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3/1

AGL - AUTONOMOUS GROUP LEARNING

NO.3 BASIC PLANNING AND

BUDGETARY

CONTROL FOR MANAGERS

PART I

Copyright RGAB 2006/1

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3/2 ABBREVIATIONS

AGL - AUTONOMOUS GROUP LEARNINGIND - INDIVIDUAL

SG - SMALL GROUP

CSG - COMBINED SMALL GROUP

MG - MAIN GROUP

ASS - ACCOUNTING STEP BY STEP

BC - BUDGETARY CONTROL TEXT

PL - PROGRAM LEARNING

L - LECTURE

D - DISCUSSIONCR - CHAPTER

CAI - COMPUTER ASSISTED

INSTRUCTION

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3/3 ASSIGNMENT 1.0 INTRODUCTION

1.1 SPECIFIC OBJECTIVES OF THE PROGRAM

(a) Understand the language and concepts of business planning

and budgetary control.

(b) Prepare budgets and interpret budget reports.

(c) Develop confidence in dealing with practical budget problems

both human and technical.

(d) Appreciate the need for a Total Business Planning system.

(e) Motivate further study in the future.

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3/4 1.2 AUTONOMOUS GROUP LEARNING (AGL)

The AGL method is designed to achieve rapid individual learning using

special rnaterials and the stirnulus of group activity without a formal

instructor.

The groups use the rnaterials to find the answers to all problerns and

questions.

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3/5 1.3 GROUP ARRANGEMENTS

The work will be done:

(a) IND - INDIVIDUALLY, or

(b) SG - SMALL GROUP (in small groups of four members

which will change daily), or

(c) CSG - COMBINED SMALL GROUP (two small groupstogether, with one group acting as "dealers" to lead the

discussion and record key points on the flipchart"

provided), or

(d) MG - MAIN GROUP (for short taped lectures on key learningpoints with visual aids).

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3/6 1.4 SG - SMALL GROUPS

Initial group names provided by the Organizer.

Note the name of your SG and names of the other

members.

Groups change three times during the course.

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3.7 1.5 LEARNING MATERIALS

(a) Retained by members:

- Text book

- Notebook for recording every key point

- Course Diary

- CAI

- Program Learning ASS

(b) Used but not retained by members:

- Work Packs for Part 1 and II including:

introduction, cases, and key learning points to be

noted.

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3/8 1.5 (continued)

NOTE:

(a) Use your notebook. Do not mark the Work Pack,

which must be handed back at the end of each day.

You receiveall the materials in your SG. Don't look

ahead" in the workpack until you are specificallyasked to do so

(b) Acknowledgment is made to many published and

unpublished sources which have provided the basic ideasand practical experience and case materials which have

been specially adapted for this program.

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3/9 1.6 METHOD

Try to complete fully every task in the time allowed.

Work as quickly and effectively as possible.

A pattern of learning methods will be used including:

(a) Program learning

(b) Case analysis(c) Lectures

(d) Quizzes

(e) Learning patterns

(f) Homework reading and CAI

.

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3/10 1.7 LEARNING PATTERNS

a. OBJECTIVE - CONFIDENCE

LANGUAGE AND CONCEPTS

BUDGET PREPARATION

BUDGET REPORTING

TOTAL BUSINESS PLANNING

HUMAN AND TECHNICAL PROBLEMS

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b. GROUPS

INDIVIDUAL WORK

SMALL GROUP WORK

COMBINED SMALL GROUP WORK

MAIN GROUP WORK

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c. METHOD - INDIVIDUAL LEARNING FOR YOU

PROGRAM LEARNING

CASES

READINGS

LECTURES

SG, CSG AND MG LEARNING

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3/13 1.8 INSTRUCTIONS

a. Assemble in SG to introduce yourself, indicateyour past experience in planning and budgetary

control, and what you hope to contribute to, and

gain from the course.

b. Complete page one of the Course Diary and discuss

the learning objectives.

c Reassemble in MG when the bell rings.

NOTE: Check that you have a full set of learning

materials. Locate the glossary in ASS.

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3/13a 2.0 QUIZ (45 minutes)

2.1 INSTRUCTIONS

a. Assemble in SG.

b. Answer the quiz of 100 questions; mark your answers a, b, c

or d with a clear X on the special form provided in the Course

Diary.

c. Work as quickly as possible, but dont guess - just

leave blanks.

d. The Organiser will mark your answers and give you

a measure of your knowledge at the start of the

course.

e. Reassemble in MG when the bell rings.

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3/13b 3.1 PROGRAM LEARNING (45 minutes)

2.1 INSTRUCTIONS - INDIIVIDUAL WORK

a. Assemble in SG and find your copy of the ASS book.

b. Quickly read the Introduction in ASS.

c. Quickly complete aloud and in writing Ch. II of ASS.

d. Record key points in your notebook.


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3/14 4.0 BASICS OF BUDGETING

4.1 BUDGETS AND BUDGETARY CONTROL

Budgets are financial plans of future action.

Budgetary control uses budgets to measure performanceand control behavior.

Both involve technical and human problems.

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3/15 4.2 OBJECTIVES OF BUDGETARY CONTROL

(a) Plan future operations to balance objectives, resourcesand environment..

(b) Communicate targets and plans to the organization,

which must be understood to be effective.

(c) Motivate managers to achieve company objectives.

(d) Compare actual performance with budget target and

locate trouble spots for management action.

(e) Influence the behavior of managers.

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3/16. 4.3 PERIOD AND PROJECT PLANNING

Budgetary control may involve both project planning and periodplanning.

Project planning - targets for each specific project over time,

from beginning to end.

Period planning - targets by time periods (months, quarters,

years) including all activities in the planning period.

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3/17 4.4 BUDGET SYSTEMS

Flexible to meet needs - USEFUL is the key!

Factors shaping a budget system:

a. Industry - profit- making characteristics.

b. Top Management objectives - system to promote

specific objectives.

c. Other considerations - organizational structure,

information technology, incentives and staff

available.

NOTE: System initially affected by Top Management attitudes

towards financial planning and control.

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3/18 4.5 BUDGET CONCEPTS

(a) Assumptions - Budgets are future forecasts based upon

assumptions. Only as good as assumptions. Sales forecast is

usually the key assumption.

(b) Sponsorship - Top Management must convince the Organization that

the budget system is important. Top Management attitudes

revealed mainly, not by words but by action and involvement in

budget process.

(c) Responsibility centers - Organizational centers provide for control

and responsibility. Center Manager involved in setting budget

targets. Building block approach to total budget process.

(d) Participation - by both manager and "managed" in setting targets.

and continuous education to understand the system, what is

expected, and how performance is judged.

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3/19 4.5 (continued)

(f) Time - Control period is shortest time for Management to

intervene arid change performance. Varies by responsibility

centers and activity.

(g) Controllable Costs - Emphasize costs over which manager can

influence (actually and/or psychologically). Use to measure

performance.

(h) Management by Exception - Focus attention, not on all items,

but those where actual performance differs significantly from

target. Conserve management time and provide a starting point

for performance analysis. Report signals of exceptions only!

(i) Appraisal - Budget as a standard to evaluate performance -

both measured in same terms.

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3/20 4.6 BUDGET PROCESS

Operations (income statement) budget

Cash budget

Ccapital budget

Funds flow budget

Balance sheet - budget - overall financial position.

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3/21 4.7 OPERATING BUDGET

(a) Plans and targets - covers all operating statistics for future

period.

(b) Key assumption is Sales related to:

- Market potential

- Management guidelines

- Productive capacity- Cash resources

(c) Includes sales, cost of sales, overhead expense and profit.

Distinguishes fixed and variable cost. Shows "Contribution"

(sales less variable cost) to fixed cost and profit.

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3/21a 4.7 OPERATING BUDGET(continued)

(d) Normal period one year - six months in detail and six

months in total.

(e) Budget set from past performance. Ratios, managers'

reasonable estimates and good common sense.

NOTE: Negotiating the budget is a MANAGEMENT GAME calling

for skill, strategy, shrewdness ... and quiet manipulation (but be

sure to call it creativity )

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3/22 4.8 BUDGETED BALANCE SHEET

Budget of overall financial position. Assets and how they are financed

from liabilities and owners equity.

Plan balance sheet at end of budget period. Forecast:

1. Current assets and current liabilities from sales target in operating

budget, or alternatively, each item of current assets and current

liabilities separately:

a. debtors as % of sales

b. stock as % of cost of sales

c. creditors as % of cost of sales

d. tax as actual liability

2. Fixed asset requirements in a special "capital" budget.

3. Loans by specific management policies.

4. Owner's equity (balance plus profit less dividends).

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3/22a 4.8 (continued)

The difference between required assets

and finance available (liabilities and owner's equity)

represents cash surplus or deficiency

for the budgeted level of activity.

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3/23 4.9 OTRA APPROACH TO BUDGET PROBLEMS

Evaluate a budgetary control system in terms of:

O - Objectives - Define specific objectives which management

seeks to achieve with the budget system, within the specific

company organization.

T - Targets - Analyze how the system provides guidance and I

interaction in setting the key budget targets.

R - Reporting - Analyze the frequency, content, design and

effectiveness of the reporting system. Compare actual

against budget (target) performance.

A - Action - Evaluate the effectiveness of the system in terms of

action taken and behavior-patterns of managers in achieving

overall company objectives.

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a. BUDGET OBJECTIVES

PLANNING

COMMUNICATION

MOTIVA\TING

CONTROLLING

TO INFUENCE THE BEHAVIOUR OF MANAGERS

AND THE WAY THEY DANCE

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b. BUDGET SYSTEMS

INDUSTRY PROFIT MAKING FACTORS

ORGANIZATION

TOP MANAGEMENT OBJECTIVES

SYSTEMS - FIXED OR FLEXIBLE

USEFUL? CREATIVE? DEFENSIVE?

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c. BUDGET CONCEPTS

ASSUMPTIONS

SPONSORSHIP

RESPONSIBILITY CENTERS

PARTICPATION

INTERACTION

CONTROL COSTS

MANAGEMENT BY EXCEPTION

APPRAISAL

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d. OPERATING BUDGET

MARKET

GUIDELINES

CAPACITY

CASH

SALES TARGET

SALES = COST OF SALES + OPERATING EXPENSE

+ PROFIT

3/28 4 10 LEARNING PATTERNS

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e. BALANCE SHEET

ASSETS ARE FINANCED BY OWNERS EQUITY

AND LIABILITIES.

AS SALES EXPANDREQUIRED ASSETS EXPAND...

AND HAVE TO BE FINANCED, EITHER FROM

PROFITS RETAINED IN OWNERS EQUITY, OR

FROM EXPANDED LIABILITIES

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f. OTRA

OBJECTIVES

TARGETS

REPORTING

ACTION

3/29a 4 11 INSTRUCTIONS

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3/29a 4.11 INSTRUCTIONS

INDIIVIDUAL AND SG WORK

a. Assemble in SG.

b. Study and discuss the lecture, to be sure that every member of your

SG, really understands, every key issue.

c. Record key points in your notebook.

d. Quickly read the case study (JOHN MARAIS) which follows.

e. Then work as a very efficient and effective action team, to quickly

resolve the case.

f. Be sure to record the complete answer to each question and your

final decision, on the SG f lip chart provided, so that you are fully

EI in what you agree upon.

3/29b 6 O CASE - JOHN MARAIS

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3/29b 6.O CASE JOHN MARAIS

6.1 - THE STORY OF THE GASE

John Marais finances business expansion with a bank loan. He budgetsa need of 75m.

His results show increased sales over forecast and slightly increased

profits.

However, dividends use up necessary cash; inventory is high; and

creditors are stretched.

The equity/debt relationship is weaker. Was the expansion really

worthwhile?

What budget should be set for next year?

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3/29c 6.2 BUDGET FOR NEXT YEAR - SELLING AND

ADMINISTRATION EXPENSE

Suggested solution: Actual Budgetthis yr next yr

000 000

Selling Expense:

Sales salaries 25 45

Office Salaries 15 20

Office Expense 16 20

Sales Commission 70 100

Travel Expense 25 45

Advertising 60 70

General Promotion 35 50

Discounts allowed 80 120

326 470

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3/30 6.2 . (continued)

Aministrative Expense:

Actual Budgetthis yr next yr

000 000

Salaries 25 25

Office expense 29 35Legal expense 6 10

Audit expense 4 10

General expens, interest

and depreciation 26 30

Total 90 110

Total S & A Expense (below) 416 580

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NOTE:

(a) Moderate increase in sales expense, except for sales

commission, travel, advertising, promotion. Discounts allowed

increased substantially.

(b) Administrative expense well controlled.

(c) Total (416 - 580) due to sale increase from 1,583 -2,500. Fixed

cost stable but variable cost increased.

(d) ALL BUDGET TARGETS ARE ONLY REASONABLE

ESTIMATES. (YOU MAY HAVE ALTERNATIVE SOLUTIONSTHAT ARE EQUALLY ACCEPTABLE).

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3/32 6.3 BUDGET NEXT YEAR - OPERATIONS

Suggested solution: Actual Budgetthis yr next yr

000 000

Net Sales 1,583 2,500

Cost of sales 1,053 1,667

Gross profit 530 833 (33%)

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Suggested solution: Actual Budget

this yr next yr000 000

Gross Profit 530 833

Selling and administrative expense 416 580

Operating profit 114 253

Income tax (40%) 45 101

Net profit 69 152

Dividend paid 43 43

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3/34 6.4 BUDGET NEXT YEAR - BALANCE SHEETS

Suggested solution:

Actual Budget

this yr next yr000 000

Current Assets:

Cash (19)

Accounts receivable (debtors) 127 208

Inventory (stock) 314 559441 748

Fixed Assets:

Cost 92 92

Less: Accumulated Depreciation 12 3080 62

Total Assets 521 810

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3/35 6.4 (continued)Actual Budget

this yr next yr

000 000

Current liabilities:

Accounts payable (creditors0 139 288

Current tax liability 45 101

Bank (loan) 75 50

259 439Owner's Equity:

Share captal 100 100

Accumulated profit 162 271

262 371

Total Liabilities and Owner's equity 521 810

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3/36 6.4 ASSUMPTIONS

NOTE:

(a) AR - Sales 2, 500 @ 8.2% = 208.

(b) INV - Cost of sales 1, 667 @ 33.3% = 559

(c) AP - Cost of sales 1,667 @ 16.6% = 288.

(d) OE - Accumulated profit 162 plus net profit 152

less dividend 43 = 271.

(e) CASH - Difference - cash deficiency (19)

3/37 6 5 EVALUATION OF NEXT YEAR'S BUDGET

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3/37 6.5 EVALUATION OF NEXT YEAR'S BUDGET

(a) Operations - Expansion of sales and profits, despite reduced

gross profit % and loss of purchase discounts. Good cashflow (152m + dep. 18m).

(b) Capital - No substantial additions. Will this be possible with

the increased sales?

(c) Cash - Liquidity difficult even with stock, debtors and

creditors controlled.

(d) Overall Financial Position - Poor. Required assets increased

by 289 (521 - 810) yet profit retained only 109 (152 - 43).This forces a stretching of creditors to finance the assets.

(e) Assets - Expansion at reduced margins is dangerous

unless "required assets controlled. Need higher equity base.

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3/38 6.6 ITEMS TO BE CAREFULLY WATCHED

(a) Continued expansion to achieve budget targets, which provide:

profit, cash flow to improve liquidity and equity base.

(b) Control carefully the following:

1. Sales - not to expand above budget because it would

involve increase in required assets.

2. Gross Profit - hold sales prices, avoid inventory losses,

improve purchasing, take cash discounts, etc., and thus

hold the 33% margin (gross profit percentage).

3. Sales expense - control carefully salesmen commission,

sales discount and advertising - the major costs.

4. Administrative expense - watch general expense and

hold other costs.

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5. Debtors and Inventory - hold to budget levels with

careful controls.

6. Fixed assets - avoid substantial new expenditure.

7. Creditors - take cash discounts as available but stretch

other payables if possible.

8. Dividends - control to budget level or cut to nil if

possible. Get more equity!

(c) Overall - Sales and profits expansion can only lead to financial

strength, if finance is available for the increased assets. Thiscompany needs to get more equity base - and control operations

very carefully - cash availability is vital!

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3/40 6.7 PERFORMANCE THIS YEAR-

ACTUAL AGAINST BUDGET

(a) Operations:

1. Sales increased substantially (1,163 - 1, 583).

2. Gross profit increased (430 - 530).

3. Gross profit percentage fell substantially (37.6% - 33.3%)

4. Selling expense exceeded budget (232 - 326) due to

sales commission and excessive sales discount allowed.

5. Administrative expense controlled but general expense

requires investigation (15 - 26).

6. Dividends used up most of the cash flow (43 - 69).

7. Excess sales (1, 583 - 1,163 = 420) produced onlysmall additional net profit (69 - 65 = 4) due to falling

margins and high sales discount.

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(b) ACTIVITY

1. Inventory higher than budget (183 - 314) and

inventory turnover fell (4.0 - 3.3 times).

2. Receivables higher but consistent with increased sales

(30 - 29 days).

3. Payables stretched (9 - 48 days).

(c) LIQUIDITY:Poor. Company will find it difficult to repay 25 to the

bank within two weeks.

(d) OVERALL:

Excessive activity at lower margins led to increased need forassets. Liquidity crisis and deterioration in equity/debt ratio

(2.8:1 - 1:1). Need to restrain sales or increase equity base with

new cash or retained earnings.

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3/42 6.8 FALL IN GROSS PROFIT PERCENTAGE

May be due to:

- poor inventory valuation- selling price cuts

- excessive returns and allowances

- inventory losses

- poor purchases- loss of purchase discounts

- embezzlement of cash

- sales not recorded to avoid tax

- etc...

Did you get them all?

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3/43 6.9 LEARNING POINTS

(a) Increased sales target must increase stock (inventory) and

debtors.

(b) Operating budget based upon assumptions of sales, margins

and overhead expenses. Margin means gross profit percentage.

(c) Capital budget provides fixed assets to support operating sales

targets.

(d) Overall financial position - budgeted balance sheet based on

assumptions for: stock, fixed assets, debtors, creditors and

capital.

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(e) Distinguish fixed costs which remain stable from variable costs

which increase with sales volume.

(f) With sales expansion the increase in required assets must be

carefully controlled by management.

(g) Equity/debt position may be improved by high retained profits

and low dividends or new equity.

(h) Budgets not merely for operations, but also the effect of

operations on cash, capital and the overall financial position.

(I) Budgets based upon assumptions.

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k. Use the past performance, ratios, estimates and common

sense to forecast budget for the future.

l. Evaluate a budget in terms of: sales, costs, profit, assets

required and finance available.

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a. EXPANSION

AS SALES EXPAND

REQUIRED ASSETS EXPAND...

AND HAVE TO BE FINANCED, EITHER FROM

PROFITS RETAINED IN OWNERS EQUITY,

OR FROM EXPANDED LIABILITIES


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b. SALES

THE NEW SALES TARGET AFFECTS:

OPERATING BUDGET

CASH BUDGET

CAPITAL BUDGET

BALANCE SHEET BUDGET

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c. COSTS

DISTINGUISH:

FIXED COSTS - STABLE WITH INCREASED SALES

VARIABLE COSTS - NOT STABLE

SEMI-VARIABLE COSTS - NOT STABLE


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e. BUDGETS

OPERATING BUDGET

S = COS + E + PROFIT

BALANCE SHEET BUDGET

CA + FA = L+ OE

NOTE: CA + FA = REQUIRED ASSETS


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e. ASSUMPTIONS

ALL ESTIMATES BASED ON:

PAST

TRENDS

RATIOS

FUTURE FORECASTS

COMMON SENSE


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a. Re-assemble in CSG.

b. Study and discuss the guide to the case. Compare it to

your solution. Be sure that every member of your CSG,

really understands every key issue.


d. Re-assemble in MG when the bell rings.

3/50b 7.0 PROGRAM LEARNING (45 minutes)

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a. Assemble in new SG and find your copy of the ASS book.

b. Introduce yourself to the other SG members.

c. Quickly complete aloud and in writing Ch. III of ASS.



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3/50c 8.0 BUDGET PREPARATION

8.1 CASH BUDGET

Plan cash to finance immediate operations and avoid shortages.

Translate sales, costs, and expenses into weekly and monthly cash

receipts and payments based on assumptions of credit terms.

Determine future cash needs - timing and duration of peak cash

requirements.

Revise forecast monthly for twelve months ahead.

Cash availability is ABSOLUTELY VITAL.!

3/51 8 2 CAPITAL BUDGET

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3/51 8.2 CAPITAL BUDGET

(a) Key to long term profitability. Invest now for benefits in the

future.

(b) Plan future requirements for fixed assets, research and

development, investments and other major expenditures.

(c) Key decisions which affect the long term "shape", direction,

financial strength of the company.

(d) Create the environment for future business operations.

(e) Need long term (five year) capital budget to make annual capital

budgets meaningful.

(f) Plan both new "investment" and new "dis-investment" (sale of

fixed assets, etc. ).

3/52 8 3 FUNDS FLOW BUDGET

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3/52 8.3 FUNDS FLOW BUDGET

Forecasts future sources and uses of funds.

Sources of funds are: profit before depreciation, new capital, newlong term loans, sale of fixed assets, reduction of working capital.

Uses of funds are: dividends paid, fixed assets, investments,

repayment of loans, increase in working capital, etc.

Sources always equal uses - the difference, simply changes working

capital. If the required working capital" is computed - then the

difference between sources and uses of funds represents: fund

surplus or deficiency to requirements.

Management provides funds by: (a) increasing sources, or (b)

reducing uses. Funds flow shows key management decisions in

allocating company resources in the period.

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NOTE:

Profit is computed after charging depreciation but since

depreciation is a non-cash expense, the cash flow from operations

is always:

(a) Profit after charging depreciation plus

(b) Depreciation expense

which is the same as "profit before depreciation .

3/54 8 4 ASSUMPTIONS

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Budgets are based on assumptions.

Usefulness of the budget depends on the validity of the

assumptions.

Broad assumptions only justify broad figures.

Detailed "pseudo accurate" figures are neither justified nor useful

to Management.

3/55 8 5 ANALYSIS OF COSTS

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3/55 8. 5 ANALYSIS OF COSTS

There is no "true" cost - only a "useful' cost to Management.

Cost may be:

(a) Variable cost - varies in total with volume (e. g. direct materials).

(b) Fixed cost - constant in total with volume (e.g. rent, office

salaries, audit fees).

(c) Allocated cost - charged to centers on "fair" basis; never "true"

cost, but it may motivate managers (psychologically) e.g.

selling and administrative overhead "allocated" to departments.

(d) Engineered cost - directly related to production, e.g.direct

labour, materials, etc.

3/56 8 5 ( ti d)

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(e) Managed cost - spent as management judges; no "right" level;

good performance is not no cost e.g. advertising must be

spent!

(f) Standard cost - target cost levels based on engineering

standards; variances between actual and standard analyzed

by: price, efficiency and volume e.g. direct labor and

materials.

(g) Committed cost - fixed over the short term regardless of activity

level e.g. depreciation.

(h) Direct cost - clearly associated with a product e.g. directmaterial. Conversely - indirect cost is overhead.

NOTE: Any one cost may be classified in several ways!

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3/57 8.6 FIXED BUDGET

Fixed budget assumes unchanging sales target and fixed plans toachieve it.

No automatic adjustment for cost and profit targets when sales

target not achieved.

Changed only as a specific budget revision which involves

technical and human problems.

3/58 8.7 VARIABLE OR FLEXIBLE BUDGET

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3/58 8.7 VARIABLE OR FLEXIBLE BUDGET

Not a fixed budget.

Series of alternative budgets according to differentforecasted sales levels (i.e. 60%, 80%, 100%, 120% of

target sales).

Cost and profit targets change in relation to sales targets.

Shows behavior of cost with sales volume. Distinguishes

fixed from variable costs.

Computes "contribution" (sales less variable cost equals

contribution).

Adds flexibility and complication to budget system, BUT

may not motivate managers as effectively as a fixed budget.

3/59 8.8 BREAK EVEN ANALYSIS

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3/59 8 8 S S

(a) Useful tool for understanding the effect on profit, of volume,

cost and price. Sales and costs computed at different sales

volumes. Distinguishes fixed and variable costs. Break evenpoint - sales equals total cost - no profit and no loss.

(b) Break even analysis aids understanding of the budget:

1. Shows profit(loss) at different sales volumes.2. For any volume, indicates what must be changed to

achieve profit target i. e. managed costs, engineered

costs, allocatedcosts, sales prices, product dropped etc.

(c) Not accurate. Only an estimate for a limited known range of

volumes. Conceals real difficulty of changing assumptions, i.e. it

may be much more difficult to reduce cost by 2% than to

increase sale price by 4%.

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3/60 8.9 CONTRIBUTION ANALYSIS

Sales less variable cost equals contribution.

Contribution less fixed cost equals profit.

Contribution to fixed cost and profit. Contribution for a product is

easily computed since fixed costs are ignored (not allocated).

TO ACHIEVE PROFIT, CONTRIBUTION FOR ALL PRODUCTS

MUST EXCEED TOTAL FIXED COST.

3/61 8 10 BUDGET PREPARATION PROCESS

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3/61 8.10 BUDGET PREPARATION PROCESS

(a) Budget guidelines

- Top Management sets objectives for the year and

outlines the means to achieve them.

- Forecast of the general economic, political and

business environment.

- Data circulated to responsible managers.

3/62 8 10 (continued)

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(b) Setting the targets and defining 0rganisational

responsibilities.

- Responsible managers at every level prepare

estimates for their centres based on the guidelines.

- Interaction and discussion with supervisors leading

to targets for approval.

- Controller's staff aid in computations, provide

historical data etc., but managers should set targets

(at least in theory).


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(c) Co-ordination:

- Separate budgets consolidated to form overallbudget for the firrm

- Budgets for each responsibility center are the

building blocks for the overall budget.

- Products and services transferred from one

department to another valued at special transfer

prices (cost plus profit or fair" market price or

negotiated price, or committee agreed price, etc. )

- Danger in "transfer prices" of inefficiency beingpassed along. Need to meet long term reasonable

market prices, but not short term or "dumping"

prices.

3/64 8 10 (continued)

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(d) Review and Approval

- Budget moves upwards through the organization

for review, approval and change in discussion with

responsible managers.

- Top management gives final overall approval.

- Targets then communicated to managers

throughout the organization.

3/65 8 11 OVERALL BUDGET PREPARATION

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3/65 8.11 OVERALL BUDGET PREPARATION

In all stages there is interaction between different management

levels. Inter-action is not time wasted.

It is essential to:

(a) avoid decision without discussion

(b) provide participation as key to motivation to achieve goals

(c) "condition managers psychologically to accept final targets

(d) allow time for managers to change.

Controller's staff and top management create an organizational

environment which may be "creative" or "defensive".

3/66 8 12 OTRA APPROACH

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3/66 8.12 OTRA APPROACH


(a) Objectives

- What are the key profit-making factors of the

industry?

- How is the firm formally organized into cost, profit or

investment centers. Informally what really happens?

- What are Top Management objectives from the

budget system - short term and long term?

- How does Top Management want the responsible

manager to behave?


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(b) Targets:

- Does Top Management give adequate, and timely,

guidelines?- Is the organizational environment defensive or

creative?

- Who sets initial and final targets?

- How much interaction and participation is involvedto set the targets? How creative and realistic are

the agreed targets?

- Do the targets motivate managers in terms of

challenge, responsibility and sense ofachievement?

(c) Reports and (d) Action to be discussed in Part II.


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a. CASH BUDGET

RECEIPTS, PAYMENTS AND BALANCES

FOR THE BUDGET PERIOD.

KEY DATA: THE PEAK CASH NEED AND THE

DURATION OF THE PEAK.

CASH IS MORE IMPORTANT THAN PROFIT!


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b. CAPITAL BUDGET

LARGE AMOUNTS

LONG TERM

COCONUTS NOT PEANUTS

PLANNING FOR KEY INVESTMENTS AND

DIS-INVESTMENTS

EI IS RELEVANT HERE!!


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c. FUNDS FLOW BUDGET

KEY MANAGEMENT DECISIONS REVEALED.

SOURCES OF FUNDS:

PROFIT BEFORE DEPRECIATION

NEW LOANS AND CAPITALSALE OF FIXED ASSSETS

USES OF FUNDS:

FIXED ASSETSDIVIDENDS

LOAN REPAYMENT

THE DIFFERENCE BETWEEN SOURCES AN USES

FLOWS AUTOMATICALLY INTO WORKING CAPITAL.


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d. COSTS

FIXED

VARIABLE

ENGINEERED

MANAGEDSTANDARD

COMMITTED

ALLOCATED

DIRECTINDIRECT ETC.


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e. BREAK-EVEN CHART

ASSUMPTIONS VALID ONLY FOR A LIMITED RANGE

OF VOLUME OF SALES

SFC

VC

BEP - THE BREAK-EVEN POINT IS WHERE SALES

EQUALS FIXED COST PLUS VARIABLE COST.


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f. BUDGET STEPS

TOP MANAGEMENT GUIDELINES

TARGETS

REVIEW, COORDINATION AND APPRAISAL

ALL BASED ON ASSUMPTIONS .


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g. FIXED AND FLEXIBLE BUDGETS

BUDGET CHANGE - AFFECTS MOTIVATION OF

MANAGERS.

FIXED BUDGET - ONE TARGET FOR SALES, COST

AND PROFIT - NOT NORMALLY CHANGED.

FLE/XIBLE BUDGET - SEVERAL TARGETS,

FOR DIFFERENT LEVELS OF SALES.


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INDIIVIDUAL AND SG WORK

a. Assemble in SG.




d. Quickly read the case study (GILTIM A) which follows.


resolve the case.




3/75 10.0 CASE: GILTIM A

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10.1 THE STORY OF THE CASE

Giltim is a quoted public company organized into decentralized"

divisions.

The Glass Division has separate marketing and manufacturing

arrangements, but plant managers have profit responsibility.

The budget system involves a long interaction in setting sales and

profit targets to achieve company objectives.

Does it motivate the managers to behave appropriately?

3/76 10 2 TOP MANAGEMENT OBJECTIVES

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3/76 10.2 TOP MANAGEMENT OBJECTIVES

Top management requires increased earnings per share (EPS)

every year.

Probably concerned with stock market reaction of EPS on the

market price of the company. Willing to sacrifice even better long

term development and profit for .... a continuous but steady

improvement in earnings regardless of the poor economic climate.

Managers encouraged to economize in costs even below budget

levels unless sales targets achieved. Increased profit this year and

every year - "a reliable growth company". Fixed not flexible budget

system.

3/77 10.3 INDUSTRY PROFIT- MAKING FEATURES

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Product quality, customerservice, cost control and

delivery.

Plant manager best able to meet and control achievement,

in these critical areas.

3/78 10.4 ORGANIZATIONAL STRUCTURE

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Company "decentralized" into divisional profit and investment

centers.

Divisions function as independent companies except for: labor

relations, capital expenditure, finance and the many informal controls

that Head Office imposes without realizing it.

Sales districts andplants are not consistently organized for special

reasons not explained in detail in the case.

Plant manager not merely cost but profit conscious. Extreme

pressure on the plant manager if sales fall off. Budgets consolidated

at divisional level but considerable Head Office pressure on plants.

Are divisions really managing the plants?

3/79 10.5 BUDGET PREPARATION

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May - Division heads submit estimates of sales, profits and capital

requirements.

June - Market research forecasts of overall political, economic and

business environment. Head Office sets the guidelines for

each division.

July - Divisional marketing managers and district sales managersset and adjust targets.

August - Sales targets allocated to plant to develop operating

budgets.

September - Head Office Controller visits plants.


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October - Plant and divisional budgets consolidated for Head Office

review and approval.

November - Changes negotiated and final targets agreed to achieve

overall objectives.

December - Top management final approval. Targets communicatedto responsible managers as fixed commitments for the budget

year.


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NOTE:

Top management retains complete control of long term planning.

Managers involved in short term budgets for many months.

This continuous "interaction" probably leads to budget "acceptance".

Management by exhaustion?

Budget appears to be imposed but probably agreed by managers

during the long period of "conditioning".

3/81 10.6 CONTROLLER'S VISIT

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Worthwhile for many reasons.

Investigates budget "padding' and obtains information to justifythe budgets to Head Office.

Demonstrates Head Office interest and involvement. Allows lower

managers to express aggressions. Creates relationships with

Head Office and lower levels.

Tends to bypass the Divisional Managers and emphasizes the

close centralized control - not at all decentralized!

3/82 10.7 BEHAVIOUR OF PLANT MANAGERS

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(a) Plant manager best able to control quality, delivery and cost

competitive features of the Industry.

(b) Feels responsible for profit because of extensive interaction

in setting targets.

(c) System seeks behavior that achieves profit targets.Environment probably highly defensive and managers may

try to "pad" cost budgets and keep targets of sales activity

low, to provide the necessary freedom to live" under the

system. May result in poor quality of production at year end.


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(d) Probable tendency to economize on anything but

absolutely necessary maintenance, training, research and

development, etc. in early months of the year when salesand profits are uncertain.

(e) Such behavior is probably economic and effective for cost

economy and profit achievement SINCE NO COSTS ARE

ABSOLUTELY VITAL EXEPT IN RELATION TO OTHERPRIORITIES.

(f) The manager who gets promoted in GILTIM is probably

the one who meets. budget targets.

3/84 lO.8 BUDGET REVISION

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Company needs improved EPS every year for stock market

purposes. Needs to achieve a fixed profit target every year. Fixed

budget targets are clear and definite.

Revision may excuse poor performance and may encourage

managers to devote more energy to justifying budget revision than

to achieving the budget.

Revised budget could relieve the plant managerof undue pressure

due to poor sales performance.

3/85 lO.8A BUDGET PROBLEM AT PLANT X

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(a) Decision: Plant Manager should fight hard for:

1.Capital equipment budget (600) required to putthe plant into an efficient condition and then accept

the required profit target, OR

2. Lower profit target for the technical reasons

outlined in the case.

NOTE: If unsuccessful, accept the required target then, if sales fall

off, press for budget revision. Lower sales target and profit target

could be achieved by cutting costs for this one further year despite

manufacturing inefficiency. Possibly request an "action team" tohelp the plant. Get Divisional Manager's support for this critical

period and it will help the budget revision request.

3/85a lO.8A (continued)

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(b) Justification:

Company's policy to hold Plant Managers responsible for meetingHead Office targets motivates "beating the system" through,

padding and sabotage, etc. However, overall company need for

earnings per share, takes precedence over immediate technical

efficiency in the plant, although long term problems must be dealt

with by the system.

NOTE: Key problem in budget setting is the strategic power of the

parties concerned. Does the Plant Manager have the power and

support to overcome the Controller's sales and profit objectives? If

not, he may as well accept the targets, do his best and then pressfor revision early in the year. However, if he gets his capital budget

substantially, then he must meet the targets.'

3/86 10.9 MOTIVATION AND BEHAVIOUR

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A sophisticated budget preparation designed fora specific industry

and organization to achieve specific objectives.

Interaction over long periods "conditions" managers to believe that

budget targets have been participatively agreed" .... they probably

feel responsible and act accordingly, even though in purely rational

economic terms, this is ridiculous ... but then managers neverbehave rationally in purely economic terms or do they?

System probably very effective in achieving short term goals. May

well perform adequately (if not optimally) in long term. However,

does not "develop" creative managers!

3/87 10.10 LEARNING POINTS

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(a) Budget preparation systems, depend not only on technical

problems but also the organizational environment.

(b) Before setting the budget system determine the industry's

critical profit making factors.

(c) Top Management sets short term and long term objectives

.... it may well prefer reasonable rather than "optimum"long term goals.

(d) Top Management and the controller create the

organizational environment for the budget system.


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(e) Controller and Head Office visits provide both technical

and hurnan benefits.

(f) Defensive or creative environments, motivate managers

accordingly

(g) Budget preparation may involve several months of technical

and human interaction .... interaction is not necessarily

"wasted" time since manager motivation is complex!

(h) Top Management can agree the key common assumptions

about the political, economic and business environment and

then sets sales and profit guidelines.

(i) Market research at corporate level ensures consistent

overall assumptions at the lower levels.


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(j) Managers may be "conditioned" by interaction in the

budget process to accept "irrational responsibilities and

yet be motivated to achieve required targets.

(k) Budget revision may excuse poor performance and reduce

motivation to achieve targets.

(1) Organizational structure and responsibility must be clearlydefined for effective budget systems.

(m) The lower in the organization we locate profit centers, the

more profit oriented the managers behave. Get "profit

orientation into the FRONT LINE".


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(n) Managers should be profit rather than merely cost

conscious.

(o) In multi plant operations, it may be possible to use divisional

standard costs and to budget local deviation from standards.

(p) Cost reduction. programs can be featured in annual budget

targets.

(q) OTRA approach.

(r) Motivation of managers is a complex problem: money, status,

fear, jealousy and KITA may be less effective than challenge,

responsibility and achievement.


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a. BUDGET PREPARATION SYSTEM

INDUSTRY PROFIT MAKING FEATURES

ORGANIZATIONAL CLIMATE.

TOP MANAGEMENT OBJECTIVES

CONTROLLERS - ACCOUNTING AND BUSINESS

DEFENSIVE OR CREATIVE?


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b. INTERACTION

TOP MANAGEMENT

CONTROLLER

MANAGERS

WASTED TIME OR CONDITIONING TO ACCEPT

TARGETS?


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c. MOTIVATION

MONEY, STATUS, JEALOUSY, KITA?

CRA? ORGANIZATIONAL CLIMATE?

COST, PROFIT OR INVESTMENT CENTERS?

IN THE FRONT LINE?


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d. BUDGET REVISION

TARGET REVISED REVISED REVISED

EXCUSES PROMISES EXCUSES

MANAGEMENT TIME PRIORITY?

TARGET REVISION OR TARGET ACHIEVEMENT?


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e. CONTROLLER

LOCAL MANAGMENTCOST CONTROL

HUMAN PROBLEMS

BUDGET

LAWPROFIT TAX AND CASH

HEAD OFFICE

TECHNICAL PROBLEMS

ACCOUNTING

ORGANIZATIONAL PRBLEMS

AND HE MUST BE CREATIVE?


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f. OTRA

OBJECTIVES

TARGETS

REPORTING

ACTION


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3/96 11.0 SUMMARY FOR PART I

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11.1 ESSENTIALS OF BUDGETARY GONTROL

Budgetary Control involves:

- planning for the future

- communication of ideas and plans

- motivation through interaction (and participation)

- appraisal of performance against target as a basis foraction.

Period plans incorporate project planning.

Budget systems are never "correct" - but only "useful" to achievespecific objectives.

3/97 11.2 BUDGET CONCEPTS

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Assumptions - underlying all budgets

Sponsorship - by Top Management

Responsibility centers - for motivation and control

Interaction - for participation, discussion, "conditioning"and

agreement.

Educati6n - necessary and continuousTimely - budget period that fits objectives

Management by exception - to highlight key areas

Appraisal - actual vs. budget.

3/98 11.3 TYPES OF BUDGETS

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(a) Operating Budget - Forecasts plans and targets of all

operating statistics fora future period. Shows contribution

(sales - variable cost) to fixed costs and profits.

(b) Cash Budget - Forecasts cash flow from operations, based

upon assumption of credit terms.

(c) Capital Budget - Forecasts key long term investments in:property, plant, equipment. R & D, advertising, etc. Key to

long term profitability. Invest now for benefit later. Also plan

"dis-investments" (despite the EI!).

(d) Budgeted Balance Sheet - Forecast the overall financial

position of firm at end of budget period. "Required assets"

financed by liabilities and owners equity.


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(e) Funds Flow Budget - Forecasts the sources and uses of

long term funds. Reveals effects of key management

decisions on long term resource allocation.

Sources of Funds:

profit (before depreciation), new capital, new long

term loans, sale of fixed assets, reduction of working

capital.

Uses of funds:

dividends, fixed assets, repayment of long term

loans, increase of working capital.

NOTE: Alll budgets are inter-related. Thus with an opening balance

sheet plus operating, cash and capital budgets, allows a budgeted

balance sheet to be produced by fairly simple arithmetic!


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Usefulness of budget rests on validity of assumptions.

Broad assumptions only justify broad figures.

Highly detailed figures not justified not useful.

Probably a bit fraudulent!

3/101 11.5 COSTS

Variable ar ith ol me

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Variable - vary with volume

Fixed - do not change with increased volume.

Allocated - charged to responsibility center by judgment

of what is a "fair" distribution.

Engineered - costs that necessarily increases with volume of

activity; not management discretion; easily

determined.

Managed - costs spent as a matter of management judgment.

S tandard - a control mechanism calculation of efficient product

costs .

Committed - fixed costs over short term that cannot be changed.

Opportunity - cost or value of benefit missed by failure to take

advantage of an available opportunity. Absolutely

vital concept, but never recorded on the books!

3/102 11.6 FIXED & FLEXIBLE

BUDGETS & REVISION

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BUDGETS & REVISION

Fixed budget - unchanging sales volume and profit targets.

Flexible budget, changed profit targets based on sales volume:

- series of "fixed" budgets, which show expected behavior of

costs and profit at different sales volumes (60%, 80%, 100%,

120% of budget).

- adds flexibility, usefulness (and complication) to budget

system and affects management motivation.

Fixed budget - revision when sales fall off? - No! Normally better to

leave original budget targets unchanged but to change "forecast" of

expected activity to year end.


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NOTE:

(a) In stable organizations fixed budgets work well.

However in rapidly developing companies any

budget system may give troubles to management!

(b) Budgets should set frontiers" within which managers mayoperate effectively. However these frontiers should never

become an IRON CURTAIN. "Meeting the budget is not

necessarily doing the job!

(c) Review and improve all accounting and budget systemsat least every five years!

3/103 11.7 BREAK-EVEN ANALYSIS

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AND CONTRIBUTION

Determines profits at varying sales volumes.

Break-even point - sales volume where revenue equals total cost.

Aids understanding and effectiveness of planning.

Contribution - computed as sales less variable cost.

Contribution to fixed cost and profit. Computed by product and for

whole company.

3/104 11.8 BUDGET PREPARATION PROCESS

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Guidelines - circulated to responsible managers setting objectives.

Estimates - by responsible managers with discussion, change andapproval by superiors.

Review and Appraisal - Interaction, participation and discussion at all

levels to "condition" and motivate managers to achieve

targets.

NOTE ON MANAGER MOTIVATION: Money, fear, jealousy, status

and the KITA, do work in practice, but may create a defensive

environment. Challenge, responsibility and sense of achievement

however, allow a creative organizational environment to develop.

3/105 11.9 OTRA APPROACH

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(a) Objectives

- What are the key profit-making factors of the

industry?

- How is the firm formally organized into cost, profit orinvestment centers. Informally what really happens?

- What are Top Management objectives from the

budget system - short term and long term?

- How does Top Management want the responsible

manager to behave?


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(b) Targets:

- Does Top Management give adequate and timely, guidelines?

- Is the organizational environment defensive or creative?

- Who sets initial and final targets?

- How much interaction and participation is involved to set the

targets?

- How creative and realistic are the agreed targets?

- Do the targets motivate managers in terms of challenge,

responsibility and sense of achievement?

(c) Reports and (d) Action, to be discussed in Part II.


a ESSENTIALS OF PBS

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a. ESSENTIALS OF PBS

PLANNING

COMMUNICATION

COORDINATION

APPRAISAL

BEHAVIOUR TO ACHIEVE

THE HO OBJECTIVES ...


b BUDGET CONCEPTS

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b. BUDGET CONCEPTS

INTERACTIONEDUCATION

EXCEPTION

TIMEAPPRAISAL

ASSUMPTIONS

SPONSORSHIP

ORGANIZATIONRESPONSIBILITY


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c. BUDGET TYPES

OPERATING

CASH

FUNDS FLOW

CAPITAL

BALANCE SHEET

ALL DEPEND UPON ASSUMPTIONS ...


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d. GIVE ME THE COST OF XXY!!! SAID THE MANAGER .

SO THE CONTROLLER WONDERED WHAT TO GIVE:

FULL OR DIRECT COST?

VARIABLE OR FIXED?

HISTORICAL OR CREATIVE?STANDARD OR ACTUAL?

DIRECT OR INDIRECT?

CONTROLLABLE OR NON-CONTROLLABLE?

ENGINEERED? MANAGED? COMMITTED? SUNK?

OPPORTUNITY? REPLACMENT? DISPOSAL?

WHAT DO YOU WANT THE COST FOR?


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e. BREAK EVEN AND CONTRIBUTION

S - VC = C

WHEN: C = FC THEN SALES ARE AT BEP


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f. PREPARATION

GUIDELINES

ESTIMATES

REVIEW

APPRAISAL


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g. MOTIVATION

MONEY

JEALOUSY

FEAR

STATUS

KITA - PHYSICAL

KITA - PSCHOLOGICAL

CHALLENGERESPONSIBILITY

SENSE OF ACHIEVEMENT AND YOU?


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h. OTRA

OBJECTIVES

TARGETS

REPORTING

ACTION

ORGANIZATIONAL CLIMATE? C OR D?

COST, PROFIT OR INVESTMENT CENTERS?

GET PROFIT INTO THE FRONT LINE!!!

3/115 FINAL NOTE

Thi d P t I f th h it h b

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This ends Part I of the program we hope it has been a

challenge to you in helping each other to learn

And now to reinforce the learning of the day we have

a little exciting homework tonight so that tomorrow

PART II will be downhill all the way

so on we go together ...

3/116 AGL - AUTONOMOUS GROUP LEARNING

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NO.3 BASIC PLANNING AND

BUDGETARY

CONTROL FOR MANAGERS

PART II

3/117 1.0 REVIEW & QUIZ

1.1 INSTRUCTIONS

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a. Assemble in new SG.

b. Discuss all the work done in Part I, your summaries of

key points and all questions arising.

c. Do the short quiz of 50 questions as a SG.

d. Check your answers, discuss and make notes.

e. Re-assemble in MG when the bell rings.

3/117a 3.0 PROGRAM LEARNING (45 minutes)

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b. Quickly complete aloud and in writing Ch. III of ASS.


d Reassemble in MG when the bell rings.

3/118 3.0 TOTAL BUSINESS PLANNING

3 1 TBP CONCEPTS

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3.1 TBP CONCEPTS

TBP starts with Strategy" for a five year planning horizon.

It relates objectives to resources and environment.

Sets management objectives in words and figures.

Allocates resources to meet objectives.

Sets meaningful basis for annual budget preparation and

reporting systems.

3/119 3.2 REPORTING BY ORGANIZATIONALRESPONSIBILITY

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(a) Reports should meet managers' needs at both head office and

local levels.

(b) Reports designed for managers by responsibility centers:

EXPENSE centers - performance measured as actual cost against

target.

PROFIT centers - performance measured as actual profit against target.

INVESTMENT centers - manager responsible not only for profit target

but also the return on assets, I.e. assets employed to achieve

the profit

(c) Reports should pyramid to provide summary data for top management.

Each report built upon reports from lower responsibility centers.

3/120 3.3 FUNCTION OF REPORTS

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Reports for control and action.

Designed to achieve results.

Materiality is important.

Unnecessary detail distracts attention from the key data.

Objectivity - do "try" to avoid bias (the selection of what is

chosen to be reported automatically adds to some bias).

3/121 3.4 REPORTING ESSENTIALS

(a) Design - serve user needs, signal variances, minimum data with

maximum information

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maximum information.

NOTE: Every report can be designed to fit one sheet of paperwith supporting detail on following pages. Thus each page is

complete in itself. Report complexities are NOT unavoidable.

(b) Speed - rapidly changing situations need quick decisions and

rapid reporting. Conversely - when nothing can be done, no rapid

reporting! Increased speed trades off for less accuracy.

Timeliness of decisions affected by delay in reporting.

(c) Frequency - changing situations need reporting but too many

reports restrict the manager and are "dis-functional".


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(d) Clarity - reports absolutelyclear to the user- withoutundue effort

and with proper training. Significant data only.

(e) Signals - managers need signals of key items. They do not need

all the information all the time. Distinguish routine from special

reporting.

NOTE: All figures are estimates based on assumptions. Generally fast

and adequate!

3/123 3.5 COMMUNICATION

Reports must communicate information not merely contain it.

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Reports must communicate information not merely contain it.

Design reports for the user - accountants like figures, engineers like

graphs, managers like the (sexy) pictures.

Pictures and patterns communicate basic ideas rapidly.

Show deviation of actual from one target only - and the reasons

why?

NOTE: 0ne way communication is always poor. Restrict everynumber to the vital digits only.

3/124 3.6 MARKETING BUDGET REPORTS

( ) T t t "i f ti d t " t b " k t d"

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(a) Treat reports as "information products" to be "marketed"

as skillfully and professionally as the company markets its

products to customers.

(b) Research the "market" for reports: Who? Why? Where? When?

How?

(c) Adapt the product to customer needs and personalities.

(d) Set a "product policy" for reports - standardization. fitted

to the organisation, minimum interruption of daily

functions.


(e) Set a price policy for reports - value of the information must

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( ) p p y p

consider the opportunity cost or value of NOT having the

data. (Not recorded by accountants?). Difficult to get data that

is not routinely recorded.

(f) Set a promotion and distribution policy for reports - "sell" and

deliver reports. Encourage fast, adequately accurate reporting,

educate managers to use the reports, create the need for reports,

promote reporting aggressively. (Test occasionally by not sendinga report to get a quick reaction as to its urgency and value?)

NOTE: Need an appropriate "marketing mix" to "market" budget reports

effectively to managers throughout the organization. Think of

reporting in marketing not merely selling terms - satisfy needs!!

3/126 3.7 RESPONSIBILITY REPORTING

Focus on the responsible manager

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Focus on the responsible manager.

Report for each center to build up from centers below.

Trace variances through reports to managers responsible,

But tread softly

NOTE: Don't bury the manager in a grave of paperwork.

3/127 3.8 HUMAN PROBLEMS

(a) The budget is a device to achieve objectives in organization.

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3/1 2 7 3 .8 HUMAN P ROBLEMS(a )T h e b ud get is ad ev ice to ac hie veo bje ctiv es

in org a niz atio n.(b )Co - op era tio nis th e ke y.Willi ng ne ss topa rtic ipa te an db ec ome inv olv ed

d isc ou rag esind ivid u ala nd gro u po pp os itio ntoT opMa na ge me nt.

(c )P e o ple g en era lly may "sa y" tha tthe y do no tlik e targ ets o rb ud ge tsbu tin pra c tice s uch b ud gets d op rov ide :ch alle ng e, res po ns ibil ity an das en se ofac hie ve ment. '

(d ) M o tiv atio n is vita l. He lpman ag ers a ndemplo ye es to rec on cile h ea do ffic e,lo ca l an dp ers on al prio rit ies . Mo tiv atio n

is co mple x,but in the lo ng ru nc ha lle nge ,re sp on sib ility a nda ch iev emen ta re effe cti ve .1NOTE :Othe rmeth o ds ma ya ch iev e

( ) g j g

(b) Co-operation is the key. Willingness to participate and become involved

discourages individual and group opposition to Top Management.

(c) People generally may "say" that they do not like targets or budgets

but in practice such budgets do provide: challenge, responsibility and a

sense of achievement.'

(d) Motivation is vital. Help managers and employees to reconcile head office,

local and personal priorities. Motivation is complex, but in the long run

challenge, responsibility and achievement are effective.1

NOTE: Other methods may achieve the results to survive today withoutdeveloping anyone for the future. i.e. Fear! Money! KITA!

3/128 3.9 ORGANIZATIONAL ENVIRONMENT

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Top Management and the controller set the organizational environment

which is key to the effectiveness of the budget system.

A defensive environment encourages managers to: set low targets, show

little initiative, be reluctant to make decisions and to settle for safe plans.

A creative environment (whereby managers feel secure yet motivated)

encourages managers to: set high achievable targets, make confidentbold decisions, use resources creatively, take balanced risks, and achieve

both personal and corporate goals.

NOTE: How is your organizational environment?


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a. TBP

OBJECTIVES - RESOURCES


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b. REPORTING

DESIGN, SPEED, FREQUENCY, CLARITY, SIGNALS

MANAGEMENT RESPONSIBILITY - FORMAL & INFORMAL

ORGANIZATIONAL PYRAMID

COMMUNICATION FOR ACTION


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b. ENVIRONMENT

TOP MANAGEMENT & CONTOLLER

ORGANIZATION

CREATIVE OR DEFENSIVE?


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d. MOTIVATION

FEAR, JEALOUSY, MONEY, KITA

CHALLENGE, RESPONSIBILITY, ACHEIVEMENT

SURVIVE TODAY

DEVELOPMENT FOR LONG TERM


MARKETING CONCEPTS FOR REPORTING

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e. MARKETING CONCEPTS FOR REPORTING

FIND A NEED - FOR MANAGER INFORMATION

DECIDE ON A MARKETING MIX

PRODUCT, PLACE, PRICE, PROMOTION

SATISFY THAT NEED (PROFITABLY)

REPORTS AS TOOLS FOR MANAGEMENT ACTION


f OTRA

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f. OTRA

OBJECTIVES

TARGETS

REPORTING

ACTION

3/135 3.11 INSTRUCTIONS

INDIVIDUAL AND SG WORK

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a. Assemble in SG.




d. Quickly read the case study (GILTIM B) which follows.


resolve the case.




3/136 5.0 CASE: GILTIM B

5.1 THE STORY OF THE CASE

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Giltim (A) described budget objectives and preparation.

Giltim (B) deals with reporting and action.

Problems arise in evaluating the reporting system and its effect on the

behaviour of managers in the company.

3/136 5.2 EVALUATION OF REPORTING SYSTEM

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(a) Design - reports include actual and target data. H.O. requires

reforecasting of activity that deviates from budget.

Highlight on excess spending over budget but no importance attached

to under-spending. Concentrates on problem areas with special

reports. Report sample badly designed.

(b) Speed - flash reporting in three days and full reporting to H.O. in 8 days

provides timely data for management.

Probably achieved by cut-off of activities before the month end and

efficient data processing.


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(c) Frequency - monthly data on regular operations, weekly or daily

data for critical problems - excellent.

(d) Clarity - poor layout and lack of graphical presentation.

(e) Effectiveness - highly effective for H.O. control of activity

against budget. Provides control data to focus manager on

target achievement and critical problems. Probably over-

emphasizes short term "meeting the budget" at the expense of

long-term performance.

3/138 5.3 PERFORMANCE AT PLANT X AND

DESIGN OF REPORT NO. 1

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(a) Difficult to evaluate the performance of Plant X from this reportsince the 'year to date" figures not provided.

(b) However, evaluation of March performance raises many

questions to be investigated:

1. Sales seriously below target with very high discounts and

allowances - why sales department failure?

2. Variable cost of sales controlled - due to manufacturingefficiency?


3. Fixed manufacturing cost seriously above target - why?

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4. Operating income well below target both in the amountand percentage - due to failure of sales?

5. Special costs and profits generally consistent with targets

but why did Plant Manager fail to cut back costs to makeup for the lack of activity?

6. Plant income well below target and return on assets

employed unacceptable.


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NOTE: Plant Managers action depends on results for "year to date". If

below target he could apply for budget revision on the grounds that thesales are failing to meet targets. Alternatively, he could cut other special

costs extensively and press the Sales Manager hard to achieve both

sales volume and prices!

Controller also should press Sales Manager and then "follow" Plant

Manager in cutting costs where possible. Situation requires immediate

investigation and possibly an Action Team" to visit the plant and Sales

Department to help them achieve results.


(c) Improvement of Report No. 1:

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1. Eliminate previous month and last year figures since the

budget is the real target.

2. Show only actual data for the month and from the budget

(not budget itself), but the year to date with variances

3. Eliminate all data below 000 to reduce the digits to

significant items only. Reports should not be "too black withfigures".

4. Design each report page as a complete entity supported by

detail on subsequent sheets. Every report can be so

designed for easy and effective communication.

5. Design report with graphical sections to highlight signals.

3/142 5.3 GILTIM COMPANY (B)

Revised Plant Operating Summary - March This Year REPORT NO.1

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MONTH YEAR TO DATE

Actual (Under) Actual (Under)

Over Over

Budget Budget

GROSS SALES 264 (62) 847 (122)

DISCOUNTS & ALLOWANCES 47 31 84 56NET SALES 217 (93) 763 (66)

% GAIN (LOSS) (30.0%) (7.9%


Actual u/o Budget Actual u/o Budget

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GAIN (LOSS) DUE TO:

SALES PRICE (150) (10)

SALES VOLUME 50 (34)

SALES MIX 7 (22)

(93) (66)

VARIABLE COST OF SALES 142 (45) 384 (64)

GROSS MARGIN 75 (48) 379 (2)

% SALES 34.5% (4.0%) 49.6% 3.6%


Actual u/o Budget Actual u/o Budget

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FIXED MANUFACTURING

EXPENSE 41 5 211 10OPERATING INCOME 34 53 168 (12)

% SALES 15.6% 22.0%

SPECIAL COSTS (PROFITS) 23 (30) 12 11

10.5% 1.5%

PLANT INCOME 11 (83) 156 (1)

% SALES 5.1% 20.4%

ASSETS EMPLOYED 1,816 (58) 1,816 (58)

% RETURN 6% 5.1% 8.6% 8.4%

3/144 5.3 GILTIM COMPANY (B)

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REVISED PLANT OPERATING SUMMARY

EXAMPLE OF GRAPHICAL REPORTING

SEE WORK PACK FOR DETAILS

3/145 5.4 MOTIVATION OF MANAGERS

(a) System provides highly centralized control by HO and is

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( ) y p g y y

probably defensive.

(b) Extensive "interaction in setting the targets probably

"conditions managers to accept them. Personal contact with

HO staff and visit by Controller most helpful.

(c) Unreasonable to expect plant managers to meet profit targets ifsales fall off, but quite possible for them to feel bound to do so

and to "accept" and believe that they can ... and to achieve

target.'

(d) Plant managers probably underspend on maintenance,

research, training, etc. in the early months of the year until

sales levels indicate that they can "afford" to spend up to the

budgeted cost levels.


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(e) Plant managers motivated to achieve targets by

1. Budget preparation process.

2. Top management interest and follow up of reporting.

3. Salaries and bonuses.

4. Competition among plants.

5. Staff assistance and daily reports on critical problems.

6. Requirement to continually re-forecast any expected

performance below target.

7. Budget effect on personal promotion in the company.

(f) Tendency to achieve short term targets with some loss of long

term potential. However, this loss may not be significant.


(g) Long term planning retained by HO and Divisional

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Management (latter fairly impotent). Little motivation to think

beyond current year at plant level. Poor development of plantmanager's potential.

(h) Fairly dynamic environment created by the constructive friction

between plant, HO and Division.

(i) May achieve lower level of long term performance but all staff

not merely cost but PROFJT oriented.

(j) System meets Top Management objectives of profit now. Puts

profit responsibility close to operations which achieve profit.

Relates to the specific industry features of: delivery, qualityand efficient cost.

3/148 5.5 CHANGES RECOMMENDED

(a) Consider the technical human and organizational problems that

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(a) Consider the technical, human and organizational problems that

any change would have to overcome.

Managers may prefer "The devil they know , to the devil they

don't" and therefore be reluctant to accept and to work with

any new system!

3/148a 5.5 CHANGES RECOMMENDED

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(b) Consider all alternatives and their implications:

1. Make Division a profit center (plants become only cost

oriented)?

2. Make plant responsible for the sales department as well

(new type of plant manager)?

3. Makes sales districts and plants profit centers with a

"Transfer Price" system and guaranteed volumes

(arguments over the transfer price)?

4. Allow budget revision when sales fall off (managers more

motivated to justify revisions than to achieve profit

target)?


(c) Proposals

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1. Try to assign sales and profit responsibility to one

manager in one center.

2. If not possible, introduce some flexibility in budget

revision when sales fall off substantially.

3. Expand budget system to "Total Business Planning"in words and figures for a five year horizon period.

Replan every year for five years ahead. Let the

annual budget targets be developed from the first year

of the plan.

4 Include all managers in short and long term planning


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4. Include all managers in short and long term planning

process.

5. Introduce a training and development program for

managers to provide an understanding of long term

and short term planning.

6. Discourage the idea that meeting the budget is the

same as doing the management job!

3/150 5.6 LEARMNG POINTS

(a) Budget reports should be available three to eight days after the

month end.

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(b) Achieve fast reporting day early cut off" and efficient dataprocessing (possibly use critical path techniques to determine

delay factors).

(c) Design reports for use by managers not accountants. Simple,

graphic, exciting. Exclude non-target history.

(d) Report signals of key factors, not complete detail.

(e) Design reports for local as well as top management.

(f) Recognize that manager motivation is not automatically

achieved by participation but is a complex factor resulting from

the total system.

3/151. 5.6 (continued)

(g) Managers may sometimes not be rationally "responsible" but

may be convinced that they are responsible and may act

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y y p y

accordingly. Behavior is not completely rational in logical or

economic terms .. emotional needs.

(h) To modify the budget system and motivate managers is a

complex problem. They may not work as effectively under a

new "better" system.

(j) Sales and manufacturing together make a more logical basis

or a profit center, but transfer price systems are available if this

combination is not practicable.

(j) Set profit centers as close to operations ("the front line") as

practicable, to make managers not merely cost oriented but

profit oriented:

(k) HO "advice" may really be "orders".


(1) Plant "agreement" may really be imposed by HO.

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(m) Budget technical problems are fairly easy to solve but humanproblems are complex and difficult.

(n) Top management involvement in the budget process is vital if

it is to motivate managers.

(o) Total business planning in five year horizons involving all

managers is more useful than mere budgetary control each

year. The TBP provides the under-lying data for the annual

and monthly budget targets.

(p) Design the budget system in relation to top managementobjectives, industry profit-making factors and the

organizational structure of the firm.


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(q) Measure the effectiveness of the budget system by the action

and behavior of the managers and not by what managers say

(r) Review and redesign budget reports periodically to meet current

needs.

(s) Recognize that reports for HO may not necessarily meet localmanagement key needs - thus leading to two (or more)

reporting systems formal and informal.


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a. REPORTING

FLASH - 3 DAYS

DETAILED - 5 DAYS

PROBLEM AREAS - DAILY

RE-FORECAST FAILURES TO YEAR END - DONT

CHANGE THE BIUDGET!


b. DESIGN

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SIGNALS

ACTUAL v BUDGET

GRAPHS

INTERESTING - NOT DULL!!

ELIMINATE: NON STANDARD OLD DATA , ITEMS

FOR INTEREST ONLY, USELESS DETAIL AND DIGITS


c. DO DIGITS COUNT?

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TO THE MANAGER?

TO THE ACCOUNTANT?

HOW MUCH IS USEFUL:

9,824,463,26

9,824,000

9,824m or just 9.8 million?


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d. MOTIVATORS OF THE PLANT MANAGER

PERSONAL, ACTION TEAMS, RE-FORECASTING,

HO ADVICE, COMPETITION, PROMOTION, TOP

MANAGEMENT ACTION, MONEY, INTERACTION, DAILY

REPORTS ...

KITA OR CRA?


e PROFIT CENTERS

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e PROFIT CENTERS

PLANT OR SALES?

DIVISION?

TRANSFER PRICES

COST OF CHANGE - HUMAN AND TECHNICAL

KEEPING PROFIT IN THE FRONT LINE ...



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3/158b 6.0 CASE: BILL BROWN

6.1 INSTRUCTIONS

a Assemble in SG

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a. Assemble in SG.

b. Answer the questions.

c. Check your answers, discuss and make notes.


3/158c 7.0 PROGRAM LEARNING (45 minutes)


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b. Quickly read the Introduction in ASS.

c. Quickly complete aloud and in writing Ch. IV of ASS.



3/159 8.0 PLANNING & CONTROL SYSTEMS

8.1 TOTAL BUSINESS PLANNING

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(a) Budget is more than a one year phenomenon. More meaningfulas part of a long term plan which indicates direction and growth

of firm. Basis of a planning and control system.

(b) Need to define business strategy for at least five years ahead:

- relate objectives to resources and environment- set out objectives in words and figures, with plans

showing how to achieve them

- allocate resources to meet specific marketing, financial,

production and research goals

- include alternative plans to achieve objectives

(c) Re-plan every year for five years ahead (not merely revision!


(d) Annual re planning involves:

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(d) Annual re-planning involves:

- set overall business strategy

- set management guidelines and major policies

- functional plans

- detailed planning (including budgets)

- interaction and revision of plans

- approval of final five year plan and communication to

managers

- development of detailed monthly budgets for first year

of the five year plan.

3/161 8.2 TOTAL BUSINESS PLAN

& MANAGEMENT BEHAVIOR

TBP t l t i fl t b h i

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TBP a tool to influence management behavior.

As manager participates in planning and quantifying targets, he achieves

a more precise definition of responsibilities and becomes further

motivated to achieve those targets!

Top management creates the organizational environment whichinfluences managers:

- system used not to threaten but to plan co-operatively.

- system communicates to help managers.

- system develops confident creative managers who seek high

levels ofperformance.

3/162 8.3 PLAN AND ACTION

T t l b i l t l b d t b t l f ti d

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Total business plan not merely budget but a plan for action and

reaction.

Alternative plans of action are included in the TBP to cover

reaction to different situations (especially sales above or below

target).

3/163 8.4 CONTROLLER'S FUNCTION IN THE

CONTROL SYSTEM

(a) Design the planning and control system. Periodic revision of the

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(a) Design the planning and control system. Periodic revision of the

system to meet developing needs. No system works well

indefinitely because the environment and the organization

change!

(b) Information recording, storage and retrieval.

(c) Aid to managers in (i) developing and using data effectively,

and (ii) developing TBP and budgets.

(d) Review and control of TBP and budget system.(e) Reporting.

(f) Encourage an organizational environment in which control

system functions creatively not defensively.

NOTE:System should encourage not repress action to achievecorporate objectives.

3/164 8.5 BEATING THE SYSTEM

A poorly designed or poorly functioning system or a non-creative

environment will result in efforts to beat the system Managers

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environment, will result in efforts to beat the system. Managers

normally take defensive action against an oppressive system.Techniques forbeating the system:

(1) Setting low targets:

- low sales targets

- "padded" cost targets

- "no change from previous year"

(2) Timely use of secret reserves:

- orders, sales and purchase invoices delayed or

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