Chapter 22: Business and Financial planning

Principles of budgeting

Formulating strategies, objectives and goal

Vision and Mission

The mission statement
must capture the reason for the existence of the firm of organization and serve as a guide for all its future activities by emphasizing its core business

Vision needs to indicate what dream of firms future is

Porters strategy Corporate strategy:

  • Cost leadership; firm manufactures or buys and sells standard products to the broad market at the lowest possible cost
  • Differentiation means firm makes a unique product from the standard product, charges higher price than other suppliers( Roll Royce)
  • Focus strategy, can be either cost focus or differentiation focus but will be targeted a specific markets.

Risk identification, management reviewing the firms objective to identify the risks the face,

  • Risks can either be an internal or external cause

Internal risks are caused by people, processes or systems

Externally the risk may be: PESTLE

Once risks are id'd, they then get assessed in terms of its probability and severity, Risk is now measured by probability X severity

The risk is scaled 1-5, Management keeps it that way by keeping their critical risks to a max of 5, then management makes a visual representation of the risks(risk matrix)

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Operational planning starts with an estimate of the expected sales of the firm next year:

  • Profit planning and control is a short term aspect in fin management and the org carries it out through a budget
  • ProfPandC can be done by using pervious years expected sales and their actual sales on continuous basis

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Variable costs increase as the number increase as the number of units manufactured and /or sold increases, i.e. Packaging cost for 1 pdt is R4, then 1000 pdts boosts up to R4000

Semi-variable cost has an element of both fixed and variable cost i.e. maintenance cost, some costs are scheduled others have incurred once equipment, machinery or systems fail and need to be replaced or fixed

Fixed cost don't increase with the amount of units produced

Budgeting process:
normally stars with the projection of the expected sales during the planning period:


  • Firms forecast is influenced by the GDP
  • Firm estimates its market share and the extent which a change in then GDP will benefit or harm sales in the industry
  • Economic variable such as intra movement, infla movement, exchange rate between countries, employment and governments budget deficit

An integrated budgeting system for a manufacturing business consists of two main types of budgets: operating and financial budgets.

Operating Budgets:

  • Cost budgets, 2 costs; mft cost budgets and discretionary cost budgets
  • Income budgets, are developed to measure marketing and sales effectiveness; Expected sales Quantity x Expected unit selling price of each pdt
  • Profit plan or profit budget; combines both costs and income budgets used by managers who have responsibilities for both expenses and income of their units

Financial Budgets;
perpared from info contained in the operating budgets integrate the fin planning of biz with op planning


Fin budget serves 3 major purposes:

  • Verifying the operating budget
  • reveal the financial actions that the business must take to make execution of its operating budgets possible
  • The indicate how the operating plans of the business will affect its future fin performance and position

Budgeted statement of financial performance;
has to be developed to evaluate the budgeted income relative to expenses in the short term and to evaluate plans which could improve profitability

Basic Steps required to prepare the budget statement:

  • estimate expected sales
  • estimate the expected CoS(cost of sales)
  • id the op expenses to achieve firms objectives
  • determine the payable intra during the next fin year
  • confirm tax rate of the firm
  • Compile the budgeted statement of fin performance

Management involvement:

  • top mngmt responsible for the strategic mngmt of the firm.
  • top management should provide guidelines to middle and lower levels of management that could be used in drawing up budgets
  • Middle and lower management execute these plans
  • inputs of middle and lower mngmt must be taken into account by top mngmnt before plans and budgeting are finalized

Adaptability:

  • Circumstances can and will change as the budgets are implemented during a fin year
  • Budgets should not be so rigid that no changes can be made during the course of a year(with in reason)

Accountability according to responsibility:

  • Managers must be made accountable for their actions, but should also be given responsibility and be empowered to achieve the goals that been set.

Effective communication:

  • must succeed in getting realistic plans and budgets in place which will serve to motivate managers and employees
  • if not done, non-co-operation, mistrust and negativity will occur

Realistic expectations:

  • Realistic expectations have an important influence on the motivation of the managers who have been given the responsibility for their budgets
  • if budgets are unrealistic, the chances are the managers will not make serious attempts at meeting their budgets

Acknowledgement: Acknowledgement of performance is the key to successful budgeting. the closure management gets to matching budgeted figures the greater the acknowledgement

Follow-up and feedback: involve regular reports, the budgeted vs actual figures are compared and any deviations are investigated.

5 considerations of performing ratio analysis:

  1. the dates of financial statements being compared have to correspond
  2. best to use audited financial statements
  3. data being compared must be developed in the same way
  4. use of different accounting treatments may distort the results of the ration analysis, regardless of the method applied
  5. notes in the fin stmnt usually explain some of the accounting policy decisions that mgmt. mad during the compilation of the stmnts, and may have a significant impact on the financial stmnt