business, starting at the top with the owner or board of directors, must be convinced of the usefulness of the budget.
Fixed and Flexible Budgets. A fixed budget is the one that is set at the start of the budgetary period and remains unchanged whatever the level of activity.
A way of overcoming the difficulty caused by a fixed budget is to use a flexible budget. This recognizes the different behavior patterns of fixed costs and variable costs, depending on the level of output. Thus, an amended budget is produced on the basis of costs expected to be incurred at different production levels.
Zero-based Budgeting. With this system, the budget starts from zero, and each item going into the budget has to be justified on the basis of business activity.
Cash Budget. The cash budget is the subsidiary budget that brings together all the other individual budgets. From a cash budget (which is often known as a cash flow forecast) can be produced the master budget. This takes the form of forecast financial statements, i.e. projected trading and profit and loss account, and balance sheet.
The purpose of a cash budget is to detail the expected cash and bank receipts and payments, usually on a month-by-month basis, for the next three, six or twelve months (or even longer), in order to show the estimated bank balance at the end of each month throughout the period.
From the cash budget, the managers of a business can decide what action to take when a surplus of cash is shown to be available or, as is more likely, when a bank overdraft needs to be arranged.
Limitations. Many cash budget and cash flow forms have columns for both projected and actual figures.
A cash budget does not indicate the profits, or losses, being made by a business. To
supplement the cash budget, it is quite usual to prepare a master budget, in the form of forecast final accounts.
A cash budget is prepared on the basis of certain assumptions, for example:
— debtors pay, in full, in the month following sale
— purchases from suppliers are paid for two months after the month of purchase
Cash: a limiting factor. It might be that the cash budget shows, for certain months, a potential bank overdraft which is beyond the limits of the business. It might be unacceptably high for the business because of the interest cost, or the bank may not be prepared to allow such overdraft facilities. Thus a shortage of cash may be the limiting factor for a business, and it may have to rethink the other budgets in order to change its plans so as to work within its cash resources. After all, it is a shortage of cash that forces most companies into liquidation, even if they provide a good product or service: thus the efficient use of cash resources is one of the most important control aspects for the management of a business.
Points to note when preparing forecast final accounts:
— The sales figure shown in the trading account is the total amount of goods sold, whether paid for or not (sales made, but not yet paid for, are recorded as debtors in the balance sheet).
— Likewise, the figure for purchases is the total of goods bought, with amounts not yet paid for recorded as creditors in the balance sheet.
— Depreciation, which never appears in the cash budget, is shown amongst the expenses in the profit and loss account, and deducted from the cost of the fixed asset in the balance sheet.
(Note that, in the example above, depreciation is for a period of six months.)
BUDGETARY CONTROL
Budgetary control is the name given to the control system which uses budgets as the basis for monitoring actual performance.
Key elements of a good control system
1. There must be a plan.
2. There must be a comparison between planned performance andwhat is actually happening. This is usually called monitoring performance.
3. The comparison must be made often. This ensures that any variations between planned performance and actual events are identified before serious adverse effects occur.
4. Variances must be reported to the responsible manager.
5.Feedback must be fast.
6.A decision has to be taken. Faced with a significant variance in performance, the wise manager will choose a suitable course of action. There are only three possible courses of action:
- Do nothing at all. This is only recommended if the reason for the problem is a unique occurrence and is unlikely to happen again.
- Change the plan. Events occur outside the control of anyone in the organization.
— Adjust operations. The problem may have arisen because part
of the organization is not working at a normal level of efficiency.
7. Good news or bad news? Often an adverse variance is used as a way of criticising a manager's performance. This may well be needed tin occasions, but a better use is as a basis for a discussion on how things can be improved.
8. The costs of the system must be justifiable. With cost control systems, the potential loss involved should greatly exceed the cost of running the system.
OTHER BUDGETARY CONTROL MATTERS
Identifying the responsible manager
The manager with the budget and the responsibility must also have the power and authority to do something if things go adrift. Ultimately, in every organisation, the chief officer receives the overall variance on the budgeted profit and loss account. He has to account for the overall result, but subordinates have to account to him for their own spheres of responsibility.
Is an adverse variance always bad?
The short answer is 'No', because sometimes additional costs are incurred in making extra sales. A poorly developed budgetary control system will not allow for this, so to be sure that proper account is taken, the report that accompanies the variance statement must state:
— what happened;
— Precisely where the variances occurred.
False budgets for added protection
This kind of activity is not uncommon and gives budgetary control a bad name. It is found most frequently in organizations which do not really understand the nature of the technique, and where the committee is more concerned to make sure the budgets add up to a reasonable-looking figure, rather than representing real plans in realistic monetary terms.
The activity is also to be found where overall expenditure limits have been set and the sum of individuals' budgets exceeds the total. This occurs frequently in government departments and local authorities when it is felt that taxes cannot be raised high enough to meet spending departments' demands. Similarly, in business, capital expenditure is sometimes 'rationed' if insufficient finance is available to satisfy all needs.
Padding (Дополнение) the budget
Sometimes budgets are set artificially high, if the manager knows that he will be judged on the size of the variance — if the actual costs of his department are much less than the budget, he gets a pat on the back. Clearly this is not a desirable system.
The imposed budget
Another way of setting budgets is if someone other than the responsible manager does it. If the manager is lucky he gets more than he needs, but if he receives less than he needs he may be forced to make cuts that will harm his department's efficiency or effectiveness.
Inflexible budgetary control
Budgetary control can be a very effective system. It must, however, have flexibility; otherwise initiative is lost. Eventually the system runs the organisation and that can be fatal.
