Budgeting & Forecasting Course Presentation, Lecture notes of Corporate Finance

Download Budgeting & Forecasting Course Presentation and more Lecture notes Corporate Finance in PDF only on Docsity! Budgeting & Forecasting Peep ec Cae) Course learning objectives corporatefinanceinstitute.com 01. Identify good ways for managers to use a budget 06. 02. 03. Identify the components of a master budget 07. Identify the steps that must be taken before preparing a budget 08. 04. Identify the traits of incremental budgeting 09. Identify the advantages of performing multiple regression analysis 11. Identify causes of favorable and unfavorable variances in profit Calculate variance percentage change Identify the goals of a variance dashboard 05. Categorize expenses into the four different types of costs 10. Know when to use Solver and Goal Seek in Excel Identify reasons to use dedicated budgeting tools Budgeting Within A Strategic Framework corporatefinanceinstitute.com 01. Learning objectives corporatefinanceinstitute.com Explain how budgeting fits into the overall framework of decision- making, planning and control Describe the purposes and uses of budgets in organizations Create a process for setting key performance indicators (KPIs) that are both financial and non- financial which drive the budgeting process corporatefinanceinstitute.com Consider the following question: Strategic budgeting What is the most significant barrier to improving your budgeting process? Organizational attitudes toward budgeting Time Cost Inflexible IT systems Controlled by another group There are no significant barriers corporatefinanceinstitute.com Translating high level strategy (mission, vision, goals, etc.) requires you to consider four distinct but related dimensions: Translating strategy into targets and budgets What are you trying to achieve? 01. Increase spend per customer OBJECTIVES How are you going to achieve it? What must you do to support the strategy? 01. Expand product offering 02. Source new suppliers 03. Promotion and marketing 04. Pricing STRATEGIES MEASURES What are output measures? What are input measures? 01. Average weekly spend per customer 02. Spend by product type 03. Average price changes TARGETS Quantifiable Time-based 01. $increase 02. Volume increase 03. %staff trained in new products corporatefinanceinstitute.com Business performance should be measured from the perspective of strategy implementation rather than relying simply on financial results. Organizations need a balanced set of financial and non-financial performance measures and targets. Kaplan and Norton’s balanced scorecard A balanced set of performance measures will ensure that the entire organization participates in strategy implementation and should include: Financial measures Customer measures Process measures Learning and growth measures corporatefinanceinstitute.com Scorecard perspectives FINANCIAL To succeed financially, how should we appear to our shareholders? OPERATIONS To satisfy customers, what operational processes must we excel at? PEOPLE To achieve our vision, what capabilities must our people have? CUSTOMERS To achieve our vision, how should we appear to our customers? MISSION AND STRATEGY corporatefinanceinstitute.com What are our budgeting goals? To motivate managers to strive to achieve the budget goals: • By focusing on participation • By providing a challenge/target To control activities: • By comparison of actual with budget (attention directing/management by exception) To evaluate the performance of managers: • By providing a means of informing managers of how well they are performing in meeting targets they have previously set corporatefinanceinstitute.com What to watch out for Budgets can become a major barrier to responsiveness The main criticism of planning and budgeting include: Budgets are rarely strategically focused Budgets encourage “gaming” Budgets are based on unsupported assumptions Budgets may make people feel undervalued Building a Robust Budgeting Process corporatefinanceinstitute.com 02. corporatefinanceinstitute.com Types of budgets Revenues and expenses for the various budget centers within an organization Budgeted amounts divided into major categories such as revenues, salaries, benefits, and non-salary expenses Encompasses supporting info such as head counts OPERATING BUDGETS Requests for large assets which create major demands on an entity’s cash flow Buildings, renovations, automobiles, software systems, furniture Purpose to allocate funds, control risks in decision making, and set priorities CAPITAL BUDGETS An estimation of the cash inflows and outflows for a specific period of time Used to assess whether the entity has sufficient cash to fulfill regular operations Identifies whether too much cash is being left in unproductive capacities CASH BUDGETS corporatefinanceinstitute.com Master budget for a manufacturer Sales budget Production budget Direct materials purchases budget Cost of goods manufactured budget Overhead budgetDirect labor budget Cost of goods sold budget Selling and admin expense budget Budgeted income statement Budgeted Balance sheet Cash budget Capital budget Operating budgets Financial budgets corporatefinanceinstitute.com Master budget for a retailer Sales budget Purchases budget Cost of goods sold budget Selling and admin expense budget Budgeted income statement Budgeted Balance sheet Cash budget Capital budget Operating budgets Financial budgets corporatefinanceinstitute.com Most larger companies start their budgeting process four to six months before the start of the financial year. Most organization set budgets and undertake variance analysis on a monthly basis. A budgeting process Planning Communication Establish objectives & targets Develop detailed budget Compilation and revision Budget committee review & approval Board approval Implementation and management corporatefinanceinstitute.com Budget psychology Behavioral and social aspects are an integral part of the budgeting process and should not be divorced from the technical side. Budgets may motivate or de-motivate managers depending on: • Where the target is set • The level of controllability • The level of involvement in budget setting Budgets should not be used to pinpoint blame Budgets should be linked to other performance measures corporatefinanceinstitute.com The effect of budget target difficulty on performance P er fo rm an ce Budget target difficulty Easy Adverse budget variance Expectations budget Optimal Performance budget Difficult Actual performance Personal goal Budget Source: Adapted from Otley, 1977 A Practical Guide To Developing Budgets corporatefinanceinstitute.com 03. Learning objectives corporatefinanceinstitute.com Apply different best practice approaches to budgeting including: • Incremental budgeting • Value proposition budgeting • Output/input budgeting • Zero based budgeting Explain the “beyond budgeting” alternative to traditional budgeting corporatefinanceinstitute.com There are 4 common approaches to developing a budget: Developing the budget Incremental budgeting Activity–based budgeting Value proposition budgeting Zero-based budgeting corporatefinanceinstitute.com Inputs are determined by outputs, not the other way around. Avoid starting by assessing the resources you have and then trying to assess what is achievable. Output/input or activity based budgeting The activities I need to undertake to achieve my business aim The cost expectation of delivering these activities Output Input corporatefinanceinstitute.com Value proposition budgeting For each budget item/amount, ask: Why is this amount included in my budget? Has a need for this item been demonstrated? Does the item create value for customers, staff, or other stakeholders? Does the value of this item outweigh its cost? If not, is there another reason why this cost is justified? corporatefinanceinstitute.com Zero-based budgeting starts with the assumption that all department budgets are zero. Managers are required to build their budgets from the ground up, justifying every penny they wish to spend. Bottom-up budgeting can be a highly effective way to “shake things up”. It is most effective when there is an urgent need for cost containment. However it is: Zero-based budgeting Best suited for discretionary costs (not essential operating costs) Extremely time consuming Most effective when only used occasionally corporatefinanceinstitute.com Beyond budgeting principles Goals Set ambitious medium term goals; not short- term fixed targets Rewards Base rewards on relative performance; not on meeting fixed targets Planning Make planning a continuous and inclusive process; not a top-down annual event Coordination Coordinate interactions dynamically; not through annual budgets Resources Make resources available just-in-time; not just-in-case Controls Base controls on fast, frequent feedback; not budget variances Forecasting Techniques Ceo g eC eee = <= ak *< ’ “a CFI Learning objectives corporatefinanceinstitute.com Better analyze costs for improved forecasting Effectively forecast revenues and expenditures using quantitative techniques Use tools such as PEST analysis and Porter’s 5 forces to aid qualitative forecasting corporatefinanceinstitute.com Cost structures and earnings volatility Fixed cost High fixed cost organizations have volatile earnings: small volume changes have material impact on profits Organizations with low fixed costs have to generate large increases in revenues for modest increases in profits $ Time Revenues Costs Variable costs Time Revenues $ Costs corporatefinanceinstitute.com Cost structures and flexibility Analyzing costs into fixed and variable highlights factors affecting the level and volatility of profits: Example Sales Variable labour costs (overtime, casual, temps) Gross contribution Fixed labour costs (full time staff salaries) Net profit Service A $ 100,000 % 100 40,000 40 60,000 60 40,000 40 20,000 20 Service B $ 100,000 % 100 60,000 60 40,000 40 20,000 20 20,000 20 corporatefinanceinstitute.com Cost structures and flexibility Example What is the breakeven point? Fixed costs Contribution margin What is the margin of safety? Sales – Breakeven sales Sales What will the profit be if volumes fall by 50%? What sales are needed to produce $50,000 profit? Service A Service B X 100% corporatefinanceinstitute.com There are a range of widely used quantitative budget forecasting tools including: Quantitative forecasting methods Technique Moving averages Use Repeated forecasts Math involved Minimum level Data needed Historic data Simple linear regression Multiple linear regression Comparing one independent with one dependent variable Compare more than one independent variable with one dependent variable Statistical knowledge required Statistical knowledge required A sample of relevant observations A sample of relevant observations corporatefinanceinstitute.com Moving averages is a smoothing technique that looks at the underlying pattern of a set of data to establish an estimate of future values. Moving averages Last 12 months 3 month MA 5 month MA 5 8 7 6.7 8 7.7 8 7.7 7.2 9 8.3 8.0 7 8.0 7.8 9 8.3 8.2 5 7.0 7.6 7 7.0 7.4 5 5.7 6.6 8 6.7 6.8 4.00 2.00 - 6.00 8.00 10.00 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Revenues Revenues 3 month MA 5 month MA Month Radi o ads Revenues Jan 21 8,350 Feb 180 22,755 Mar 50 13,455 Apr 195 21,100 May 96 15,000 Jun 44 12,500 Jul 171 20,700 Aug 135 19,722 Sep 120 16,115 Oct 75 13,100 Nov 106 15,670 Dec 198 25,300 corporatefinanceinstitute.com Regression analysis is a widely used tool for analyzing the relationship between variables for prediction purposes. Simple linear regression y = 78.075x + 7930.4 R² = 0.9327 $30,000.0 $25,000.0 $20,000.0 $15,000.0 $10,000.0 $5,000.0 $0.0 0 50 150 200 R ev en ue s 100 Number of radio ads Ads vs Revenue corporatefinanceinstitute.com Here are the summary outputs and how to use them… Multiple linear regression results using Excel If we expect: Forecast “Promotion” to be 125 and Forecast “Advertising” to be 250… Note: X Variable 1 is “Promotion” Note: X Variable 2 is “Advertising” Revenues = 763.10 + (2.46 x 125) + (-0.45 x 250) = 958.10 corporatefinanceinstitute.com PEST is a useful framework for building expectations about the future and its impact on the budget: Qualitative forecasting tools Political forecasting and trends Social forecasting and trends Economic forecasting and trends Technological forecasting and trends corporatefinanceinstitute.com PEST analysis overview Political forecasting Technological forecasting Social forecasting Economic forecasting Identify Opportunities And threatsAnticipat e React