1. Budgetary Control Nursery Management Understanding and Managing Finance.

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

3. Steps in the budget setting and control process 1. Establish responsibility for the budget-setting process 4. Prepare the budget for the area of the limiting factor 5. Prepare draft budgets for all other areas 8. Communicate the budgets to all interested parties 2. Communicate budget guidelines to relevant managers 3. Identify the key or limiting factor 6. Review and co-ordinate budgets 7. Prepare the master budgets 9. Monitor actual performance relative to the budget 10. Act to ensure performance conforms to the budget Click on each box for an explanation

4. Step 1: Establish Responsibility  Normally, this is the work of a Budget Committee, consisting of a senior representative of each of the important areas (Sales, Production etc.)  Often a Budget Officer is appointed to carry out tasks required by the committee.  This person is often an accountant.

5. Step 2: Communicate Guidelines  At this stage, all previous work (e.g. strategic planning, overall business objectives for the year) are communicated to the heads of the various departments.  This will normally be an interactive process, and heads of departments will often have played an important part in drawing up the planning documents.  At this stage, it may be the case that each departmental or section head will be asked to prepare a draft budget for the following year for their area, as a ‘bid’ for funding, within the guidelines set. (This may also occur later – at step 5)

6. Step 3: Identify the Limiting Factor  The Key or Limiting Factor is the aspect of business that is crucial to it achieving the objectives set.  For many businesses this is sales; however in some circumstances it may be labour, or even the ability to maintain supplies of raw materials. It may even be, a cash flow issue, where an overdraft needs to be carefully managed.  Clearly this will need to be as a result of detailed analysis of the current position.  It should also be noted that the Limiting Factor may change from year to year.

7. Step 4: Prepare the Budget for the Limiting Factor  Often, this is simply preparing the Sales budget. If so, it would be based on market research and on evidence from sales in past years*.  If the Limiting Factor is another area, clearly, the capacity of the business to operate in that area would need very careful analysis of the available evidence to ensure that the information is as accurate as possible.  This factor will now define the overall activity level of the business for the next 12 months. *N.B. In research by Dury et. al, 1993, 85% of all businesses based such targets on opinions of sales staff. (see M and A. p 368)

8. Step 5: Prepare draft budgets for all areas  Once the details of the Limiting Factor Budget are known, other budgets can then be prepared.  Two methodologies can be employed: 1. A Top-Down approach: Senior management of each area originates the targets, then filters then down, requiring managers lower down to prepare budgets which conform to these targets. 2. A Bottom-Up approach: Targets are fed upwards from the lowest levels, then negotiate with the manager higher up in order to achieve a budget which conforms to the constraints set by the limiting factor.  The Bottom-Up approach clearly involves more effort, and may result in several rounds of negotiation at different levels before agreement is reached. It does however hold the promise of achieving greater consensus.

9. Step 6: Review and Co-ordinate  All budgets are submitted to the Budget Committee for scrutiny, to ensure that they are complementary, and dovetail together well.  Where discrepancies occur, the budget committee will exert its authority and budgets will be returned for amendment.

10. Step 7: Prepare Master Budgets  The Master Budgets are normally:  The budgeted Profit and Loss account  The budgeted Balance Sheet  Possibly a Budgeted Cash Flow  This work is undertaken by the budget committee.

11. Step 8: Communicate Budgets  The budgets agreed by the committee are now passed to individual managers.  Normally this is filtered down through senior, middle and junior management layers, to the budget holder.

12. Step 9: Monitor Performance  Monitoring of performance may be carried out weekly, monthly or quarterly.  Examination of actual performance against targets will be done by the budget holder – the person responsible for the budget, and the target.  Where there is significant variation from the budgeted value, managers would be expected to act.

13. Step 10: Ensure Performance matches the Target  This is the process of control.  There are two ways in which we may match performance with target: Modifying behaviour: it may be clear that an ‘overspend’ is occurring, or that predicted sales are not being achieved. If so, curbs to spending must be put in place, and sales campaigns re-energised. Modifying the target: it may become clear that targets were unrealistic. If so, new targets must be negotiated, and a new budget issues with amended targets. This would undoubtedly have repercussions elsewhere in the business.  The latter part of this presentation concerns itself with the details of this process.

14. Budgetary Control Structures Budgets provide a useful mechanism for control.  This starts with the detailed planning within the budget, which forms the basis for exercising control  In addition we need a basis for measuring actual performance against planned performance  Finally in exercising control, we need a means of finding out where and why events deviated from the plan, and ways of rectifying these.

15. The budgetary control process Prepare budgets Perform and collect information on actual performance Respond to variances between planned and actual performance and exercise control Click on each box for a fuller explanation

16. Performance Monitoring Techniques The figures within a budget serve as a basis for measuring the performance of a team or department. The following interrelated techniques can be used:  Simple Performance Comparison Simple Performance Comparison  Flexible Budgeting Flexible Budgeting  Variance Analysis Variance Analysis

17. Sample Variance Analyses Sales Volume Variance The difference between the profit as shown in the flexed budget and the actual profit Flexed Budget:Profit :£30,000 Actual FiguresProfit:£12,000 Sales Volume Variance:£18,000 Adverse

18. Typical Variance Analyses carried out Direct Material PRICE variance (Actual material purchased x standard price) less Actual cost of material purchased Direct Material USAGE variance (Standard quantity of material required for actual production x standard price) less (Actual material x standard price Total Direct Material variance Standard direct material cost less Actual direct material cost

19. Types of Control There are essentially two types of control used in budget management:  Feedback Control: where the information from actual performance is used to cause actions to be taken to rectify an unfavourable situation.  Feedforward control: where action is taken in advance to anticipate what might occur, and therefore avoid an unfavourable outcome.

20. Key elements for budgetary control  Achievable yet rigorous targets  Accurate, relevant, customised and timely reporting  Short reporting periods (e.g. one month)  Clear lines of responsibility  Accountability of the budget holder  Records of action taken to control operations  Flexibility provided where appropriate  Serious attitude from higher management towards importance, relevance and accuracy of budgets

21. The use of Targets for Control  Targets in themselves are a useful means of control. These are devolved down to junior managers who are able to monitor and self-correct.  Regular upwards reporting of performance to targets means that problems which occur will be relatively minor and easier to deal with.  It is only when large variances occur between targets and actual performance that further investigation and intervention is required.

22. Investigating Variances  This can be expensive in terms of time and money.  Knowing the reason for a variance is only useful if an investigation into its cause can yield a method for rectifying it.  To decide whether this should be done, we can use the statistical notion of significance. In this case, we would regard variance to be significant if it was greater than 5%. In this case: Significant adverse variances will need to be acted upon. Significant favourable variances should be investigated. Insignificant variances should simply be kept under review.  We can only act on variances if the cause of them is known, and there are clear courses of action to be taken

23. Activity Comment on the following: (a)The main function of calculating variances is to provide feedback to managers on performance. (b)All variances should be investigated to find their cause. (c)It is highly valuable to calculate variances because they will tell you what has gone wrong.

24. Activity a Solution (a) The main function of calculating variances is to provide feedback to managers on performance. Solution This misunderstands the term ‘feedback’, viewing it simply as “information”. Variances are used dynamically as either feedback or feedforward control mechanisms, so that managers can act either compensate for an already-existing unfavourable situation (feedback), or to prevent one occurring (feedforward). The variances identify what needs to be modified, and can help to suggest courses of action.

25. Activity b Solution (b) All variances should be investigated to find their cause. Solution (i) It is extremely unlikely that any budget target will be hit exactly; that is simply a fact of life. To that extent, variances will occur on all targets, even if this is only by a few pounds or pence. If we were to investigate all variances, we would waste a lot of effort and a lot of time. (ii) Investigating variances can be expensive. Significant variances only (greater than 5%), should be investigated, and only then if this appears to promise a course of action.

26. Activity 10.3c Solution (c) It is highly valuable to calculate variances because they will tell you what has gone wrong. Solution Calculating variances identifies a discrepancy between a predicted amount and an actual amount. If that difference is significant, then it might tell you that something has gone wrong, but the cause might be somewhere else. Investigating variances might (or might not) identify the ‘root cause’ of the problem, but it might not tell you how to rectify it; for example, the discrepancy could be caused by an over-ambitious budget target.

27. Activity 2 A Sales Manager believes that she could reach her overall sales budget target by reducing prices and selling a higher volume of units. 1. Why might it not be sensible for her to do so? 2. What overall issues does this raise about budget monitoring and control?

28. Activity 2 Solution (1) A Sales Manager reaches her overall sales budget target by reducing prices and selling a higher volume. This is not sensible because: Production targets will have been set in the production budget; this will involve budgeting for raw materials and labour etc. Suddenly selling more will cause problems elsewhere; this will mean that higher stock levels will be required, and may cause problems with debtors. Similarly, reducing prices will reduce profitability. This will have an effect on the company’s balance sheet, and may ultimately reduce dividends to shareholders.

29. Activity 2 Solution (2) What overall issues does this raise about budget monitoring and control? Budgets are interrelated, and targets are set to dovetail; individual managers need to know how their targets match with those of others. One way to do this is through a budgetary committee, and participation in the budgetary process. Managers not only need targets, they need to know to what extent under ‘normal conditions’ those targets can be flexed, that is, by how much can we exceed or fall short without a new budget needing to be set?