BUDGETING AND BUDGETARY CONTROL

An important Project Management Tool

What is a budget?

·         A Plan

·         A Limit

·         A Schedule

·         A Reality Check

·         An Allocation

Budget – a definition

“A planned expression of money”

   Wright.D 1994 “A practical foundation in costing” Routledge

For a defined activity shows;

·         Income & Expenditure

·         Total estimated costs

·         Defined period of time

Another definition

   A budget process is a system of rules governing the decision-making that leads to a budget, from its formulation, through its legislative approval, to its execution.

   

More definitions

BBudget = Quantitative expression of a plan

A plan expressed in monetary terms, prepared and approved prior to the budget period and which shows income expenditure and the  capital employed. It may be drawn showing incremental effects on former budgeted figures or complied by zero budgeting.

Budgets are therefore not prepared in isolation and then filed away but are concrete components of what is known as a budgetary control system. Such a system essentially ensures communication, coordination and control within an organization. The basic functions of management are allocation of resources, planning and control.BBudgets involve – Planning & Control

·         Budgeting in Context

·         A budget helps

·         Why use a budget?

·         Stay within a limit

·         Control

·         Forecasting

·         Delegate

·         Prioritise Wants, Organise Needs,

·         Within the realm of what we Can

PURPOSE OF A BUDGET

·         Co-ordination- Important for the achievement of organization goals e.g.

·         Coordinate inputs and outputs in order to ensure balance of efforts and effects.

·         Coordinate budget lines within the organization to ensure effective implementation of  plans and monitoring of results.

·         Coordinate responses to economic trends and challenges posed by the environment within which programmes and activities are undertaken

PREPARATION OF THE BUDGET

1. Identify objectives

2. Gather data about alternatives

3. Select alternative courses of action

4. Discuss the plans/activities and allocate the budget.

5. Establish monitoring mechanisms.

6. Respond to problems encountered in the previous budget.

• Communication: The budget is used to communicate plans and to control information. Once formulated the aspects of the plan having a bearing on a particular division of the organization are communicated to that division.
• Motivation: The budget seeks to motivate managers to achieve objectives and thereby establish control within the organization
• Performance Evaluation: a budget is used to evaluate the capability of managers to achieve targets.Good performance is associated with achieving better performance targets set on costs of operations and benefits to the organisation.
• Authorization: The budget is used to authorize  expenditure or to pursue certain initiatives once a budget is approved:

a.       it becomes a permission to spend.

b.      acceptance that either a project or activities should commence.

DATA FOR BUDGET PROCESS

INTERNAL INFORMATION

1. Production and operational information
2. Financial information
3. Research and development information
4. Personnel information
5. Sources of internal information-expected outputs  - performance targets, control and monitoring and evaluation mechanisms.

EXTERNAL INFORMATION

1.      Market and competitors

2.      Economic conditions

3.      Industrial structure

4.      Political factors

5.      Technological change

6.      Demographic trends and social factors

7.      Government statistics, commercial data, banks.

8.      Media coverage, business trips, conferences.

Types of budgeting

There are three common budgeting methods:

1.      Top-down Budgeting

2.      Bottom-up Budgeting

3.      Iterative Budgeting

Top Down Budgeting

         Top-Down Budgeting is the term given to a budgeting process based on estimating the cost of higher level tasks first and using these estimates to constrain the estimates for lower level tasks

         A crucial factor for successfully implementing this method for estimating budgets is the experience and judgement of those involved in producing the overall budget estimate.

Organisations need the ability to allow:

Financial Managers to establish centralised budgets to control organisation spending.

Project Managers to establish projects budgets that consume the centralised organisation budget and control project spending.

Advantages

1.      Takes less time

2.      Promotes upper-level commitment

3.      Involves no multilevel participation Aggregate budget is quite accurate, even though some individual activities subject to large error

4.      Budgets are stable as a percent of total allocation and the statistical distribution of the budget is also stable leading to high predictability

5.      Small costly tasks don’t need to be identified early in this process - factored into overall estimate

6.      Lower management better understands what upper management expects

7.      Presented down the ladder

Disadvantage
1.      Translating long-range budgets into short-range budgets.
2.      Problems scheduling projects in a "sub-optimal way" to meet the strategic goals
3.      Result of top management's limited knowledge of specifics of project tasks and activities
4.      Competition for funds among lower-level managers, try to secure adequate funding for their operations.
5.      May cause unhealthy competition.
6.      This process is a zero sum game--one person's or area's gain is another's loss.
7.      Subordinate managers often feel that they have insufficient budget allocations to achieve the objective

Bottom Up Budgeting

         Sometimes called Zero Based Budgeting

Bottom-up budgeting begins with identifying all the constituent tasks that are involved in implementing a project and working out the resources and funding required by each

Provides the opportunity to create organisation level    budgets by rolling up project budgets

Create centralised project level budgets from their sub-project budgets (WBS)

         Advantages

• Project Managers have the flexibility to define their project budgets independently
• Financial Managers have the ability to centrally review the total project budget/s
• Is in the accuracy of the budgets for individual tasks
• Clear flow of information
• Use of detailed data available at project management level as basic source of cost, schedule, and resource requirement information.
• Participation in the process leads to ownership and acceptance

Disadvantage

•  Takes more time
•  Involves cross-section of the organisation
• Presented up the ladder
•  Seeks participation at all levels
•   Encourages commitment to the plan
• Top management has limited influence over the budgeting process,
• Individual tend to overstate their resource needs because they suspect that higher management will probably cut all budgets by the same percentage
• More persuasive managers sometimes get a disproportionate share of resources
• A significant portion of budget building is in the hands of the junior personnel in the organisation
• Sometimes critical activities are missed and left unbudgeted

Iterative Budgeting                           Iterative – to repeat or do again

A combination of top-down and bottom-up budget building

·         Higher project level estimated (top down)

·         Lower level costed (bottom up)

·         The two costs negotiated and reconciled

Disadvantage

1.      Is in the relative inefficiency and time consuming nature of the negotiations over the budgets.

2.      Process may not work well when communication channels are either informal or blocked between lower-level managers and senior management

Advantage

1.      It promotes employee involvement and stimulates a high degree of information flow between those involved in the project at different levels

2.      Both senior management and lower level managers closer to the actual process participate in the budgeting process

Top Down vs. Bottom Up

•       Top-down           Bottom-up

Problems of Bottom-up Budgeting

1.      Difficult to control aggregate spending

2.      Allocations may not be optimal

3.      Hard to keep multi-year perspective

Top Down & Bottom Up Compared

• Bottom-up                                • Top-down      

      

  - Annual                                             - Multi-year     

  - Time consuming                              - Delegated authority

  - Ownership of proposals is               - Creates joint ownership of

     specific                                              proposals

  - Reactive                                           - Proactive

Activity Orientated Budget

1.      The traditional budget is activity based

2.      Individual expenses classified and assigned to basic budget lines e.g. phone, materials, personnel, clerical, utilities, direct labour, etc

3.      Diffused control so widely that it was frequently non-existent

Task Orientated Budget

Also known as Program Budgeting

Aggregates income and expenditures across programs (projects)

The project has its own budget

Pure project organisation, the budgets of all projects are aggregated to the highest organisational level

Functional organisation income/expense for each project are shown

Planning Programming Budgeting System (PPBS)

1. The system focuses on funding those projects that will bring the greatest progress toward organisational goals for the least cost
2. Basically a Program and Planning Budgeting System
3. Planning Programming Budgeting System (PPBS)
4. Identification of goals and objectives for each major area of activity - planning
5. Analysis of the programs proposed to obtain organizational objectives - programming
6. Estimation of the total costs for each project, including indirect costs. Time phasing of costs is detailed.
7. Final analysis of alternative projects in terms of costs, expected costs, expected benefits, and expected project lives.
8. Cost/benefit analyses are performed for each program so programs can be compared with each other and a portfolio of projects can be selected for funding
9. Budget Planning linked to Project Activity
10. Only way a detailed budget can be produced
11. Can monitor budget usage against project activity
12. Can be done when the project schedule has been determined
13. Completion Times, Project Activities, Costs
14. Direct relationship of these items
15. Will affect the final budgeted figure
16. Is a “trade off”

Budgetary Control

This is the establishment of a budget relating the responsibilities of executive management to the requirement of a policy and continuos comparison of actual and budgeted results.

Control should ensure that actions are accordance with the objective of the policy in question

Also provides a basis for its revision.

ELEMENTS OF BUDGETARY CONTROL

Setting up budgets i.e. planned targets on revenue, expenses, assets and liabilities relating to the activities concerned.

Measuring actual results against the budgets on a continuous basis

Identifying and analyzing deviations from budgets and modifying both actual operations and subsequent budgets.

MAIN AIMS OF BUDGETARY CONTROL

·         To establish the degree of progress to the achievement of short term plans

·         To allow delegation to occur without losing overall control

·         To provide a measure for allowing flexibility in operations

·         To establish short term plans and aid the organization’s planning process

The ability to control anticipated expenditures for your project using a project cost budget.

   The Projects Budgetary Controls feature includes the following:

1. Flexible Setup of Controls
2. Defines Control Amounts
3. Defines Control Levels
4. Funds Check - Performs the available funds verifications.
5. Maintenance of Available Balances - Maintains the available balance for each project budget line.

Actual Transactions;are recorded project costs. 

         Examples include labour, expense report, usage and miscellaneous costs.

Commitment Transactions;

         are anticipated project costs. 

         Examples include purchase requisitions and purchase orders or contract commitments.

Features of an effective budget

1.      Accurate forecasting

2.      Based on organisational goals

3.      Information is timely and accurate

4.      Formed with multilevel input

5.      Regular reviews are built-in

Problems with budgeting

The process is too long

There is a lot of game playing

Business decisions change but the budget does not

People in charge of budget are held accountable in areas where they have no responsibility

Applying an arbitrary percentage to prior period actual

Analysing Variance

·         Budget deviation analysis (variance analysis) regularly compares what you expected or planned to earn and spend with what you actually spent and earned. 

·         Variation analysis can help greatly when detecting how well you’re tracking your plans, how much to accurately budget in the future, where there might be upcoming problems in spending.

Example of a variance report

Date:                      June 30, 2006

                                                        

Account:  Product Development                 MONTH TO DATE

                                

ACCOUNT   REF.   ACTUAL       BUDGET       VARIANCE              %

SALARIES    5025    £48,000           £43,750          - £4,375                      - 10

TRAVEL       6442      £1,500           £1,200                - £300                       - 25

SUPPLIES     5320         £500           £700                    £200                         28.5

Benefits to checking variance

1. Understand the reason for the differences
2. Prepare a more accurate budget in the future
3. Evaluate budget goals
4. Isolate problems
5. Identify weak areas
6. Motivate managers
7. Communicate with all levels
8. Forecast
9. Response to budget warnings
10. Freeze spending
11. Freeze activity
12. Put off “unnecessary” projects activity
13. Re-schedule/cost your project
14. Downsize your project