BUDGETING AND BUSINESS PERFORMANCE MANAGEMENT Maria Gogolukhina, Ph. D
Act before there is a problem. Bring order before there is disorder. —Lao Tzu
What is a budget? n n a formal expression of plans, goals, and objectives of management that covers all aspects of operations for a designated time period a financial plan to control future operations and results, expressed in numbers show the company’s cash will be spent on labor, materials, and capital goods and indicate how cash will be obtained At the beginning of the period, the budget is a plan. At the end of the period, the budget is a control instrument
Budgeting terms n n n short term (one year or less) intermediate term (two to three years) long term (three years or more)
Budget period depends on: n n n n business risk sales and operating stability production methods length of the processing cycle seasonality inventory turnover financial activities
Budgeting areas Budgeting Planning Coordinating Directing Analyzing Controlling
Effective budgeting requires n n n Predictive ability Clear channels of communication, authority, and responsibility Accurate, reliable, and timely information Compatibility and understandability of information Support at all levels of the organization
Budgets should be n n n understandable tight but attainable flexible computerized participative
Budgets should consider n n n manpower production scheduling, labor relations, pricing, resources, new product introduction and development, raw material cycles, technological trends, inventory levels, turnover rate, product or service obsolescence, n n n n n reliability of input data, stability of market or industry, seasonality, financing needs, marketing and advertising. economy, politics, competition, changing consumer base and taste, market share
Types of Budgets n n n Master Budget Operating Budget Financial Budget Cash Budget Static (Fixed) Budget Flexible (Expense) Budget Capital Expenditure Budget Strategic Budget Activity-based Budget Target Budget Continuous (rolling) Budget
STRATEGIC PLANNING
Strategic Planning n n n means by which the company uses its capital, financial, and human resources to achieve its objectives ranging from 2 to 30 years, with 5 to 10 years being most typical is continuous and looks where the company is going done by upper management and divisional managers the information used is external to the company considering the internal and external environment, strengths, and weaknesses
Elements of a strategic plan n n The company’s overall objectives, such as market position, product leadership, and employee development The strategies necessary to achieve the objectives, such as engaging in a new promotion plan, enhancing research, product and geographical diversification, and eliminating a division The goals to be met under the strategy The progress to date of accomplishing the goals; examples of goals are sales, profitability, return on investment, and market price of stock
Strategic planning should take into account n n n n the financial position, economy, political environment, social trends, technology, risks, markets, n n n n competition, product line, customer base, research support, manufacturing capabilities, manpower, product life cycle, major problems
Strategic planning process
Budgetary checklist
Budget report
BUDGETARY PROCESS
Budgeting is a management function that incorporates ◆ ◆ ◆ setting objectives establishing detailed financial estimates delegating specific responsibility monitoring performance reacting to expectations
Budgetary Process Setting Analyzing Estimating objectives resources components Coordinating Obtaining components approval Distributing budget Operational process
Financial structure of the company n Financial responsibility centers (FRC): n n n Cost center (CC) Revenue center (RC) Marginal revenue center (MRC) Profit center (PC) Investment center (IC)
Financial structure of the company IC Board of Directors CC Manufacturing Workshop 1 Workshop 2 MRC Departments Business 1 Business 2 PC Enterprises Region 1 Region 2 RC Sales Department Product 1 Product 2 IC Projects Project 1 Project 2 CC Administration Accounting Development
Financial structure of the company FRC CC RC MRC PC IC Objectives Expenses Revenue Profit of a business Profit of the company ROI Can include CC RC CC, RC, MRC PC, MRC, CC, RC, IC Can be included into CC, PC PC MRC, PC PC, IC IC
Organizational and financial structures of the company Organizational Financial structure Based on functional Based on economic & specialization of financial relationships departments Hierarchy of subordination Hierarchy of financial responsibility Possible personal factors Real business factors
Ways to organize financial structure 1. Define a business structure 2. Outline key processes 3. Define investment activities 4. Define assets 5. Define a profit structure 6. Define departments structure 7. Outline the main managerial relationships
Directions of the budgetary process Budget Objectives of the segment Bottom-up Top-down Company objectives Budget
Steps to from a budgetary structure 1. 2. 3. 4. 5. 6. 7. 8. 9. Operations list Managerial balance sheet: assets/liabilities & equity Contents of the Income/Expenses Budget Contents of the Cash Flow Budget List of operational budgets View “FRC-Budget” View “Budget-Item” View “FRC-Budget-Responsibility-Item” Structure of pro-forma financial
BREAK-EVEN AND CONTRIBUTION MARGIN
Break-even and Contribution Margin Analysis 1. What sales volume is required to break even? 2. What sales volume is necessary to earn a desired profit? 3. What profit can be expected on a given sales volume? 4. How would changes in selling price, variable costs, fixed costs, and output affect profits? 5. How would a change in the mix of products sold affect the break-even and target income volume and profit potential?
Types of costs n n n Variable costs are expenses that change in proportion to the volume of production: n Materials n Labor Fixed costs are business expenses that are not dependent on the activities of the business: n Heating n Water for non-production purposes n Salaries n Selling & administrative expenses… Semi variable cost is an expense which contains both a fixed cost component and a variable cost component. : n Electricity n Communication means…
Types of costs n Total costs / quantity Total costs, RUR n TC = FC + (VC*Q) Total costs Variable costs Semi variable costs Fixed costs Quantity, units
Income statement
Contribution Margin n Unit CM n CM Ratio CM = S – VC UCM = p – v CMR= CM/S =(S – VC)/S= 1 – VC/S CMR= UCM/P = (p – v)/p = 1 – v/p
Contribution Margin Sales per unit Sales it VC n ru pe ts r Va ia ble s co Contribution margin Fixed costs Profit
The break-even point Break-even point = F / UCM Break-even sales = F / CMR Target income volume =(F+TI)/UCM Margin of safety = (Exp. Sales-BES)/ Exp. Sales
Break-even chart
Profit-volume chart
Sales Mix Analysis n n Break-even point = F / / Weighted Average Unit CM Break-even sales = F / / Weighted Average CMR
Analytical usefulness of contribution margin analysis n n n A change in either the selling price or the variable cost per unit alters CM or the CM ratio and thus the break-even point. As sales exceed the break-even point, a higher unit CM or CM ratio will result in greater profits than a small unit CM or CM ratio. The lower the break-even sales, the less risky the business and the safer the investment, other things being equal. A large margin of safety means lower operating risk since a large decrease in sales can occur before losses are experienced. Using the contribution income statement model and a spreadsheet program, such as Excel, a variety of “what-if” planning and decision scenarios can be evaluated. In a multiproduct firm, sales mix is often more important than overall market share. The emphasis on high-margin products tends to maximize overall profits of the firm.
Managers can improve profitability of their responsibility unit by n n n n minimum number of employees reducing operating costs buying rather than leasing emphasizing previous success keeping up-to-date high-technology equipment eliminating useless operations and paperwork being productive and progressive improving the reliability of the product expanding into new areas improving supplier relationships alternative sources of supply screening new hires for honesty and competence having adequate insurance
MASTER BUDGET
Master Budget n n is a formal statement of management’s expectation regarding sales, expenses, volume, and other financial transactions for the coming period consists basically of a pro forma income statement, pro forma balance sheet, and cash budget
Master budget categories 1. Operating budgets n Sales budget n Production budget n Direct materials budget n Direct labor budget n Factory overhead budget n Selling and administrative expense budget 2. Financial budgets n Cash budget n Pro forma income statement n Pro forma balance sheet
Budgets of FRC Spheres of activity FRC CC MRC PC IC * Sales RC * * * Purchases * * Production * * Storing * * Transport * * Administering * * * Financial activity * * * Investing activity * * *
Types of budgets Spheres of activity Budget type Cost Financial Natural Sales * * * Purchases * * * Production * * Storing * * Transport * * Administering * Financial activity * * Investing activity * * *
Planning horizon & corrections frequency Budgets Planning horizon year qtr mth Corrections frequency qtr mth Sales * * * day * Production wk Direct materials * * Direct labor * * Factory overhead * * Sell. /adm. expenses * * * Financial … * *
Five steps in preparing the budget 5. 1. 2. 3. 4. projected sales expected costs cash financial forecast production Flow statements volume
Master Budget
The SRS (a sources-ofrevenue statement) Model breaks revenue into five categories: 1. Continuing sales to established customers (known as base retention) 2. Sales won from the competition (share gain) 3. New sales from expanding markets 4. Moves into adjacent markets where core capabilities can be leveraged 5. Entirely new lines of business unrelated to the core
Case 1. Master Budget
Monthly cash collections from customers The budgeted cash receipts for June and July are computed:
Production Budget Production
Inventory Purchases, Merchandising Firm
Direct Material Budget
Direct Labor Budget
Factory Overhead Budget Schedule 5
Ending Finished Goods Inventory Budget
Selling and Administrative Expense Budget 1, 200 3, 600
Cash Budget
Cash Budget Schedule 8 Cash balance, beginning The credit is taken for 3 quarters of the year The credit is taken for a half a year
Budgeted Income Statement
Budgeted Balance Sheet
Budgeted Balance Sheet
VARIANCES
Inaccuracy of the budget figures can be because of n n n economic problems political unrest competitive shifts in the industry introduction of new products regulatory changes
Types of Standards Basic Maximum efficiency Currently attainable Expected
Budget Accuracy Sales Accuracy = Actual Sales/Budgeted Sales Cost Accuracy = Actual Cost/Budgeted Cost Profit Accuracy = Actual Profit/Budgeted Profit
Degrees of significance of variances n n tolerable range - no steps are necessary intolerable range - either performance must be improved or new standards formulated and a relevant model should be developed
Performance reports may be prepared for n n n n Production in terms of cost, quantity, and quality Sales Profit Return on investment Turnover of assets Market share Growth rate
The performance-tobudget report
The benefits of budgetary control ◆ A budget forces management to express in figures its future intentions. ◆ It provides a yardstick by which individuals or groups can be measured and rewarded. ◆ It allows some responsibility and authority to be decentralized without loss of information required by management for control purposes. ◆ Budgeting provides a mechanism to control in detail the revenue, costs, cash and capital expenditure of the firm. ◆ It facilitates an atmosphere of cost consciousness. ◆ It helps ensure that ROI is optimised.
Variances, causes and responsible parties 1. Labor efficiency variance Cause Responsibility excessive number of workers Production manager poor job descriptions Personnel overtime and poor scheduling Production Planning poor-quality workers Personnel or Training overpaid workers Production manager inadequate supervision Foreman improper functioning of equipment Maintenance insufficient material supply or poor quality Purchasing
Variances, causes and responsible parties n 2. Material Variances Cause Responsibility High price, no discounts, bad specifications, low- Purchasing grade material, irregular purchases required Manager Poor material mix, low qualification, improperly adjusted machines, poor scheduling, poor production technique, lack of equipment, unexpected volume changes Production Manager Failure to detect defective goods Receiving Manager Inefficient labor, poor supervision, or waste Foreman Inaccurate standard price Budgeting High transport charges Traffic manager lack of funds for purchasing Financial
Variances, causes and responsible parties n 3. Overhead Volume Variance Cause Responsibility Buying the wrong size plant Production manager Improper scheduling Production Planning Insufficient orders Marketing Shortages in material Purchasing Machinery failure Maintenance Long operating time Production Planning Inadequately trained workers Personnel or Training
Variances, causes and responsible parties n 4. Profit Variance Cause Responsibility Changes in unit sales price and cost sales managers and production managers Changes in the volume of products sold sales managers and production managers Changes in sales mix sales managers and production managers
Case 5. Sales Mix and Quantity Variances U
FORECASTING
Who Uses Forecasts? n n n top management - for planning and implementing long-term strategic objectives and planning for capital expenditures. marketing managers - to determine optimal sales force allocations, set sales goals, and plan promotions and advertising. Market share, prices, and trends in new product development are also required production planners - to schedule production activities, order materials, establish inventory levels, plan shipments
Who Uses Forecasts? n n financial managers - to maintain corporate liquidity and operating efficiency, to estimate cash inflows accruing from the investment, to plan credits, to plan acquisitions human resources managers – to hire and train the needed personnel purchase managers – to plan contracts with materials suppliers managers of multinational companies – to predict foreign exchange rates
Sales forecast and managerial functions
Forecasting Methods Quantitative Naïve methods Qualitative Executive opinions Moving average Delphi technique Exponential smoothing Sales force polling Trend analysis Decomposition of time series Regression analysis Consumer surveys
Criteria to select a forecasting technique 1. What is the cost associated with developing the forecasting model, compared with potential gains resulting from its use? 2. How complicated are the relationships that are being forecasted? 3. Is it for short-run or long-run purposes? 4. How much accuracy is desired? 5. Is there a minimum tolerance level of errors? 6. How much data are available?
Assumptions underlying the forecasting 1. 2. 3. 4. Techniques are based on historical data Forecasts are rarely perfect Forecast accuracy decreases as the time period covered by the forecast increases Forecasts for groups of items tend to be more accurate than forecasts for individual items
Steps in the Forecasting Process 1. Determine the what and why of the forecast 2. Establish a time horizon 3. Select a forecasting technique 4. Gather the data and develop a forecast. 5. Identify any assumptions of the forecasting 6. Monitor the forecast to see if it is performing in a manner desired. Develop an evaluation system for this purpose.
CASH BUDGET
Major sections of the cash budget 1. 2. 3. 4. Cash receipts Cash disbursements Cash surplus or deficit Financing
Major cash flow components of a cash budget
Flowchart of a planning model
Percentage of sales forecasting method n n permits a company to forecast the amount of financing it will need for a given increase of sales the difference between the forecasted asset increase and the forecasted current liability is equal to the total financing the company will need
Percentage of sales forecasting method
Percentage of sales forecasting method
To support the sales increase the management has to decide whether to (1) (2) (3) (4) borrow on a short-term basis, to borrow on a long-term basis, sell additional common stock, cut dividends
ZERO-BASED BUDGETING
Zero-base budgeting (ZBB) n n n n can be used by nonfinancial managers to identify, plan, and control projects and programs is a priority form of budgeting, ranking products and services begins with a zero balance and formulates objectives to be achieved sets minimum funding amounts for each major activity. amounts above the minimum level must be fully justified in order to be approved by upper management if an activity cannot be supported as having value, it is not funded the manager is not concerned with the past but rather looks at the current and future viability
The ZBB process involves 1. 2. 3. 4. 5. Developing assumptions Ranking proposals Appraising and controlling Preparing the budget Identifying and evaluating decision units
A decision package contains this information n n Description of the activity and reasons to carry it out Statement of objectives and benefits to be derived The plan to achieve the program The priorities established Cost and time estimates along with evaluation Alternative methods of achieving the activity stated in cost and time Measures of output Resources needed, including physical and personnel support from other responsibility centers Legal, technical, and operational aspects Risk considerations
Decision package
BUSINESS PERFORMANCE MANAGEMENT
…to succeed in war, one should have full knowledge of one's own strengths and weaknesses and full knowledge of one's enemy's strengths and weaknesses. Lack of either one might result in defeat. – Sun Tzu
Business performance management (BPM) n n n or corporate performance management, enterprise performance management, operational performance management, business performance optimization consists of a set of processes that help organizations optimize their business performance. provides a framework for organizing, automating and analyzing business methodologies, metrics, processes and systems that drive business performance
Business performance management (BPM) n n n involves consolidation of data from various sources, querying, and analysis of the data, and putting the results into practice characterized by a high degree of predictability which is put into good use to answer what-if scenarios provides key performance factors (KPIs) that help companies monitor efficiency of projects and employees against operational targets
Communication challenge
The purpose of BPM is to decide 1. What products or service lines should we offer or not offer? 2. What markets and types of customers should we serve or not serve? 3. How are we going to win?
Performance management framework
The concept of value 1. Shareholder value - detect whether the profit margin generated from satisfying existing and future customers is also sufficient to reward shareholders 2. Customer value - maximize communications, interactions, and sensitivity to each customer’s unique needs. Enable differentiated treatment levels, deals, and offers to more valuable customers. 3. Supplier-employee value - ensure that specific groups of people, equipment, and other assets are working on high priorities and performing in high alignment with senior management’s strategies
BPM integrates n n n n n strategy mapping, balanced scorecards, managerial accounting (including activity-based management), budgeting and forecasting, resource capacity requirements. customer relationship management (CRM), supply chain management (SCM), risk management, human capital management (HCM) systems, Six Sigma
Areas from which top management could gain knowledge by using BPM 1. 2. 3. 4. 5. 6. customer-related numbers: n new customers acquired n status of existing customers n attrition of customers (including breakup by reason for attrition) turnover generated by segments of the customers - possibly using demographic filters outstanding balances held by segments of customers and terms of payment - possibly using demographic filters collection of bad debts within customer relationships Demographic analysis of individuals (potential customers) applying to become customers, and the levels of approval, rejections and pending numbers delinquency analysis of customers behind on payments
profitability of customers by demographic segments and segmentation of customers by profitability campaign management realtime dashboard on key operational metrics 7. 8. 9. n 10. 11. 12. 13. 14. Overall equipment effectiveness clickstream analysis on a website key product portfolio trackers marketing channel analysis sales data analysis by product segments callcentre metrics
Case Study LUBEOIL: SHAPING BUSINESS TODAY AND IN THE FUTURE
World Lube Demand 2005
Objectives n n n to understand what customers, products, and segments to focus on to capture as much of the market as possible to take over the number-one position in lubrication products worldwide to achieve a 33% increase in after-tax profits by the year 2000 three broad strategies: growth, cost reduction, and a stronger competitive position to implement activity-based costing (ABC)
ORGANIZATIONAL ISSUES n n n Lubricants are one of the highest profit margin areas of Lube. Oil’s downstream business. Lube. Oil is an integrated supplier of lubricants, producing lubricants from base components (i. e. , crude oil and chemical additives) and delivering finished products to end-customers. Lube. Oil operates lubricant businesses in more than 60 countries with 40 manufacturing locations.
n n n The first ABC project at Lube. Oil took place at the US Lubricants Division in 1994 Suspection that the high degree of complexity was adding cost to his business, because all products were treated equally (manufacturing costs of $80 million were volumetrically applied to the 250 million gallons of lubricants) By using activity drivers instead of volume drivers, ABC could expose fundamental differences in the costs of producing thousands of product and package combinations Management decided to incorporate ABC into the single profitability reporting tool used to manage the business Positive has become: profits, return on capital employed (ROCE), manufacturing expenses. The only business indicator with a negative trend is volume.
Initial Efforts n n was selected an off-the- shelf software package called Oros (today called SAS Activity-Based Management) by ABC Technologies (now SAS) as initial pilot sites were chosen: Lube. Oil Korea and Lube. Oil Brazil (medium size with moderate business dimensional complexity)
Pilot Phase n n n Korea proved to be the most dramatic example of ABC’s success. The affiliate was wrestling with a decision to divest a large portion of its business because of its apparent lack of profit. Activity-based analysis revealed that the existing cost accounting overstated production costs for the designer lubricant by 300%. The affiliate had grown in volume in the last few years, mostly in the designer product segment— production unit costs had decreased, and profits had increased nearly 100% over that period.
Phases of the ABC Implementation
ABC Implementation Process
Global Benchmark Template (Lube. Oil Scorecard)
Affiliates’ Cost Structure
Cost Reduction Process Rules
The main results n n n After-tax profit raised from $400 bln in 1995 up to $600 bln in 2000. Lube. Oil successfully implemented and uses ABM The company participated in a multibillion-dollar merger. ABM helped to shape the new organization.
Lessons Learned by the ABM team n n n Highlight and act on opportunities for cost reduction Categorize segment/customers/product combinations Optimize logistics operations Link ABM to performance management Design a decision-making process
Скачать презентацию BUDGETING AND BUSINESS PERFORMANCE MANAGEMENT Maria Gogolukhina Ph
Budgeting Presentation.ppt