1. Managing Finance and Budgets
Lecture 9
Budgets (1)

2. Session 9 – Budgets (1) LEARNING OUTCOMES
To understand the importance and role of budgets in organisations
To understand the processes involved in the setting and monitoring of budgets

3. Key Concepts Budget definitions and purpose The budget-setting process
Types of budget

4. Section A:
What are Budgets?

5. Budgets - definitions
“A plan, qualified in money terms, prepared and approved prior to a defined period of time, usually showing planned income to be generated and/or expenditure to be incurred during that period, and the capital to be employed to attain given objectives”
(CIMA definition)

6. What exactly is a Budget?
Predicts the contribution to income which will be expected to be generated by each department and each project.
Allocates to each department, project or activity an appropriate share of the of funding in order to enable that income to be generated.

7. What exactly is Budget for?
A budget:
enables a business to plan appropriately for the future
Important tool for management agenda-setting and control
sets targets in monetary terms for departments and projects
provides a way of sharing out resources to departments and projects so that they can have continued existence.

8. Example of a Cash Budget
This example budget shows how we set targets, allocate money, make predictions and set targets.
Example of a Cash Budget
Receipts (£000) Jan Feb Mar Apr May Jun
Debtors
Cash Sales
Total
Payments (£000) Jan Feb Mar Apr May Jun
Creditors
Salaries
Electricity
Other overheads
Loan repayments
Total payments
Cash-flow
Opening Balance
Closing Balance

9. Example of a Cash Budget
These are predictions about the cash inflow . These will become monthly targets for sales and for debt collection.
Example of a Cash Budget
Receipts (£000) Jan Feb Mar Apr May Jun
Debtors
Cash Sales
Total
Payments (£000) Jan Feb Mar Apr May Jun
Creditors
Salaries
Electricity
Other overheads
Loan repayments
Total payments
Cash-flow
Opening Balance
Closing Balance

10. Example of a Cash Budget
These are predictions about the cash outflow . Most of these are fixed and will be paid at the times stated.
Example of a Cash Budget
Receipts (£000) Jan Feb Mar Apr May Jun
Debtors
Cash Sales
Total
Payments (£000) Jan Feb Mar Apr May Jun
Creditors
Salaries
Electricity
Other overheads
Loan repayments
Total payments
Cash-flow
Opening Balance
Closing Balance

11. Example of a Cash Budget
This is our predicted monthly cash inflow/outflow. We can use this to detect peaks and troughs
Example of a Cash Budget
Receipts (£000) Jan Feb Mar Apr May Jun
Debtors
Cash Sales
Total
Payments (£000) Jan Feb Mar Apr May Jun
Creditors
Salaries
Electricity
Other overheads
Loan repayments
Total payments
Cash-flow
Opening Balance
Closing Balance

12. Example of a Cash Budget
Finally we can monitor the cash balance on a month by month basis. We can predict for example where overdrafts are needed.
Example of a Cash Budget
Receipts (£000) Jan Feb Mar Apr May Jun
Debtors
Cash Sales
Total
Payments (£000) Jan Feb Mar Apr May Jun
Creditors
Salaries
Electricity
Other overheads
Loan repayments
Total payments
Cash-flow
Opening Balance
Closing Balance

13. The uses of budgets Five areas of usefulness: Forward planning
Co-ordination
Motivation
Control
Authorisation

14. Budgets - Purpose
Encouraging forward planning and identifying any possible future problems to enable solutions to be implemented in advance
Ensuring co-ordination across the organisation so that all departments are able to fulfil organisational objectives
Motivating managers to improved performance against set benchmarks
Providing a basis for control systems
Providing a basis for a system of authorisation, so that managers know exactly what are the limits to their authority, manage within them.

15. How are Budgets Created?
Section B:
How are Budgets Created?

16. How are Budgets created?
The budget-setting process is quite complex, and often very time-consuming.
It involves a number of stages, some of which ask the business to question precisely what it is doing, and where it is going – almost at a ‘philosophical' level
Other stages involve detailed calculations of amounts of money and negotiations about who gets what.
A complex budget may take six months to one year to produce.

17. Budget Setting
This is often an annual process linked to a review of long-term plans – Planning & Control
It is an iterative process. Tentative plans are created, which are thrown open to discussion. These discussions then lead to modifications and further discussion, and so on until the budget is set.
Should be participative – all interested parties involved, with the process ‘transparent’.
A combination of top-down(i.e. agenda-setting) and bottom-up (i.e. recognition of needs) approaches is required.

18. The Planning & Control Process
1.Identify business objectives
2. Identify available options
3. Evaluate and select options
4. Prepare detailed plans or budgets
5a.Collect information on performance
5b. Identify and respond to variances
5c. Revise Plans if necessary

19. 1. Identifying Business Objectives
Business Aims and Objectives are normally encapsulated in a Mission Statement. Such statements often aspire to ideals:
Liverpool Hope University College aspires to: “educate students in mind, body and spirit”
Railtrack plc has a vision of : “a safe, reliable, efficient and modern railway”
On the other hand, some companies take an altogether more pragmatic view.
Cadbury Schweppes plc has a mission statement committed to: “..growth in shareholder value”

20. 1. Identifying Business Objectives
Objectives are normally more specific than the aims.
These vary, but will include consideration of such things as:
The kind of market the business seeks to serve
The market share it aspires to
The level of operating efficiency
The kind of product it offers
The level of growth to be attained
The level of profit required
These objectives should be quantifiable and be consistent with the Mission statement.

21. 2. Identifying Available Options
To achieve the business objectives, a number of strategies may be available.
In order to uncover these, information will need to be collected,
This process may be time-consuming
The information will include
an analysis of the external competitive environment,
and an analysis of the internal resources and capabilities of the business

22. 2. Identifying Available Options
External considerations might include:
Market size, growth
Level of competition
Threat of newcomers
Relative powers of trades unions, interest groups etc.
Internal Considerations might include:
Culture within the organisation
Marketing, distribution issues
Manufacturing capability
Finance and administration
Research & Development
Human Resource Management

23. 3. Evaluating and Selecting Options
During the evaluation phase, Managers must examine the available information on each option to determine which one most closely fits with the objectives that have previously been set.
NB Research suggests that too much information may produce ‘information overload’, where managers become confused and distracted by irrelevant data.
Sometimes this is called ‘paralysis by analysis’.

24. 3. Evaluating and Selecting Options
During the selection phase, the options chosen will form the basis of the long-term plan
These options will specify things such as:
Products or service to be offered
Sources of finance and the amounts
Capital investments
Personnel requirements

25. 4. Setting the Budget
A budget is basically a short-term plan (normally one year) which is expressed mainly in financial terms.
Budgets will normally define precise targets for such things as:
Cash Receipts & Payments
Sales targets for each item or department
Stock requirements
Labour requirements
Production Levels

26. 5a. Collecting Information on Performance
Control = the process of making planned events actually occur.
Accounting is very useful in this context. Plans are set in accounting terms, and outcomes can be matched against targets.
Where differences occur, these are highlighted as variances.

27. 5b. Responding to Information on Performance
Managers will be alerted to variances between the budgeted amounts and the actual figures.
Action will be needed in order to get the business on track towards achieving budgets.
For example if sales targets have not been achieved, the manager may need to review the sales strategy, to discuss alternative forms of marketing or to make concerted efforts to find new customers.

28. 5c. Revising Plans and Budgets
If variances continue and are not rectified, or figures are produced on the basis of incorrect assumptions, or circumstances alter, then a revised budget may need to be published.
This new budget will set different targets, and reallocate the remaining funds in order to respond to the new circumstances.

29. The Planning & Control Process – a summary
Mission, Aims, Objectives
Market, Products, Services
Sales, Costs, Profits, Returns
1. Identify key objectives
Limiting factors: External & internal
Environment - market size, production
capability, competition
2. Identify available options
3. Evaluate and select options
Markets, products, financing,
physical resources, human resources
4. Prepare detailed plans or budgets
Short-term plans: Sales, Cash, Stock,
Labour, Production à Master budget
5.Collect information and control
Identify variances and respond
as appropriate

30. Activity One
List the advantages and disadvantages of using budgets in an organisation.

31. Activity One - solution
Advantages
Each are of the business knows exactly what they need to achieve
Each manager knows precisely what resources are available to work with
The business can plan effectively for expansion and be proactive, not reactive. .
Disadvantages
Targets tend to be met, but not exceeded
Resources tend to be ‘used up’, even where they are not required.
The business finds it hard to respond to new initiatives, since the resources are already set.

32. What are the different types of Budget?
Section C:
What are the different types of Budget?

33. Budgets – Time horizons
Periodic budget
This is a one-off budget set for a year (e.g.)
It is normally broken down into monthly or weekly amounts
Continual Budget
This will be updated continually (still for one year, but a new month will be added to replace the one which has passed.)

34. Budgeting Principles Incremental budgeting
This is a method of budgeting based on what happened last year, but with alo9owance for factors such as inflation (e.g if spending was £8,000 last year, we might increase it to £8,250 this year.)
Zero-Base Budgeting
This rests on the philosophy that all spending needs to be justified; there can be no ‘carry over’. Managers will need to be convinced that each activity represents ‘value for money’.

35. Types of budget Cash budget Stock budget Debtors budget
Creditors budget
Income & Expenditure budget
Capital budget
Discretionary budget
Master budget

36. Cash Budget - Example Receipts (£000) Jan Feb Mar Apr May Jun
Debtors
Cash Sales
Total
Payments (£000) Jan Feb Mar Apr May Jun
Creditors
Salaries
Electricity
Other overheads
Loan repayments
Total payments
Cash-flow
Opening Balance
Closing Balance

37. Stock & Debtors Budgets - Example
Stock Jan Feb Mar Apr May Jun
Opening Balance
+ Purchases/Production
- Usage
Closing Balance
May be calculated in units (by product) or in £
Debtors Jan Feb Mar Apr May Jun
+ Sales
- Cash received

38. Creditors Budgets - Example
Creditors Jan Feb Mar Apr May Jun
Opening Balance
+ Purchases
- Payments made
Closing Balance

39. Income & Expenditure Budget - Example
Jan Feb Mar Apr May Jun
Sales
Direct Costs
Materials
Labour
Total Direct Costs
Gross Profit
Overheads
Admin Salaries
Travel
Other costs
Total Overheads
Net Profit (5)
Cumulative (5) (2)

40. Preparation of budgets in SMEs Source: Chittenden, F. , Poutziouris, P
Preparation of budgets in SMEs Source: Chittenden, F., Poutziouris, P., and Michaelis, N. Financial management and working capital practices in UK SMEs, Manchester Business School, 1998
Budgeted balance sheet
Sales budget
Budgeted profit and loss
Overheads budget
Cash budget
Purchases budget
Production budget
Frequency of preparation (%) 20 80 60 40
100 21 35 46 63 73 76 78

41. Setting Complex Multiple Budgets
Clearly, where there are a number of interlocking budgets to create, the process can be quite complex.
Often departments are asked to create ‘spending plans’ (speculative, often optimistic documents, bidding for money and suggesting targets)
Managers will be called to interview to justify these plans, and to negotiate realistic targets.
Out of this process, draft budgets will be created, which will be reviewed and co-ordinated.
Finally the master budget will be created and communicated.

42. Steps in a complex budget setting process
Establish responsibility for the budget-setting process
Communicate budget guidelines to relevant managers
Prepare the budget for the area of the limiting factor
Identify the key or limiting factor
Prepare draft budgets for all other areas
Review and co-ordinate budgets
Communicate the budgets to all interested parties
Prepare the master budgets
Monitor actual performance relative to the budget

43. Sensitivity Analysis
This is a tool used in setting technically complex budgets:
It investigates changes to profit due to adjustments in key variables
It identifies key areas for managers to focus on for maximum effect
In order to use it, managers need to:
Identify key questions to be answered – e.g. what is the effect on profits of 10% decrease in sales? Or a 10% increase in cost of sales?
Use spreadsheets or other types of computer software in order to create ‘what-if’ analyses.

44. Thought Activity – Creating a Budget
You have hired a venue to host a touring theatre company for three nights of performances of “Jumpers” by Tom Stoppard. You need to prepare an Income and Expenditure Budget and a Cash Budget for the performances. You need to allow for three income streams: ticket sales; sale of refreshments; and programme sales.
You need to identify key questions you need to ask to enable you to estimate your income, direct costs and indirect costs as accurately as possible.  
Having prepared a budget, you need to decide which are the parameters you would like to vary, in order to carry out appropriate sensitivity analysis.

45. Follow-Up to Lecture Nine - Activities
Preparation: read Chapter 12
Describe key concepts:
Budget definitions and purposes
Budget-setting process
Different types of budget
Exercises 12.3 and 12.7