Section A Planning and Budgeting Concepts The External Environment in Planning and Budgeting Planning does not occur in a vacuum. A business must interact with its external environment, and this environment includes influences that will impact the plans that management makes. These external events will impact not only the companys plans but also its budget. Although past financial results and information may be used in developing the budget for the next period, the budget is still a documented expression of what the company would like to accomplish financially in future periods. For instance, sales in the current year-to-date may have been impacted by the economy or an internal situation that has changed. The past is not a predictor of the future, and the plan and the resulting budget should reflect the conditions anticipated for the coming period, not the conditions that existed in the past period or periods. Three interrelated environments affect managements planning and budgeting : • The industry in which the company operates, • The country or the national environment in which the company operates, • And the wider macroenvironment in which the company operates. An industry analysis involves assessing the companys industry as a whole, the companys competitive position in the industry, and the competitive positions of its major rivals. The nature of the industry, the stage the industry is in, the dynamics and the history are all part of this analysis. For example, the industry the company operates in may be highly competitive, or it may be less competitive. The amount of competition the company faces will impact the prices it can charge, the marketing effort needed, research and development needs, and so forth. Likewise, if the industry is growing, the company can expect and plan to benefit from that growth; or, if the industry is in a decline, the company should plan how it needs to respond to that. Analyzing the national and international environment includes assessing domestic as well as international political risk and the impact of globalization on competition within the industry. International political risks include the obvious risks of government expropriation (government seizure of private property with some minimal compensation offered which is generally not an adequate amount); and war (which can affect employee safety and create additional costs to ensure employees safety)_ The macroenvironment includes macroeconomic factors that will effect the entire industry or economy as a whole. The most important macroeconomic factors in planning and budgeting are (1) the growth rate of the economy, (2) interest rates, (3) currency exchange rates, and (4) inflation or deflation rates. • Economic growth leads to more consumer spending and gives companies the opportunity to ex pand their operations and increase their profits. Economic recession leads to a reduction in consumer spending and, in a mature industry, may cause price wars. Both will affect demand and thus sales revenue and net income in the future. • The level of interest rates can affect a companys sales and net income if the company is in an industry where demand is affected by interest rates, such as the housing market or the manufacture of capital goods. Rising interest rates will cause demand to decrease, while falling interest rates will cause demand to increase. Interest rates also affect any companys cost of capital and thus its ability to raise capital and invest. • Changes in currency exchange rates affect the competitiveness of companies in international trade. A declining U.S. dollar creates opportunities for increased international sales while at the same time, it decreases foreign competition. An increasing U.S. dollar causes the oppOSite condition. • Both Inflation and deflation cause businesses to be less willing to make investments in new projects. When inflation increases, it is difficult to plan on what the real return will be from an in vestment. Deflation also causes a lack of stability in the economy, because when prices are deflating, companies with a high level of debt and the obligation to make regular fixed payments on the debt can find themselves unable to service that debt. So those companies will be reluctant to commit to new investment projects.
Posted on: Sun, 20 Oct 2013 10:05:47 +0000
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