Mastering Budgeting and Balanced Scorecard for Financial Planning

Budgeting Fundamentals for Business Success

What is a Budget?

A budget is a spending plan that helps determine in advance if you will have enough money to achieve your goals. It involves simply balancing expenses with income. Always start with sales budget preparation.

Key Budgeting Concepts

Limiting Factor

A limiting factor is a key factor that creates a bottleneck, hindering your objectives.

Budget Periods

• Periodic Budget: A budget for a specific period (e.g., January-December).
• Continual Budget: Revised every month, requiring more effort and cost depending on the business.

Five Main Benefits of Budgeting

Budgeting offers several crucial benefits for organizations:

• Promotes forward-thinking and identifies short-term problems.
• Motivates managers to better perform.
• Provides a basis for a system of control.
• Provides a system of authorization.
• Helps coordinate various sections of the business.

Steps in the Budget-Setting Process

1. Establish responsibilities (e.g., by title).
2. Communicate budget guidelines to relevant managers.
3. Identify key or limiting factors.
4. Prepare budgets for areas with limiting factors.
5. Prepare draft budgets for all other areas.
6. Review the budget.
7. Prepare the master budget.
8. Communicate the budget to all parties.
9. Monitor actual performance relative to the budget.

Types of Budgets

• Fixed Budget: Based on one level of activity (e.g., a master plan).
• Flexible Budget: Recognizes different cost behaviors with changes in activity volume.
• Incremental Budget: Assumes little or no changes, often adjusted for inflation.
• Zero-Based Budget: Each allowance must be justified; otherwise, the allowance is zero.

Criticisms of Budgeting

While beneficial, budgeting has its drawbacks:

• Cannot deal with fast-changing environments.
• Focuses on short-term financial targets.
• Takes up much management time.
• Encourages incremental thinking.
• Protects costs rather than lowering them.
• Often based on business functions instead of business processes.

The Balanced Scorecard: A Strategic Performance Tool

Understanding the Balanced Scorecard

The Balanced Scorecard is a performance metric used in strategic management. It identifies and improves various internal functions of a business and their resulting external outcomes.

Key Perspectives of the Balanced Scorecard

• Financial Perspective

  Focuses on financial performance and value creation:

  • Prosperity: Profit Margin, Return on Investment (ROI), Return on Equity (ROE), Return on Capital Employed (ROCE).
  • Success: Higher Revenue Growth.
  • Survival: Current Ratio, Cash Ratio, Acid Test Ratio.

• Customer Perspective

  Measures customer satisfaction and market share:

  • Satisfaction
  • Loyalty
  • New Product Development

• Internal Business Process Perspective

  Evaluates the efficiency and effectiveness of internal operations:

  • New Product Development
  • Design Productivity

• Learning & Growth Perspective

  Assesses the organization's ability to innovate, improve, and learn:

  • Employee Satisfaction/Motivation (surveys)
  • Employee Turnover
  • Employee Productivity

Essential Financial Formulas & Budgeting Calculations

Inventory Valuation

Opening Stock

The value of goods available for sale at the beginning of a period.

Closing Stock

The value of goods unsold at the end of a period.

Key Budgeting Formulas

• 1) Production Budget Formula

  P = CS + Sales - OS

  Alternatively: CS = Sales - P + OS

  Where: P = Production, CS = Closing Stock, OS = Opening Stock

• 2) Raw Material Purchases Budget Formula

  Purchases = Usage + CS - OS

  Alternatively: CS = Usage - Purchases + OS

  Usage:

  • Usage in units = units per product × production
  • Cost of material used = cost per unit × production (result is budgeted material costs)

• 3) Cost of Finished Goods Sold Formula

  COGS = OS + Production Cost - CS

  Alternatively: CS = COGS - Production Costs + OS

  *Only for finished goods.*

• 4) Cash Receipts Budget Formula

  Cash Receipts = Opening Debtors + Credit Sales - Closing Debtors

  Alternatively: Closing Debtors = Cash Receipts - Credit Sales + Opening Debtors

• 5) Cash Payments Budget Formula

  Cash Payments = Opening Creditors + Credit Purchases - Closing Creditors

  Alternatively: Closing Creditors = Cash Payments - Credit Purchases + Opening Creditors

Budgeting Exercise Notes

• Product Overhead Budget Calculation

  To get the overhead absorption rate per direct labor hour, divide the total product overhead budget by total labor hours.

• Budgeted Unit Cost of Manufacturing

  Add unit costs for raw materials, direct labor, and production overhead. (Unit cost / units produced / total cost = sum all to get standard cost of production).

• Cash Budget Structure

  Opening cash balance + Receipts = Total cash available;

  Less payments (purchases, direct labor, factory overheads) = Budgeted closing cash balance.