Budgeting

Overview

A key topic within managerial accounting

•       development, implementation, monitoring

Inevitably a space for conflict

•       an enabling device

•       a control mechanism

Continues to be widely promoted

Need to deploy for greatest benefit

Budgeting and strategy

What is strategy?

•       how a business seeks to achieve its objectives

•       over the long term

•       viewed to be the ‘best way’ to proceed

Budgets provide an annual plan

Plan is represented in financial terms

·         continual monitoring and refinement

Functions of budgets

A number of functions widely recognised

•       a means of planning future operations

•       a means to coordinate varied activities

•       a vehicle to permit communication

•       a motivating device

•       a means of controlling activities

•       a basis for performance evaluation

•       the authorisation function

Behavioural implications apparent from outset

Departmental/functional budgets

Every part of the organisation has a budget

Often understood as being imposed from above

In principle budgets developed locally

•       financial management plans at a local level

These plans then need to be amalgamated

Creation of the master budget

•       lengthy, complex and sensitive negotiations

Can identify a logical sequence

Begin with the sales budget

•       projected sales levels over time

•       projected revenue levels

Make use of probability models to fix income

Ideally incorporate a measure of flexibility

•       customers become more powerful over time

Production budget – ensure availability

•       needs to reflect demand

•       take account of other demands on resources

•       safe levels of materials for input

•       reliable levels of finished product

Then you require

•       labour budgets

•       materials budgets

Nowadays many more functional budgets

•       marketing and sales (customer service)

•       operations management (quality)

•       research, design and development

•       people management

•       finance/financial management

•       administration

Remember Porter’s value chain

Cash budgets

Need to take account of cash/flow aspects

•       sales revenues: cash/credit/discounts

•       creditor management

•       prepayments and accruals

•       salaries and bonus payments

•       periodic outlays: dividends, interest, tax

Need to ensure cash/overdraft facility available

Capital budgeting techniques

•       accounting rate of return

•       payback

•       NPV/DCF

These permit investment decision making

Having decided to make an investment

Need to ensure that cash budget is refined

Responsibility accounting

Recognition that budgeting needs to be inclusive

Managers understand the reality of practice

Secure management buy-in

•       insights from organisational psychology

•       involvement/participation

•       ‘owning’ budgets

•       take responsibility for targets

Responsibility centres

Four different types of responsibility centres

Initially responsibility for either

•       cost/expense centre

•       revenue centre

Thirdly responsibility for both elements

•       profit centre

Less commonly additional responsibility

•       investment centre 

Controllability

Taking ownership/responsibility means

•       accepting monitoring and evaluation

In return maximise controllability

Take responsibility for controllable items only

Items that cannot be controlled excluded

In cases where significant changes occur

‘Flex’ the original budget - restate

Incremental budgeting

An early budgeting research insight

Ad hoc practice of uprating budget numbers

Managers exploiting their own knowledge

Over time significant budget drift

Resulting loss of efficiency/resource utilisation

Conversely budgeting is not an exact science

Experience can prove highly valuable

Zero-based budgeting

Developed to counter incremental drift

Pioneered at Texas Instruments in late 1960s

Promoted by Jimmy Carter

Basic principle – take all budgets back to zero

Rebuild budgets annually

Highly resource intensive and time consuming

Priority-based budgeting as an alternative

Rolling (continuous) budgeting

Traditional model of annual budget

•       developed for four quarters

•       significant activity in fourth quarter

Evolution of a continuous process

Makes use of a fifth quarter

Which in time becomes fourth quarter and so on

Accountants adopt an enabling role 

Activity-based budgeting

Activity-based costing technique in later 1980s

Greater level of overhead expenditures

Quickly evolved into activity-based management

ABB is an aspect of ABM

Budgeting for overhead expenditures

Previously overhead absorption rates

Recognised to be too indiscriminate

‘Beyond budgeting’

Became very fashionable around millennium

Relatively late in the relevance debate

•       Hope and Fraser as leading advocates

Rediscovery of the responsibility arguments

Changing emphases of managerial accounting

The need for greater focus on forecasting

And on the balanced scorecard

Forecasting

The new commercial reality

•       increased competition

•       need for flexibility

•       rapid response

•       timely action vs control

Continuous real time iteration of financial plans

Greater involvement from managers needed