1. 1 Budgets and budgetary control Lecture 2 Semester B Dr. Haider Shah Dr. George H. Papadopoulos

2. 2 Learning outcomes  Understand preparation of production budget  Understand preparation of cash budget  Understand use of flexed budget

3. 3 Sales Budget  Sales forecast prepared ( normally various drafts before a final achieved)  Production capacity forecast prepared  Based on these the Sales Budget prepared in detail

4. 4 Production & related budgets Is this the ‘principle budget factor’? Need to check

5. 5 Production & related budgets  Production director may need to face problems of excesses or shortfalls in capacity  Final budget will reflect quantities and costs for each product and product group.  Must cross relate with Sales budget and various inventory budgets

6. 6 Eaxmple- Production & Direct labour Budget  A company XY has 2 products X & Y  At year end 31 st Dec.2008, stock is expected to be 800 and 950 units respectively.  Budgeted unit sales are 3,000 of X and 4,000 of Y.  Closing inventories will need to be equal to 3 months sales.  The labour force is currently paid a standard rate of £2.50 per hour and take 2 hours to produce a unit of X and 3 hours of Y.  A wage increase of 50p per hour will occur from 1st Jan with an improved efficiency of 20% expected

7. 7 Production Budget- Product X Units Sales3,000 Closing stock (3/12 x 3,000) 750 Opening stock800 Decrease)/ increase in Stock(50) Production requirement 2,950

8. 8 Direct Labour Budget - Product X Hours reqd. = 2,950 x 2 x 0.80 = 4,720 hours Cost: 4,720 x (£2.50 + £0.50) = £14,160

9. 9 Production Budget- Product Y Units Sales4,000 Closing stock (3/12 x 4,000) 1000 Opening stock950 Decrease/ increase in Stock50 Production requirement 4050

10. 10 Direct Labour Budget - Product Y Hours reqd. = 4050 x 3 x 0.80 = 9,720 hours Cost: 9,720 x (£2.50 + £0.50) = £29,160

11. 11 Cash Budget ‘Detailed budget of estimated cash inflows and outflows incorporating both revenue and capital items.’ CIMA official terminology

12. 12 Solving cash flow problems  Short-term surplus 1. Make short term investments 2. Use it to finance growth(e.g.debtors) 3....  Short-term deficit 1. Reduce receivables 2. Review payables (timing / delay) 3....

13. 13 Solving cash flow problems  Long-term surplus 1. Make long term investments 2. Expand / diversify 3. Replace / update capital items  Long-term deficit 1. Raise long term finance 2. Consider disinvestment 3. Consider exit strategy

14. 14 Cash Budget – monthly basis  How much you already have in pocket at start of this month?  How much would you need to pay?  How much would you receive? (from work, parents, friends)  How much would be the balance in the end?  This will be starting balance for next month

15. 15 Cash budgets – a proforma Month 1 Month 2 £ £ Opening balance (a) x x Cash Receipts: Sales x x Other x x (b) x x Cash Payments Purchases x x Other x x (c) x x Net cashflow (b-c) X X X X Closing balance (a+b-c) X X

16. 16 Example: Shuxing designer sportswear Sales (all cash) Purchases (2 month credit) Expenses 1 month credit Jan£2,000,£1000£300 Feb£3,200£1600£500 Mar£4,320£2,160£600

17. 17 Rent and rates £4,000, payable quarterly starting on 1st March. She receives an interest free loan from her parents in February for £1,000 She buys a computer (£2,000) in January Equipment(£5,000) is to be paid for in on 1st January Opening cash balance is £1,000 REQUIRED Using the pro forma, prepare a cash budget for Shuxing for the first three months of trading. Interpret her cash position, explaining her options. Shuxing designer sportswear

18. Control and Controls Finish Control is the ability to stay on the path which leads to the desired end. Controls are the devices with which you are able to exercise control. e.g brake, clutch, gear, mirrors etc

19.  The comparison of actual results with those budgeted.  The variances between these elements are calculated and reported to management so that appropriate action can be taken Budgetary control

20. Budgets can be viewed either as:  Fixed : ◦ do not change with the level of activity ( A major limitation for control purposes)  or  Flexed ◦ are the opposite they are constructed such that they can be altered to reflect the actual activity achieved. So excludes any volume variance from the total variance. Budgetary control

21. A Flexed budget excludes any volume variance from the total variance. Impact of Volume  £10  £8  £11

22.  UH sports café sold 156 mars bars in a week for £62.40.  It had a budget of 150 bars at £67.50.  This gives a variance of £5.10. What caused this variance? Example:

23. Qty Price Total Actual = 156 0.40 62.40 Budget = 150 0.45 67.50 Variance 5.10 U Causes Volume = 6 0.45 2.70 F Price = 156 0.05 7.80 U Total variance 5.10 U A Flexible budget would eliminate the volume variance Answer UH sports cafe

24.  If budgets are being adjusted to reflect changes in activity levels then: Cost behaviour 1. We need to know how the planned costs/revenue react to output 2. The fundamentals of variable costing apply. 3. So for each we ask what type of cost is it? – Variable?, Fixed? Stepped?....

25.  At the planning stage If output is uncertain then a number of flexible budgets may be constructed and then the outcomes can be assessed prior to the acceptance of one as the fixed. (‘What if?’ analysis)  At the control stage Businesses are dynamic, so its improbable that actual activity will match that what was planned Management need to know what elements have caused a variance in order to exert control and react Importance of flexible budgets

26.  Revise the budget to reflect the volume that actually or now expected to occur  Identify what costs are related to the level of output (variable costs)  Identify the fixed costs  Can now make more valid comparison between this budget and the actual one  This is known as the volume variance  The other variances can now be investigated Flexible budget – the steps

27. Original Budget Actual Output Production & sales (units) 11001150 ££ Sales110,000113,500 Raw Materials(44,000)(44,000m)(46,300)(46,300m) Labour(22,000)(5,500hrs)(23,200)(5,920 hrs) Fixed OHs(20,000)(19,300) Profit24,00024,700 Example: Baxter Ltd (Solution in Tutorial 3) Requirement: Produce a report that illustrates all potential variances