1. AAF001-6 Financial Analysis
Budgeting
AAF001-6 Financial Analysis

2. Planning and Budgeting
Budgeting is part of the planning function of an organisation
Budget or forecast?
Planning is
The design of a desired future and the effective ways of bringing it about
Ackoff 1970

3. The planning process Identify objectives - mission etc.
Search for strategies
Resource and environmental audit
Gather data/measure payoffs
Select Strategy
Implement the plan
The Budgeting Process
Monitor and evaluate
Respond to divergences

4. Why produce budgets Planning Co-ordination Communication Motivation
Control
Performance Evaluation

5. Conflict and Budgets A budget system has several purposes Conflict!
Planning
Realistic
Motivation
Challenging
Performance evaluation
Changing circumstances

6. Periodic Budgets
In a periodic budget a budget is prepared periodically for each planning period
Periodic budgeting is typically performed once per budget period - usually once a year
Planners may, however, update or revise the budget based on latest realistic forcasts.

7. Continuous or Rolling Budgets
As one budget period passes, planners drop that budget period from the master budget and add a future budget period in its place
Usually a month or a quarter
The length of the budget period reflects the competitive forces, skill requirements, and technology changes that the organisation faces
Long enough for the organisation to anticipate important environmental changes and adapt to them
Short enough to ensure that estimates for the end of the period will be reasonable

8. Periodic or Rolling Rolling budgeting
keeps the organisation planning, and assessing, and thinking, strategically year-round rather than just once a year at budget time
but is much more expensive as a system
Periodic budgeting provides planning benefits at a smaller cost
but do periodic budgets become out of date

9. The Budgeting Process Policy from Board
(Gives authority)
Identify principal budget factor
Sales budget
Initial departmental budgets
Negotiation for resources
Co-ordinate and review
Master budget
Final Acceptance
Ongoing review

10. Responsibility and Control
Feedback control compares actual against budget.
Budget against actual gives variances
Feedforward control compares budgets with long term plans and thus attempts to anticipate problems.

11. Reasons for Variances Operating Planning Measurement Random
Performance not up to plan
Planning
Poor predictions
Measurement
Planning or operating miscalculation.
Random
Equipment failure
Weather etc
Strikes
Factor shortages (materials, labour, demand).

12. Controllability and flexibility
Managers should not be held accountable for those aspects which they cannot control.
Uncontrollable costs
apportioned costs
committed costs
sunk costs
some (not all!) fixed costs
Uncontrollable events

13. Flexibility - example Performance report Budget Actual
Output units
Costs £
Increased costs could mean punitive measures

14. Flexibility - example Budget Actual
Suppose £15000 of cost is uncontrollable, controllables are therefore £1 per unit
Budget Actual
Original Flexed
Output units
Uncontrollables £
Controllables £
Total £

15. The problems with budgeting
A number of surveys have revealed that senior managers are dissatisfied with the results of budgeting systems (e.g. Develin &Partners/CBI)
Constraining and not controlling
budgets based on limited knowledge - Career patterns influence behaviour
compromises in budget setting - negotiation!
lack of performance measures - over emphasis on inputs rather than outputs
too inward looking - focussing too much on the immediate function and not on cross functional processes, i.e. the contribution of departments to other departments.

16. Traditional approaches
Line item budgets - ledger expense categories
AND
Incremental budgets - based on current cost levels
plus/minus changes due to inflation, volume, efficiency
Problems of ensuring efficiency
No measures of cost/benefit

17. Profit is not the final arbiter of success Outputs can be imprecise
Budgeting in “Not - for - profit” organisations, or in service departments
Problems
Profit is not the final arbiter of success
Outputs can be imprecise
Advice/consultancy
Objectives are difficult to quantify
To provide help to old people (how many people? How much help? What help?)
Often concerned with inputs (expenses)

18. Service departments Similar problems to NFP organisations
Personnel departments
Legal departments
Research departments
Finance departments!!

19. Zero based budgets
Projected incomes and expenditures are computed as though for the first time
“What should happen?”
Value for money
Should an activity be performed at all
What is the right level of performance
What level of performance is acceptable
Zero-based budgeting arose to combat indiscriminate incremental budgets where projects that take on a life of their own.

20. How to ZBB Stages in ZBB Advantages Disadvantages Sons of ZBB!
describe decision packages
prioritise packages
allocate resources
Advantages
does not extend past inefficiencies
creates a questioning attitude by staff involvement
focuses on outputs
Disadvantages
Very resource intensive and draining on staff.
Sons of ZBB!
Priority Incremental Budgets - what if costs are increased by 10%
Priority Based Budgets - we have £1m to spend - in what order should we place our projects

21. The future of budgeting
Criticisms of budgeting can lead to guesses about its future
The critics say it is – a ritual!, rigid, time-consuming, does now answer how/why, focuses on the short term, implies a 12month commitment, implies meeting the budget is all that is required.
Alternative ideas come from the Beyond Budgeting Round Table – BBRT.org
A flexible approach with rolling budgets – focusing on innovation/shareholder value/ethics and reputation/empowerment/customer orientation.

22. Budgeting and conflict
Budgets are produced for a variety of reasons
planning
co-ordination, communication, co-operation
cost awareness and quantification
control and evaluation
goal orientation
motivation
Inevitably there will be conflict
e.g. planning v motivation

23. Budgeting and behaviour
Approaches to budgeting - 1
Imposed - top down
Advantages
managers have wide perspective
managers are aware of resource availability
quicker and cheaper
Disadvantages
managers not aware of detail
imposition reduces commitment

24. Budgeting and behaviour
Approaches to budgeting - 2
Participative - bottom up
Advantages
Commitment at all levels
Detailed low level knowledge
Disadvantages
Empire building - inflates importance of mundane
Encourages softer targets
Costly and time consuming

25. Budgeting and behaviour
Approaches to budgeting - 3
Negotiated
Takes best of each
Senior management set objectives
Lower levels commit departments
Flexible

26. Ideal systems and management style
Theory X
authoritative
scientific management
emphasis on control and rewards
Theory Y
participative
encourages goal congruence (McGregor)

27. Ideal systems and motivation
the need to achieve an objective AND
the drive that influences action (Lucey)
To improve motivation
clear objectives
participation in planning
participation in control
emphasise the positive (Stedry)
To reduce motivation
use budgeting to pressure and police (Argyris)

28. Dysfunctional behaviour
Reduction of goal congruence (Hopwood)
Reactions to pressure -distrust, hostility, lower performance
Emphasis on short term
Poor communication - result manipulation, conflict
Sub-optimisation - individual goals at the expense of the whole
Budgetary slack built in – budgetary games (see later)

29. The perfect budget? Tight or loose?
Constant achievement of loose budgets reduces motivation
constant failure to reach tight budgets reduces motivation
Individuals work harder when involved (Caplan)
Individuals desire to be challenged (McClelland)
Individuals respond best to challenges just beyond their reach (Hofstede)