Description
The budget information problem is the following: the budgeting problem ( the bonus budget is set at the start of the financial year by the finance team and given to the incentive team to to manage. The budget of the sales department is 24% of the full time employees salary. This is reviewed every quarter due to any over spend or under spend depending on sales. The issue that if there is any overspend the next quarter the agents are then impacted by the incentive scheme been reviewed and lowered. As a department we do not see the budget or have any idea on how the budget is performing. The agents are paid a certain % based on their conversion and revenue. Part of the issue is that the marketing team can send out marketing that drives calls into the call centre and this can have a positive effect on the agents conversion meaning that the incentive team are paying out more than they budgeted for within that quarter. When the bonus is reviewed if this negativity effects the agents and team moral can drop, Using the following concepts I want you to analyse the problem. Page 134-135 Week 11 the control loop (i need you to anotate and include a annotated image of fig 11.1 Page 135-136 week 11 The function and possible benefits of budgets. Page 137-138 week 11 the Pyramid of purpose. (i need you to anotate and include a annotated image of fig 11.2) also discuss the limiting factors. Page 141 week 11 The time factor. Also if you look at week 12 if any on the concepts are fit in please use these. Where you anyalse using a concept please reference with the following OU, PGXX
B629 Managing 2: Marketing and finance
Week 11 Budgets for planning and control
This publication forms part of the Open University course B629/BZX629 Managing 2: Marketing and finance. Details of this and other Open University courses can be obtained from the Student Registration and Enquiry Service, The Open University, PO Box 197, Milton Keynes MK7 6BJ, United Kingdom (tel. +44 (0)845 300 60 90; email [email protected]).
Alternatively, you may visit the Open University website at www.open.ac.uk where you can learn more about the wide range of courses and packs offered at all levels by The Open University.
To purchase a selection of Open University course materials visit www.ouw.co.uk, or contact Open University Worldwide, Walton Hall, Milton Keynes MK7 6AA, United Kingdom for a brochure (tel. +44 (0)1908 858793; fax +44 (0)1908 858787; email [email protected]).
The Open University, Walton Hall, Milton Keynes, MK7 6AA
First published 2009
Copyright © 2009 The Open University
All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, transmitted or utilised in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without written permission from the publisher or a licence from the Copyright Licensing Agency Ltd. Details of such licences (for reprographic reproduction) may be obtained from the Copyright Licensing Agency Ltd, Saffron House, 6–10 Kirby Street, London EC1N 8TS (website www.cla.co.uk).
Open University course materials may also be made available in electronic formats for use by students of the University. All rights, including copyright and related rights and database rights, in electronic course materials and their contents are owned by or licensed to The Open University, or otherwise used by The Open University as permitted by applicable law.
In using electronic course materials and their contents you agree that your use will be solely for the purposes of following an Open University course of study or otherwise as licensed by The Open University or its assigns.
Except as permitted above you undertake not to copy, store in any medium (including electronic storage or use in a website), distribute, transmit or retransmit, broadcast, modify or show in public such electronic materials in whole or in part without the prior written consent of The Open University or in accordance with the Copyright, Designs and Patents Act 1988.
Edited, designed and typeset by The Open University
The paper used in this publication is procured from forests independently certified to the level of Forest Stewardship Council (FSC) principles and criteria. Chain of custody certification allows the tracing of this paper back to specific forest-management units (see www.fsc.org).
ISBN 978 1 8487 3270 4
1.1
Contents
Week 11 Budgets for planning and control
Introduction
What are budgets for? Last week you saw that financial information is necessary for planning, control and decision-making. It is now time to consider specifically the importance of financial information for budgetary planning and control. If there is one aspect of finance that all managers are likely to encounter on a regular basis, it is budgeting. The benefits an organisation achieves from the operation of a well-constructed budgeting system can be greatly enhanced if all managers are committed to the process of budgeting. This, in turn, requires that managers have a good understanding of the purposes of budgeting. This week, therefore, we look at the functions of budgets. We also see how budgets fit into the organisation’s long-term planning process and look at the process of constructing and operating budgets.
Week 11 activities
- Activity 1 Advise an organisation’s managers (based on a case) on how budgeting can contribute to solving financial problems of the organisation. (Allow 4 hours for this activity.)
- Activity 2 Identify the budgetary information required by managers in your own organisation. (Allow 3 hours for this activity.)
Readings
- Reading 1 The function of budgets
- Reading 2 Budgets and planning
- Reading 3 Budgetary procedures and structures
Readings 1–3
Why do many organisations spend so much time (and money) operating formal budgeting systems? What advantages do such systems provide? Reading 1, The function of budgets, discusses the role of budgets. Note the five ways in which budgets can be useful to organisations. Think about the sort of information that is necessary for each of these five functions.
Budgets are part of an organisation’s overall planning and control procedures; they have an important role in linking the long-term objectives to the day-to-day activities. Reading 2, Budgets and planning, discusses how budgets fit into an organisation’s overall planning process. Consider the four steps involved in the cycle of planning; try to think of the sort of financial information that must be provided at each step. As a manager, you may have been aware only of your own part in the wider planning and control process and, perhaps, of your own budget and the way in which you control it. Now you should be able to see how your activities fit into an organisation-wide planning and control process.
Having looked, in general terms, at the information generated by a budgeting system, it is appropriate to look in some detail at the budgeting process and the constituents of a budget. Reading 3, Budgetary procedures and structures, provides a description of how the organisation’s budget is constructed and used, in order to fulfil the intended five functions discussed and to link the organisation’s overall objectives to the day-to-day activities. After completing these three readings, you should have a good understanding of the purpose and process of budgeting.
Activity 1
Allow 4 hours for this activity.
This activity requires you to resolve a problem, using a scenario. The purpose is to highlight the benefits that budgeting brings to an organisation, by looking at the implications of not budgeting!
Garden Furnishings Ltd
Garden Furnishings Ltd is a family-owned business that manufactures garden furniture, which it sells to (predominantly large) retailers. The owners have traditionally also managed the business, but are now retiring and have appointed you as the new finance manager. The owners have always considered budgeting a waste of time – seeing it as costly and time consuming, constraining (restricting managers’ ability to respond to changing circumstances), and largely irrelevant as it is not possible to predict the future. A prominent family member had been heard to say that ‘in an uncertain world, the budget is out of date before the ink is dry!’
As the new finance manager, you are rather alarmed at the situation you have inherited: poor profitability and regular cash flow problems, partly as a result of the business being very seasonal, with most sales in the spring and summer. You feel that the business could be in danger of not surviving! Profit margins are very low (compared to the industry average) on most items sold, even though selling prices are similar to those of competitors.
Individual managers don’t know exactly what is expected of them; consequently, each does whatever he/she thinks is appropriate. For example, although the production manager chats regularly to the sales manager, he is largely dismissive of the latter manager’s views and therefore produces the amounts that he thinks are appropriate for each product. Similarly, the purchasing manager tends to buy the amount of raw materials he thinks appropriate, based on past experience of usage levels, rather than relying on forecasts by the production manager.
This lack of communication and coordination – together with the continuous low level of profit and occasions when the organisation almost runs out of cash – has led to a culture of cynicism and low morale. Some managers also feel that, while they are careful to avoid waste, others are wasteful, yet there is no positive recognition of those who behave in the organisation’s best interest and no negative consequences for those who don’t.
As the new finance manager, you should advise the management team how they might address the problems currently experienced, using the problem-solving method you were introduced to in Week 2 of the course and the material on budgeting presented in this week’s readings.
The problem-solving method, you should recall, requires you to:
- identify the problem
- analyse the problem
- draw conclusions from your analysis
- propose a solution as a set of SMART recommendations
- acknowledge the strengths and weaknesses of your proposal
- identify any significant wider implications if your proposal were to be implemented.
If you would like to remind yourself of the elements of the problem-solving approach, you could re-read the section called Problem-solving and decision-making in Tools and Techniques.
You should apply this approach to problem-solving in the finance part of the course where appropriate, as in this activity. In order to focus on the finance concepts and principles, some problem situations will not require all six steps in the problem-solving process to be taken. In some, the problem may be identified for you; in others there may not be enough additional information for you to determine the wider implications of your proposed solution, or perhaps all the strengths and weaknesses of your proposal. So just address those parts of the problem-solving process that the information given and the nature of the particular problem situation allow.
Activity 1 continued
Use Table 11.1 to record your output (you will be called upon to use this next week). Some questions and guidance to help you with your problem-solving are set out below.
First, you will need to identify the fundamental problem: what is the financial situation of the organisation? Then, you can start to analyse the problem: what reasons appear to be contributing to this situation? You should recognise a number of managerial issues, identified in the scenario, that are likely to contribute to the current financial situation of the business.
After completing the analysis, your conclusion should draw together the main points into a concluding statement. Do the reasons highlighted in your analysis have an underlying common theme? This conclusion should point the way to a specific solution, presented as a series of SMART recommendations. In making such recommendations, you should specify the sequence of actions that need to be taken, by whom and the timescale involved. As the finance manager, you are likely to be the prime mover in this process, but you will need support from the other managers and particularly from senior management.
Having made your recommendations, you should then identify the strengths of your proposal, how it will address the causes of the problem highlighted in your analysis. You should also acknowledge any weaknesses: what disadvantages may result for Garden Furnishings? Are the benefits likely to outweigh the costs (remember costs and benefits can be financial or non-financial)?
Finally, in considering the implications of your proposal, you should consider the impact your recommendations may have across the organisation: for example, is there likely to be a need for staff training? Is there likely to be resistance from certain vested interests who may be threatened by your proposal (and why)?
Table 11.1 Garden Furnishings: solving the problem
| Problem identification |
| Analysis (investigation) |
| Conclusion to the analysis (results of the investigation) |
| The solution, listed as a set of SMART recommendations |
| Strengths and weaknesses of the recommendations |
| The implications of the solution, if implemented |
This activity should have enabled you to link the various purposes of budgeting (coordination, control, communication, and so on) to the organisation’s overall financial performance and situation. If so, then you clearly have a good understanding of the role of budgeting in managing organisations. You may have identified, for example, that the lack of co-ordination between functions (sales, production and purchasing) is likely to result in either running out of stock and lost sales or holding excessive stocks of finished goods or raw materials with money thereby invested in idle assets. There are a number of other issues highlighted in the Garden Furnishings’ scenario which will also impact adversely on the financial situation of the organisation.
Activity 1 output
- A completed version of Table 11.1 Garden Furnishings: solving the problem.
Activity 2
Allow 3 hours for this activity.
This activity requires you to consider your own budgetary information requirements, in the organisation in which you work. (If you are not responsible for an aspect of the organisation’s budget – a department or function, for example – consider the budgetary information requirements of your line manager/immediate boss.) The purpose of this activity is to provide you with an opportunity to apply to your own work context some of the ideas you have been studying. It will also serve as the basis for a full problem-based activity you will undertake next week.
What budget-related information is required by you/your line manager and for what purpose? In answering this question, think how the information could facilitate one or more of the five functions of budgets (communication, control, coordination etc.), and also how it contributes to one (or more) of the steps in the cycle of planning (preparation, authorisation, implementation, and so on).
For this activity you may have to do some research, which is why we have suggested you allow up to three hours for it. If you are responsible for an aspect of your organisation’s budgeting you will need to recall and bring together all that you know about your budget, and what purposes it serves. If you are not responsible for any aspect of budgeting you will need to talk to your line manager or someone else who does have budgeting responsibility and get the required information from them.
Make brief notes summarising the budgetary information requirements and their purpose in a Word file with the title: Week 11 Activity 2 Budgetary information requirements. The note need be no longer than 400 words.
This activity may have made you think in a different way about budgeting in your organisation and how your role fits into the wider scheme of things. As you considered the various functions of budgeting, it hopefully became clear how budgeting links your/your department’s activities to the organisations overall objectives. Budgetary planning and control are, therefore, an essential part of organisational management!
As you considered your/your line manager’s budgetary information requirements, you may have been conscious of shortcomings in the information with respect to your needs. In Week 12, we will look at the practical issues involved in budgeting which can result in the sort of shortcomings that you have experienced.
Activity 2 output
- A Word document noting your/your line manager’s budgetary information requirements.
Week 11 activity outputs
- A completed version of Table 11.1 Garden Furnishings: solving the problem.
- A Word document noting your/your line manager’s budgetary information requirements.
Learning outcomes
After completing this set of activities and readings you should be able to:
- recognise the function that budgets play in the process of planning and control
- identify the procedures involved in preparing and using a budget
- apply these concepts to a case study and to their own organisation’s budget.
Week 12 The practical use of budgets
This publication forms part of the Open University course B629/BZX629 Managing 2: Marketing and finance. Details of this and other Open University courses can be obtained from the Student Registration and Enquiry Service, The Open University, PO Box 197, Milton Keynes MK7 6BJ, United Kingdom (tel. +44 (0)845 300 60 90; email [email protected]).
Alternatively, you may visit the Open University website at www.open.ac.uk where you can learn more about the wide range of courses and packs offered at all levels by The Open University.
To purchase a selection of Open University course materials visit www.ouw.co.uk, or contact Open University Worldwide, Walton Hall, Milton Keynes MK7 6AA, United Kingdom for a brochure (tel. +44 (0)1908 858793; fax +44 (0)1908 858787; email [email protected]).
The Open University, Walton Hall, Milton Keynes, MK7 6AA
First published 2009
Copyright © 2009 The Open University
All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, transmitted or utilised in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without written permission from the publisher or a licence from the Copyright Licensing Agency Ltd. Details of such licences (for reprographic reproduction) may be obtained from the Copyright Licensing Agency Ltd, Saffron House, 6–10 Kirby Street, London EC1N 8TS (website www.cla.co.uk).
Open University course materials may also be made available in electronic formats for use by students of the University. All rights, including copyright and related rights and database rights, in electronic course materials and their contents are owned by or licensed to The Open University, or otherwise used by The Open University as permitted by applicable law.
In using electronic course materials and their contents you agree that your use will be solely for the purposes of following an Open University course of study or otherwise as licensed by The Open University or its assigns.
Except as permitted above you undertake not to copy, store in any medium (including electronic storage or use in a website), distribute, transmit or retransmit, broadcast, modify or show in public such electronic materials in whole or in part without the prior written consent of The Open University or in accordance with the Copyright, Designs and Patents Act 1988.
Edited, designed and typeset by The Open University
The paper used in this publication is procured from forests independently certified to the level of Forest Stewardship Council (FSC) principles and criteria. Chain of custody certification allows the tracing of this paper back to specific forest-management units (see www.fsc.org).
ISBN 978 1 8487 3270 4
1.1
Contents
Week 12 The practical use of budgets
Introduction
What are the practical issues that must be resolved in operating a budgeting system? Last week, you looked at the purpose and process of budgeting in fairly general terms. Now it is time to consider the detail: the practical issues involved in budgetary planning and control, including consideration of the ‘human factor’ – how budgets affect people and how people influence budgets. Budgeting is far from being a purely technical, financial exercise. An effective budgeting system must take into account human motivation and behaviour, including various budget ‘games’ that people play.
Week 12 activities
- Activity 1 Prepare a budget and discuss how budgets can be used to improve financial performance, based on a case. (Allow 4 hours for this activity.)
- Activity 2 Consider the application of budgets in your own organisation, identifying the practical problems arising. (Allow 3 hours for this activity.)
Readings
- Reading 1 Different approaches to budgeting
- Reading 2 Budgets and people
Readings 1 and 2
How are budget numbers established? Do we start with last year’s figures and add a bit for inflation and any new activities, or do we start afresh each year and ask why we should spend anything at all on a particular item or how much expenditure (on say marketing or research and development) is necessary to achieve clearly specified individual goals? Reading 1, Different approaches to budgeting, discusses these alternative approaches to setting budgets and the different types of budget that result. Note that a choice is necessary as to whether budget figures, once set, should remain in force for the whole budget period (typically one year) or be adjusted to reflect changing circumstances. After completing this reading you should be aware of the alternative approaches to establishing budget figures that are used by different organisations and of their advantages and limitations.
Why is budgeting so problematic? Why does the process create so much ill will and resentment? What is required to get managers to take part in the budgeting process and then commit themselves wholeheartedly to achieving the targets set? Reading 2, Budgets and people, sets out how budgets are affected by people (and vice versa) – why they sometimes don’t take responsibility for them, overestimate what they may need, fear them, try to use budgets to reflect their status, and so on. Note, in particular, that if managers are to commit themselves fully to the budgeting process, it may be appropriate to allow them to participate in setting the targets they are expected to achieve.
Activity 1
Allow 4 hours for this activity.
This activity requires you to prepare a budget for Garden Furnishings Ltd, the organisation you first encountered in Week 11, and use the information to suggest specific management actions that should be taken. The purpose is to demonstrate how the information derived from budgets can help managers to act to improve the financial situation and performance of the organisation. In Week 11, you identified problem areas where budgeting could help in managing Garden Furnishings. This enabled you to focus on the general principles of budgeting. This week’s first activity requires you to actually prepare part of the budget for Garden Furnishings and suggest how the information in the budget can be used to guide management in taking specific actions.
As the new finance manager you decide to introduce a formal system of budgetary planning and control. First, you ask all the managers to attend a meeting to explain to them the advantages of budgeting. Then you work with each of them individually, gathering data to develop a detailed budget. You believe that the starting point should be the establishment of a sales budget, from which all other activities and expenditures follow. After compiling budgets for each functional area of the business – marketing, production, and so on – you have summarised these functional budgets in a master budget – see Table 12.1.
Step 1: From the master budget and additional information provided, you should now prepare a cash budget for the year. The template below (Table 12.2) provides you with the structure and content of the cash budget – all you have to do is fill in the numbers.
Step 2: When you have constructed the cash budget, suggest how the specific information now available (in the master budget and cash budget) might be used by the managers at Garden Furnishings to improve the financial performance and situation of the organisation. In doing so, you should think back to Week 11, to some of the issues that arose in Garden Furnishings as a result of not having budget information: which ones could be addressed by the information now available?
Record your thoughts and ideas briefly in a Word document of approximately 400 words, with the title: Week 12 Activity 1 Use of budget information.
Step 3: Then, post the contents of this Word document in a message to your activity forum (or attach the document to your message).
Activity 1 continued
Note that some tables in this and following weeks, like Table 12.1 below, are reproduced in Word as the website does not support underlining in tables. Follow the link or look in the printed book to view these tables.
Table 12.1 Master budget for Garden Furnishings Ltd for financial year ended 20XX
| Q1 | Q2 | Q3 | Q4 | Total | |
| Sales revenue
|
£216,000
|
£616,000
|
£924,000
|
£324,000
|
£2,080,000
|
| Materials cost | £36,000 | £84,000 | £126,000 | £54,000 | £300,000 |
| Labour cost | £72,000 | £168,000 | £252,000 | £108,000 | £600,000 |
| Electricity and consumables | £19,200 | £44,800 | £67,200 | £28,800 | £160,000 |
| Rent and insurance | £65,000 | £65,000 | £65,000 | £65,000 | £260,000 |
| Cost of goods sold
|
£192,200
|
£361,800
|
£510,200
|
£255,800
|
£1,320,000
|
| Gross profit
|
£23,800 | £254,200 | £413,800 | £68,200 | £760,000 |
| Selling costs | £21,600 | £64,800 | £86,400 | £43,200 | £216,000 |
| Admin costs | £85,000 | £86,900 | £122,750 | £103,150 | £397,800 |
| Net profit/(loss) | £(82,800) | £102,500 | £204,650 | £(78,150) | £146,200 |
The following additional information is provided to enable you to convert the information concerning revenue earned and expenses incurred in the master budget, to cash inflows and outflows in the cash budget. The reason for preparing a cash budget is that cash is not usually received or paid out in the same month that sales are made (revenues earned) or expenses incurred.
- Completed goods are sold in the same period in which they are produced. Customers are large stores who have a considerable degree of market power and do not pay smaller businesses promptly. Consequently, about 60% of sales revenue earned is received in the same quarter that sales are made, while the other 40% is received in the next quarter.
- Materials are used in the same quarter in which they are purchased. Garden Furnishings must pay suppliers promptly to ensure continuity of supply and maintenance of credit terms; consequently 80% of the cost of materials purchases is paid to creditors in the same quarter that purchases are made; the remaining 20% is paid in the next quarter.
- All other expenses are paid for in the same quarter in which they are incurred.
- Opening balances for the year are:
- Debtors £120,000
- Creditors £12,000
- Cash £5,000
Currently the firm does not have an overdraft facility available.
Note: Very simply put, creditors are people to whom you owe money.
Debtors are people who owe money to you.
Table 12.2 Template for cash budget
| Q1 | Q2 | Q3 | Q4 | Total | |
| Receipts: | |||||
| Customer balance brought forward plus 60% of quarter’s sales | |||||
| Payments: | |||||
| Suppliers balance brought forward plus 80% of quarter’s purchases | |||||
| Labour
Electricity and consumables Rent and insurance Selling costs Administration costs |
|||||
| Total payments: | |||||
| Opening balance
Net in/(out) flow Closing balance |
Congratulations on working through your first set of numerical calculations in the finance part of this course! If your calculations are correct, they will provide some very significant results which the Garden Furnishings management must act on. Importantly, we hope you were able to link the numbers in the master and cash budgets to some of the problems that are contributing to Garden Furnishings financial situation. If you were able to recognise these links you are well on your way to understanding budgeting!
Activity 1 outputs
- A completed version of Table 12.2 Template for cash budget.
- A Word document discussing practical application of master and cash budget information to problems of Garden Furnishings.
- A contribution to this week’s activity forum to include the contents of the Word document.
Activity 2
Allow 3 hours for this activity.
This activity will help you to consider the adequacy of the budgeting system in your own organisation. The purpose is to reveal the difficulties that arise in operating a budgeting system in practice. In Week 11 Activity 2 you looked at the budgetary information supplied to you or your line manager and identified the purpose for which it was supplied. The various practical issues of budgeting that you have considered this week imply that no budgeting system is likely to be perfect.
- Assess whether the budgetary information you (or your line manager) are provided with is completely satisfactory and if not (as is likely to be the case) make recommendations as to how the situation could be improved.
- Use Table 12.3 to record your output. You first need to specify exactly what the limitations of the information received are. Is it, for example, the budget targets you are responsible for? Or, perhaps, that the control information you receive as feedback does not, for some reason, allow you to take the necessary corrective action?
You will then need to investigate: what are the reasons for the situation; who is responsible? After drawing your conclusions, suggest a possible remedy presented as a set of SMART recommendations. You should identify the strengths and acknowledge the possible weaknesses of your proposal, together with its wider implications – who will be affected and how?
Table 12.3 Resolving a budget information problem
| Problem identification | |
| Analysis (investigation) | |
| Conclusion to the analysis (results of the investigation) | |
| The solution, listed as a set of SMART recommendations | |
| Strengths and weaknesses of the recommendations | |
| The implications of the solution, if implemented |
You may not previously have considered the causes of the limitations of the budgetary system in your organisation and how these may be addressed. If this is the case, this activity should have provided you with valuable insights. Whatever the problem you identified, it is likely to be one that is experienced in many other organisations. Budgeting is more of an art than a science and, as a result, there are many opportunities for organisations to make a less than perfect job of it!
Activity 2 output
- A completed version of Table 12.3 Resolving a budget information problem.
Week 12 activity outputs
- A completed version of Table 12.2 Template for cash budget.
- A Word document discussing practical application of master and cash budget information to the problems of Garden Furnishings.
- A contribution to this week’s activity forum based on the discussion in the Word document.
- A completed version of Table 12.3 Resolving a budget information problem.
Learning outcomes
After completing this set of activities and readings you should be able to:
- identify the different budgeting bases used in practice (incremental, zero base, fixed, flexible and rolling bases)
- recognise the implications of the severity of budget targets for motivation and performance
- understand the impact of participation in setting budget targets on motivation and performance
- recognise how senior management’s attitude towards failure to achieve budget targets can influence behaviour (in both desirable and undesirable ways).
