OPERATING AND FINANCIAL

BUDGETS
SESSIONS 5, 6, 7
MANAGEMENT CONTROL

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GOALS
 Define budgeting and discuss its role in planning, control & decision making

 Understand the critics of budgeting

 Understand the cycles of budgeting

 Develop simple integrated budgets

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BUDGET ROLES & DEFINITION

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WHAT IS A BUDGET ?
A budget is a financial and quantitative summary of an action plan for a forthcoming
accounting period
• Types of budget:
– Functional (sales, production, purchasing etc.)
– Capital investment and cash budgets
– Master budget (includes all budgets)
• Budgeting (also called forecasting) is about planning future activities.
ROLES & OBJECTIVE OF BUDGETING
1/ Budget = instrument for coordinating the organization

 Creativity factor (imagining plans to create value), exchange trigger

between operational services in coordinating and strategic alignment

 Triggers a flow of information between corporate managers/employees

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ROLES & OBJECTIVE OF BUDGETING
2/ Budget = delegation tool

 Encouraging managers to agree to the general objectives of the company

 Empowerment

 Partial delegation to achieve general objectives

 Allows monitoring and control

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ROLES & OBJECTIVE OF BUDGETING
3/ Budget = the reference to measure and control performance

 Implementation of a process of measure and control of achieved results

 Comparison between budgeted and actual performance

 Performance management: corrective decision making to achieve the

objectives

 Allows budgetary control

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ROLES & OBJECTIVE OF BUDGETING
4/ Budget = simulation and decision making tool

 Organize relevant information to anticipate

 Model relations between objectives and the resources necessary to

achieve them

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TYPES OF PLANNING
Strategic planning: analyze and decision STRATEGY
on the major orientations of the
company (long term 5 to 10 years)

Operational mid-term activity programs :

plan the necessary means to achieve
the strategic goals (capital expenditure, OPERATIONAL PLANNING
HR planning, financing plan…) (mid term 2 to 5 years)
Annual budgets: Numbered and
detailed translation of the annual
operational plan (in monthly planning):
sales budget, operational budget… BUDGET
financial budget.
(short term)

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BUDGETING AGENDAS
F06 2023
F03 2023
Budget 2023
F09 2022
Budget 2024
Budget 2023

Oct. January April July Oct Dec Dec.

2022 2023 2024
01
Budgeting work usually starts Rolling forecasts are 12-
early September and cover the month budgets that are revised
12-month period from Jan to every quarter
Dec of the following year
BUDGETING PROCESS TIMELINE
 May-June N
Budget framework
Macro-economic assumptions
General management (GM) strategy

 July-September N
Budget discussion rounds: pre-budgets

 September-October N
Arbitration
Critical comparison of consolidated pre-budgets with objectives

 November N
GM approval: finalisation of N+1 budgets
The following year
Budget implementation and monitoring (budget control and reforcast)

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Source: Performance management and control, Loning and al, Dunod, 2016, page 66
PLANNING, CONTROL & BUDGETS

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Source: Hansen & Mowen 2000
 COMPANY STRATEGY
= Implementation in the USA BOARD OF
DIRECTORS

-Need private capital

-Earning potential for shareholders: FINANCE

FUNCTION

-Increase net income by 10 %

OBJECTIVES OBJECTIVES MANAGEMENT

Division A : Division B CONTROL
= Double turnover = margin/turnover by 5 %
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 Division B

MEANS

Action plan 1: Action plan 2

production costs R&D costs
resource: resource: MGT
Move to 2 teams Phase out projects CONTROL
Sell 1/2 equipment Optimize processes

RESULTS
Workshop hourly rate Research costs
= - 10% = - 0,5 M€
ROLLING FORECAST

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Source: The rolling forecast, a tool for more accurate budgeting and planning, Controller’s report, November 2014
HOW A ROLLING FORECAST WORKS

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Source: The rolling forecast, a tool for more accurate budgeting and planning, Controller’s report, November 2014
 Company Objectives Capital Expenditure Plan

Sales Budget

Inventory policy Manufacturing budget Production capacity

Human Resources adjustement

and training Administrative
expenses budget
Procurement Budget
Forecasted financial performance

Cash Budget Forecasted Income Statement Forecasted Balance Sheet

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Source: Managerial Accounting, Creating Value in a Dynamic Business Environment (Hilton, 2014)
FROM SALES FORECAST TO PURCHASES
Exercise
A company forecasts for 2022 to purchase the equivalent to 110% of its
production needs.

The production should be equal to 105% of its sales.

Sales volume forecast should be equal to 120,000 products.
Each product needs 2 components

How many components does this company forecast to purchase in 2022?

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CRITICS OF BUDGETING

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ROLES OF BUDGETS: PLANNING VERSUS CONTROL

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Source: Budget choice, planning versus control,
Churchill, Harvard Business Review, 1984
MANY CRITICS AGAINST BUDGETS

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GENERAL CRITICS ABOUT BUDGETS
1. Budget gaming
Budget gaming usually refers to preparing either a better or worse budget
than the budgetee actually believes is the most likely outcome for the
budgeted period.
Example from Management control systems, European edition, 2014:
“The most important determinant for the gaming in our case was the
profitability level. If we were expecting a very bad year (we did have
some), we tended to show a more positive future in the budget. The reason
for this was quite simple: we did not want to be shut down. If, on the other
hand, we expected a very good year (we had some of those too) we
tended to show a less optimistic budget. There was just no reason to show a
very positive budget, because our superior would be content with a fairly
positive one. If we could then perform as well as we thought we could, it
would just be an extra plus!” (Manager in a Swedish company)

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GENERAL CRITICS ABOUT BUDGETS
2. Myopia (source: Management control systems: european edition, 2014)
Myopia refers to sub-optimization and short-termism.
Sub-optimization means that budgeting makes managers and
employees focus on what is best for their small part of the organization
rather than what is good for the whole organization. Because managers
are made accountable for the performance of their own department or
responsibility centre in the budget, rather than for the performance of
the whole organization, this may very well be the case.
Short-termism means that managers become mainly occupied with
short-term performance and focus very much on showing good figures in
their next report, rather than focusing on the long-term performance of
the organization. This is also a plausible risk given that the performance is
usually evaluated aignst the budget quite frequently, often monthly.
Some critics also state that the budget tends to be so focused on
financial numbers that it makes both problems even worse.

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GENERAL CRITICS ABOUT BUDGETS
Other critics
Budgeting is too resource consuming
Calendar year is not a good time period
It is impossible to make a reliable budget these days
The budget makes organizations less flexible
…

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BEYOND BUDGETING MOVEMENT

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BUDGETS: NEED TO CHANGE FROM A “FIXED PERFORMANCE CONTRACT” TO
A “RELATIVE PERFORMANCE CONTRACT”

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Source: Who needs budgets?, Hope and Fraser, Harvard Business Review, 2003
ELEMENTS FOR BUDGETING
EXERCISES

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FREE CASH FLOW CALCULATION (FROM CASH BUDGETS)

Cash Collection
- Cash disbursements
= Cash Flow

Initial Cash Flow + Cash Flow = Final Cash Flow

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FREE CASH FLOW CALCULATION (FROM OPERATING INCOME)

Operating income
+ Depreciation and amortization
= EBITDA (Gross Operating Income)
- Change in working capital requirements
= Cash flow from operating activities
- CAPEX
= Free cash flow

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 FREE CASH FLOW CALCULATION (FROM OPERATING INCOME)
Change in WCR = WCRF - ICRF
= (ending inventory + ending receivables - ending payables) - (beginning inventory + beginning
receivables - beginning payables)
= (ending inventory - beginning inventory) + (ending receivables - beginning receivables) - (ending
payables - beginning payables)

Change in WCR = change in inventories + change in receivables - change in payables

With :
inventory change = ending inventory - beginning inventory
change in receivables = ending receivables - beginning receivables
change in payables = ending payables - beginning payables

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CASE STUDY: INTRODUCTION TO
BUDGETING

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CASE: INTRODUCTION TO BUDGETING
Question

Create P&L budget for N+1 and

calculate the budgeted cash flows in 3 different ways.

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CASE STUDY: INTRODUCTION TO
BUDGETING (2)

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CASH FLOW BUDGET (EXAMPLE 2)
A company has the following values:
The sales and purchases forecasts for January and February N+1 are :

Data January N+1 February N+1

Sales of finished products in € 32 500 € 39 000 €
Purchasing of components in € 19 000 € 21 000 €

Collection Information:
 Customers pay their invoices as follows: 60% in the month of the sale and 40% in the
following month.
 The balance of accounts receivable at December 31, N is 16,000 €. It will be paid in
January N+1.

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CASH FLOW BUDGET (EXAMPLE 2)
Disbursement Information:
 Payments of invoices to suppliers are made as follows: 40% in the month of purchase
and 60% the following month.
 The balance due to suppliers on December 31, N is 12,500 €. It will be paid in January
N+1.

Other information:
 Salaries paid: €3,500 per month
 General production costs paid: €4,400 per month
 Commercial and administrative expenses paid: 2 800 € per month
 The final cash balance of December N is 16 000 €.

What would be the value of the final cash balance at the end of February N+1?

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CASE STUDY TEXAS REX

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CASE STUDY KERRY

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Merci de votre attention.