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    Effective Budgetting
    Effective Budgetting
    Effective Budgetting
    Ebook266 pages1 hour

    Effective Budgetting

    By Palani Murugappan

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    About this ebook

    Effective Budgeting using Microsoft Excel by Palani Murugappan
    LanguageEnglish
    PublisherBookBaby
    Release dateAug 1, 2014
    ISBN9789671275634
    Effective Budgetting

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      Book preview

      Effective Budgetting - Palani Murugappan

      [email protected]

      What is budget and budgeting?

      Many of us are often confused with the various terminologies that uses the keyword budget. To begin with, budgets are forecasts of future revenues and expenses. Budgeting is the process of gathering information to assist in making these forecasts.

      Budgets are often used for planning and control within an organization. Budgeting is all about planning for and managing the business operations and its cash flow. It is often used as a tool to fulfill future goals set by management based on relevant financial and non-financial factors.

      For many shoppers, most will have a budget as to how much they will spend on a shopping spree. For example, a trip down the nearest shopping mall and passing by a shop with new designer clothes often attracts the eye of women. They then decide if they want to purchase the designer outfit by looking at the tab. If it is within their budget, they will decide to purchase it. Otherwise, they may have to save further and come back another day to purchase it (assuming they do not swipe their credit card to make the payment!).

      In any organization, the use of budgets provide all employees and the management a control feature to ensure that anything financial is adhered to according to a plan, which is coordinated well by the respective heads of departments or leaders of groups.

      Some of the disadvantages of applying a budget includes (but not limited to) increased paper work (i.e. leaders need to sit and work out many months ahead of what future expenses or revenue will be in the next financial year); time consuming (i.e. if budgets are not forecasted appropriately and on time); inflexible (i.e. due to unforeseen circumstances, budgets may not be appropriate at a point in time if a certain degree of allowance is not catered for); and meeting with resistance (i.e. if management decides to slash some of the overtime activities, employees may not act favorably to this).

      Difference between budgeting and forecasting

      Very often, the terms budgeting and forecasting are used interchangeably. However, there is a difference between the two.

      Forecasting involves estimating future events and analyzing their implications on the budget. It is an integral part of budgeting.

      Budgeting on the other hand, involves preparing budgets and using them as the basis for control and planning. A budget is somewhat a financial plan.

      To go a step further, within an organization, forecasting may be done for various purposes such as future business conditions, identifying future opportunities, etc. These estimates are not included in the budgeting process.

      In a snapshot, budgeting looks into the development, management and the analysis of an organization.

      Factors influencing budgets

      Some of the factors that can influence budgets are as follows:

      Inflation – be prepared should an inflation (or recession) takes place.

      Exchange rate – there is no guarantee that the exchange rate will remain the same throughout the budgeting period.

      Creditors – if there is a cash flow problem, can the company still pay its creditors on time?

      Taxation – assume tax rate will remain the same.

      Interest rate – in the event the base, overdraft and lending rates increases, will this have an impact on the budget?

      Wages – if the organization performs well, how many percent of salary increase will be declared across the board?

      Why are budgets important to managers?

      In the preparation of budgets, managers (or heads of departments) are meant to think and be prepared for the changing environment. In this manner, budgets are used as aids in planning, communicating, setting standards of performance, motivating personnel towards individual and departmental goals, measuring results, and directing attention to problem areas that require investigation.

      Budgets are used to transfer information to individual decision makers in the organization. For example, in the bottom-up budgeting, each of the departmental budgets are compiled to estimate how much of cash is needed by the organization for a given period.

      In top-down budgeting, the CEO or Managing Director will decide on how much cash each department will get.

      More often than not, budgeted amounts can be used as goals to motivate employees. For example, the insurance manager informs his team that if they manage to collect a premium of $1 million collectively, an incentive of an overseas trip to the team will be rewarded. In this way, the manager will be motivating his team to ensure that they do meet their target in order for him to fulfill his budget of $1 million.

      Variances in budgets

      In most budgets, they are bound to be some variations. For example, if you had budgeted a sales figure of $1 million for the next 12 months but only end up with $800,000, then you had over-budgeted (also known as unfavorable) as you could not attain the original budgeted figure.

      However, if you had budgeted a sales figure of $1 million and actually achieved a sales of $1.5 million, then you had under-budgeted (also known as favorable) as the actual sales is far more than the budgeted sales for the given time frame.

      The following exercise will help you understand this better. It compares the budgeted sales figures against actual sales. If the budgeted figures are greater than the actual figures, the difference is placed in the Unfavorable column, otherwise it is placed in the Favorable column.

      Note that in the Unfavorable column, the difference (or variance) is denoted as a positive value only and not as negative.

      Now if you take the total of both the Unfavorable and Favorable columns, you would get the following values i.e. total for Unfavorable is $31,000 and Favorable is $7,000. The variance (difference) between these two values if $24,000 which is unfavorable (unfavorable outweighs favorable).

      The above exercise indicates that the budgeted values have been overestimated as compared to the actual values.

      What interpretation can you conclude? One could have any of the following explanations:

      Market conditions may have been different as compared to when the budget sales figures were calculated.

      There could have been more competitors in the market for similar products.

      Sales team may have lost their motivation to serve better.

      Customers not happy with products or quality of products may have been compromised.

      Customer relationship may have been compromised.

      Pricing of products may not be competitive anymore.

      Products may have reached the maturity or decline stage of the product life cycle curve.

      Planning and control in budgets

      Many managers (or heads of departments) will often tend to report budget figures that are easy to achieve. Preparing budgets require long term planning and cannot be done overnight.

      For example, if the production manager says that he can produce 50,000 units per annum, the factory manager may say that this is insufficient and ask the production manager to produce 70,000 units per annum. This may or may not be achievable. Thus, both will need to sit down and come to some compromise based on existing conditions.

      Motivating factors in budgeting

      When preparing budgets, one needs to be able to include some motivating factors to ensure that whatever was budgeted can be achieved. What are the motivating factors? These are as below:

      Being able to understand what budgets and budgeting is all about. All participating employees should be told well before hand on what and how the budget for the following term will be planned to achieve.

      All budgets must be achievable. If it is not, one needs to re-evaluate it and answer why it could not be achieved.

      Budgets involve team effort. No one team member should be left out – no matter how junior the person is in the organization.

      There should be a sense of open communication among executing members of the budget. If one feels there is a better way of achieving the budget, then this point should be raised to all team members.

      Corrective actions should be imposed when there is a slightest sign of the budgets not being achieved. This will ensure that the team remains effective and the final budget is achieved.

      A sample flow of budgeted data should be as in the illustration shown.

      Budgeting process

      What is required for the purpose of forecasting? One needs to make the following assumptions:

      Would there be a price increase in the goods sold during the budgeted period? If so, how much and when?

      Do you anticipate a change in market condition i.e. would there be an increase or decrease in consumer spending based on the previous years?

      How soon do you expect your debtors to pay you? Are you likely to get most if not all of your payments within the stipulated 30 days, 60 days, etc based on the receipt of the invoice? If you are unable to collect your payments, is there enough cash flow in the organization to sustain the operations?

      Due to unforeseen circumstances or varying global marketing conditions, if the price of raw materials increases, would you be able to sustain your current price? If so, for how long can you sustain? If you are unable to do so,

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