BUDGETING ? ? ? ? Sales projections Inventory needs Business trends New competition

What is a budget? A formalized plan describing the use and source of financial and operating resources over a given time period

PURPOSES OF BUDGETING Forces management planning Motivation Evaluation and control Communication Coordination Education

FEATURES OF A SOUND BUDGETARY SYSTEM Participative budgeting Frequent feedback on performance Realistic standards Controllability Flexible budgeting Multiple measures of performance Monetary and nonmonetary incentives

The Budgeting Process

Strategic Plan Monitoring of Actual Activity Long-Term Objectives Short-Term Objectives Comparison of Actual & Planned Short-Term Plan Budgets Investigation Feedback Corrective Action

The MASTER BUDGET is a collection of various types of budgets Sales Production Purchases (Direct materials) Labor Manufacturing overhead Administrative Cash

Master Budget Outputs

OPERATING BUDGETS Sales plan Production plan Materials purchasing plan Labor hiring and training plan Capital spending plan Administrative and discretionary spending plan

Sales Budget The sales budget represents the expected quantity of each type of product/service to be sold multiplied by its expected selling price.

Generic budget format Amount needed for current requirements + Amount desired for future needs = Total needs - What is already on hand = Amount to be acquired

Production Predicted sales quantity + Desired ending inventory Note the sales budget figure will be the starting point for this budget. Predicted sales quantity + Desired ending inventory Total needed units - Amount already on hand (beginning inventory) Units to be produced

Direct Materials (Purchasing) This budget is for planning the acquisition of raw materials to support the organization’s production needs identified in the production budget. Units to be produced x Raw material required per unit produced Total raw material needed for production + Desired ending inventory = Total raw material needed - Inventory on hand = Raw materials to be acquired

CAPITAL BUDGET Purpose is to plan for the acquisition of land, buildings, and capital equipment for expansion and/or replacement.

Master Budget usually presented in three forms: FINANCIAL BUDGETS Master Budget usually presented in three forms: A statement of expected cash flows The projected balance sheet The projected income statement

FLEXIBLE vs. STATIC BUDGETS Flexible budgets - those that vary with the activity level in the firm Static budgets - those that do not change with changes in activity levels The use of the budget data determines which type of budget is most appropriate

BUDGETING APPROACHES Incremental budgeting Zero-based budgeting A budgeting approach that assumes the starting point for each budget item is the amount spent on it in the previous budget The new budget is seen as last year’s +/- a specified increment Less costly but may not be strategically sound Zero-based budgeting A budgeting approach that assumes the starting point for each budget item is zero Essential feature is a review of the necessity of each expenditure element/activity as part of the budgeting process More costly but more strategically sound

Behavioral Aspects of Budgeting

DESIGNING THE BUDGET PROCESS How should budgets be determined? Who should be involved in the budgeting process? At what level of difficulty should the budget be set to have the greatest positive influence on people’s motivation and performance?

Top management wants our budget figures for the month. What should we tell them?