STARTING WITH SALES BUDGET

Managing Finance (MNGFIN)

Week 4: Budgeting and accounting for control

Budgets and strategic planning Textbook reading (Atrill & McLaney: Ch. 6) At this point in your studies, you are most likely familiar with the importance of

strategic planning for organisations. Such planning requires the setting of a long-

term mission that all individuals within the company seek to fulfil. This is

accomplished through the development of smaller, more specific goals and

objectives that are to be accomplished in a shorter time period. These specific goals

and objectives are expressed and shown through the determination and use of

budgets. Budgets are very important tools that play an integral role in the strategic

planning process. In simple terms, budgets are tactical and operational plans

established from strategic plans and are prepared to attain certain objectives

expressed in financial terms. While the company may have a goal of, say, ‘being the

largest organisation within its industry’, this statement falls short in terms of

measurement. In order to judge whether this goal was accomplished or not, we must

express the objective in certain financial terms, such as market share, sales revenue,

or profits.

Budgets offer the benefit of serving as a measuring stick against which actual

performance can be compared to planned or desired performance. By expressing

goals in financial terms, the organisation is then able to properly compare its actions

and results to ensure that efforts are in line with its strategic mission. Usually

prepared for a 1-year time period and then broken down into smaller units, such as

months, budgets offer flexibility while also being forward-looking. These tools should

not be thought of as constraining, where staying within the budget must take place

no matter what must be sacrificed. Rather, budgets serve as a control mechanism,

providing a framework that the organisation or business unit should seek to work

within. Realistic budgets should serve as a motivating factor for managers to meet

certain standards and also serve as a barometer that detects when things are going

off course. In this reading you will explore how budgets support the strategic

planning process as well as how different types of budgets are interrelated. The

authors also provide a general overview of the planning and control process.

Budgets for performance evaluation Textbook reading (Atrill & McLaney: Ch. 6) While budgets serve as frameworks that help to guide individuals within the

organisation, they are also excellent methods for evaluating the performance of

divisions, business units, managers, and/or employees. Since budgets incorporate

desired results, organisations are able to compare the actual results against the

planned and desired results to determine if objectives were met. If not, managers are

better able to discern what areas fell short of expectations. By examining the areas

for concern, such as sales, materials, labour, etc., the organisation is then able to

identify those functions, managers, or employees that will need to explain why they

were unable to stay within the budget. This may bring to light such realisations that

the budget figures were unrealistic, that unforeseen events prevented the attainment

of goals, or that effort and performance were simply not adequate.

To this point, the discussion has focused on evaluating performance at the end of

the budget period. Even more importantly, budgets allow for the evaluation of

performance at regular intervals within the budget horizon. Performance can be

assessed on a monthly or quarterly basis to detect possible deviations from the

budget. Action can then be taken to correct any shortfalls in effort or revise figures

that have been deemed to be unrealistic. But even more importantly, budgets serve

as motivators of performance for managers from the commencement of the specified

time period. Having managers and employees involved with the budgeting process

creates a sense of ownership in terms of results and serves to direct efforts and

behaviours towards the meeting of goals that have been outlined.

The reading for this topic provides a foundation for how budgets are developed and

how they can be used to help managers. It is important to understand how the

budgeting process works in order to fully comprehend how budgets can be used.

Such concepts as incremental and zero-base budgeting are explored in this reading

as well. It is important to note that different methods and styles of budgeting are

appropriate for different organisations and industries. There is no one way that is

recommended or suggested; such decisions must be based on the activities and

demands of the individual organisation or business unit.

Variance analysis Textbook reading (Atrill & McLaney: Ch. 7) Budgets are very important tools with regards to evaluating performance. This topic

serves to examine the methodology for such evaluation. When the planned or

budgeted figures are different from actual results, they are said to vary from the

budget. This ‘variance’ is an important concept with regards to budgeting and judging

how well plans were set. It is necessary to note that all elements within a budget

need to be examined for variance, not just the final measure. An organisation may

have met its budgeted profit goals, but it may have fallen short of its budgeted sales

and only met the profit measure due to having lower overhead costs for that

particular time period. Analysing the variations of such elements as sales revenue,

materials costs, labour costs, and overhead costs will better enable the organisation

and managers to see how each particular area performed. It also brings to light

trends that may be occurring, such as permanent increases in the price of materials,

or one-time occurrences that do not call for any further action.

Examining the variations that occur within a budget also allows organisations to

focus on those particular areas or functions that need to be addressed or questioned.

If labour costs are higher than expected, it can be found out why this is occurring by

questioning line managers. It is possible that employees had to work longer hours

due to an unnecessary delay in a certain production process; this delay could then

be corrected. Such instances where variances cause the actual profit to be lower

than expected are unfavourable. On the other side, favourable variances can also

occur, such as when costs are lower than expected or sales volume is higher than

budgeted, resulting in higher-than-budgeted profits.

It is important to realise the true cause for a variance. An unfavourable variance in

production costs may be the result of higher-than-budgeted sales, resulting in the

need to purchase more materials. Or it may be the result of poor planning by a line

manager. This underlines the need for proper and realistic budgeting. Unforeseen

events can be dealt with and budget figures can be revised; however, setting lower

or higher budget figures for the purpose of looking good later undermines the entire

purpose of budgeting. Analysing variances can help to detect when changes occur

and what is causing them and then develop a course of action to correct it.

You will examine various areas for analysing variance within a budget as well as

reasons that differences may occur in such areas. You should read and work

through the activities provided in the chapter, as these will help to illustrate how

variances are computed as well as solidify the concept.

Effective budgetary control Textbook reading (Atrill & McLaney: Ch. 7) It would be ideal if an organisation were able to develop budgets and have each

department or business unit meet their prescribed objectives. However, it is not as

simple as developing the budget because this tool serves merely as a framework. It

is necessary to properly develop a system within the organisation that better allows

managers and employees to work towards their goals. This system must allow

individuals the freedom to accomplish what is needed while also supporting and

encouraging certain behaviours, efforts, and actions.

The textbook reading for this topic examines some of the common features shared

by organisations that operate successful budgetary control. As you will see, it is

important that management have a clearly defined and authoritative role in the

budgeting process and also that budgets are established to challenge performance

while not setting individuals up for failure. In evaluating performance, it is vital that

the necessary reports, such as production schedules or cost structures, be produced

that provide pertinent and current information. Creating a system that collects and

provides data to management in a timely and useful manner will better allow the

determination of variances and take action to regain operational effectiveness.

It was previously mentioned that budgets have impacts on the behaviours of

managers. Just as realistic budgets can be great motivators for pushing performance,

unrealistic budgets can hamper motivation. It is important that budgets be realistic

while also challenging. There are many different views regarding the impact that

budgets have on the attitudes and behaviours of managers, especially towards those

individuals that they supervise. The Hopwood study (pp. 256–257) examines how

budget information was used to evaluate performance. The failure to meet a budget

must be dealt with carefully by management. Some behavioural aspects of

budgeting control are illustrated in your reading (Real World 7.5).

Standard costing Textbook reading (Atrill & McLaney: Ch. 7)

You have examined the budgeting process and some of the important issues that

organisations must consider when utilising budgets. The final topic for this week

briefly examines one of the basic concepts on which budgets are based: standard

costing. In developing a budget, organisations base their plans on certain standards

in terms of costs, revenues, and quantities. For example, a budgeted figure for sales

revenue is based on a standard selling price per unit. The same goes for other areas,

such as raw materials and labour. These costs all have been assigned unit

standards such as cost per unit, usage per unit, price per unit, and time or rate per

unit. These standards are then used to develop the complete budget. Just as with a

budget, it is important that these standards be realistic, or practical, in nature. Failure

to develop practical standards will result in figures that are unrealistic and possibly

unattainable.

In this reading you will examine how such standards can be developed and how they

can be used not only for performance evaluation but also for income measurement

and pricing decisions. You will find that great care must be taken regarding how

standards are developed and that they must be analysed for accuracy and

applicability on a regular basis. There are certain problems associated with the use

of standard costing. You should examine the issues outlined by the authors to better

understand how standards can be used while recognising their shortcomings.