Plan Financial Management Approaches

• Sales budget
• Purchases budget
• Cost of goods sold budget
• Operating expenses budget
• Inventory budget
• Budgeted income statement
• Budgeted balance sheet
• Cash flow statement

Manufacturing Businesses utilise the follow budgets;

• Sales budget
• Production budget
• Direct material purchases budget
• Direct material usage budget
• Direct labour budget
• Factory overhead budget
• Cost of goods sold budget
• Operating expense budget
• Inventory budget
• Budgeted income statement
• Budgeted balance sheet
• Capital expenditure budget
• Cash flow statement

Irrespective of the industry, business structure or management style, budgets must meet the requirements of the accounting code of practice, reflect management accountabilities, the decision making structures and processes that support these arrangements?  Budgets for managers should be grouped to reflect the reporting arrangements to a more senior manager.  Budgets also need to identify those managers responsible for non-operational budgets.

The financial management process contains the detail of the planned allocation within the organisation in order to achieve the objectives.  It needs to be analysed and reported to the target audience and key stakeholders.  Ensuring that the process is effective is critical to providing individuals and the business with useful information to control the direction and profitability of the business.

Whilst budgets focus largely on the financial projections and results it is vital to be aware and factor into the process the non-financial elements.  Non-financial elements are those factors which at face value have tangible cost to the business, however, can affect the profit and loss.  The most commonly understood non-financial elements are staff morale and reputation.  In both instances, there is no definable expense which can be allocated however the deterioration of these elements can have a major effect on the business.   The increase or decrease of moral on staff can affect production numbers, quality issues, sales performance, and handling of customer complaints to mention a few.  Publicity, both positive and negative, effects the reputation of a business. 

Qantas once upon a time was the only airline in the world not to have had an airplane accident or issue; however a cutting of the maintenance budget in attempt to reduce costs has resulted in this safety record being destroyed.  How much was this worth to the company?  Was it really worth the cost cutting savings made in maintenance?

FINANCIAL STATEMENTS – THE FUNDAMENTALS

Irrespective of the type of business, industry or management structure there are three budgets that are essential for a business to report on its financial position.  Each one of these budgets is required for annual reporting and governance of the finances by responsible authorities.

These budgets are:

• Balance Sheet
• Profit and Loss Statement
• Cash Flow Statement

BALANCE SHEET

The Balance Sheet (or is also known as Statement of Financial Position) is a statement at one point in time, which shows all the resources controlled by the business and all the obligations due by the business.

The purpose of the balance sheet is to communicate information about the financial position of a business at a point in time.  It provides information of both the assets and liabilities of the business.

It is important to understand that balance sheets are prepared at least once a year and are at a ‘point in time’.  This means that they are only good for that one point in time.

The accounting convention dictates that a normal accounting period is a year, and tax laws and other legislation are set upon that basis.  In many businesses it may be necessary to report for different periods based on the location of the business and the location of the businesses head office.

The balance sheet is essentially made up of three categories;

• Assets
• Liabilities
• Proprietorship/Capital/Owners Equity

Example 1:

How Many More Budgets To Go! Pty Ltd

Budgeted Balance Sheet as at 31 March 2010

These categories are defined in the definitions section.

PROFIT AND LOSS STATEMENTS

Where the balance sheet shows the financial position of a business at a point in time, the profit and loss statement shows the position for a period of time.  For regulatory purposes, this is usually a year, but for internal purposes this can be quarterly, monthly, weekly and on occasion even daily.  The shorter periods provide management with the ability to measure how the business is performing against a previous period or budgeted figures.

It is not uncommon for banks and other lending institutions to request the profit and loss statement as a means of determining the businesses ability to pay back any money lent.  The purpose of the profit and loss statement is to measure the profit or loss for a period.  It does this by summarising the revenues for the period, and subtracting the expenses from the revenue.  Where the revenues are greater than the expenses, profit results, where the expenses are greater, a loss.

CASH FLOW STATEMENTS

Cash is the lifeblood of every company and is not sales.  The cash flow statement is produced to provide management with the information on the liquidity of the business; it shows the businesses incoming and outgoing money (sources of cash) during a time period.  .  The statement should identify any potential cash shortfalls which would require corrective action or identify any excess cash requirements which could be better utilised within the business (or invested to earn more income).  A statement is an analytical tool used in determining the shortterm viability of a company, in particular, the businesses ability to pay its expenses.   The analysis can be broken down into three core areas;

Operating

Investing 

• Financing

Operating Activities include the production, sales and delivery of the businesses products (or services) as well as collecting payment from its customers and making payment to its suppliers.

Operating cash flows can include;

• Cash receipts from the sale of goods and services
• Cash receipts from the sale of loans, debt or equity instruments
• Interest received from loans issued by the business (may be considered an investing activity depending on the type of business)
• Tax payments
• Payments to suppliers for goods and services
• Payments to employees (or on behalf of employees)

Investing Activities focus on the purchase of the long-term assets a business needs in order to make and sell its products.  

Investing cash flows include;

• Interest received from loans issued by the business
• Collections on loan principle and sales of other business’s debt instruments
• Receipts from purchase of plant and equipment
• Expenditure for purchase of plant and equipment

Financial Activities include the inflow of cash from investors such as banks and shareholders as well as the outflow of cash to shareholders as dividends as the business generates income.

Financial cash flows include;

• Proceeds from issuing shares
• Proceeds from issuing short or long term debt
• Payments of dividends

Payments for repurchase of company shares

Repayment of debt principal, including capital leases

The Cash Flow Statement only deals with items which affect the bank account.  If it doesn’t affect the bank account, it does not affect this statement.  There are a number of expenses which specifically fall into this account.  The three main non-cash expenses are;

• Doubtful debts
• Discount allowed
• Depreciation

Be mindful when preparing the Cash Flow Statements that these items are not included.

As cash is the lifeblood of the business, it is vital that sufficient controls exist.  Businesses control cash by;

• Setting up controls over payments – irrespective of the size of business procedures and policies need to be set up to ensure that correct payments are made to the right suppliers in a timely manner which suits the business
• Using electronic systems – there are many systems available, most of which are a form of EFTPOS (Electronic Funds Transfer Point Of Sale) and electronic banking systems. These facilitate the receipt of payments from customers and payments to suppliers.  These have the advantage of reducing the amount of physical cash, theft and the reduction of bank transaction costs.  It is important to ensure that appropriate audit and fraud controls exist
• Setting up policies and controls over receipts – the collection of money owed to any business, whether big or small requires systems and controls to ensure the correct, timely and efficient receipt of money occurs
• Actively managing all of the elements of the operating cycle – the amount of funds invested in raw materials and inventory, and how quickly this can be turned back into ‘cash.'

DEVELOPING BUDGETS 

The process of developing budgets comprises ultimately of four key stages;

Preparing budgets & other financial plans 

Collecting actual operating data & information

• Analysing & reporting deviations or variances
• Taking corrective action including revising plans as appropriate

The effectiveness of this process relies on each stage being conducted, reviewed and reported on.  Identifying and understanding why variances have occurred does not assist the business unless the information has been shared with those in the business who can affect the results going forward.  

Collecting actual operating data and information of a business firstly assumes that the activities of a business are recorded.  In most businesses, this is the case through Point Of Sale (POS) dockets, invoices, credit card receipts, contracts, quotations, job costing, purchase orders, time sheets, payroll and other systems.  The systems for recording need to meet the requirements for producing data for meaningful reporting and conform to audit and legal obligations.  With any system, accuracy needs to be paramount and maintaining these systems needs to occur regularly to ensure all information is gathered and available.  All businesses are required to produce reports in some manner.  For some, it is a combination of both internal and external reports, others it is just the external reporting for legal and professional requirements.  Both kinds of reporting assist in controlling the processes within a business.

Analysing and reporting deviations or variances need to occur in a timely manner to ensure that corrective action can occur promptly.  Depending on the requirements of the business, different reports will be disseminated to different levels of the business.  Generally the higher up the report goes in an organisation, the more summarised the version is.  The most detailed reports are sent to the departmental managers to act on.

Budgets are only as effective as the information used to prepare them and the people involved in monitoring the results.  Without the final stage of review preparing budgets is merely an exercise in plotting numbers.  The process of reviewing the budget numbers requires the actual numbers to be plotted against the budget and any variances identified.  A variance is any amount which arises between the budget and actual figures.  Once a variance has been identified, it is necessary to understand why a variance has occurred.  Is it due to poor planning in the budget preparation stage?  Did something occur in the environment which resulted in the difference?  Was there over/under spending?  Sales, how did they perform, did the marketing work?

Given so many items contained within budgets and many of them likely to result in a variance, many businesses determine an acceptable variance amount.  This is the material amount or percentage that identifies which specific items will be investigated.  It is important to remember however that there are rules around this, it is not appropriate to not investigate sensitive figures

merely because the results are unfavourable.   The most fundamental rule is; all variances exceeding 5% or $1000 must be investigated.  NOTE:  these amounts are examples; a business will determine what is appropriate as each business is different.  Coles would not bother about a variance of $1000. However, a small retail store may be concerned with a variance of over $500.  The main message however that is once the rule has been determined it applies to all results and any item which falls outside of the rule must be investigated and reported on.

Reporting variances is vital to the budgeting process.  It is through understanding the differences, clarification on the operation of the business can occur.  The projections initially planned, have they been realised as expected?  If not, why not?  If they have, was it through good planning or luck.  Understanding why you have succeeded is just as important as understanding why things have not occurred as expected.  By reviewing the actual figures compared to budget regularly, management is provided with an early warning system should the results start deviating from the expected.  Should this occur, changes may be needed to the original budget.  Contingency plans may need to be developed, or if already developed, implemented.

ACCOUNTING PRINCIPLES

Accounting has been around for many years and over that time a number of Accounting Principles have been developed as a standard by which all accounting is applied.  These principles are essential for the preparation of budgets and must be adhered to for regulatory purposes.  Below is a list of the most commonly accepted principles and their definitions.

• Business Entity

The accounts are accurate records of the business activity – for accounting purposes, each individual business organisation is an isolated entity, separate from owners, employees, managers and other business entities.

• Historical Cost Concept

All transactions are recorded at original cost (not the value of the item today).  Accounting reflects past and historical events.  

• Going Concern

Assumes the business is ongoing and not being ‘wound up’ – the business will continue indefinitely.

• The Accounting Period

Financial statements cover certain fixed periods, i.e. weekly, monthly, quarterly, annually.

• Objectivity

Transactions are recorded on the basis of objective and verifiable evidence.

• Conservatism

Use the figure that will result in a lower end profit.

• Consistency

Using the same methods of accounting over different periods.

• Materiality

Items reported have a material impact on the accounts.  (The exclusion of cents in the accounts is not considered ‘material’).

BUDGETING APPROACHES

There are a number of different approaches to budgeting, and as with budgeting as a whole, it depends on the type of business, the industry and the management style.  The approaches listed below detail the most common utilised in business, these may be used at differing stages of a business’s life.

• Unit Cost budgeting o Linkage of financial information to activity levels
  • Identify all of the costs associated with a delivery of a unit of service or product.
  • Enables comparison across areas or products/services.
• Bottom Up budgeting
  • Identifies the different resources tied up in delivery and attaches a value to each.
  • Need to identify every detail.
  • Complex and time consuming to perform.
• Top Down budgeting
  • All relevant expenditure is assembled and divided by units of activity.
  • Difficult to ensure consistency in definitions when comparing areas across an organisation.
  • Difficult to ensure all areas of expenditure have been identified.
• Zero Based budgeting o Common approach in current economic crisis o Managers create budgets from scratch
• Identify every single line of expenditure and scrutinise it – regardless of previous history or performance.
• Requires a lot of time and effort.

PREPARE CONTINGENCY PLANS IN THE EVENT THAT INITIAL PLANS NEED TO BE VARIED

When making plans, in any situation, it is vital to be aware of and prepare a contingency plan.  Contingency plans deal with the ‘what if’ scenarios.  With no crystal balls handy, it can be difficult to prepare for every scenario, however, understanding what can go wrong assists in the planning process.

In recent times, there has been a number of ‘extreme situations’ affecting businesses, many of which, at the time, there were no contingencies in place.  Now with the benefit of hindsight, plans and processes can exist to limit the effect or increase the recovery that some of these ‘extreme situations’ can cause.  

Some examples of these situations include but are not limited to;

• The world Economic Crisis
• 9/11
• Natural Disasters o Victorian Bush Fires o Hurricane Katrina o Flu Pandemics
• Climate Change
• Mining Boom in Western Australia and Queensland

Many businesses fail to make contingency plans as it is seen as ‘counter’ cyclical to all the other initiatives in the business’ which are predicted on the ‘status quo’.  Essentially meaning that all other plans are based on what has occurred in the past.

Contingency planning competes for the same resources in the business, time and money without any visible return on that investment, unless something goes wrong and it can be executed.  However, pending disasters do occur and an organisation without a contingency plan is far more likely to suffer greater damage and take longer to recover than one with a well thought out plan.

There are costs associated with a ‘no response’ plan and the opposite an ‘over responsive’ plan. The key is to get the risk assessment right and balance the investment in the recovery plan against the potential cost and likelihood of the disaster

A good example of both was the responses to the Y2K (Year 2000) issue. This issue was a potential programming problem in worldwide computer software which was sensitive to the “0099” fields in date sensitive programs.

Businesses response to this potential disaster covered the whole spectrum. Many businesses and some countries (China) largely ignored the issue. Other business and some countries (USA and Australia) became obsessed with the issue. This overreaction was mainly in the area of legal compliance in the event of a major supply chain failure.

Both responses proved to be wrong. The ‘disaster ‘did not eventuate but some companies did experience problems which could have been avoided. On balance, it is arguable that the whole Y2K issue did little to support the argument for organisations to develop contingency plans for extreme situations. No doubt 9/11 and Katrina had the exact opposite effect.

So where do these events place contingency planning within the business environment? Simply put a contingency plan prepares the business to respond coherently to an unplanned event. It can also be seen as the Plan B when expected results fail to materialise

The process of developing a plan involves the convening of a team representing all areas of the organisation. The task of this cross-functional team is to identify;

• The nature of the extreme situation
• The potential risk involved
• The likely impact on the business
• The costs associated with the plans implementation
• A recovery plan

The process of developing a contingency plan will require, as do all business projects, its own budget and a critical path with defined milestones. Such a critical path will;

• List all the activities of the plan
• Establish the interdependencies of each activity
• Determine the resources and time required by each activity
• Determine the sequences of each activity
• Track and test the progress of the plans development.

The Contingency Planning team should not only involve all areas of the business but be driven by representation for the senior management team. The team should also have a good cross section of ‘diverse’ thinkers. The need for a ‘whole’ brain approach is critical to the development of a successful plan.

The nature of the plan will be to test the business plan assumptions and this will involve the testing of the labour market strategy which underpins the business plan.

More often than not the contingency plan will be about external factors but not always. A contingency plan is just as valid for unplanned events within the business. One of these events could be rapid unplanned growth. Labour strategies should be able to address both contingencies. i.e. rapid growth or rapid contraction. The development of a flexible labour structure is a good platform on which to build a responsive contingency to either of these events.

INITIATIVES TO SUPPORT WORKFORCE PLANNING OBJECTIVES

            “People hate change, but without change there would be no progress.”

            Anon circa 1800.

Despite 200 years of progress, this maxim still holds true today. Structural change in any organisation will be opposed and resisted in some quarters. The key is to develop a sense of ownership for the proposed change. The first task in achieving ownership is the WIIFM test…..what’s in it for me.

People need to know what the change is. Why it is being made. How it will impact on them. Failure to cover off on these issues will spell failure in the WIIFM test.

Managing effective change requires the following steps.

• A clear vision
• The ability to model the way
• The pressure for change
• The capacity for change
• Actionable first steps
• Reinforcement and consolidation

Without each of these steps, the effort to effect sustainable change will fail.