Manage Budget and Financial Plans

Planning a Budget
Davis Service Group is a large public limited company employing around 17,000 people. Its shares are quoted on the London Stock Exchange.The business is based on service contracts to source, clean and maintain industrial textiles, such as protective clothing and linens. This is across four key sectors: workwear, healthcare, hotels and restaurants, and general facilities, such as washroom linen Budgets are forward financial plans. They show financial targets over a given period of time for income, expenditure and cash flows within a business. Davis uses budgets to plan the future use of its resources, either in the short or long term. For example, operational areas need to assess the costs of the people needed to meet production targets or the marketing team must determine costs of promoting services to increase sales. Budgets are also communication tools which allow employees to understand where the business is heading. Section 2 –

Advantages and disadvantages –
There are many advantages to using budgets. They:
provide a method of allocating and using resources within the organisation help to monitor and control operations
promote forward thinking show employees an overall picture of the direction of the organisation which can motivate staff help to co-ordinate different departments and align them towards shared objectives provide a framework for delegation.

Sensitivity Analysis –
Managers use sensitivity analysis to review different scenarios. They ask questions and consider the impacts of various alternatives (the “what-ifs”). For example: The economic outlook – What is the overall economic trend for the UK and Europe? For example, increased redundancies during a recession would mean less demand for workwear. A sharp rise in the value of the euro against the British pound would make earnings from Davis” European business more valuable to the company.

Customers – How are customer needs likely to change? For example, some larger clients have been moving from simply buying a textile service to wanting a complete solution to cleanliness and safety needs. Will demand from the hospital sector grow more than that from hotels and restaurants? Staff – Is the company recruiting sufficient staff? Are salaries high enough to keep vital knowledge and experience within the Group or does Davis need to recruit additional expertise? Different types of variances –

Variances may be favourable (better than expected) or adverse (worse than expected). Small variances are inevitable and usually not significant. A key task of managers is to watch for variances that are unexpected, either in their size or timing, and take action accordingly.

Adverse variances prompt investigation into what has gone wrong. They may suggest: unrealistic budgeting; budget data may need to be revised or flexed a failure with part of the process  a change in the external environment
Assumptions –
A budget needs to make assumptions about how internal and external business conditions will develop and change. Once the effects of these assumptions have been evaluated, managers can set forecasts for sales turnover and costs to meet profit targets. Detailed planning can then follow to estimate the plant capacity, staffing, materials and marketing needed.They ask questions and consider the impacts of various alternatives. For example –

The economic outlook
Competition
Customer needs
Suppliers activity

Variables –

A company’s objectives budget is the overall financial plan showing expenditure of the available funds. It is driven by the aims and objectives of the organisation as well as what the organisation can actually accomplish. Many variables in a business can be budgeted. These include: sales

output
costs operating and fixed
profits
cash flow
capital investment.
Operating and zero budget –
The budget will be based on key assumptions about likely business conditions for the year ahead. These inform the detailed operating budgets that plan month-to-month sales, activity levels and expenditure, for example, staff costs.Managers may need to accommodate unexpected changes with flexible budgets. For example, sales may be lower than originally expected, so the budget may need to reduce marketing expenditure and/or operational activities. An increase in orders may require additional recruitment costs for temporary staffing. Sometimes managers use zero budgeting. This means that they must start every year from zero and justify all planned expenditure, rather than starting from the previous year’s figures. This may be appropriate for a specific, self-contained project. Variance –

Variances may be favourable (better than expected) or adverse (worse than expected). Small variances are inevitable and usually not significant. A key task of managers is to watch for variances that are unexpected, either in their size or timing, and take action accordingly. KPI –

Budgets use resources so they are closely linked with key performance indicators (KPIs). KPIs help to evaluate the overall performance of the business. Davis Service Group’s KPIs include measurement of: organic revenue growth (i.e. sales growth excluding acquisitions) operational throughput (e.g. tonnage of linen processed)

management retention rate (i.e. keeping experienced staff in the company) health and safety records (e.g. major incident injury rate)
Environmental performance (e.g. water and energy consumption). Section 3 –
Purpose of budgets –
Budgets are forward financial plans. They show financial targets over a given period of time for income, expenditure and cash flows within a business. Davis uses budgets to plan the future use of its resources, either in the short or long term. For example, operational areas need to assess the costs of the people needed to meet production targets or the marketing team must determine costs of promoting services to increase sales. Budgets are also communication tools which allow employees to understand where the business is heading.

Relationship between objectives and operational budgets –
A company’s objectives budget is the overall financial plan showing expenditure of the available funds. It is driven by the aims and objectives of the organisation as well as what the organisation can actually accomplish. The budget will be based on key assumptions about likely business conditions for the year ahead. These inform the detailed operating budgets that plan month-to-month sales, activity levels and expenditure, for example, staff costs.

Managers may need to accommodate unexpected changes with flexible budgets. For example, sales may be lower than originally expected, so the budget may need to reduce marketing expenditure and/or operational activities. An increase in orders may require additional recruitment costs for temporary staffing. Sometimes managers use zero budgeting. This means that they must start every year from zero and justify all planned expenditure, rather than starting from the previous year’s figures. This may be appropriate for a specific, self-contained project.

Adverse variances prompt investigation into what has gone wrong. They may suggest: unrealistic budgeting; budget data may need to be revised or flexed a failure with part of the process (e.g. missed targets by sales force); this needs immediate management attention a change in the external environment (e.g. a new competitor); this might require a counter-attack with an increased marketing budget. Favourable variances represent good news but should not be ignored. Instead they may carry an opportunity perhaps a new market is emerging or a competitor has withdrawn? Either way, managers are responsible for their budget variances and would need to report on outcomes and propose action to their own. There are many advantages to using budgets. They:

provide a method of allocating and using resources within the organisation help to monitor and control operations
promote forward thinking show employees an overall picture of the direction of the organisation which can motivate staff help to co-ordinate different departments and align them towards shared objectives provide a framework for delegation.

Most importantly, budgets are an early warning system. They highlight where investigation and appropriate corrective action is necessary. For example, Davis recognized as early as 2008 that the recession was affecting its UK linen operation. It took action to ensure the impact was managed for the second half of 2008. It then assessed the implications of recession right across the business management was put on ‘full alert’.

These benefits do not come problem-free:
Staff time devoted to budgets carries a real opportunity cost. At Davis, 750 people are involved with budgeting. The time these workers give to the budgeting process means they are not available to carry out other responsibilities. Errors and inaccuracies will always remain since it is impossible to predict the future. Major external events such as rising energy prices or the global recession may distort the whole process. Budgets involve and affect people, they may cause conflict. There may be difficult choices over where limited funds are spent. Some departments with tight budgets could feel constrained. This carries the risk of frustrating initiative and enterprise. Section 4 –

Davis operates across 15 countries and has sales turnover of over £1 billion. To meet its needs, the company has developed a robust and detailed budgeting and planning process involving its managers. Budgeting provides an essential forecasting, control and feedback system on which effective management depends. This process translates competitive strategy into reality. Evidence of the power of managed budgeting was seen as recession gripped the European economies in 2008. Davis was able to assess effects and build new and realistic assumptions into its budgets for the remainder of 2008 and 2009. These have proved resilient in practice. As an exceptionally challenging year ended, the company was on track to fulfil budget expectations.By identifying and managing risks, Davis Service Group has been able to return profits, dividends and cash flow for shareholders in a difficult economic climate. This also allows the business to invest for growth in 2010 and beyond.