As with every task, there is some terminology to learn. The short glossary given below gives the most common usages but there may well be variations and it is important to clarify these before making any budget predictions. This is particularly relevant if changing companies or managers.
Terminology
Budget period (sometimes planning period): The basis is usually 12 months. This may be a calendar year, but normally corresponds to the company's financial year and is usually broken up into weekly, four weekly or monthly periods.
Annual budget (or, sometimes, the annual operating plan, and frequently referred to as the budget): Financial projections are made in detail and the final budget is usually approved at board of directors level. As such, it cannot, and should not except in exceptional circumstances, be changed during the budget period and then only with board approval. This means that the annual budget does not change when you leave one charter and enter another at a different charter rate, that is part of normal trading. It will, of course, throw up variances (qv) in the actual to budget reconciliation, but that is quite normal-and, if the charter rate is higher, healthy. If the budget is revised or changed for some fundamental reason, it is good practice to clearly define it as a revised budget and logically, it should have its revised assumptions and data.
Data: These are facts used in the calculation of your budget which you know to be true-your vessel's cargo-carrying capacity is (or should be) one; number of crew, classification cycle and bunker consumption could be others.
Assumptions: These are beliefs; statements about the future which you, or the company, believe will be true. Freight rates during the budget period will be an assumption unless the vessel is fixed on a time-charter, in which case the income becomes data. Absolute clarity of assumptions and data used in budget calculations is the single most important factor in building and negotiating budgets since this is your chart datum. Many things may change, both during the budget
negotiations and during the financial year; you may know where you are, but if you cannot
remember where you started from you will not be able to calculate set and drift and make the right adjustments to achieve your objective. We will look at assumptions in greater detail.
Be aware of the budget basis; different ships may have different longsplices and beware of assumptions built upon assumptions.
Projections or predictions: These are the result of applying Assumptions to Data. Assumption x Data = Predictions
e.g. I
Freight Rates x Cargo Capacity = Trading Income
Actuals and Accruals: As the year progresses, the management information system
(sometimes management accounts) builds up a picture of actual financial progress which can be compared with the budget. This comparison produces a variance (qv), a kind of financial set and drift. The actual year to date (YTD) figure for cost and profit centres is calculated from the transactions which have already entered the accounting system together with a best estimate of
any costs (or income) incurred but not yet in the system-these are accruals. (Accruals must, of course, be reversed out of the system when the actual transaction is formally recorded.)
Estimates: The term can have two meanings. Sometimes circumstances can dictate that a vessel is to operate on a revised estimate and this may be for part or all of the budget period. It may happen, for example, if a vessel changes trade-say, a product carrier was budgeted on a specific time-charter carrying dirty products but the charter fell through and she ended up in the spot market trading clean. The overall effect at company level may not be significant enough for the formally approved budget to be changed, which would need to be sanctioned at board level but comparisons of actual against original budget would give variances (qv) not best suited to achieving good budgetary control. In such cases, revised budget may be recommended.
Estimate, sometimes Forecast, is also the term used when predicting performance against budget during the balance of the budget period. That is, for the rest of the (budget) year (ROY).
Journals: The generic term for all methods of making an entry into the accounting system; these days computer software ensures that a single (Journal) entry generates the double
(debit/credit) entry which forms the basis of the bookkeeping function. Journals provide evidence of transactions and are the method by which instructions are entered into the system. (There are also other types of evidence of transactions, a bank statement being one.)
Management accounts: These are addressed later in this chapter. In best practice, they are the financial end of a general management information system (GMIS). It is the area where the budget and the financial accounting system meet in order to throw up comparisons between the two (variances). The GMIS should be able to do much more than just perform high-speed bookkeeping; it should be able to provide a wide range of historical and analytical data as well, and is a central tool in the planning process.
Periodising: This is dividing the budget into usable segments. In shipping this is usually quarters or months. Periodising may be achieved by simple division (e.g. by 12) or by taking into account significant factors, such as seasonal changes or drydocking or repair periods. The approach to periodising is important when considering the cashflow. Taking the above example of drydocking, a period of no income and high expenditure, whose cash flow implications are not highlighted by simply dividing the budget into 12 equal monthly periods.
Reconciliation: The essential but unexciting task of comparing the computer output with what you thought you input; mistakes need to be corrected (a contra entry made). (Like cleaning one's teeth, it needs to be done regularly, or rot sets in.)
Sensitivities: A method of checking the robustness of the budget result or of the effect of changing assumptions or data. It is often done on a percentage basis and especially useful in project budgeting- e.g., what happens to the bottom line profit (in, say, pounds sterling and in which currency you pay half your operating costs), if the exchange rate in US dollars, in which you receive all your income, changes by 5% or 10%.
Variances: The difference between budget and actual or estimate and the manager's major tool for analysing and correcting performance. Usually measured for the latest budget period (a month or a quarter), the year to date (YTD) and for the balance of the budget period (rest of year-ROY).
Variances are either positive or negative and depend upon whether the budget item is income or expenditure. The conventions are not always the same, so beware that you understand them before entering into a discussion or making an analysis. They are also sometimes expressed in percentage terms-e.g., income is 110% of budget.
Item Budget Actual Variance
Time-charter equivalent
of freight rate ($/day) 9,038 9,592 + 554 Bunker consumption 78,000 82,120 -4,120 Victualling 36,500 32,950 +3,550
The variances also must have an explanation, especially where figures have been consolidated and a small resultant variance might conceal significant variances from budget in a number of the subaccounts which require attention. In the examples above:
The first variance might represent the budgeted T/C equivalent rate for a voyage charter predicted to take 26 days and earn US$235,000 in freight. In this case the explanation might be that the voyage was completed in 24.5 days. (T/C equivalents will be discussed later in this chapter).
We budgeted a consumption of 30 tonnes per day for a 26-day passage at $100 per tonne and (1) adverse weather resulted in an increased consumption of 41.20 mt for the passage,- or (2) the actual cost of bunkers was $105.28 per tonne;
or, indeed, a combination of both factors.
Item three represents an annual victualling budget of $5.00 per man for a 24-man crew. Again, the reason for the positive (beneficial) cost variance requires explanation. Is it because stores were purchased at below budget cost or is it because two crew members were removed five days into the budget year? In the latter case the maintenance budget needs examining to see if the use of shore gangs has increased as a result and thus whether the overall saving is positive or negative.
It cannot be emphasised too strongly that the careful analysis of variances is one of the most powerful tools for understanding what is happening, not just in your budget area (i.e., your vessel), but also across the fleet, in real as well as in financial terms. Because variances are used to correct the course, it is essential that management information should be prepared and delivered in a timely fashion. An effective and efficient system is needed that gives a reasonably accurate picture of what is happening now; there is no benefit from over time-consuming detail. A final word, be very suspicious of small variances covering a number of budget items. Such variances inevitably cover large and opposite variances in underlying areas of activity, any one of %%7hicb can suddenly run out of control. And to monitor variances properly, it is essential to understand the basic budget assumptions.
Budget consolidation: Company or group budgets are constructed by consolidating individual Operating unit budgets- e.g., similar types of vessel or vessels operating in the same trade or geographical areas. Because of this, it is essential that all of the individual operating unit budgets use the same data and assumptions. Because budget preparation and consolidation is a
time-consuming process, there is frequently severe time pressure on managers responsible for unit level budgets.
Strategic budget: Part of the strategic plan and often calculated by projecting the annual budget forward using given rates of inflation. Specific adjustments may be made for major items such as dry-docking and special surveys or for anticipated changes in freight rates or levels of economic activity affecting local or international trading conditions. This helps the company not only to understand its overall future trading opportunities but also its future cash position.
Project budget: A budget made for a specific purpose. This could range from a long-term (10 years or more) calculation to assess the viability of purchasing a new vessel to a one- or two-week detailed budget for a repair period. One of the most common project budgets is the voyage charter calculation explored later in this chapter.