Part 1 essenial budgeting

Essential Of Budgeting

Iyad S. Attari

INTRODUCTIONEssential Of Budgeting

INTRODUCTION

• The managers most likely to succeed in today’s business environment, are those who understand how to use budgets as business tools, for departmental and personal success.

• Managing Budgets is an informative and practical guide to the essential skills needed.

• produce accurate and useful budgets.

INTRODUCTION

BUDGETING IN BUSINESS

BUDGETING IN BUSINESS

• Using budgets is vital for the planning and control of a business.

• Budgets help co-ordinate actions of different managers and departments to achieving results.

BUDGETING IN BUSINESS

• Budgets also give authority for departmental managers to sustain expenditure by their department.

• And provide targets for earning revenue.

BUDGETING IN BUSINESS

• Budgets are a way for an organization to generate information.

• It can measure actual performance.

WHY BUDGET?

• Budgets help an individual, department, and organization achieve planned objectives.

• Budgets also help to show the financial responsibilities of the organization Stakeholders.

WHY BUDGET?

THE DISADVANTAGES• Budgets increase paperwork and

consume time, especially in the early hours.

• Budgets are slow to work, since the benefits will not be seen until the next year.

THE DISADVANTAGES• Budgets require standardization, which

can lead to inflexibility.

• Budgets can meet with resistance from managers unwilling to hold new procedures.

Managing BudgetsChapter One

Managing Budgets

Three key stages of budgeting to improve the quality of your budgets:

• preparing• writing • monitoring

UNDERSTANDING BUDGETING

• Budgeting is the process of preparing, gathering, and monitoring financial budgets.

• It is a key management tool for planning and controlling a department within an organization.

WHAT IS A BUDGET?

• A budget is a plan for future activities.

• It can be expressed in a number of ways, but usually it describes all of a business in financial terms.

• It is the scale by which a organization’s performance is measured.

DEFINING A BUDGET

• A budget is a statement of monetary plans.

• that is prepared in advance of a coming period, usually one year.

DEFINING A BUDGET

• Include only planned revenues and expenditures (the profit-and-loss account).

• which show the income that each part of anorganization is expected to generate and the total cost that it is authorized to incur.

DEFINING A BUDGET

• Budget should also include a plans for assets and liabilities (budgeted balance sheet).

• And the estimates for cash receipts and payments (budgeted cash flow).

Managing Budgets

First: WRITING A BUDGET

Second: MONITORING A BUDGET

Managing Budgets

First: WRITING A BUDGET• GATHERING INFORMATION

• ANTICIPATING REVENUES

• ESTIMATING EXPENDITURE

• UNDERSTANDING COSTS

• PRODUCING THE FIGURES

Managing Budgets

First: WRITING A BUDGET• UNDERSTANDING CAPITAL BUDGETS

• PRODUCING CASH BUDGETS

• CONSOLIDATING BUDGETS

• FINALIZING A BUDGET

Managing Budgets

Second: MONITORING A BUDGET

• ANALYZING DISCREPANCIES

• MONITORING VARIANCES

• ANALYZING BUDGET ERRORS

• INVESTIGATING UNEXPECTED VARIANCES

Managing Budgets

Second: MONITORING A BUDGET

• MAKING ADJUSTMENTS

• RECOGNIZING BEHAVIORAL PROBLEMS

• BUILDING ON BUDGETING

• ASSESSING YOUR SKILLS

WRITING A BUDGET

First Step

WRITING A BUDGET

To write a budget you must:

gather information.

estimate figures for income and expenditure.

and bring everything together in one agreed overall document.

GATHERING INFORMATION• By gathering information on all the

possible internal and external influences on your budget.

• Be able to determine what can and what cannot be achieved.

• And what limiting factors might constrain your organization’s activities.

GATHERING INFORMATION• External influences can have a

greater effect on the success of a business than internal influences.

• So pay them close attention.

• Do not ignore the internal influences.

GATHERING INFORMATION

• Take time to understand what is happening and what is about to happen around you.

Type Of Risks what is the obstacles not only effect the business negatively

(income) but also to Maximize income .

Inflation Risk : Inflation has an advantage for producers but disadvantages for

consumer. To measure the inflation= The Average of all goods and services.

( The important prices and non important prices taking together . So the simple average not considered to measure inflation and

replaced by the Weighted Average . Weighted Average (price level) = (p1 * w1) + (p2 * w2)+…………

(pn * wn) = Points. The relationship between inflation and unemployment . ( is

negative , when the inflation increase the employers or producers use more employees to collect more revenues from the increase prices because it become worth it . ( Fillips theory ).

Political Risk :

Political Risk :

• The probability of loss from actions of governments.

• Political system in the country .• Changes in public opinion ,government

policy , tax laws, regulations on exportations, foreign influence, & War.

Exchange Rate Risk : Is the risk that a foreign currency transaction will be

negatively exposed in exchange rates.For example the Jordanian currency drop in year

1989 against the us dollar.Foreign currency risk : Hard currencies ( US Dollar,

Euro , Pound , Yen )

Other currencies called the Soft currencies.What effect the currency price : a) GNP b)

Inflation c) The increase in the interest rate on the currency

effect to increase the demand on it .

Interest Rate Risk : Is the risk of fluctuations in the value of assets due to

changes in interest rates.Greater the longer the maturity of the asset.• The value of bonds decline when the interest rates increase .• If interest rate Decline lower return will be available for reinvestment of

interest & principal payments received .

Default risk: Is the risk that the borrower will be unable to repay

debt.The higher the default risk the higher the rate of return

required by the investor .

Credit Risk :

Ex. When you can collect the loans after 3 years so the purchasing power will decrease.

Type of credit risk :( Default risk , interest rate changes ).

Credit Policy : Credit period. ( 2/10 , net 30 ) Discounts given for early payments. ( 2/10 , net 30 ) Credit Standards. ( financial strength can accept credit customers, but this cause

bad debts). Collection Policy. ( speed up collections but it might also anger customers).

Market Risk :

Changes in prices will result from changes that effect all firms. The Competition is the risk but not the monopoly . Prices correlated to some degree with broad swing in the economy caused

by recession , inflation high interest rates ,etc. Called unsystematic risk or no diversifiable risk.

Business Risk : Is the fluctuations in earnings before interest & tax ( Operating income)

when the firm it used no debt. Depends on factors such as: 1) Demand Variables. 2) Sales Price Variables. 3) Input Price Variables. 4) Amount Of Operating Leverage.

Regulations Risk : Such as the central bank regulation for the local banks to increase

their capitals for a higher limits . The solution here is to increase the capital or merge with other banks .

Finance Risk : The possibility that an asset cannot be sold on short notice for its

market value . Which is the risk to the shareholders from the use of financial

leverage. Called the liquidity risk for the short term period but when it

became a chronic or long term we call it Bankruptcy. From business failure , stock market, interest rates, etc.Employee Risk : Strikes. Labor unions. Unskilled labor. Ethical risk .

Management Risk : Inefficient management. mismanagement. Ethical risks.

Technological Risk : Old machines or systems for production and services. From advances in technology technical failure etc.

Natural Risk : Earth quick. Volcano. Flood. Fires. Accident Disease.

Environmental Risk : Pollution.

Natural of the Business Risk : Place of the building, (position far from the harbor or airport ). Operational ( to distribution to supplies & operations, loss of access to

essential assets , failures in distribution).

Portfolio Risk : Is the risk remaining after allowing for risk reducing effects of combining

securities into a portfolio . Portfolio risk is attributable to the poor balance of risks within the

portfolio. There is a limitation for the no. of securities in the portfolio.

1 2 3 4 5 60

20

40

60

80

100

120

Diversification by using portfolio

Size of portfolio

Risk

1

3

2

4

According to the source of risks

A) National Risk : Inside the co. Firm risk. ( any risk inside the firm). Market risk. ( Competition from other co. from the

same country ). Inflation risk. ( and the local industry for the same

industry ).

B) International Risk : Outside the co. Firm risk. ( in the international markets). Market risk. ( Competition from other co. from the

other country ). Inflation risk. ( International relations between 2

co. such as Mercedes international effect Mercedes in Jordan strongly ).

Economy

Market

firm

According to the standard of controllability risk

A) Controllable Risk : You can minimize it but can not delete it. Called Firm risk Systematic risk Avoidable risk.

Diversifiable risk.

B) uncontrollable Risk : The risk that you can not minimize it . Called Market risk Economy risk Unsystematic risk

Non-Diversifiable risk.

2nd Anticipating Revenues

Managing Budget

Anticipating Revenues• Most budgets are driven by the overall

level of sales.

• so to produce an accurate budget you must correctly estimate the type, amount, and timing of revenues.

• Focus on the sources of income, to be expected volume and price, and the timing of receipts.

Anticipating Revenues• ASSESSING REVENUE TYPES

• ESTIMATING REVENUE AMOUNTS

• PROJECTING REVENUE TIMING

Anticipating Revenues

ESTIMATING EXPENDITURE

Managing Budgets

ESTIMATING EXPENDITURE

• Actual expenditure is usually greater than that budgeted for.

• Organizations are often surprised by this, even though it happens every year.

ESTIMATING EXPENDITURE

• To ensure an accurate expenditure forecast, focus on the types, amounts, and timing of expenditure.

ESTIMATING EXPENDITURE

• To ensure an accurate expenditure forecast, focus on the types, amounts, and timing of expenditure.

• (costs driven by particular products and services)

(costs driven by particular products & services)

(shared costs incurred for the whole organization)

(incurred when starting or growing a new operation)

ESTIMATING EXPENDITURE

• ESTIMATING THE AMOUNT OF EXPENDITURE

• Ask every relevant department • about quantities needed, prices, and total

amounts for all the different possible costs.

ESTIMATING EXPENDITURE

• ESTIMATING THE AMOUNT OF EXPENDITURE

ESTIMATING EXPENDITURE

• PROJECTING EXPENDITURE TIMING

• Timing of expenditure is crucial to producing an accurate cash flow forecast.

• Especially the timing of the largest expenditure.

ESTIMATING EXPENDITURE

• PROJECTING EXPENDITURE TIMING

• It is important to coordinate with the purchasing department.

• since they might have recently negotiated some expenditure timings

UNDERSTANDING COSTS

UNDERSTANDING COSTS

• It is important to fully understand costs.

• so you can produce accurate budget.

• And provides a better basis for analysis and decisions.

UNDERSTANDING COSTS

View costs from two perspectives:

• fixed or variable, • and direct or indirect.

UNDERSTANDING COSTS

PRODUCING THE FIGURES

PRODUCING THE FIGURES

CHALLENGING MONETARY AMOUNTS• You should check and double-check your

figures carefully.

• When the budget committee examines your budgeting you must be confident that you have accurate figures.

PRODUCING THE FIGURES

PRODUCING THE FIGURES

CONSOLIDATING BUDGETS

CONSOLIDATING BUDGETS• Submit your budget to the budgeting

committee to prepared the master budget.

• When budgets consolidated, you may have to modify your budget.

CONSOLIDATING BUDGETS

NEGOTIATING BUDGETS• Budget meetings requires an

understanding of the agendas of each member of the budget committee.

• understanding why they are there, and what they are trying to achieve.

FINISHING THE BUDGET• Once the budget committee has agreed on

the master budget.

• All departmental and subsidiary budgets will have been consolidated.

FINISHING THE BUDGET• The Master Budget will contains:

Profit-and-loss accountsBalance sheets.Cash flow statements.

FINISHING THE BUDGET• These documents used to plan and control

activities for the following year.

• Your budget will remain the centerpiece of control in your department.

Second: MONITORING A BUDGET

Managing Budgets

MONITORING A BUDGET

• ANALYZING DISCREPANCIES

• MONITORING VARIANCES

• ANALYZING BUDGET ERRORS

• INVESTIGATING UNEXPECTED VARIANCES

MONITORING A BUDGET

• MAKING ADJUSTMENTS

• RECOGNIZING BEHAVIORAL PROBLEMS

• BUILDING ON BUDGETING

• ASSESSING YOUR SKILLS

MONITORING A BUDGETOnce you have written the budget:

Revenues must be achieved.Expenditure must not be exceeded.

• You should constantly review your budget and adjust as necessary.

MONITORING A BUDGET

ANALYZING DISCREPANCIES

• There will always be discrepancies between your budget and actual performance results.

• Understand and analyze all discrepancies.

MONITORING A BUDGET

ANALYZING DISCREPANCIES

• Understand why there are discrepancies.

• No matter how small discrepancies.

• Understand and analyze all discrepancies.

MONITORING A BUDGET

ANALYZING DISCREPANCIES

By assessing why discrepancies occurred You will be able to ensure that:

The chances are reduced And the future discrepancies are more

efficiently expected.

MONITORING A BUDGET

MONITORING VARIANCES

By assessing why discrepancies occurred You will be able to ensure that:

The chances are reduced And the future discrepancies are more

efficiently expected.

MONITORING A BUDGET

ANALYZING BUDGET ERRORS• Budget errors occur as a result of poor

preparation of the original budget. • Sales will be lower than expected. • While costs will be out of control.• It is vital that you understand where you went

wrong so that you do not make the same mistakes again.

MONITORING A BUDGET

ANALYZING BUDGET ERRORS

CHECKING OFF SALES REVENUE• Use a checklist to help investigate the source

of errors when predicting sales revenues.

• It will help to discover possible explanations in a logical and systematic way.

MONITORING A BUDGET

INVESTIGATING UNEXPECTED VARIANCES

• There are often cases where a variance could not possibly have been predicted or avoided.

• There may be something you can do about them and ways that you can learn from their consequences.

MONITORING A BUDGET

INVESTIGATING UNEXPECTED VARIANCES

• There are often cases where a variance could not possibly have been predicted or avoided.

• There may be something you can do about them and ways that you can learn from their consequences. View

MONITORING A BUDGET

MAKING ADJUSTMENTS• The process of comparing actual figures with

budget is a continuous one.

• You should constantly adjust the budget.

MONITORING A BUDGET

RECOGNIZING BEHAVIORAL PROBLEMS• Manage not only financial interactions but also

the staff in your department.

• To success: budget will depend on the co-operation of all those who are involved in all stages of the budget process.

MONITORING A BUDGET

BUILDING ON BUDGETING• After your budget has been set and monitored,

you should look back over your budgeting activities to learn from your experiences.

• You should do this after the first three months of your budget and at regular times later.

Thank YouIyad S. Attari 2009