F5-Chapter 8 Budgetary systems Lecturer: FangFang 23.06.2018

Budgetary systems Chapter Preview Planning and control cycle Objectives of budgetary systems Traditional budgetary systems Alternative budgetary systems Incremental budgeting ZBB ABB Fixed & flexible budgets Rolling budgets Beyond budgeting

Overview Planning and control cycle Objectives of a budgetary planning and control system Budget perparation Various budget types 3

Objectives Objectives Corporate objectives Profitability Growth Market share Cash flow ROCE EPS Unit objectives --specific to individual business units 23.06.2018

Objectives Corporate objectives may conflict with divisional objectives Setting objectives is a political process using bargaining Conflict is resolved using prioritisation, compromise, negotiation and satisfying. Goal congruence 23.06.2018

The planning and control cycle Identify objectives Implement the long-term plan Identify potential strategies Measure actual results and compare with plan Control process Planning process Evaluate strategies Respond to divergences from plan Choose alternative courses of action 23.06.2018 6

Planning and control Determine objectives Control - variances Planning – set budget Actual operations 23.06.2018

Objectives of a budgetary systems Achievement of the business’ objectives Motivations Compel planning Communications Control system Coordinate activities Objectives 23.06.2018

Planning and control in the performance hierarchy Long-term and short-term planning Planning hierarchy 23.06.2018

Profit-making business School Profit-making business Objective To provide a high quality of education, so that within 5 years, 95% of pupils achieve grades A or B in their final examination To achieve a 20% return on capital every year. To increase earnings per share by 10% every year for the next 5 years Strategic plans (1) Reduce class size. Raise new funds to invest 1 million in new equipment and facilities. Attract the highest quality of teacher by paying good salaries Cut cost by 15% in domestic markets. Expand into markets in Asia. Increase domestic market share by 10% in the next 5 years. 23.06.2018

Profit-making business School Profit-making business Tactical plans (2) Set a target for this year for examination results. Increase the number of teacher by 10% by the end of the year. Plan the launch of a fund-raising campaign. Carry out a cost reduction program next year. Establish business relationships with customers in Asia and carry out market research. To increase the size of the work force in order to improve total sales Operational plans (3) Prepare teaching schedules for next term. Monitor the marks gained by students in mock examination. Provide whiteboard training to teaching staff. To obtain prices from more than one supplier before purchasing materials. Offering a bulk purchase discount of 10% to a major customer. 23.06.2018

Other aspects of budget preparation long-term plan limiting factor budget manual sales budget production capacity functional budgets discretionary costs consolidation and coordination cash budget master budget 23.06.2018

Participation in budgeting Budget-setting styles imposed (top down) participation (bottom up) negotiated 23.06.2018 13

Top-down budgeting Advantages Disadvantages Top management prepare a budget with little on no input from operating personnel Advantages Disadvantages 23.06.2018

Bottom-up budgeting Disadvantages Advantages Budgets are developed by lower-level managers who then submit the budgets to their superiors. Disadvantages Advantages 23.06.2018

Negotiated style of budgeting In top-down budgeting, operational managers will try to negotiate with senior managers. In bottom-up budgeting, senior managers usually review and revise budgets presented to them. 23.06.2018

Traditional budgetary systems Incremental budgeting add a certain percentage to last year’s budget to allow for growth and inflation. It encourages slack and wasteful spending to creep into budgets. Example: P184-5.3 23.06.2018

Fixed budgets VS flexible budgets --on the basis of an estimated volume of production and an estimated volume of sales. -- not adjusted to reflect actual activity levels Fixed budgets --change as activity level changes by recognising different cost behaviour patterns 23.06.2018

Zero based budgetary systems (ZBB) The initial budget is zero and every items of expenditure has to be justified in its entirety to be include. Step 1 Step 2 Step 3 Define decision packages Evaluate and rank Allocate resources 23.06.2018

Zero based budgetary systems (ZBB) Advantages Identify and removes inefficient and/or obsolete operations Provide a psychological impetus to employees to avoid wasteful expenditures Leads to a more efficient allocation of resources 23.06.2018 20

Zero based budgetary systems (ZBB) Disadvantages Involves time and effort Can cause suspicion when introduced Costs and benefits of different alternative can be difficult to quantity Ranking can prove problematic 23.06.2018

Activity based budgeting (ABB) Define the activities and using the level of activity to decide how much resource should be allocated, how well it is being managed and to explain variances from budget. Example: P223-4.2 23.06.2018 22

Principles of ABB It is activity which drive costs and the aim is to control the costs drivers. 1 Not all activities are value adding. 2 2 Not all activities are value adding. Most departmental activities are driven by demands and decisions. 3 Additional measures are needed. 4 23.06.2018

Rolling/continuous budgets Continuously updated by adding a further accounting period when the earlier accounting period has expired. 1 2 3 4 5 6 7 8 9 10 11 12 Annual Month Quarter Semiannual 23.06.2018

Rolling/continuous budgets Advantages Reduce uncertainty Up-to-date budget always available Realistic budgets are better motivators Disadvantages Involves more time, effort and money 23.06.2018 25

Criticisms of budgeting Beyond budgeting Criticisms of budgeting Time consuming and expensive Provide poor value to user Fail to focus on shareholder value Too rigid and prevent fast respond Stifle product and strategy innovation Focus on sales targets rather than customer satisfaction Divorced from strategy Reinforce a dependency culture Lead to unethical behaviour 23.06.2018 26

Beyond budgeting fundamental concepts Use adaptive management processed rather than the more rigid annual budget Move toward devolved networks rather than centralised hierarchies 23.06.2018

Other budgeting issues Sources of budget information—past data, sales forecasts, production department costing information. Difficulties of changing budgetary practices Allowing for uncertainty—flexible budgeting, rolling budgets, probabilistic budgeting, sensitivity analysis 23.06.2018

End of Chapter 8 Thank You ! 23.06.2018