Budgeting: Tool for Planning and Control

Why do organisations prepare budgets?

Reasons:

• Compel planning
• Communicate ideas and plans
• Coordinate activities
• Provide a framework for responsibility accounting
• Establish a system of control
• Provide a means of performance evaluation
• Motivate employees to improve their performance
CIMA Official Terminology
 Budget purposes: 'Budgets may help in:
 Authorising expenditure,
 Communicating objectives and plans,
 Controlling operations,
 Co-ordinating activities,
 Evaluating performance,
 Planning and rewarding performance.
 Often, reward systems involve comparison of ACTUAL
with BUDGETED PERFORMANCE.'
A budget, since it has different purposes, might mean different things to
different people.

Forecast

Different
Means of
Target
things to allocating
different Resources
people

Yardstick
Budget: CIMA Official Terminology
 A budget is a 'quantitative expression of a plan for a
defined period of time.
 It may include planned:
 Sales volumes
 Revenues
 Resource quantities
 Costs and expenses
 Assets, liabilities and
 Cash flows.
Responsibility for budgets
 The manager responsible for preparing each budget
should ideally be the manager responsible for carrying
out the budget.
 For example, the preparation of particular budgets might
be allocated as follows.
 (a) The sales manager should draft the sales budget and the
selling overhead cost centre budgets.
 (b) The purchasing manager should draft the material
purchases budget.
 (c) The production manager should draft the direct
production cost budgets.
Steps in the preparation of a budget

The first task in the budgetary process is to identify

the principal budget FACTOR. This is also known
as the key budget factor or limiting budget
factor. The principal budget factor is the factor
which limits the activities of an organisation.
Principal budget factor
 The principal budget factor 'limits the activities of an
undertaking. Identification of the principal budget factor is
often the starting point in the budget setting process.
Often the principal budget factor will be sales demand
but it could be production capacity or material
supply.'
The principal budget factor
is usually SALES demand.

For example, if sales are the principal budget factor then the production manager
can only prepare his budget after the sales budget is complete.
 Developing the Master Budget:
Case of Snowcap Music Festivals
Snowcap is a producer and event manager of destination music events
worldwide.The company prides itself on attracting leading musical talent to its events,
known as SMurFests, while also exposing festival guests to the “next big thing” by
identifying and promoting new talent.The Snowcap brand enjoys exceptional consumer
loyalty: frequent festivalgoers call themselves, naturally, SMurFs and SMurFettes.This
translates into profits through repeat business, strong festival attendance, and significant
merchandise sales. The company works hard to create a stimulating and creative but
safe environment.

Snowcap Music Festivals is based in Boulder, Colorado, with European operations

managed from a satellite office in Salzburg,Austria.The company is wholly owned by
founder Wendee Redhawk and two partners. Redhawk started the company from her
apartment in Boulder almost 20 years ago. Initially it wasn’t so much a company as a
project to host a really big party for her college friends, their friends, and the community.
But she managed to attract some talented bands to that first festival.After one of them
subsequently became an international phenomenon, word of the festival spread quickly.
Redhawk decided to make it a business venture and “We heard them first at Snowcap”
became the company’s slogan.
 Unfortunately, Wendee Redhawk proved to be better at picking bands than she was
at running a business. After three difficult years she brought in a partner with business
training. The new partner, Doug Wing, realized that the fun festival scene would only be
sustainable if supported by a modern business organization, keeping operations running
smoothly while ensuring that Snowcap Music Festivals stayed profitable. Wing’s business skill
and Redhawk’s ear for music were a winning combination: Snowcap became
a big success and the SMurFest phenomenon was born. After expanding to multiple festivals
in the United States, Snowcap took on a European partner to expand the company into
festivals abroad, beginning in Europe.

As explained by Doug Wing, the core element of this business organization is the
company’s Financial Planning and Analysis (FP&A) system. The FP&A system includes
preparation of a master budget for each of the festivals. These festival budgets are
combined with the headquarters budget to create an overall master budget for Snowcap
Music Festivals. “When we run a festival, we have to commit to everything in advance: how
many bands, what we’ll pay them, how many T-shirts to order, how much cash we’ll need
to borrow or invest, and so on. The master budget is our formal plan for each event and the
overall company. It helps us to achieve our FP&A goals.”
When pressed for specific examples of these,
Wing listed the following:
1. Documenting our plan for operations and financial results. Which festivals are
most and least profitable? How profitable is the company overall? How will we manage
cash flow?
2. Communicating our plans for, and assumptions about, the various festivals. Which
festivals are planned for this year? When does each start and end? How many people
should we plan for at each one?

3. Deciding how to share resources. How many people are needed for marketing? For
operations? At each festival? At headquarters?
4. Controlling operations by developing benchmarks for the financial and operational
results of the festival. How much profit is each festival expected to generate? What is
the goal for T-shirt sales? What is our carbon footprint goal?

5. Evaluating performance of festival managers against those benchmarks, providing a

baseline for incentive compensation. Who is responsible for achieving attendance goals?
What is the reward for meeting and exceeding attendance goals?
 In conclusion, Wing noted that, “Planning a festival
without a master budget would be like driving to the
festival without a map: you would have a rough idea of
where you wanted to go but no idea of the best way to
get there. And by the time you found your way the party
might be over!” Wendee Redhawk added

“Is budgeting a pain? Sure it is.

But so is practicing guitar: you can’t be any
good without it, and at least in budgeting your
fingers don’t bleed!”
 We will trace Snowcap Music Festival’s 20x2 master budget for its three-
day Rocky Mountain SMurFest, which will be held on the second weekend
of July 20x2. The festival’s MASTER BUDGET contains the
following schedules,

Schedule Sequence of Budgets Budget Category

1 Sales Budget Sales Budget
2 Purchases Budget Operational Budget
3 Direct Labor Budget Operational Budget
4 Production Overhead Budget Operational Budget
5 Selling, General and Administrative Expense Budget Operational Budget
6 Cash Receipts Budget Financing Budget
7 Cash Disbursements Budget Financing Budget
8 Cash Budget Financing Budget
9 Budgeted Income Statement Budgeted Financial Statement
10 Budgeted Statement of Cash Flows Budgeted Financial Statement
The order of budget preparation
1. Sales budget
2. Finished goods inventory budget
3. Production budget
4. Resources for production.
5. Materials usage budget, machine usage budget and a
labour budget.
6. Materials inventory budget
7. Raw materials purchases budget
8. Overhead costs budget
9. Budgeted income statement
10. Budgeted statement of Financial position
11. Capital expenditure budget
12. Working capital budget
13. Cash budget