1. F5 Performance Management

2. 2 Section C: Budgeting Designed to give you knowledge and application of: C1. Objectives C2. Budgetary systems C3. Types of Budget C4. Quantitative analysis in Budgeting C5. Behavioural aspects of Budgeting C1. Objectives C2. Budgetary systems C3. Types of Budget C4. Quantitative analysis in Budgeting C5. Behavioural aspects of Budgeting

3. 3 C2: Budgetary systems Learning outcomes  Explain how budgetary systems fit within the performance hierarchy. [2]  Select and explain appropriate budgetary systems for an organisation, including top-down, bottom-up, rolling, zero-base, activity-base, incremental and feed forward control. [2]  Describe the information used in budgetary systems and the sources of the information needed. [2]  Explain the difficulties of changing a budgetary system. [2]  Explain how a budgetary system can deal with uncertainty in the environment. [2]

4. 4 Top management & shareholders Lower management Middle management Top management Mission statement Strategic planning Operational planning Operational activities Performance hierarchy The budgetary systems fit within the performance hierarchy

5. 5 Small organisation Appropriate budgetary systems for an organisation, including top-down, bottom-up, rolling, zero-based, activity-base, incremental and feed-forward control Top-down approach Budgets are prepared in line with the strategic objectives of an organisation Top management (Mgmt) makes the guidelines, specifies their expectations & objectives Enables communication between top level of mgmt & other levels Most suitable to small organisations where superiors have overall knowledge of organisation’s working Suitable in situations where the organisation can’t allow much time or cost for planning Big organisation Bottom- up approach A budgeting system in which all budget holders are given the opportunity to participate in setting their own budgets Opposite of the top-down approach Budget is more realistic Detailed planning and co-ordination between departments Suitable in large and established organisations. Continued…

6. 6 Construction organisation works in uncertain environment Rolling approach:  One which needs to be continuously updated by deducting the earliest period and taking the future period into consideration.  Prepared on basis of near experience by taking current period into consideration.  Continuously updated with the help of current information.  Suitable to organisations working in an uncertain environment. Example A budget may initially be prepared for a year i.e. January to December 2008. At the end of first quarter i.e. at the end of March 2008 the first quarter’s budget is deleted. Then a further quarter is added to the end of the remaining budget, for January to March, 2009. The remaining portion of the budget is updated in the light of current conditions. This means forces must continually plan ahead. Continued…

7. 7 Zero-base approach (ZBB):  Requires each cost element to be specifically justified, as though the activities to which the budget relates are being undertaken for the first time.  Without approval, the budget allowance is zero.  For an activity where there is no clear relationship between the input and output, a zero- base budget can be used.  ZBB can be successfully applied to discretionary costs and support activities.  Best suited to service industries and not-for-profit organisations. Example Shan, a marketing manager for Choice Plc, has included advertisement expenditure of $5,500 in the budget just because last year it was $5,000 and this year he expects a 10% increment. With effect from the current budget period the company has introduced zero- base budgeting. The general manager does not agree with Shan and will not allot any amount for advertisement expenses unless justification for incurring such expenditure is given. Shan should explain how this amount will contribute to increasing the sales of Choice Plc in order to get his budget proposal accepted. Continued…

8. 8 Uses an ABC system TOYOTA moving forward Activity-based budget approach (ABB):  Method of budgeting based on an activity framework and utilising cost driver data in the budget-setting and variance feedback processes.  ABB seen as more appropriate as it identifies the cause and effect relationship between activity and cost / product.  Calculates the costs of individual activities and assigns the activity costs to products.  Suitable for organisations where activity-based costing system (ABC) has been adopted. Example Activities such as machine operation drive cost. To carry out this activity, resources in the form of power, fuel, labour etc. are needed. In activity-based budgeting, the costs towards these resources would be authorised. Continued…

9. 9 Highly volatile environment Broker Feed forward control approach:  A control system where variables i.e. factors affecting the system, are predicted and corrective actions are taken before they occur allowing organisations to successfully pursue objectives  Suitable to those organisations working in a highly volatile environment Incremental approach:  A traditional way of preparing budgets.  Budgets are prepared on the basis of the previous year’s budget with some additions and deletions for the forthcoming budget period.  An incremental budget is suitable for all organisations which have the previous year’s budget. However, it is criticised for not justifying the cost elements included in the budgets. Even so, it is widely accepted by organisations. Continued…

10. 10 Suppliers Legal framework Financial & economic environment Political & regulatory framework CustomersCompetitors Information used in budgetary systems Internal informationExternal information The information used in budgetary systems and the sources of the information needed Sources of the information needed:  Internal forms & records  Market research & focus group  Newspapers & other news media  Information from regulatory authorities  Suppliers’ price lists & brochures  Government reports & statistics

11. 11 The difficulties of changing a budgetary system Difficulties:  Resistance to change  Threat of new system  Reluctance to learn new system  Requirement of continuously updating with recent changes  Time & cost consuming

12. 12 The budget systems can deal with uncertainty in the environment Uncertainty can be dealt with using the help of:  Rolling budget  Feed forward control  Market research & focus groups  Contingency planning  Predictions of changing economic parameters  Shorter budget periods  Other forecasting techniques  Application of probability theory

13. 13 RECAP  Explain how budgetary systems fit within the performance hierarchy. [2]  Select and explain appropriate budgetary systems for an organisation, including top-down, bottom-up, rolling, zero-base, activity-base, incremental and feed forward control. [2]  Describe the information used in budgetary systems and the sources of the information needed. [2]  Explain the difficulties of changing a budgetary system. [2]  Explain how a budgetary system can deal with uncertainty in the environment. [2]

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