1. THHGLE13B Manage Finances Within a Budget Prepared by Jonathan Lavaro

2. PO Box 20512 World Square NSW 2002 lavaro@live.com http://lavaro.tripod.com/thhgle13b.htm 0415315443

3. “Who of you that wants to build a tower does not first sit down and calculate the expense, to see if he has enough to complete it?” - Luke 14:28 Budgeting

4. Budgets Key financial objectives are derived from strategic objectives Budgets developed around financial objectives Key financial objectives usually expressed in profitability terms (e.g., net profit target, percentage return on investment, profit margin in sales)

5. Budgets Budgets are plans showing dollar or unit values Financial budgets are expressed in dollar terms Contains financial estimates of expected results of the operation in a future period Budget periods should be 12 months or can be split for shorter periods if required Estimates should be realistic and achievable Should be developed in consultation with personnel affected by them

6. Role of budgets Planning Control Employee motivation

7. Planning Budgets are quantitative plans that reflect operational objectives for a future period Contain estimates of future physical operations, expressed in dollar terms The estimates are targets to achieve

8. Control Budget estimates provides standards for evaluating actual results Corrective actions are employed if results are unsatisfactory

9. Employee motivation Budgets can be used to communicate business objectives to employees and management Makes employees aware what is expected of them Knowledge of targets helps motivate employees to perform especially if tied in with a desirable bonus/incentive

10. Discuss Why should employees be involved in budget preparation?

11. How Budgets Can Be Abused We are asked to prepare a budget to show how we would spend money if we got it for a program or project - so we inflate everything, assuming that we will never get as much as we ask for Towards the end of the financial year, we spend heavily to match the budget expectations - because there is a danger that if we fall below budget, we will not stand a chance of getting an increase in the next financial year, regardless of increased needs items appear constantly in budgets because they have become implanted - there is no longer a need for them, but they get passed automatically and serve as a contingency for other shortfalls

12. Types of Budgets

13. Operating budgets Prepared for each operating activity of the operation Includes: –Sales budget –Production budget –Purchases budget –Cost of production budget –Cost of goods sold budget –Operating expenses budget

14. Cash Budgets forecasts of how much cash the organisation will have on hand and how much it will need to meet expenses can reveal potential shortages or the availability of surplus cash for short-term investments

15. Capital Budgets Summarise proposed acquisitions and disposal of long-term assets used in the operation

16. Revenue Budgets is a forecast because it is based on projecting future sales Managers must take into consideration their competitors, advertising budget, sales force effectiveness and other relevant factors, and they must make an estimate of sales volume Then, based on estimates of demand at various prices, managers must select an appropriate sales price

17. Financial Statement Budgets Main financial plans of the business Composite budgets that summarise the estimates in the operating and capital budgets of the operation Presented in the same fixed formats as financial statements for past results

18. Three main financial statement budget Budgeted income statement Budgeted cash flow statement Budgeted balance sheet

19. Static budgets Show estimates at one level of assumed business activity

20. Static budget example Sales budget _____________________________________ July $ _____________________________________ Sales 14,000 TOTAL 14,000

21. Flexible budgets Show expected results at various levels of assumed business activity Saves time, as new budgets do not have to be prepared if business activity changes

22. Flexible budgets Sales budget _____________________________________ Worst expected Best expected _____________________________________ July July $ $ _____________________________________ Sales 12,000 16,000 TOTAL 12,000 16,000

23. Short-term budgets Prepared for periods of up to one year ahead Can be weekly, monthly, quarterly or annually

24. Long-term budgets Prepared for periods exceeding one year and up to five years ahead e.g., a three-year operational business plan will include annual budgets for the three-year period of the plan

25. Approaches to Budgeting

26. Incremental Budgets Program Budgets Zero-Based Budgets

27. Incremental Budgets Traditional Has two identifying characteristics: –First, funds are allocated to departments or organisational units. The managers of these units then allocate funds to activities as they see fit –Second, an incremental budget develops out of the previous budget. Each period's budget begins by using the last period as a reference point. Only incremental changes in the budget request are reviewed

28. Problems with Incremental Budgets how to identify inefficiencies and waste when only incremental changes in the budget request are reviewed? Nothing ever gets cut money can be provided for activities long after their need is gone

29. Program Budgets allocate funds to groups of activities (programs) that are needed to achieve a specific objective funds are allocated to activities, not to departments designed to deal with one of the major incremental budgets problems, funds are allocated to activities, not to departments

30. Zero-Base Budgets originally developed by Texas Instruments requires managers to justify their budget requests in detail from scratch, regardless of previous appropriations designed to attack the second drawback in incremental budgets: activities that have a way of becoming immortal shifts the burden of proof to the manager to justify why his or her unit should get any budget at all

31. Problems with Zero-Base Budgets increases paperwork and requires time to prepare important activities that managers want funded tend to have their benefits inflated

32. Questions to ask when budgeting what do we want to achieve? how will we go about it? what resources will we need? how many people? how much time? what rates of pay? what can go wrong and how can we plan for emergencies?

33. Desired Profit Target

34. Should be determined before preparing budgets Minimum acceptable profit required for the operation to remain viable Guide for preparing annual budgets

35. The Desired Profit Target is to Remunerate a business owner for the time and effort put into the business Provide an adequate ROI

36. Formula Required rate of return on owner’s funds invested (%) = Required rate of investment on (%) (current bank deposit rate) + Premium for risk (%) Risk allowance is normally between 10% and 20% The higher the risk, the higher the premium

37. Example Amount of investment: $61,740 Wage to hire a manager to manage the business: $50,000 Current bank deposit rate: 6% per annum Risk rate: 12% Calculate the desired rate of return (p.a) $50,000 + $11,113 = $61,113 6% + 12% = 18% $61,740 x 18% = $11,113

38. Your turn Alan wants to know the minimum net profit he should accept for his business He could earn $38,000 per annum employed as a manager in a competitor’s business He currently has $40,000 invested in the business The current bank deposit rate for a sum of $40,000 is *% per annum The acceptable risk premium rate for businesses in the industry is 15% per annum Determine the annual net profit for Alan’s business

39. Budget-Building Process

40. Annual budget-building process Specific operating budgets Sales budget ($) Production budget (units) Purchases budget (units) Cost of production budget ($) Cost of goods sold budget ($) Operating systems budget ($) Capital budgets Capital expenditure budget ($) Capital disposals budget ($) Financial statement budgets Budgeted income statement ($) Budgeted cash flow statement ($) Budgeted balance sheet ($)