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Budgeting

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by

Qasim Salam

on 18 June 2014

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Transcript of Budgeting

Session 1
INTRODUCTION TO BUDGETING
BUDGETING IS AN ESTIMATION OF THE REVENUE AND EXPENSES OVER A SPECIFIED FUTURE PERIOD OF TIME.


ROLE OF BUDGETING
CO-ORDINATION
Co-ordinates financial components from units, division and departments into organization’s overall operational objectives and strategic goals
ROLE OF BUDGETING
COMMUNICATION
Budgets are designed to give managers clear understanding of the company’s financial goals from expected cost savings to targeted revenues

ROLE OF BUDGETING
ADVANTAGES OF BUDGETING
BUDGETS AND STRATEGY
Budgets perform four basic functions, each of which is critical to the success of a company in achieving its Strategic objectives. These functions are:

FACTORS TO BE CONSIDERED IN BUDGETING
Long term objectives of business
Corporate and strategic planning

Internal factors

Staff training and morale, available finance, etc

External factors
International, political, economic, environmental, etc
PLANNING
COORDINATING AND COMMUNICATING
Budgets from individual divisions are coordinated and integrated into a larger, cohesive result. A master budget is sum of the all individual divisions.

The budget will assist in communicating the company’s strategic objectives to all levels of the organization.

OPERATING BUDGET
OPERATING BUDGET is the annual budget of an activity stated in terms of Budget Classification Code, functional/sub-functional categories and cost accounts.
It contains estimates of the resources required for the operations and estimates of workload identified by cost accounts.

CASH BUDGET
An estimation of the cash inflows and outflows for the Company or a Business Unit for a specific period of time.
Cash budgets are often used to assess whether the entity has sufficient and/or whether too much cash is being left in unproductive capacities.
CAPITAL BUDGETING
Capital budgeting helps organizations to identify, evaluate, plan, and finance major investment projects
Project's lifetime cash inflows and outflows are assessed to determine whether the returns generated meet a sufficient target benchmark
WHY BUDGET?
MONITORING PROGRESS
EVALUATING PERFORMANCE
Budgets can be used as a yardstick to measure the performance at different managerial levels.
Effective performance evaluation systems contribute to the achievement of strategic goals.
Variance is the difference between actual revenue or costs and budgeted (planned) revenue or costs.

Variance analysis uses calculations to discover the factors which have contributed to the variances.

Variances are described as “favourable” if they contribute to the profitability of the business. If they decrease the profitability of a business then they are described as “adverse”.
VARIANCE ANALYSIS
A
All sounds good in theory...
In Reality there is often a disconnect between the Budgeting Process and Strategic Plans of the Company.

HOW TO MAKE BUDGETING WORK
HOW TO MAKE BUDGETING WORK
STRATEX
WHY BUDGETING FAILS?
Reliance on “ pre-agreed” budget outcomes has an adverse effect on the budgeting process
When used as part of overall strategic management plan; defeats the original purpose of financial control mechanism


WHY BUDGETING FAILS?
Degenerates to internal bargaining process rather than causal model of resource allocation
Insufficient external focus
WHY BUDGETING FAILS?
WHY BUDGETING FAILS?
PROBLEMS WITH TRADITIONAL BUDGETING APPROACH
BUDGETING PROCESS AS A MOTIVATIONAL TOOL
PEOPLE LIKE TO BE MOTIVATED

“They want to feel a sense of accomplishment"

Motivational feature of budgets is that they present a specific, measurable goal. Hence there is a clearly stated goal, staff can work toward meeting that goal.




Performance can be tied to:
Salary Reviews
Promotions
Bonuses


BUDGETING PROCESS AS A MOTIVATIONAL TOOL
HOW TO SELL THE BUDGETING PROCESS TO THE TEAM
Co-operation and communication.

Interaction between people in different departments should be increased.

Budgets should encourage flexibility in operational decision making.

Session 2
ALIGNING BUDGETING WITH STRATEGY
Budgeting Techniques
Key Performance Indicators
ALIGNING BUDGETING WITH STRATEGY
A wise man once said...


CASH IN MUST BE MORE THAN CASH OUT

OR

YOU WILL BE ON YOUR WAY OUT

BUDGETING TECHNIQUES
SHORT-TERM BUDGETS
LONG-TERM BUDGETS
FLEXIBLE BUDGETS
A flexible budget provides budgeted data for different levels of activity

Another way of thinking of a flexible budget is a number of static budgets

It is designed to change so as to relate to the actual volumes of output.

Flexible budgets are an essential factor in budgetary control and variance analysis.

Flexible budgeting distinguishes between fixed and variable costs

For example where demand for the product relies on a lot of variable factors like in fashion industry

Suppose that a company expects to sell 10,000 units of output during the year. A fixed budget would be prepared on the basis of this expected volume. However, if the company thinks that output and sales might be as low as 8,000 units or as high as 12,000 units, it may prepare contingency flexible budgets, at volumes of say, 8,000, 9,000, 11,000 and 12,000 units.

EXAMPLE
ROLLING BUDGETS
Rolling budget is a plan that is continually updated.

It focuses management's attention on current and likely future realities within the organizational context.

In rapid-change industries, a rolling budget is very useful.

Planning and control is based on a recent plan which is likely to be more realistic than a fixed annual budget.
ROLLING BUDGETS
The organization can keep ahead of changes and be more in control of its response to the challenges it faces.

Realistic budgets are likely to have a better motivational effect on managers.

A lot of time, effort and money is required to keep these budgets updated.

The High Tech industries often utilise this approach.

ZERO-BASED BUDGETING
A method that begins each new budgeting cycle from a zero base, or from the ground up, as though the budget were being prepared for the first time. Every process or expenditure then has to be justified in its entirety in order to be included in the next year’s budget.
ZERO-BASED BUDGETING
BUDGETING AND PLANNING
HOW TO MAKE IT WORK?
KEY PERFORMANCE INDICATORS
Key Performance Indicators (KPIs) are the tools used to assess the business’s performance. There are both:
Financial and
Non-Financial Indicators
A KPI is a key part of a measurable objective, which is made up of a direction, KPI, benchmark, target, and time frame. For example: "Increase Average Revenue per Customer from $3,000 to 3,500 by EOY 2014". In this case, 'Average Revenue' is the KPI.
EXAMPLES OF FINANCIAL KPIs
Gross profit ratio
Net profit-to-sales ratio
Contribution margin
Debtors’ turnover
Stock turnover
Wages-to-sales ratio
Average sale per customer
Earnings per employee
Working capital ratio
Return on equity
EXAMPLES OF NON-FINANCIAL KPIs
DEVELOPING KPIs
DEVELOPING KPIs
Establish a clear understanding of what is possible
Set upper and lower limits of the KPI
Set limits with reference to the market
Set benchmarks
Benchmarks are introduced by evaluating:
Current performance
Considering industry averages
KPIs vary considerably according to the stage of company development

KPIs must be:

Aligned with your business strategy

Derived from the organization goals

Driving your marketing plans

DEVELOPING KPIs
USES OF KPIs
Once good Key Performance Indicators have been defined they can be used as:

Performance management tool
To spot potential problems or opportunities
To set targets for departments and employees
To give a clear picture of what in organization is important, of what they need to make happen
To manage performance
To make sure that everything the people in the organization do is focused on meeting or exceeding those Key Performance Indicators
To closely monitor the results of actions
To track the effect of making a change

EXAMPLE
A business receives 100 calls a day from potential
customers but only 30 end up doing business with
the company? That is a success rate of 30%.
What can be done to improve this rate?

Perhaps staff needs more training,
Or maybe advertising is resulting in customers who aren’t right for your business ringing in.
It could also be that pricing structure does not compare favourably with your competitors.


EXAMPLE
A business has discovered that the average sale per customer is $50. If this were increased to $55;

What is likely to happen to the profit?
How can the business achieve this increase?


Think of the famous line…
“Would you like fries with that, sir?”




EXAMPLE

Following is an example of set of KPIs for a typical manufacturing company:

Session 3
HOW TO ALIGN BUDGETING WITH STRATEGY?
A balanced scorecard bridges the gap between vision and strategy, and execution. It systematically translates vision, mission and strategy into a balanced and linked set of strategic objectives, operational initiatives and performance targets for the entire company.
The balanced scorecard is a strategic planning and management system.

BALANCED SCORECARD
BALANCED SCORECARD
BALANCED SCORECARD
Customer
Who do we define as our customer? How do we create value for our customer?
Employee Learning and Growth
How do we enable ourselves to grow and change, meeting ongoing demands
BALANCED SCORECARD
BALANCED SCORECARD
The balanced scorecard supplements traditional financial measures with criteria that measure performance from three additional perspectives:
BALANCED SCORECARD
The scorecard approach gives meaning to every thing that is done with in an organization at every level.
The scorecard is not a replacement for financial measures; it complements them
The scorecard is a paradigm shift in thinking!
MANAGING STRATEGY: FOUR PROCESSES
MANAGING STRATEGY: FOUR PROCESSES
Globally businesses are looking for innovative ways of linking budgeting and strategy. BSC does just that.

BALANCED SCORECARD
BALANCED SCORECARD
BUILDING A STRATEGIC MANAGEMENT SYSTEM
BUILDING A STRATEGIC MANAGEMENT SYSTEM
BUILDING A STRATEGIC MANAGEMENT SYSTEM
BALANCED SCORECARD
SUMMING IT UP
Forces companies to integrate their strategic planning and budgeting processes and therefore helps to ensure that their budgets support their strategies.

Accounting & Finance must not be looked at in isolation.

At the end of the day, it all links directly with business strategy.

Must keep in mind that while everything has a financial perspective, it also has a customer perspective, an internal business processes perspective and a learning & growth perspective.

ANY QUESTIONS?
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