2DefinitionBudget –Management’s formal quantification of the operations of an organization for a future period.It is an aggregate forecast of all transactions expected to occur.
3Functions of BudgetsThere is a trade-off between these two functions. It helps to have different people in charge of each of the two functions.
4Nature of Budget Generally covers one year Often broken down into monthly or quarterly budgetsSometimes have revolving or continuous budgets; one quarter ends and another quarter is addedCan prepare longer term budgets (3-5 years) to avoid short-term focus
5Relation to Strategic Planning Precedes budgetingProvides the framework for the annual budgetBudget is a “slice” of the strategic planning pieBudget focuses on individual responsibility centers; not whole company like strategic plan
6Purposes of Budgeting To fine-tune the strategic plan To help coordinate the activities of the several parts of the organizationTo assign responsibility to managers, to authorize the amounts they are permitted to spend, and to inform them of the performance that is expected of themTo obtain a commitment that is a basis for evaluating a manager’s actual performance
7Advantages of Budgeting Translate strategy into a detailed planCommunicate plansthroughout organizationThink about andplan for the futureAdvantagesCoordinateactivitiesServes as a means ofallocating resourcesUncover potentialbottlenecks
8Questions for Managers Does the organization’s strategy create economic value?Does the organization have enough cash to fund the strategy and remain solvent?Does the organization create enough value to attract the financial resources that it needs to fund long-term investment in new assets?Is there sufficient resources to implement the intended strategy?
9Issues in Budgeting Budgetary Slack Budgeting Revisions Participation in the Budgeting ProcessHuman Factors in BudgetingDifficulty in Meeting BudgetNew Approaches to Budgeting
10Budgetary Slack Budgeting revenues lower than expected Budgeting expenses or costs higher than expectedRepresent easier targets to achieveBudgeting superiors must attempt to find this slack and eliminate it
11Budgetary Slack Some companies: Ratchet effect Reward managers for meeting exact budgetsAutomatically decrease expense figures and increase revenue figures for slackPenalize managers more for large unjustified increases in actual income than for decreases in actual incomeRatchet effectBasing next year’s standard of performance on this year’s actual performanceCauses employees to underperform
12Budgeting RevisionsToo many changes in the budget renders it a useless control toolMust establish procedures for changing the budget during the periodSome companies use sensitivity analysis with best, worst, and most likely cases. Managers are expected to discuss what decisions they would make in the best and worst cases.
13Participation in the Budgeting Process Top downTop management determines the budget and passes it down throughout the organizationBottom upLower level management formulates the budget and top management makes changes if necessaryMore successful than top down
14Participative Budget System – Bottom Up Flow of Budget Data
15Participation in the Budgeting Process Bottom upMust make sure budgets meet the company’s strategyMust make sure slack is limitedParticipative budgeting is especially helpful for responsibility centers that operate in dynamic environments since lower level managers have more information about their operations.
16Human Factors in Budgeting The success of budgeting depends upon:The degree to which top management accepts the budget program as a vital part of the company’s activities.The way in which top management uses budgeted data.When rewarded for meeting/not meeting the budget, employees may take risky actions.
17Degree of Budget Target Difficulty Budget should be challenging but attainable.Achievable budgets reduce data manipulation.Achievable budgets create positive attitudes among workers.If too difficult, budgets are often ignored.Overly difficult budgets may cause over commitment of resources.If too easy, managers may coast when budget is met.
18New Approaches to Budgeting Line-item budgetsManagers can spend only up to the specified amount on each line item (no borrowing from other areas).Budget lapsingNo carryover of unused amounts to future yearsZero-based BudgetsEvery line item must be justified
19New Approaches to Budgeting Beyond Budgeting (Break the annual performance trap!)Do not use budgets in performance evaluation or reward systems; use them only for PLANNING purposes.Evaluate employees on other measures, including benchmarking or nonfinancial factors
20Examples of Budgets Revenues Production costs and cost of goods sold Variable and fixed costsOther budgets
21Revenue Budgets Estimate level of sales First and most important budgetDrives all other budgetsIf sales are too low, inventory may build upCan start with past sales and adjust for economic and other factorsOften very uncertain
22Cost Budgets Budgeted production cost and cost of sales Often represent the standard cost of items produced or acquiredIncludes budgets for the necessary production materials, labor and overheadIncludes inventory assumptions
23Cost Budgets Variable costs Nonvariable costs Often vary by sales Delivery costs, commissions, order takingNonvariable costsCommitted costs - costs already determined by previous decisions in the short-run; salaries, rent, depreciation, past advertising commitments
24Cost Budgets Nonvariable costs Discretionary costs - costs that can be incurred or not depending on available resources; training, advertising, travel, research and developmentActivity-based indirect costs - costs that vary with some other cost driver than sales or production volume
25Other Budgets Capital Budget Planned spending on capital projectsBudgeted Balance Sheet – contains revised balances after previous budgets preparedBudgeted Cash flow Statement – shows how much cash will be needed and whether outside financing sources will be neededManagement by Objective – management objectives are quantified and managers are held accountable for them.
26Homework Computer Budget Project #1 – 50 points DUE WEDNESDAY, APRIL 8