This preview shows page 1. Sign up to view the full content.
Unformatted text preview: 5. Planning and Budgeting
Outline – Planning and budgeting – Budgeting cycles: profit, cash, ROE – Types of budgets: Master, capital, operating – Example – Alternative budgeting approaches – Behavioral issues in budgeting Advantages, characteristics, good budget target Bus 424 fifth lecture presentation 1 Financial results controls Three core elements: – Financial responsibility centers The apportioning of accountability for financial results within the organization – Formal management processes Planning & budgeting to define performance expectations and standards for evaluating performance – Motivational contracts To define the links between results and various organizational incentives Bus 424 fifth lecture presentation 2 Example: Planning and budgeting
Desired future state
How to achieve the desired future state Long term and short term objectives To become the worldwide leader in retailing To give ordinary people the chance to buy the same thing as rich people Cost leadership: “Everyday low prices” Financial and nonfinancial objectives Mission Strategy Budgets Bus 424 fifth lecture presentation 3 Planning and budgeting Produce written plans that specify: – – – Where the organization wishes to go? How it intends to get there? What results should be expected? Purposes of the planning and budgeting process? – – – – To engage in longerterm thinking. To achieve coordination (topdown, bottomup, sideways). To enhance management control. To arrive at challenging but realistic performance targets. Bus 424 fifth lecture presentation 4 Advantages of budgeting Communicate management’s plans throughout the organization Planning as top priority Resource allocation Uncover potential bottlenecks Coordinates activities of the entire organization Benchmarks for evaluating subsequent performance
Bus 424 fifth lecture presentation 5 Planning cycle
Increasingly specific, detailed, short-term, and dispersed at all organizational levels Strategic Planning Programming Capital Budgeting • Relatively broad processes of thinking
about the missions, goals and strategies. • Normally a top-management process. • Specification of specific action programs
to be implemented over the next few years and specification of the resources each will consume. • It involves many more people at different organizational levels (top-down/bottom-up). Operational Budgeting • Short-term financial planning. • Budgets match the organization’s responsibility structure. • Emphasis on quantitative data.
Bus 424 fifth lecture presentation 6 Characteristics of a budget It is usually stated in monetary terms. It generally covers a period of one year. It contains an element of management commitment, i.e., the managers agree to accept the responsibility for attaining the budgeted objectives. The budget is approved by an authority higher than the budgetee. Once approved, the budget can be changed only under specified conditions. Periodically, actual financial performance is compared to budget and variances are analyzed and explained. Bus 424 fifth lecture presentation 7 Budgeting and management control Budgeting involves setting targets which are often used later as standards against which to evaluate performance — results controls Planning and budgeting processes involve formal reviews of plans and include the actions that are felt to be good for the organization to take — action controls Planning and budgeting processes serve to get information needed for decision making to the right managers — personnel controls Bus 424 fifth lecture presentation 8 The budget preparation process
Budget Committee Top-Down I 1. 3. Negotiation Budget Department ss Bottom-Up The budgeting process takes about four months in most firms. Bus 424 fifth lecture presentation 9 2. l itia In e nc ua es lin i de Gu of P et dg Bu l sa po ro 4. Approval Business Managers Types of financial performance targets Modelbased (engineered)/historical/negotiated Internally/externallyderived – Target costing – Benchmarking Information asymmetry Fixed/Flexible – Should managers be held accountable for achieving their plans regardless of the business conditions they face? – Relative performance targets. Bus 424 fifth lecture presentation 10 Target Costing System
•Target Costing: Strategic cost management system that support the following objectives: product functionality, quality, and cost during the planning and design stages of a new product •Contribute to the competitiveness of Japanese companies
Ideas: -Market oriented -Upstream mgt -Build-in cost Tools: Target Costing Deploying method -Rugby approach -Cross fn. Team -Supplier relations Bus 424 fifth lecture presentation 11 -VE -Cost table Japanese Target Costing System
Cust. Value Value SH Value Target Profit Competency Gap Current Competence Resources Future Competence Bus 424 fifth lecture presentation 12 Target Price Target Cost Estimated Cost Target Costing
Committed Cost Actual Cost Ideas SOP End of Life Cycle
13 Bus 424 fifth lecture presentation Budget participation Topdown/bottomup budgeting The budgetee is both involved in and has influence over setting the budget. Leads to better acceptance of budget targets, and hence, commitment to achieve them. Is an effective way of information sharing: – Corporate priorities and constraints – lowerlevel insights about business potentials and risks. But, slack, bias, conservatism, lack of budgeting experience. Bus 424 fifth lecture presentation 14 Budget target difficulty
Motivation/Performance Easy Goal Difficulty
Bus 424 fifth lecture presentation Impossible
15 Challenging but achievable To minimize dysfunctional management actions. Myopic behavior, data manipulation To increase manager’s commitment to budget targets. To reduce the cost of organizational interventions. Managementbyexception To protect against the cost of optimistic revenue projections. Overcommitment of resources To create a “winning” atmosphere and positive attitude. Bus 424 fifth lecture presentation 16 Purpose of Budgeting What is a “good” budget target?
Target Difficulty Motivation Planning Coordination Cost control Evaluation Conservative Best guess Optimistic Target should be after-the-fact assessment of what could have been accomplished, not any of the three choices listed. Bus 424 fifth lecture presentation 17 Budgeting 3. Operating cash 2. A/R Cash Cycle
1. Sales 4. Inventory 2. Op. Expenses Profit Cycle
3. Profits 4. Investment 6. Asset Utilization ROE Cycle 4. S/E 5. ROE Bus 424 fifth lecture presentation 18 Types of budgets Master Budget: formal summary of the company’s plan Capital budgets: – sets specific targets for sales, production, material, purchases, and financing activities – culminates in projected statement of net income, financial position, and cash flow. – Can be divided into: capital budgets and operating budgets – cover acquisition of land, buildings, and other items of capital equipment and have time horizon >1 year – Cover sales, production, material purchases, cash and related items – One year period and can be a continuous (= perpetual basis) Operating budgets Bus 424 fifth lecture presentation 19 The Master Budget
The master budget:
– Represents the “grand plan of action” for an upcoming period Translates the organization’s shortterm objectives into action steps Culminates in the preparation of a set of proforma financial statements Communicates to employees and managers alike the expectations of top management Helps coordinate subunit activities Bus 424 fifth lecture presentation 20 – – – – Master Budget
Sales Budget Long range sales forecast Production Budget S&A expense budget DM budget DL budget FOH budget Capital Budget Cash budget Budgeted I/S Budgeted B/S Budgeted CFS Bus 424 fifth lecture presentation 21 Budgeting Example (2nd quarter): Balance Sheet as of March 31(Given), Current Assets Cash A/R $600,000 2,500,000 $ 3,100,000 Plant & Equipment: Land 400,000 Buildings & Equipment 1,610,000 Accumulated depreciation (750,000) Total Assets Liabilities: Account payable Shareholders Equity: Common shares $ 930,000 R/E 1,118,000 Total Liability & Shareholders Equity Bus 424 fifth lecture presentation $1,260,000 $4,360,000 $ 2,312,000 $2,048,000 $4,360,000 22 Budgeting example: •An accounting firm has prepared the following sales budget: March April May 100 clients 200 clients 500 clients June 300 clients July August 250 clients 150 clients •Each client is charged $100,000 per audit engagement •Collection pattern: •70% in the month of audit • 25% in the month following audit • 5% is uncollectible. Bus 424 fifth lecture presentation 23 Budgeting example (Continued): •Each client requires 500 working hour. Auditors are paid $50 per hour. •Overhead costs: Variable: $5 per working hour. Fixed: $5,000,000 per month (include $100,000 depreciation). •S&A expenses: Variable: $2 per working hour. Fixed: $7,000,00,000 per month (include $50,000 depreciation). •Open line of credit with OCBC (monthly interest: 2%) . Excess cash to be used for debt payment (if applicable). Minimum cash balance: $500,000 •Overhead costs are applied on the basis of auditor’s working hour Bus 424 fifth lecture presentation 24 Sales Budget: April May Budgeted sales (units) Audit fee per clients Budgeted sales (dollars) Scheduled of Expected Cash Collection March Sales (25%) April Sales (70% and 25%) May Sales (70% and 25%) June Sales (70% and 25%) Total cash collection Bus 424 fifth lecture presentation 25 June Quarter Auditor Cost Budget: April May Total number of client Working hours per client Working hours required Auditor cost per hour Total auditor cost June Quarter Bus 424 fifth lecture presentation 26 Overhead Budget: April May Total working hours Variable overhead rate Variable overhead cost Fixed overhead costs Total overhead costs Less: Depreciation Cash disbursement for OH costs June Quarter Bus 424 fifth lecture presentation 27 Selling and Administrative Expense Budget: April May Total working hours Variable S&A rate Variable S&A expense Fixed S&A expense Total S&A expenses Less: Depreciation Cash disbursement for S&A June Quarter Bus 424 fifth lecture presentation 28 Cash Budget (000): April May June Cash balance: Beginning Add: Cash collections Total cash available Less: Disbursement Auditor cost Overhead costs S&A Total Disbursements Excess (deficiency) Financing: Borrowing Repayments Interest Total financing Cash balance, ending Quarter Bus 424 fifth lecture presentation 29 Budgeted I/S and B/S Budgeted I/S for the Quarter ending June 30 (000) Net sales Less: Auditor costs Overhead costs Gross margin Less: S&A expenses) Net Operating Income Less: Interest expense Net Income Bus 424 fifth lecture presentation 30 Balance Sheet as of June 30 (000) Current Assets Cash A/R Plant & Equipment: Land Buildings & Equipment Accumulated depreciation Total Assets Liabilities: Account payable Shareholders Equity: Common shares R/E (Beginning R/E+NI) Total Liability & Shareholders Equity Bus 424 fifth lecture presentation 31 Alternative Budgeting Approaches Zerobase budgeting (ZBB) is a budgeting process that requires managers to prepare budgets from a zero base
– Justify every activities/functions in the budget – Make managers aware of cost/benefits of each activity – Can be a difficult and timeconsuming process Bus 424 fifth lecture presentation 32 Alternative Budgeting Approaches (continued) Activitybased budgeting (ABB) Kaizen (Continuous improvement) budgeting Rolling (Perpetual) budget Bus 424 fifth lecture presentation 33 Behavioral Issues in Budgeting
• • • Budgetary slack, or padding the budget Spending the budget Goal congruence between divisional and company Bus 424 fifth lecture presentation 34 ...
View Full Document
- Spring '10