MBA711

ACCOUNTING & ANALYSIS

FOR MANAGERS

Week 9
Strategic Planning & Budgeting

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Welcome to Week 9! Quote for Today:
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Welcome to Week 9 – Week 8 Recap

• Self Assessment 9.2 (page 311) – cost-volume-profit

analysis and relevant costing

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Let’s begin week 9 Topic:
Strategic Planning & Budgeting
Textbook Reading: Chapter 11
Learning Objectives:
 Explain the relationship between corporate objectives, long-term plans and budgets,
and also between planning and control
 Define a budget, set out the main components of the budget-setting process, explain
how the various budgets interlink, and identify the main uses of budgeting
 Explain the importance of cash budgeting, and prepare a simple cash budget from
relevant data
 Construct a range of other budgets from relevant data
 Use a budget as a means of exercising control over the business, explain and apply
flexible budgeting, and calculate a series of variances between budget and actual to
help control activity
 Identify the limitations and the behavioural implications of the traditional approach
to control through budgets and standards
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 Corporate objectives, long-term plans
and budgets
 Corporate objectives

 Identify the broader goals of the business

 Long-term plan

 Defines the general direction of the business over next (e.g.) five years, and
covers matters like:

o market(s) the business aims to serve

o production/service methods

o levels of profit sought

o financial/financing requirements and methods

o personnel and other requirements

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 Corporate objectives, long-term plans
and budgets
 Budget

 Essentially a financial plan for a future time

 Expressed in financial terms

 Converts the long-term plan into an actionable

blueprint for the future

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 Exercising control

 Control is defined as compelling events to conform to

plan

 Variances between actual outcomes and budgets

should be highlighted by accounting information

 This can be followed by steps to get the business

back on track towards achieving the budget

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Time horizons of plans and budgets

 Long-term plans are typically five years and budgets

are typically set for 12 months

 Appropriate time horizon depends on business and

industry, e.g. five years in an IT business would be
too long due to rate of change

 Budgets may also be done on a ‘rolling’ monthly

basis (continually updated)

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 Limiting factors

 Aspects stopping a business achieving its objectives

to the maximum always exist, e.g. labour, materials
or plant

 Limiting factors need to be identified early in the

budgeting process when preparing the budget

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 The interrelationship of various
budgets
 In a business, there are normally several budgets –
each relating to a specific aspect of the business

 Ideally, there should be a separate budget for each

person in a managerial position

 The contents of all individual budgets are

summarised in a master budget

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 The interrelationship of various
budgets

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 The budget-setting process
1. Establish who will take responsibility for the budget-setting process

2. Communicate budget guidelines to relevant managers

3. Identify the key or limiting factor

4. Prepare the budget for the area of the limiting factor

5. Prepare draft budgets for all other areas

6. Review and coordinate the budgets

7. Prepare the master budgets

8. Communicate the budgets to all interested parties

9. Monitor performance relative to the budgets

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The budget-setting process
 Budget committee – a group of managers formed to
supervise and take responsibility for the budget-setting process

 Budget officer – an individual, often an accountant, appointed

to carry out or take responsibility for having carried out the
tasks of the budget committee

 Top-down – an approach to budgeting where senior

management originates the budget targets

 Bottom-up – most of the budget input comes from lower-level

staff such as sales representatives

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Incremental and zero-based
budgeting
 Incremental budgeting – based on what happened
in the previous year with adjustments for expected
future events, e.g. inflation

 Referred to as discretionary budgets

 Zero-based budgeting – adopts a questioning

approach to managers’ areas of responsibility;
considers particular activities and the ways in which
they are undertaken; starts with a zero base

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The uses of budgets

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 Non-financial measures in budgeting

 Non-financial performance indicators have a vital role

in assessing performance, e.g. customer/supplier
delivery times, set-up times, defect levels, customer
satisfaction

 Can be used as a basis for targets

 Can be incorporated into the budgeting process and

reported alongside financial targets

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 Preparing the cash budget

 The cash budget is a key budget – all aspects of a

business are eventually reflected in cash

 The cash budget reflects the whole business more

than any other single budget

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 Preparing the cash budget

1. Budget broken down into sub-periods, usually months

2. In columnar form, one month per column

3. Cash receipts and payments are identified under

headings and a total for each month is shown

4. The surplus or deficit of cash is identified for each

month

5. The running balance of cash is identified

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Example 11.1 (page 369 of textbook)

• The business allows all of its customers one month’s credit (i.e. goods bought in January
will be paid for in February, and so on). Sales in December were $60,000
• The business plans to maintain inventory at its existing level of $30,000 until March, when it is to
be reduced by $5,000.
• Inventory will remain at this lower level indefinitely.
• Inventory purchases are made on one month’s credit (the December purchases were $30,000)
• Salaries and wages and other overheads are paid in the month concerned.
• Electricity is paid quarterly in arrears, in March and June.
• The business plans to buy and pay for a new delivery van in March. This will cost a total of $25,000,
but an existing van will be traded in for $14,000 as part of the deal. The business expects to start
January with $12,000 cash
continues
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Example 11.1 (continued) Cash Budget for the six months ended 30 June

Jan. Feb March April May June

$000 $000 $000 $000 $000 $000
Receipts
Accounts Receivable1 60 52 55 55 60 55
Payments
Accounts payable2 (30) (30) (31) (26) (35) (31)
Salaries and wages (10) (10) (10) (10) (10) (10)
Electricity (14) (9)
Other overheads (2) (2) (2) (2) (2) (2)
Van purchase (11)
Total payments (42) (42) (68) (38) (47) (52)
Cash surplus/deficit 18 10 (13) 17 13 3
Opening balance 12 30 40 27 44 57
Cash balance3 30 40 27 44 57 60

20

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Example 11.1
continued

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Preparing other budgets
 Other budgets are mostly prepared in the same
format as the cash budget, for example:

 accounts receivable budgets

 accounts payable budgets

 inventory budgets

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Example 11.2 (page 371 of textbook) Accounts receivable budget

Sales in Sales in
December January

continues
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 Example 11.2 (page 371 of textbook) Accounts payable budget

December purchases January purchases

continues

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 Example 11.2 (page 372 of textbook) Inventory budget

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 Example 11.2
continued

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Using budgets for control

 Control is usually seen as making events conform to

a plan

 Budgets represent the plan and provide the basis for

exercising control over the business

 The planning and control process usually follows a

sequence

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 Example 11.3 (page 374 of textbook)

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 Using budgets for control
 Comparing actual performance with the budget

 The most important budget target to meet is the

profit target

 Draw a comparison between actual costs incurred

and budgeted costs for the level of production
achieved

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 Using budgets for control
 Flexed budget – a budget revised to reflect costs that would have
been expected for the actual activity

 Flexing the budget

 Identify which items are fixed and which are variable relative to the
level of output

 Prepare the revised (flexed) budget, then do the operating profit

comparison with actual figures

 The flexed budget makes a more accurate comparison between

budget and actual possible

 The difference between original and flexed budget profit figures is

the sales volume variance

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 Variance analysis
Key variances
 Sales volume (quantity) variance
 Sales price variance
 Materials variances:
 total direct materials variance
 direct materials usage variance
 direct materials price variance
 Labour variances:
 total direct labour variance
 direct labour efficiency variance
 direct labour variance
 Fixed overhead spending (expenditure) variance

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 Original budget Flexed budget Actual Variances
Output (production 1,000 units 900 units 900 units
and sales)
$ $ $
Sales 100,000 ($100 per 90,000 92,000 $2,000 (sale price variance )
unit) (900 x $100) (900 x $102.2) Favourable
$4,000(sales volume
variance) Unfavourable
Raw materials (40,000) ($1 per (36,000) (36,900) $900 Unfavourable:
metre); (40 metres (900 x 40 metres = (37,000 metres x Usage variance = $1,000
per unit) 36,000 m) x $1 $0.99) Unfavourable;
Price variance = $100
Favourable

Labour (20,000) ($20 per (18,000) (17,500) $500 Favourable:

hour); (1 hour per (900 x 1) x $20 (880 hour x Efficiency variance= $400
unit) $19.88) Favourable;
Rate variance: $100
Favourable
Fixed overheads (20,000) (20,000) (20,700) $700 Unfavourable
32

Operating profit 20,000 16,000 16,900

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 Using budgets for control

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 Standard quantities and costs
 Standards are planned quantities and costs (or revenues) for
units of input or output. They:

 form the building blocks of the budget

 represent targets and benchmarks by which performance is

measured

 are the basis of calculation for most variances

 should be reviewed regularly and revised if necessary

 have uses beyond the context of budgetary control

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 Investigating variances

 Can be time-consuming and expensive

 Only useful if management gains the means to regain control

so future targets can be met

 Significant adverse variances represent a potentially costly

fault and should be investigated

 Significant favourable variances represent things not going to

plan and may mean targets are set too low

 Insignificant variances should be kept under review in case

they are not the result of chance factors

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 Necessary conditions for effective
budgetary control
 A serious attitude from all levels of management

 Clearly defined areas of management responsibility

 Reasonable budget targets (focus on achievability)

 Established data collection, analysis and distribution

 Specific rather than general-purpose reporting

 Fairly short reporting periods (e.g. monthly)

 Timely variance reports made available to managers

 Action taken to regain control

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 Limitations and behavioural
implications of budgeting
 Not all expenses can be directly linked to productive
activity

 Standards can rapidly become obsolete due to

technological and price changes

 Factors outside of management control can have

impact

 Delineating management responsibility may prove

difficult in practice

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Behavioural aspects of budgetary
control
 Research indicates:

 Existence of budgets tends to improve performance

 Demanding but achievable targets seem to motivate

more than easy targets

 Unrealistic targets adversely affect performance

 Allowing managers to set their own targets improves

motivation, commitment and performance

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 Overall review

 Budgeting is critical to the success of most businesses

 It has its limitations and its critics, so any budgetary control system
must be set up carefully to ensure that:

 the environment in which the business operates is fully

understood

 the business develops an appropriate culture

 the role of the budget in terms of the fit with the strategic plan is
clearly understood

 a culture of value-adding is developed

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 Online resources

 Special Report: Better Budgeting, ICAEW & CIMA

 Corporate Budgeting, PwC

 Prepare a Budget, Business Victoria

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Summary of Week 9 Learning
Strategic Planning and Budgeting

• Strategic planning is long term planning which defines the

general direction of the business and covers broader goals for
the business
• Budgeting is a financial plan for the future of the business. It
provides the basis for exercising control over the business.
• Understand a typical budget setting process in a business

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Week 9 Action Plan & Home Learning

Textbook Compulsory Reading:

Chapter 11
Recommended reading; Corporate budgeting - PWC and Prepare a
budget – Business Victoria

Activities:
 Complete Application exercises 11.2, 11.3, 11.5 and 11.7
 Complete self assessment question 11.2 (page 384), will be
covered in class next week (week 10)

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Any Questions

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