1. Chapter 3.9 - HL BUDGETS

2. By the end of the chapter you should be able to...  Explain the importance of budgets for organization  State the difference between cost centers and profit centers  Analyze the role of cost centers and profit centers  Calculate and interpret variances  Analyze the role of budgets and variances in strategic planning

3. Introduction  Budget – a quantitative financial plan :  Estimates revenue and expenses  Covers a specific future time period  Help to set targets, and are aligned with the objectives of the business  Budget holder  Responsible for ensuring that the budget allocations are being met

4. Importance of Budgets for Organizations  Planning – setting targets, help to provide direction  Motivation – those who have budgetary control feel empowered  Resource Allocation – help to prioritize how resources are spent  Coordination – brings departments together to work for a common purpose  Control – A tool used for monitoring and evaluation

5. Cost and Profit Centers  Cost Centers – parts of the business where costs are incurred and recorded.  By department – finance, production, marketing, etc.  By product – if a business produces multiple products, can keep of costs by product  By geographic location – used by a business who has locations in multiple parts of a country or in the world

6. Profit Centers  A part or section of a business where both costs and revenues are identified and recorded  Allows a business to calculate how much profit each center makes  Enable a business to make comparisons between sections of the business  The role of profit centers  Aids decision making  Better accountability  Tracking problem areas  Increasing motivation  Benchmarking

7. Problems of Cost and Profit Centers  Indirect cost allocation – advertising, rent, insurance, difficult to allocate  External factors - factors a business can’t control, such as competition, affect cost and profit centers  Center Conflicts – if performance in centers is compared, it could lead to unhealthy competition, which isn’t good for the business  Staff Stress – managing a cost or profit center can be stressful, and can lead to demotivation

8. Variance Analysis  Variance – the difference between the budgeted figure and the actual figure  Usually calculated at the end of a budget period once actual amounts are determined  A budgeted control process  Variances can either be favorable or adverse  Favorable – when difference between budget & actual is financially beneficial to firm  Adverse – when difference between budget & actual is financially costly to firm

9. Examples – page 243  Table 3.9.1  Calculating Variances  Solution

10. Role of budgets & Variances in Strategic Planning  Strategic Planning – an organization’s systematic process of defining its future direction to determine how a business will allocate the resources  Advantages of using budgets and variances  Help to control revenue and expenses  Budgets provide realistic targets  Budgets help to coordinate business departments  Budgets should be set based on SMART criteria  Variance analysis compares actual performance to budgeted performance  Variance analysis help to detect causes of deviation  Variance analysis provides an objective way of appraising budget holders

11. Limitations of budgets & strategic planning  Inflexible budgets; don’t take into account changes to the external environment  If there are significant differences in budget v. actual, the budget may lose its importance  Budgets not look into the future, and may be too short-term  Highly underspent budgets may result in unjustified or wasteful spending  If the budget setting process doesn’t include key people, it can result in resentment

12. Chapter Wrap-up  Revision checklist – page 245  Practice Question KJC Limited – page 246