SUMMARY LECTURE – PART I
Budgetary Control involves:
-planning for the future
-communication of ideas and plans
-motivation through interaction (and participation)
-appraisal of performance against target as a basis for action.
Period plans incorporate project planning.
Budget systems are never “correct” – but only “useful” to achieve specific objectives.
Assumptions – underlying all budgets
Sponsorship – by Top Management
Responsibility centres – for motivation and control
Interaction – participation, discussion, “conditioning” and agreement
Education – necessary and continuous
Timely – budget period fits objective
Management by exception – highlight key areas
Appraisal – actual vs. budget
(a)Operating Budget – Forecasts plans and targets of all operating statistics for a future period. Shows contribution (sales – variable cost) to fixed cost and profits.
(b)Cash Budget – Forecast of cash flow from operations, based upon assumption of credit terms.
(c)Capital Budget – Key long term investments in: property, plant, equipment, R&D, advertising, etc. Key to long term profitability. Invest now for benefit later. Also plan “disinvestments”.
(d)Budgeted Balance Sheet – Budget of overall financial position of firm at end of budget period. “Required assets” financed by liabilities and owner’s equity.
(e)Funds Flow Budget – Plan of sources and uses of long term funds. Reveals effects of key management decision on long term resource allocation.
Sources of Funds: profit (before depreciation), new capital, new long term loans, sale of fixed assets, reduction of working capital.
Uses of funds: dividends, fixed assets, repayment of long term loans, increase of working capital.
NOTE:All budgets are inter-related. Thus with an opening balance sheet plus (a), (b) and (c) above, allows (d) to be produced by simple arithmetic!!
Usefulness of budget rests on validity of assumptions.
Broad assumptions only justify broad figures.
Highly detailed figures not justified, not useful. Probably fraud!
Variable – vary with volume.
Fixed – do not change with increased volume.
Allocated – charged to responsibility centre by subjective judgement of what is a “fair” distribution.
Engineering – costs that necessarily increase with volume of activity; not management discretion; easily determined.
Managed – costs spent as a matter of management judgement.
Standard – a control mechanism – calculation of efficient product costs standards.
Committed – fixed costs over a short term that cannot be changed.
Opportunity – cost or value of benefit missed by failure to take advantage of an available opportunity. (Absolutely vital – but never recorded by the accountants.)
Fixed budget – unchanging sales volume and profit targets.
Flexible budget:
-series of “fixed” budgets
-shows expected behaviour of costs and profit at different sales volumes (60%, 80%, 100%, 120% of budget).
-adds flexibility, usefulness (and complication) to budget system
-affects management motivation.
Budget revision – normally better to leave original budget targets unchanged by to change “forecast” of expected activity to year end.
NOTE:
(a)In stable organisations fixed budgets work well. However, in rapidly developing companies any budget system may give troubles to management!
(b)Budgets should set “frontiers” within which managers may operate effectively. However, these frontiers should never become an IRON CURTAIN. “Meeting the budget” is not necessarily doing the job!
Determines profits at varying sales volumes.
Break-even point – sales volume where revenue equals total cost.
Aids understanding and effectiveness of planning.
Contribution – computed as sales less variable cost. Contribution to fixed cost and profit. Computed by product and for whole company.
Guidelines – circulated to responsible managers setting objectives.
Estimates – by responsible managers with discussion, change and approval by superiors.
Review and Appraisal – interaction, participation and discussion at all levels to “condition” and motivate managers to achieve targets.
Note: Motivation – money, fear, jealousy, status and KITA do work in practice but do not develop creative environment.
Challenge, responsibility and sense of achievement do, however, allow a creative organisational environment to develop.
Evaluate a budgetary control system in terms of:
(a)Objectives
-What are the key profit-making factors of the industry?
-How is the firm formally organised into cost, profit or investment centres? Informally what really happens?
-What are Top Management objectives from the budget system – short term and long term?
-How does Top Management want the responsible manager to behave?
(b)Targets
-Does Top Management give adequate, and timely, guidelines?
-Is the organisational environment defensive or creative?
-Who sets initial and final targets?
-How much interaction and participation is involved to set the targets?
-How creative and realistic are the agreed targets?
-Do the targets motivate managers in terms of challenge, responsibility and sense of achievement?
(c)Reports
to be discussed in Part II
(d)Action
(a)Reassemble in SG now.
(b)Study these instructions carefully.
(c)Record key points in your notebook.
(d)Do the following homework tonight:
Read your copy of the summary lecture for Part I in the Course Diary.
Complete your Course Diary for Part I, including notes on each case, and the key points for review later.
Do ASS sets 3 and 10, also the postscript, study the summaries and glossary.
Further readings and tasks to be decided by the Course Leader.
(e)Hand in this Work Pack for Part I to the Organiser in the SG.
(f)Reassemble in MG when the bell rings.
Optional Quiz in Budget Arithmetic
11 Questions
Some skills in basic budget arithmetic may be developed from this short quiz. (Answers are given at the end.)
Break even analysis – company estimates fixed costs at 40,000 and variable costs at 60% of sales which are expected to reach 300,000.
What is the:
(a)Break even point
(b)Estimated profit
- Break even analysis – from the following data compute the break even point:
Unit sales price4.85
Unit variable cost2.85
Fixed costs140,000
- Operating budget – from the following data compute an operating budget for Year II:
Year I / Year II
Actual / Budget /
Budget
/Assumptions
000 / 000 / 000Sales / 100 / 200 / 300 / Given
Cost of goods sold / 100 / 100
Gross profit / 50 / 100 / 40% sales
Operating expenses / 45 / 40 / Actual plus 10
Operating profit / 5 / 60
Non-operating income / 10 / 15 / Actual less 5
PBT / 15 / 75
Taxation / 7 / 37 / 50% PBT
Net profit / 8 / 38
- Operating budget – from the following data compute alternative operating budgets:
Per Unit /
Alt. I
/ Alt. II / Alt. IIISales – units / - / 100 / 200 / 300
Sales – amount / 15 / 1500
Variable costs / 10 / 1000
Contribution / 500
Fixed costs / 400
Profit / 100
5.Overhead budget – from the following data compute every rough alternative sales departmental overhead budgets for Year II.
Year I
/ Year IIActual
000 /
Budget 000
/ Budget (high) 000 / Budget (high) 000Executive salaries / 18 / 12
Office salaries / 12 / 10
Depreciation / 16 / 14
Maintenance / 5 / 1
Legal expense / 3 / 2
Travelling / 8 / 6
Miscellaneous / 24 / 22
Advertising / 8 / 6
Sales commission / 8 / 7
102 / 80
Sales (000) / 280 / 300 / 400 / 300
6.Overhead budget – from the following data compute alternative overhead budgets for Year II.
Year IActual / Year II
Budget / Year II
Budget
Variable costs / 100
Fixed costs / 100
Total costs / 200
Sales / 2000 / 3000 / 5000
7.Operating budget – from the following data compute the operating budget for Year II.
Year I Actual 000 / Year II Budget 000 /Assumptions
Net sales / 3,300 / 4,000 / Given 4,000Cost of goods sold:
Labour / 870 / 25% sales
Materials / 660 / % of sales
Depreciation / 130 / Given 106
Overhead / 506 / Actual plus 10%
2,166 / of additional sales
Gross profit / 1,134
Operating expense:
Selling / 376 / Actual plus 100
Administration / 110 / % sales
486
Operating profit / 648
Non-operating income and expense:
Dividend received / 200 / Actual plus 200
Interest paid / (200) / Actual less 100
-
Profit before tax / 648
Income tax / 324 / 50% PBT
Net profit / 324
8.Budgeted balance sheet – from the following data, compute the budgeted balance sheet for Year II.
Year I Actual 000 / Year II Budget 000 /Assumptions
Cash / 450 / DifferenceReceivables / 750 / 20% sales
Inventory / 810 / 40% C.G.S.
Fixed assets / 272 / Actual plus 100
Other assets / 50 / Same
2,332
Payables / 327 / 20% C.G.S
Mortgage / 75 / Less 10
Bank loan / 680 / Nil
Owners equity / 1,250 / Actual plus 605
2,332 / less dividend 100
Sales / 3,300 / 4,000
Cost of goods sold / 2,166 / 2,482
9.Cash forecast – from the balance sheet in question 8 complete the following:
Opening Cash Balance / BalanceFactors favourable to the cash position:
Net profit after taxes
Depreciation / 106
Increase in payables / Total favourable factors
Factors unfavourable to the cash position:
Increase in receivables
Increase in inventory
New capital investments / 206
Dividends paid
Bank loan paid off
Mortgage payments / Total unfavourable factors
Forecast of closing cash balance / 101
NOTE: This is another approach to forecasting the cash balance which appears as a ‘difference’ on the budgeted balance sheet in question 8.
10.Cash forecast – from the following data complete the cash forecast and compute the cash balance at March 31:
Jan. / Feb. / Mar.Receipts / 20 / (Dec.)
Payments -
Purchases / 10 / (Nov.)
Other / 25 / (Jan.)
Difference / (15)
Opening balance / 10 / 5
Closing balance / 5
Data:
Sales (net 30 days) / Dec.20 / Jan.40 / Feb.60
Purchases (net 60 days) / Nov.10 / Dec.20 / Jan.15
Expenses (net cash) / Jan.25 / Feb.15 / Mar.25
11.Operating budget – from the data below compute three alternative operating budgets.
Budget / Alt. I / Alt. II / Alt. IIISales / 200 / 200 / 300 / 500
Cost of goods sold / 150
Gross profit / 50
Fixed overhead / 10
Variable overhead
20
Operating profit / 30
Taxation (50%) / 15
Net profit / 15
Gross profit % sales / 25% / 20% / 20% / 15%
Variable cost % sales / 5% / 5% / 5% / 5%
Answers to Optional Quiz in Budget Arithmetic
11 Questions
- Break even analysis:
(a)Break even point
40% of X = 40,000
therefore X = 100,000
(b)Estimated profit
Sales300,000
Contribution120,000
Fixed cost 40,000
Profit 80,000
- Break even analysis:
Contribution4.85 - 2.85 =2.00 per unit
Fixed costs2.85140,000
Break even point70,000
- Operating budget – from the following data compute an operating budget for Year II:
Year I / Year II
Actual / Budget /
Budget
/Assumptions
000 / 000 / 000Sales / 100 / 200 / 300 / Given
Cost of goods sold / 100 / 100 / 180
Gross profit / 50 / 100 / 120 / 40% sales
Operating expenses / 45 / 40 / 55 / Actual plus 10
Operating profit / 5 / 60 / 65
Non-operating income / 10 / 15 / 5 / Actual less 5
PBT / 15 / 75 / 70
Taxation / 7 / 37 / 35 / 50% PBT
Net profit / 8 / 38 / 35
- Operating budget – from the following data compute alternative operating budgets:
Per Unit /
Alt. I
/ Alt. II / Alt. IIISales – units / - / 100 / 200 / 300
Sales – amount / 15 / 1,500 / 3,000 / 4,500
Variable costs / 10 / 1,000 / 2,000 / 3,000
Contribution / 5 / 500 / 1,000 / 1,500
Fixed costs / 400 / 400 / 400
Profit / 100 / 600 / 1,100
5.Overhead budget:
Year I
/ Year IIActual
000 /
Budget 000
/ Budget (high) 000 / Budget (high) 000Executive salaries / 18 / 12 / 24 / 18
Office salaries / 12 / 10 / 12 / 10
Depreciation / 16 / 14 / 16 / 14
Maintenance / 5 / 1 / 5 / 2
Legal expense / 3 / 2 / 2 / 1
Travelling / 8 / 6 / 10 / 8
Miscellaneous / 24 / 22 / 28 / 20
Advertising / 8 / 6 / 12 / 8
Sales commission / 8 / 7 / 12 / 8
102 / 80 / 121 / 89
Sales (000) / 280 / 300 / 400 / 300
NOTE: Above is only an example – any set of reasonable figures could be ‘acceptable subject to detailed investigation’.
6.Overhead budget:
Year IActual / Year II
Budget / Year II
Budget
Variable costs / 100 / 150 / 250
Fixed costs / 100 / 100 / 100
Total costs / 200 / 250 / 350
Sales / 2,000 / 3,000 / 5,000
7.Operating budget:
Year I Actual 000 / Year II Budget 000 /Assumptions
Net sales / 3,300 / 4,000 / Given 4,000Cost of goods sold:
Labour / 870 / 1,000 / 25% sales
Materials / 660 / 800 / % of sales
Depreciation / 130 / 106 / Given 106
Overhead / 506 / 576 / Actual plus 10%
2,166 / 2,482 / of additional sales
Gross profit / 1,134 / 1,518
Operating expense:
Selling / 376 / 476 / Actual plus 100
Administration / 110 / 133 / % sales
486 / 609
Operating profit / 648 / 909
Non-operating income and expense:
Dividend received / 200 / 400 / Actual plus 200
Interest paid / (200) / (100) / Actual less 100
- / 300
Profit before tax / 648 / 1,209
Income tax / 324 / 604 / 50% PBT
Net profit / 324 / 605
8.Budgeted balance sheet:
Year I Actual 000 / Year II Budget 000 /Assumptions
Cash / 450 / 101 / DifferenceReceivables / 750 / 800 / 20% sales
Inventory / 810 / 993 / 40% C.G.S.
Fixed assets / 272 / 372 / Actual plus 100
Other assets / 50 / 50 / Same
2,332 / 2,316
Payables / 327 / 496 / 20% C.G.S
Mortgage / 75 / 65 / Less 10
Bank loan / 680 / - / Nil
Owners equity / 1,250 / 1,755 / Actual plus 605
2,332 / 2,316 / less dividend 100
Sales / 3,300 / 4,000
Cost of goods sold / 2,166 / 2,482
9.Cash forecast:
Opening Cash Balance 450 / BalanceFactors favourable to the cash position:
Net profit after taxes / 605
Depreciation / 106
Increase in payables / 169 / 880 / Total favourable factors
1,330
Factors unfavourable to the cash position:
Increase in receivables / 50
Increase in inventory / 183
New capital investments / 206
Dividends paid / 100
Bank loan paid off / 680
Mortgage payments / 10 / 1,229 / Total unfavourable factors
Forecast of closing cash balance / 101
10.Cash forecast:
Receipts / 20 / (Dec.) / 40 / 60
Payments -
Purchases / 10 / (Nov.) / 20 / 15
Other / 25 / (Jan.) / 15 / 25
Difference / (15) / 5 / 20
Opening balance / 10 / 5 / 10
Closing balance / 5 / 10 / 30
NOTE: Balance March 31 – 30
11.Operating budget:
Budget / Alt. I / Alt. II / Alt. IIISales / 200 / 200 / 300 / 500
Cost of goods sold / 150 / 160 / 240 / 425
Gross profit / 50 / 40 / 60 / 75
Fixed overhead / 10 / 10 / 10 / 10
Variable overhead / 10 / 10 / 15 / 25
20 / 20 / 25 / 35
Operating profit / 30 / 20 / 35 / 40
Taxation (50%) / 15 / 10 / 17 / 20
Net profit / 15 / 10 / 18 / 20
Gross profit % sales / 25% / 20% / 20% / 15%
Variable cost % sales / 5% / 5% / 5% / 5%
NOTE: That is the end! We hope you found the questions interesting in instructive!
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All of the steps toward sound budget practice have their roots deep in personnel administration. Each one is, in the final analysis, the reflection of a problem involving people.
The Budget
Comes of Age
1
By James L. Peirce
Any technique of management reaches maturity when, after its earlier mistakes have antagonised human beings sufficiently, it emerges with a new outlook and practice that is in harmony with the basic motivation of people. Budgeting now seems to be undergoing this metamorphosis. Out of the disturbance it has created is appearing a calmer, more orderly, more positive approach.
It is my purpose in this article to add weight to the spreading view that budgeting rests on principles which have more in common with concepts of human relationship than with rules of accounting; and that, if these principles are applied, successful practice is inevitable.
Defensiveness – The Trouble
There is no doubt that thousands of management people are well grounded in constructive budget practice and derive from it a sense of balance and direction in their business affairs. No businessman who has had extensive experience with an ably managed budget system appears to doubt its value. But there are many more thousands who are so confused on the subject that it might indeed be better for them to discard their budgets entirely than to continue as they are. Surveys have shown that in some quarters budgeting is about as popular among foremen as a layoff, and analyses stress the damage that results from the misuse of budgeting procedures.
Some executives freely admit the short-comings of their budget practices and acknowledge that they could be remedied by the application of more intelligent human relations. If it as simple as that, then why cannot budgets be made a welcome and productive feature of all business operation without delay? The answer, I think, is that the problem is not such a simple one – just as human beings are not simple, just as the science of human relationships is not simple, as witness the many failures to apply it effectively.
How shall we go about the task of instilling revitalised ideas in place of negative or short-sighted attitudes?
We can accomplish nothing until we face up to the fact that many of us have acquired a defensive approach to the subject through painful experience. Here we must dig deep into the recesses of thought – not omitting the realm of emotional misconception that colours our word associations. Why do the two words ‘budget’ and ‘people’ repel each other? Why should they, when taken together, suggest the image of a problem? Why, in fact, should it even be necessary to discuss a positive approach to the matter of budgets and people?
This unhappy reaction comes from the fact that people generally do not like budgets. We must remember that foremen are people first and supervisors second; so are department managers and top executives. Budgets represent restriction. They are in the same category as school bells and Monday mornings. Each of us has entered business life with a primitive aversion to restraint, only thinly veneered by academic training.
Someone should have presented the budget idea to us very constructively in order for us to accept it, much less to enjoy it. If from the very beginning of our careers we had been told, with accompanying evidence, that budgets were a help to us, affording us guidance, stability, and strength, as well as keeping us out of innumerable troubles, our responses would by now be quite different.
But what was our actual experience? Have not many of us been introduced to budgets in business when the budget was blamed, rightly or wrongly, for our failure to get a raise in pay? Have not many of us become acquainted with the budget only as a barrier to spending what we felt were necessary amounts of money for better equipment or performance? Is it surprising, then, that budgets are associated in many people’s minds with paucity and niggardliness rather than with planning and direction?
Fortunately, it is not too late to effect a correction in the thinking of the current generation of managers.
Attitudes – The Key
In probing further, it quickly becomes evident that good attitudes are the key to successful budgeting. When the attitudes of people toward each other are generous, understanding, and based on mutual respect, any technique adopted by management to further effective performance is apt to be successful. When human attitudes are dominated by distrust, criticism, and recrimination, any technique designed to improve performance is likely to fail miserably. In such cases, by a strange twist of human nature, the budgets and those how defend them bear the brunt of the blame for more fundamental errors which are entirely unconnected with budgets.
Budgeting is a trained, disciplined approach to all problems, which recognises the need for standards of performance in order to achieve a result. Hence it must be built on a base of good organisation; otherwise, favourable attitudes have no chance to operate. But at the same time it lives in an atmosphere of perpetual adjustment to the needs and capacities of people. It thrives on such fundamentals as recognition of accomplish-ment, consideration for the rights of individuals, fair play – in other words, en-lightened relationships among people.
Motivation for Budgeting
In exploring budgeting principles as they relate to people, the first consideration should be the motivation for the budget system. Why have one at all? Is the budget a part of a system of overall planning, in order that all concerned may have a measure of the amounts to be spent, and in order that action may be by design rather than be expediency? Or is the budget a pressure device designed to goad people into greater efforts? It takes a little soul-searching to determine honestly which of these concepts represent the position of a particular management.