Welcome

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Process of Budgeting & Budgetary Control
Lecture Session for PGCBM Programme of XIMB Through
Reliance Infocomm Ltd’s VC Facility

Dr. P. C. Basu

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Agenda
        Nuances of Performance Budget Budget & Business Managers Overviews Types of Budget Principal Budget Factors Development of Budget Budgetary Control Budget Manual

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Nuances of Performance Budget

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Nuances of Performance Budget
Definition
A Performance Budget is a comprehensive document containing the plan of actions, prepared in coordination with all the operating and servicing functions to achieve a preset targets during a defined period of time. It is expressed in quantitative and financial terms. “A budget is a sandwich activity between ambitious goals identified in the corporate strategic plans on the one side and hardcore reality faced at the market place and the shop floor or service generating station on the other. The objective is to plan for removing the obstacles so that the firm can be propelled towards attainment of the long term goals.”
The Institute of Cost & Management Accountants, London
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Nuances of Performance Budget . . . 2 Basic Features
 It is a comprehensive document

 It lays down the coordinated plan of actions encompassing all

the operating and servicing activities
 It is expressed in quantitative and/or financial terms

 It is prepared prior to a defined period of time
 Its purpose is to achieve the objectives of immediate future

 Ultimately directed towards achieving the long term corporate

goals A Budget is also known as ‘Annual Operating Plan’

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Nuances of Performance Budget . . . 3
Objectives
 Combining the ideas of employees at all levels  Promoting and motivating organised participation at various

levels for  Clear understanding of goals, and  Contributing towards goals
 Coordinating all products/services related and functional

activities
 Obtaining commitment for performance in the form of

divisional /departmental budgets
 Planning for  Realising optimum revenue income  Controlling input costs and other expenditure  Maxmising efficiency and profitability.
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Nuances of Performance Budget . . . 4
Objectives (contd.)
 Minimising potentially conflicting purposes among related

operating segments
 Providing a basis for  Evaluating the actual performance

 Facilitate corrective actions for the areas of adverse results
 Serving as a methodology for authorising use of scarce

resources
 Optimising efficiency and profitability

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Nuances of Performance Budget . . . 5
Behavioural Issues
“An organisational goal is a desired state of affairs, which the organisation attempts to realise”.
Prof. A. Etzioni, 1964

“Organisational goals are the desired ends or results towards which

the behaviour is directed.”

“In order to consider desired state of affairs in future as goals, evidences are to be there to prove that behaviour of all concerned are directed towards achieving those future state of affairs and thus goals become operative goals”
Encyclopaedia of Professional Management, 1978
(Mere wishful statements are of no use)

“Participation in the process of setting budgetary targets may promote better performance through facilitation of learning and knowledge acquisition”
S. K. Parker & T. D. Wall, 1998
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Nuances of Performance Budget . . . 6
Authoritative Recommendation
Managerial effectiveness improves only if the set goals are  Acceptable to managers
 Precise  All pervasive

 Attainable
 Congruent with the corporate goals at the aggregate level  Comparable against alternatives
Source: PCB’s desk survey for Doctoral Thesis on Transfer Pricing System in a Mult-divisional Environment

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Nuances of Performance Budget . . . 7
Elements of Performance Budget
 Quantitative Plans - Sales and Production

 Input/ Output Norms - Materials, Utilities and Human
      

Resource Procurement of Rates Norms for Expensing - Overheads Direct and Indirect Taxation Profit & Loss Statement Cash Flow Forecast Balance Sheet Performance Analysis

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Budget & Business Managers

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Budget & Business Managers
Psychological aspects and approaches of business managers
 Budget has no motivational effect unless they are accepted by the

concerned managers as their own;
 The targets, which motivate the best performance is the one that is

more demanding than what will generally be achieved;
 Demanding budgets are also seen as more relevant than less

difficult targets, but negative attitude sets in, if they are considered too difficult;
 Acceptance of budgets is facilitated when good upward

communication exists;
 Managers’ reactions to budgeted targets are affected both by their

own personality and more by general and organisational norms; and
 Once the target is accepted rest of the steps of budgeting exercise

becomes easier.
(Excerpts from Hofsted’s Study)
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G. H. Hofstede’s Graph for Employee Behaviour (in the Process of Target Setting)
Management Expectation A c h v e m e n t

Employee Performance

Easy Difficult Impossible Efforts - Perception of Employees / Management >
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Overviews of Budgeting

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Overviews for Budgeting
Functional and Aggregate at the Organisational Level
1. 2. 3. 4. Corporate mission, long term plans and strategies Growth in capacity, turnover, profitability, net worth, market capitalisation, etc., vis-à-vis of the industry – domestic/ overseas Limiting factors and constraints – both external and internal Expansion and modernisation and diversification of activities

5.

6.

7.

Actions initiated for:  Improving quality of products and services  Upgrading technology and value engineering  Achieving cost control and cost reduction Outcomes from market research/ survey and espionage:  Prompt proactive/ reactive actions for changes in demand,  Consumer behaviour and latent demand  Competitors’ strategies  Impending product and service obsolescence Changes in geo-physical and socio-economical environment of business.
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Types of Performance Budget

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Types of Performance Budget Zero Base Budgeting - Features
1. Every functional manager has to justify each of his budget proposal in its entirety 2. They have to provide sound practical justifications for:
 Each assumption for physical performance and turnover

 Every proposal for expenditure
 Demand for resource allocation  Action points with business processes for achieving each target

3. No budget proposal is accepted simply because it was done in the past or has been proposed based on the same assumption

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Types of Performance Budget (contd.) Zero Base Budgeting - Steps
1. Define objectives of budgeting in line with those of the divisions, product groups and the company as a whole 2. Evaluate alternative ways of achieving the budgeted objectives 3. Assess cost economics of each proposal 4. Predict consequence of not proposing the the next best alternative action other than the one selected as the budget proposal Most of the business organisations in practice follow a hybrid system of budgeting – combination of zero base and conventional methods
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Types of Performance Budget (contd.)
Rigid Budget
 Budget is not changed even if the assumptions undergo changes for reasons beyond control  Such changes are not effected even if the actual operation is at lower or higher level than the budget

 Variances are explained with justifications highlighting
 Changes in actual environment vis-à-vis the budget assumptions  Effects of such changes in performance  Corrective actions required to tide out the adverse effects  Actions required to maximise performance in case of favourable developments in the environment

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Types of Performance Budget (contd.)
Flexible Budget
 Budgets are prepared on the following bases: a. Level of activities in terms production/ sales or units of services b. Rate, yield, productivity of man, machine, software; variable costs, etc. per unit of input c. Seasonal factors for (a) and (b) d. Fixed costs for the period e. Profit is determined considering the above incomes and expenses  With changes in actual performance for uncontrollable reasons, budgets in respect of (b), (c) and (d) are also changed,  Thus allows the budget to be changed according to the current conditions and gives it a character of flexibility.  Variations from budget need not be explained to the extent they are due to changes in conditions beyond control.
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Length of Budget Period
A. Yearly Budget 1. Generally prepared for the next financial year 2. Calenderisation for each month considering seasonal fluctuations B. Rolling Budget 1. Prepared for the next twelve months’ period to start with 2. After finishing of each month or quarter, budget for the same month or quarter in the next year is prepared twelve months in advance 3. Thus budgeting is a continuous exercise 4. Next twelve months’ budget is always available

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Development of Performance Budget

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Development of Performance Budget Steps
Bottom-up Approach 1. Final ‘Performance Budget’ is prepared by consolidating the budgets of
 Individual profit centre and cost centre, or  Each type of product or service

2. The budget of each profit centre and cost centre or a product in turn is developed by consolidating the budgets of each functional area like:
      Marketing, Sales and Distribution Production/ Service Output and Maintenance Procurement and Logistics Personnel and Administration Finance Capital expenditure
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Development of Performance Budget … 2 Steps (contd.)
3. Preparation for each functional budget starts with:  Evaluation of the factors/ reasons of success and failures in the recent past  Analyses of principal/ critical factors for future performance  SWOT analysis  Steps to be taken for combating threats and availing of opportunities  Steps to be taken for further improving strengths and minimising weaknesses

4. Budget for each functional area is prepared after considering factors, specific and peculiar to its area of operation
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Development of Performance Budget … 3

Steps (contd.)
Top-down Approach The following steps are followed:
 Budget of the entire organisation is first prepared  Individual profit/ cost centre is given targets for different elements of revenue and costs  They follow the same process for preparing the budget as in case of bottom-up approach. (However, their independence is somewhat restricted by the given targets)  At the time of aggregation the second review for the consolidated budget is done

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Principal Budget Factor - All Functions
1. Principal budget factor can be one or more 2. The following can be the principal budget factors: Limitations in marketing and demands Limitation in capacity of Plant/ Service Infrastructure Limitation in availability of long/ short term fund Limitation in availability of inputs Overall corporate objective, profit and profitability Regulatory provisions Geo-political and socio-economic conditions 3. Consideration of principal budget factor is desirable in preparing a realistic budget 4. Taxation – FBT, Withholding Tax, ED and Service Tax, VAT, Octroi 5. It draws particular attention of all towards removing sub-optimality 6. Ultimately the organisation proceeds through the path of growth and prosperity
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Preparation of Functional Budgets Marketing Forecasts & Sales Budget
1.Responsibility Heads of Marketing, Selling and Distribution function 2.Overviews
 Corporate mission, long term plans and strategies  Socio-economic and geo-physical environment - domestic and overseas  Plans and policies of Governments including of the countries of major overseas buyers  Overall growth rate of the industry vis-à-vis the Company’s growth and the targeted market share  Plans and strategies of existing competitors and and threats of from potential competitors – domestic and overseas  Contemplated change(s) in capacity, technology, product mix and status of various projects in hand
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Preparation of Functional Budgets … 2
Marketing Forecasts & Sales Budget (contd.)
3. Major Factors Considered  Orders  In hand (to be executed in full)  Spillages (partly executed)  Off-takes indicated by the customers during the budget year  Tenders/ quotation submitted and chances of success  Proposed coverage of new customers and/ or geographical locations both domestic and overseas  Prevailing trend of market price, credit terms, delivery options  Impact of changes in product design, quality and utilities  Additions to and changes made in distribution network of dealers, stockists and CSAs, etc.  Changes in volumes of complementary, sample, freebies, if any  Proposed plans and programmes for advertisement, sales promotion, trade fairs, etc.  Seasonal fluctuation in demands and price
Note: Marketing budget is the Master Budget if production is not a limiting factor.
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Preparation of Functional Budgets … 3
Production/ Manufacturing & Budget
1. Responsibility Works Manager and Head of Production Planning & Engineering Department 2. Overviews  Corporate mission, long term plans and strategies  Changes contemplated in production/ service capacity (both present and future) by means of
    Expansion by addition of completed equipment and facilities Elimination of bottlenecks and balancing manufacturing capacities Modernisation Recruitment

 Status of projects for modernisation, expansion, diversification, value added services, etc. in hand  Overall work environment  Corporate plan for change in technology
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Preparation of Functional Budgets … 4
Production & Manufacturing Budget (contd.)
3. Major Factors Considered  Shift utilisation plan for:  Production  Routine, preventive maintenance and annual overhauling  Trial run of new machines and materials

 Productivity of man and machine  Additional or surplus manpower, production incentive, etc. based on work point-wise analysis  Absenteeism, overtime working and temporary manpower
 Availability of materials, services, components, and utilities  Plans for ancilarisation of components,  Outsourcing of manpower, services, etc. Note: Production budget is the Master Budget if marketing projection is not a limiting factor
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Preparation of Functional Budgets … 5
Materials and Input Services
1. Responsibility Heads of Procurement and Materials Management supported by heads of Treasury and Production Planning & Engineering 2. Overviews  Calenderised projection of product-wise production and seasonal fluctuation, if any  Availability of working capital finance  Facilities and their capacities for storage and handling  Indirect Tax planning 3. Major Factors Considered      Stock of materials in hand and orders pending with suppliers Input-output relationship of major direct materials Suppliers’ performance and reliability - schedule, quality, price, Lead time, ordering cost, safety/ buffer stock level, Trend in prices of major inputs including utilities
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Preparation of Functional Budgets … 6 Materials and Input Services (contd.)
3. Major Factors Considered (contd.)
 Changes in Governments’ plans, policies and levies  Approaches and requests from new suppliers including from overseas market  Demand for inputs arising out of growth and alternative uses  Result of value engineering, for material/ input software substitution exercise  Economics of bulk buying

 Plans and policies for outsourcing of semi-finished inputs and services, and so on

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Preparation of Functional Budgets … 7 Manpower & Establishment Expenses
1. Responsibility Head of HR function supported by heads of functions across the organisations 2. Overviews  Corporate plans and strategies for human resource development  Specific state of affairs in any group or department’s employees  Corporate plan for:  Modernisation, expansion and diversification  Changes in technology and automation  Discontinuation of any product/ service, unit or segment of operation due to outsourcing  Socio-economic and political environment  Genetic Engineering – inducting, budding and grafting  Plans for rationalisation of compensation structure – Moving towards more payments linked to performance  Industry standards
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Preparation of Functional Budgets … 8 Manpower & Establishment Expenses (contd.)
3. Major Factors Considered  Intimation from operating departments regarding additional requirement and/or surplus manpower  Scopes for re-deployment of manpower through multi-skilling and training and development

 Changes in Income Tax Rules
 Training, promotion, transfers, retirement, VRS, etc.  Ability to pay - profit and profitability of the organisation  Terms of Employment, Employees’ Manual and Long Term Settlement, etc.  Reports on job evaluation and merit rating  Demand and supply of Human Resources at the market place

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Preparation of Functional Budgets … 8
General Expenditure
A typical method for budgeting General & Administration Expenses under each head:
Last year’s actual expenses Minus Expenses for last year’s one time activities Minus Targeted reduction from normal expenses Minus Reduction arising out of planned discontinuation of old operations Plus Expenses for new activities contemplated for the budget year Plus Expenses for the budget year’s one time activities Plus/ Minus Inflationary adjustment Plus/ Minus Increase/ decrease due to statutory provisions Plus/ Minus Increase/ decrease due to changes in regulatory provisions Equal to Next year’s budgeted expenses

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Budgetary Control

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Budgetary Control
1. Most frequently used and effective ‘Tool for Performance Control’ 2. Easy and simple for application 3. Steps in budgetary control

 Actual performance is recast in line with elements of budget  Variances between budget and actual are calculated  Reasons are analysed for all variances in terms of  Magnitude  Compensatory  Relative  Subjective  Reasons are classified in the following manner:  External - controllable  External - non controllable  Internal - avoidable/ controllable  Internal - non-controllable  Targets are easy in case of large positive variance  Targets are difficult in case of large negative variance
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Budgetary Control … 2
Steps in budgetary control (contd.)  Corrective measures taken and implemented for
 Immediate results  Medium term results  Long term results

 ‘Strategic Plans’ of the company are revisited  Corporate and Perspective Plans are also revisited  Communications are sent to all concerned at all levels

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Budget Manual
It is a comprehensive document containing generally the following guidelines for preparing budget: 1. Objectives synchronised with the objective of the organisation 2. Responsibilities of employees of different functional areas across the levels
3. Length of budget period and the required periodical break up

4. Formation of budget committees - at the functional level, profit center level and the corporate level for preparation and review
5. Duties and responsibilities of the Budget Manager for preparation and exercising budgetary control 6. Procedures to be followed for computerised control

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Budget Manual …2
It is a comprehensive document containing generally the following guidelines for preparing budget:
7. Formats for preparing budget befitting the operations and functional areas to ensure uniformity and standardisation 8. Type of budgeting – Traditional or Zero-based and Rigid or Flexible 9. Guidelines for categorisation of overheads – Variable and fixed as well as according to natural/ functional head 10.Guidelines for comparison and variance analysis – Last year’s actual, last year’s budget, Corporate Plan, Standards, Competitors’ performance, etc. 11.List of financial statements to be submitted and formats for thereof – Profit & Loss Statement, Balance Sheet, Cash Flow Statement, Detailed Income and Expenses Statements and Variance Analysis 12.Organisation-specific issues
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?
Your Questions
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Thank You Very Much Indeed
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