An investigation into the operational budget risk approach of business units in Exxaro resources

Ballot, Christiaan Conrad (2008-12)

Thesis (MBA)--Stellenbosch University, 2008.


ENGLISH ABSTRACT: The budgeting process is an integral part of the annual business cycle of most organisations. The budget consists of numerous uncertain inputs, which are frequently used to produce a single EBIT figure. This implies that there is a risk of not achieving the budget that is not quantified and apparent from the prepared budget. In this report, the differences between the budgets of two business units of Exxaro Resources were analysed to gain a better understanding of the information hidden beyond the figures quoted on the surface. The budgets of Exxaro KZN Sands, a heavy minerals producer, and Zincor, a zinc refinery, were analysed to compare the respective risk approach of each. Simplified deterministic models were first constructed that contained the most important budget risk drivers. These were validated with comparisons to the official budgets. Historical actual data from 2006 and 2007 was then obtained from the business archives for the risk drivers. Probability distributions were then generated that fit the distributions of the historical data. These risk distributions were then used as input variables in a Monte Carlo simulation, performed in Crystal Ball. The EBIT for each business was thus simulated as a probability distribution. The simulation showed that the two business units applied very different approaches to budget risk. The actual budgeted EBIT of Exxaro KZN Sands of a loss of R167 579 945 had a more than 99% chance of being exceeded, showing a very conservative, worst case approach to budgeting. Zincor had only a 29% probability of exceeding their budgeted EBIT of R202 783 091, and incorporated a much larger risk of not achieving EBIT into the budget. The budgets of both business units were not suitable for the most important functions of budgeting, namely target setting, strategic planning and valuation of the business. It is recommended that Exxaro implements a procedure to standardise the risk approach to budgeting in the organisation. The budget process must firstly have guidelines to indicate how risk drivers’ values should be chosen for the official budget. Recommendations regarding average values, best three months or any other methodology will ensure that different business units follow a comparable approach. Secondly, Monte Carlo simulation must be performed on simplified business models. The KPI trees currently being used for continuous improvement provide a base model for this purpose. The Monte Carlo simulation will provide a more sophisticated and quantified analysis of risk, and give a further indication of the inherent variability of a specific business unit. Lastly, scrutiny of the Monte Carlo can indicate the biggest drivers of risk. Measures can then be implemented to better understand, or reduce, the variability of the main risk drivers. This will lead to more accurate budgeting, and a better understanding of the inherent budget risk.

AFRIKAANSE OPSOMMING: Die begrotingsproses is ‘n integrale deel van die jaarlikse besigheidsiklus van meeste organisasies. Die begroting bestaan uit etlike onseker insette, maar word meestal gebruik om ‘n enkele syfer vir inkomste te bereken. Dit beteken dat daar ‘n risiko is dat die begroting nie behaal gaan word nie, wat nie duidelik na vore tree in die begroting nie. In hierdie verslag word die verskille tussen die begrotings van twee besigheidseenhede van Exxaro Resources geannaliseer om insig te verkry rakende die inligting versteek agter die ooglopende getalle. Die begrotings van Exxaro KZN Sands, ‘n swaar minerale produsent, en Zincor, ‘n zink rafinadery, is geannaliseer om die onderskye risikobenaderings te vergelyk. Die eerste stap was om vereenvoudigde deterministiese modelle te bou wat die belangrikste begrotingsrisikodrywers bevat het. Die modelle is gevalideer deur die winste te vergelyk met die amptelike besigheidsbegrotings. Historiese data van 2006 en 2007 is versamel van die risikodrywers. Verdelings van waarskynlikheid is toe gekies wat die historiese data beskryf het. Die verdelings is gebruik as inset veranderlikes in ‘n Monte Carlo simulasie, gedoen in Crystal Ball. Die wins van elke besigheid is dan as ‘n waarskynlikheidsverdeling gegenereer. Die simulasie het aangetoon dat die twee besighede uiteenlopende benaderings tot begrotingsrisiko het. Die begrote verlies van R167 579 945 van Exxaro KZN Sands het ‘n hoër as 99% kans gehad om behaal te word. Dit dui op ‘n uiters konserwatiewe benadering, met die mees pessimistiese waardes vir risiko drywers in die begroting. Zincor het sleg ‘n 29% waarskynlikheid gewys om die begrote wins van R202 783 091 te behaal, en het aansienlik meer risiko in die begroting ingebou. Beide die benaderings was nie geskik vir meeste van die funksies waarvoor begrotings gebruik word nie, naamlik doelwitstelling, strategiese beplanning en waardasie van die besigheid. Dit word aanbeveel dat Exxaro ‘n prosedure implementeer om die risikobenadering te standariseer. Die begrotingsproses moet eerstens riglyne hê rakende die benadering tot risikodrywers. Daar moet aanbeveel word of gemiddelde waardes, beste drie maande of ‘n ander benadering gevolg moet word, om seker te maak dat verskillende besigheidseenhede dit vergelykbaar uitvoer. Tweedens moet Monte Carlo simulasie gedoen word op vereenvoudigde besigheids modelle. Die KPI bome wat tans vir deurlopende verbetering gebruik word is ‘n ideale basis vir die proses. Die Monte Carlo simulasie bied ‘n meer kwantifiseerbare benadering tot risiko analise, en dui ook aan wat die verwagte afwyking in ‘n besigheid se inkomste is. Laastens gee die Monte Carlo simulasie ‘n aanduiding oor wat die groot risikodrywers in die besigheid is. Stappe kan dan geimplimenteer word om die risikos te bestuur. Die resultaat sal meer akurate begrotings wees, asook meer insig in die inherente risiko in die begroting.

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