Chapter 6: Budgeting & Budgetary Control: Learning Objectives: After studying this chapter you should:

•

Be aware of different approaches to the budgeting process

•

Know how to prepare an operating budget

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Understand how budgets and variances are used to control operations

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Understand the role of the balanced scorecard in linking strategy and control

Ch 6: Budgeting and Budgetary Control: When the organization’s plan for the future is expressed in dollars it is called a budget.

A budget may be: part of the organizational planning process; a standard against which the organization is controlled; a target, at which the organization is aiming.

Budgets may be prepared: incrementally (previous year + % increase) “zero based” (a fundamental rethinking every year) based on previous year, but with challenges to the major assumptions

Exhibit 6.1: The Master Budget: Sales forecast/budget

changes in receivables changes in finished goods inventory changes in raw material inventory

Production budget

changes in payables

Other expense budgets BUDGETED INCOME STATEMENT CASH BUDGET CAPITAL BUDGET BUDGETED BALANCE SHEET

Sales Forecasting: The budget normally starts with a sales forecast because sales is usually the “limiting factor”.

A sales forecast may be prepared by: professional forecasters (e.g. econometricians); sales/marketing staff; a committee of informed personnel.

Useful information in preparing a sales forecast includes: past data and trends; macro-economic factors; knowledge of customer preferences; knowledge of technological change; knowledge of competitors’ plans.

Exhibit 6.2: Canadian Tire: Sales Revenue: 1996 to 2000: $ Billions 6 5 4 3 Sales $ Billions 2 1 0 1996 1997 1998 1999 2000 2001 Growth: 5.1% 7.3% 6.8% 10.6% Average growth rate: 7.45%

Production Forecasting: In a “just-in-time” environment production exactly equals sales.

Inventory of finished product allows sales and production are uncoupled, and may be different amounts, enabling smoothing of cyclical demand (e.g Christmas cards).

– + = production increase of inventory decrease of inventory sales Labour forecasting: This is generally a function of production plans and labour needs in non-production areas.

Cash Forecasting: Cash forecasting is critical to organizational survival.

+ = Opening cash balance Total cash received Total cash available Total cash received: Cash collections from sales (Sales +/- changes in receivables) + Other cash receipts: (share issues, loans, sale of plant assets)

Cash payments: To suppliers for goods purchased (cost of goods sold +/- changes in inventory and accounts payable) To employees for labour costs To other expenses Interest & dividends Major plant asset purchases Cash available – cash payments = closing cash balance

Ontario Brewery: Cash Budget: $’000 Jan Feb Sales 500 500 Collections from sales: n-1 800 400 400 n-2 Other 180 Total 980 180 580 Mar Apr May Jun 700 700 900 Jul Aug Sep Oct 1000 1700 1700 1000 800 90 490 560 90 650 560 126 686 720 126 846 800 162 962 1360 1360 180 306 Nov Dec 800 800 640 306 180 1540 1666 1106 820 1700 12000 640 144 784 Year 9040 2070 nil 11110 Payments: R.M. 500 B&K 100 D&M100 500 50 100 100 500 50 140 100 500 70 140 100 G&A 100 New plant Interest & debt repayment Total 800 750 790 810 500 70 180 100 850 500 90 200 100 200 500 100 340 100 500 500 170 170 340 200 100 100 10 10 10 1090 1050 1120 980 500 100 160 100 500 80 160 100 10 870 10 850 500 80 340 100 6000 1130 2400 1200 10 200 60 1030 10990 Net 180 Start 200 End 380 (170) (300) (160) (164) (244) (88) 420 686 236 380 210 (90) (250) (414) (658) (746) (326) 360 210 (90) (250) (414) (658) (746) (326) 360 596 (30) (246) 596 120 566 200 566 320 320

Cash Budgeting: The cash budget reveals that over the year the cash increases from $200,000 to $320,000.

However there is a cash crisis between May and August, with cash deficit rising to as much as $746,000.

If you are unaware that there will be a cash crisis you will be totally unprepared to deal with it.

If you are aware you can take steps to deal with it: Possible solutions: Delay payment for the new plant until the fall; Sell short-term investments in the spring; Get a short-term bank loan from May to August.

Note this is a temporary problem, so it needs a temporary solution: raising a long-term loan or issuing new shares would not be appropriate, as these are long-term solutions.

Budgetary Control: The budget will be used to control operations.

Once the budget is “agreed” it represents a social contract between the parties:

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The budget is accepted by the operatives as being achievable;

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The budget is accepted by management as meeting their needs.

Comparison of budget with the actual results will reveal the extent to which it has, or has not, been achieved.

Deviations from budget should be investigated:

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To reveal the responsibility area where the problem arose;

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To initiate any corrective action

Truffle Inc: North Bay Store: $’000 Sales COGS Gross Margin July 2002 Budget $ 500 250

% 100 50

250

50

Actual $ 550 290

% 100 52.7

7 months to July 2002 Variance Budget Actual $ $ 50 3,500 (40) 1,750

% 100 50

$ 3,400 1,720 260

47.3

10 1,750

50

1,680

%

Variance $

100 50.6

(100) 30

49.4

(70) Operating Expenses: Wages 160

32

150 Rent Utilities Dep’n Total200 25 5 10

40 5 1 2

192 25 7 10

34.9

27.3

4.5

1.3

1.8

10 1,120 175 (2) 35 70 8 1,400

40 32 5 1 2

1,425 1,150 175 30 70

41.9

33.8

5.1

0.9

2.1

(25) (30) 5 Operating income: 50

10

68

12.4

18 350

10

255

7.5

(95)

The Balanced Scorecard: Budgetary control focuses on the financial results of the organization. If the organizational strategy can be expressed solely in financial terms, then that is acceptable. Most organizations have strategies that are wider in scope, so a more comprehensive approach to planning and control is necessary.

The balanced scorecard is a way of envisioning strategy and measuring progress towards its achievement. The four sections commonly used are: financial perspective; customer perspective; internal business perspective; learning & growth perspective.

This articulates and communicates a balanced approach to strategic management.

Carberry Hotels: Balanced Scorecard: September 2002: Objective Measure Target

Financial perspective:

Shareholder value Return on investment Share price growth 15.0% 5.0% Actual 15.6% 6.0%

Customer perspective:

Quantity Quality Occupancy rates Room rack-rate growth Customer satisfaction Written complaints

Internal business perspective:

Cleanliness Random checks Restaurant Accessibility Menu changes Wheelchair access 90.0% 4.0% 9/10 10/10 nil 5 98.0% 93.2% 0.0% 9.3/10 10/10 nil 6 98.0%

Learning & growth perspective:

Staff training Training hours Market segments Product development New segments targeted New facilities 100 2 1 75 1 0