Planning and Budgeting

Entrepreneurship and New Business Development

26th April 2018, Evangelos Bourelos
Assistant Professor, IIE
 Overview Part 1

The budgeting process 




budgeting, planning and control







the strategic planning relationship with budgeting



forecasting and planning



budget preparation flow diagram



performance evaluation and control



responsibility centres



divisional performance



motivation and the behavioural aspects of budgeting



problems in budgeting 



 Why?

identify budgeting as one part of the strategic


management process 



define a budget, its purpose and uses



recognise the importance of forecasting within the

budget process



outline how a business may apply the budgeting process

in practice



explain the preparation of budgets for planning purposes



prepare the elements of an operating budget and a financial
budget to derive the master budget
 What?



describe the system of responsibility accounting and identify
the four different types of responsibility centre



outline the advantages and disadvantages of ways in which
divisional performance may be measured



appreciate the motivational and behavioural aspects

of budgeting



explain the preparation of budgets for control purposes

and how performance against budget may be evaluated



identify the potential problems that may be encountered during
budget preparation
 Budgeting, Planning and
Control



a budget is a plan and budgeting is one part of the strategic
planning process, which is concerned with planning and
control



planning budgets are management’s belief of what the
business’s costs and revenues will be over a specified future
time period, the budget period



control budgets are used for management motivational
purposes and in this way influence improved departmental
performance
The Strategic Planning Process
 The Strategic Planning
Relationship with Budgeting
 Forecasting and Planning

forecasts are not plans but predictions of the future,


which are required as an important prerequisite to the
budget process



prior to budget preparation, in addition to forecasting,
decisions must be made and policies formulated regarding
stock days and purchasing, debtor and creditor days, staff
costs, capital expenditure, and standard costs 



types of forecasting



qualitative



quantitative
Budget Preparation Flow Diagram
 Performance Evaluation and
Control (1)



The master profit and loss budget is prepared from each of the elements of the
operating budget:

sales

production

distribution and administration

financial



the master budget is comprised of the

profit and loss budget

cash budget

balance sheet budget



 Performance Evaluation and
Control (2)





risk assessment and risk analysis should be applied to the master budget



risk assessment and risk analysis must be closely reviewed in terms of
additional funding requirements



control budgets are usually flexed to reflect actual activity levels, and
performance against budget provided from exception reporting evaluated so
that corrective actions may be implemented as appropriate
 Responsibility Centres





as part of the control function of the budget, the system

of responsibility accounting is used to measure actual results
against budget for each of various types of responsibility centre 



a responsibility centre is a department or organisational function
whose performance is the direct responsibility

of a specific manager
 Divisional Performance

the performance of managers of responsibility

centres may be considered using the
divisional performance measures of return on
investment (ROI) and residual income (RI)
!
both ROI and RI focus only on the performance for
a particular control period
!
both ROI and RI represent single summary
measures of performance
 Motivation and the Behavioural
Aspects of Budgeting







the preparation of budgets for planning and control purposes needs the
involvement of people to provide realistic plans and the motivation for
performance targets to be achieved



managers who have been given the responsibility for each of the elements
of their budgets have a very good chance of achieving their objectives
 Problems in Budgeting





there are usually many conflicts and problems associated with the budget
preparation process in most organisations



the majority of conflicts and problems are concerned with the ‘softer’ human
resources issues of managers’ behaviour 

 Questions?
15 min break

17
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Costs and Budgeting

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Costs and Budgeting

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Costs

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Costs
• Anything incurred during the production
of the good or service to get the output
into the hands of the customer
• The customer could be the public (the
final consumer) or another business
• Controlling costs is essential to business
success
• Not always easy to pin down 

where costs are arising!

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Cost Centres

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Cost Centres
• Parts of the business to which particular
costs can be attributed
• In large businesses this can be 

a particular location, section 

of the business, capital asset 

or human resource/s
• Enable a business to identify where costs
are arising and to manage those costs
more effectively

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Full Costing
• A method of allocating indirect costs to a
range of products produced by the firm.
– e.g. if a firm produces three products - a, b,
and c - and has indirect costs of £1 million,
assume proportion of direct costs of 20% for
a, 55% for b and 25% for c
– Indirect costs allocated as 20% of 1 million to
a, 55% of £1 million to b and 25% of £1
million to c

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Absorption Costing
• All costs incurred are allocated 

to particular cost centres – direct
costs, indirect costs, semi variable
costs and selling costs
• Allocates indirect costs more
accurately to the point where 

the cost occurred

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Marginal Costing

• The cost of producing one extra unit

of output (the variable costs)
• Selling price – MC = Contribution
• Contribution is the amount which
can contribute to the overheads
(fixed costs)

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Standard Costing
• The expected level of costs
associated with the production 

of a good/service
– Actual costs – Standard costs =
Variance
• Monitoring variances can help 

the business to identify 

where inefficiencies or efficiencies
might lie

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Total Revenue

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Total Revenue
• Total Revenue = Price x Quantity Sold
• Price can be raised or lowered 

to change revenue – price elasticity 

of demand important here
– Different pricing strategies can be used –
penetration, psychological, etc.
• Quantity Sold can be influenced 

by amending the elements 

of the marketing mix – 7 Ps

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Break Even

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Break Even Analysis

Costs/Revenue TR The
Total
The break
revenue
Initially
lower even
the is point
a firm
TR TC determined
occurs
Aswill where
incur
output by
fixed
is total
the
price,
The the
total less
costs
VC price
revenue charged
costs,
generated,
steep the equals
these and
the
total total
do
therefore (assuming
the
costs
firmquantity
not
revenue –will
the
depend firm,
sold
incur
curve. onin
–
accurate forecasts!)
again
this example,
this
output will
or
of sales.
would
be–
is variable
the sumcosts FC
determined
have
these to vary
sell byQ1 to
directly
+VC
expected
generate
with thesufficient
forecast
amount
sales
revenue initially.
produced. to cover its
costs.

FC

Q1 Output/Sales

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Break Even Analysis If the firm chose

Costs/Revenue TR (p = £3) TR (p = £2) TC to set price
VC higher than £2
(say £3) the TR
curve would be
steeper – they
would not have
to sell as many
units to break
even

FC

Q2 Q1 Output/Sales

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Break Even Analysis

TR (p = £1)
Costs/Revenue If the firm chose
TR (p = £2)
to set prices
TC
VC lower (say £1) it
would need to
sell more units
before covering
its costs.

FC

Q1 Q3 Output/Sales

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Break Even Analysis

TR (p = £2)
Costs/Revenue TC

Profit VC

Loss
FC

Q1 Output/Sales

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Break Even Analysis

TR (p = £3) TR (p = £2)
Costs/Revenue TC Margin of
Asafety
highershows
price
how far sales can
VC would
Assumelower
fall before
the
current
losses
break
saleseven
at Q2.point
made. If Q1 = of
and the margin
1000 and Q2 =
safety would
1800, sales could
widen.
fall by 800 units
before a loss
would be made.

Margin of Safety

FC

Q3 Q1 Q2 Output/Sales

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Costs/Revenue Eurotunnel’s problem

High initial FC.
FCon1debt rises
Interest
each year – FC rise
therefore.

FC
Losses get bigger!

TR
VC

Output/Sales

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Break Even Analysis

• Remember:
• A higher price or lower price does not
mean that break even will never be
reached!
• The break even point depends on the
number of sales needed to generate
revenue to cover costs – the break even
chart is NOT time related!

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Break Even Analysis

•Importance of Price Elasticity 

of Demand:
•Higher prices might mean fewer sales
to break even but those sales may take 

a longer time to achieve
•Lower prices might encourage more
customers but higher volume needed
before sufficient revenue generated 

to break even

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Break Even Analysis

• Links of break even to pricing
strategies and elasticity
• Penetration pricing – ‘high’ volume, ‘low’
price – more sales to break even
• Market Skimming – ‘high’ price ‘low’
volumes – fewer sales to break even
• Elasticity – what is likely to happen 

to sales when prices are increased 

or decreased?

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Budgets

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Budgets
• Estimates of the income and
expenditure of a business or a part of a
business over a time period
• Used extensively in planning
• Helps establish efficient use 

of resources
• Help monitor cash flow and identify
departures from plans
• Maintains a focus and discipline 

for those involved

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Budgets
• Flexible Budgets – budgets that take
account of changing business conditions
• Operating Budgets – based on 

the daily operations of a business
• Objectives Based Budgets - Budgets
driven by objectives set by the firm
• Capital Budgets – Plans of the
relationship between capital spending
and liquidity (cash) in the business

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Budgets
• Variance – the difference between
planned values and actual values
–Positive variance – actual figures
less than planned
–Negative variance – actual figures
above planned

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