CHAPTER 12: BUDGETARY CONTROL AND CAPTAL INVESTMENT APPRAISSAL
1. Planning: a budget provides a detailed plan of action for a business over a definite period. of time- relating to production, sales, raw material requirements, labor needs, research and etc.
by planning many problem-soution can be sought
2. Coordination: aids managers in co-coordinating their efforts-harmonize organization objective with the objectives for each divisions
3. Communication: the accepted budget copies are distributed to every management personnel-gives adequate understanding, knowledge of the policies and programmes to be followed and also restrictions.
4. Motivation: for encouraging managers to carry out in line with the organization objectives
5. Control: to ensure that plans and objective as laid down in the budgets are being achieved. also to keep the management informed of whether planned performance is being achieved or not
6. Performance evaluation: a budget offers a useful means of telling managers how nicely they are performing in conference trgets they have formerly helped to set
- continuous comparison of the actual performance-to know the variations from budget and placing responsibility
- Taking suitable remedial action- to achiev the desires objective (if there variation of the actual performance)
- Revision of budgets in the light of changed circumtances
- Mutually exclusive projects; exist where the acceptance of one project excludes the acceptance of another project
it is recomended to use NPV method to rank mutually exclusive projects
- Qualitative fctors;
- Capital rationing; occur where there are insufficient funds available to a firm to undertake all those projects that yield a positive net present value. (describe as capital rationing)
- coordinates activities across departments
- budget translate strategic plans into action
- budget provide an excellent record of organizational activities
- budget improve communication with employees.
- budget improve resources allocation, because all requests are clarified and justified
- Budgets provide a tool for corrective action through reallocations
- the major problem occurs when budgets are applied mechanically and rigidly.
- budgets can demotivate employees because of lack of participation. if the budgets are arbitrarily imposed top down, employees will not understand the reason for budgeted expenditures, and will not be committed to them.
- budgets can cause perceptions of unfairness
- budget can create competition for resources and politics.
- a rigid budget structure reduces inititie and innovation at lower levels, making it impossibel to obtain money for new ideas.
1. NPV: is the today's value (year 0) of any future cash flow after discounting it by an appropriate dicount rate. The process of converting cash to be received in the future into a value at the present time by the use of an interest rate is called as discounting.
Compunding is the opposite of dicounting, since it is the future value of present cash flows
- IRR: this is the discount rate that will cause the net present value of an invest ment to be zero
also known as Discounted Rate of return
IRR is the 'maximum cost of capital' that can be allowed to finance project.
if your cost of capital is greater than IRR, then you are incurring losses
Technique that ignore the time value of money
1. PAYBACK METHOD: is defined as the length of time that is required for a stream of cash inflows from an investment to recover the original cash outlay of the inestment
2. ARR: also known as the return on investment and return on capital employed.
- Accept the project if NPV is positive.
- Accept the projectt if Discount rate<IRR
- Accept the project if payback is comparatively shorter
- Accept the project if ARR>expected rate of return
- Establishment of budgets for each function and ssection of the organization.