Types of Budgets l A master budget is a comprehensive set of budgets that covers all phases of an organization’s operations for a specified period of time. l Budgeted financial statements (budgeted income statement, budgeted balance sheet and a budgeted statement of cash flows) show what an organization’s overall financial condition is expected to be at the end of the budget period if operations proceed according to plan. l A capital budget shows planned acquisitions and disposal of assets, such as land and equipment. l A financial budget outlines how an organization will acquire financial resources during the budget period.

Budget Planning l The starting point for the master budget is a sales revenue budget based on forecast sales of services or goods. l According to the sales budget, a company develops a set of operational budgets that specify how its operations will be carried out to meet the demands for its goods or services. Operational budgets encompass a detailed plan for using the basic factors of production (material, labor and overhead) to produce a product or provide a service.

Operational: Production Budget l A production budget shows the number of units of services or goods that are to be produced during a budget period. Total units to be produced and sold Desired ending inventory += Total units needed - Expected beginning inventory = Units to be started

Operational: Direct-Material Budget l A direct-material budget shows the amount of material needed during a budget period. Raw material needed for production Desired ending raw material inventory += Total raw materials needed - Expected beginning raw material inventory = Raw material to be purchased Total raw materials needed

International Aspects of Budgets l A multinational firm’s budget must reflect the translation of foreign currency into U.S. dollars. l It is difficult to prepare budgets when inflation is high or unpredictable.

Behavioral Impact of Budgets l The human reactions to the budgeting process can have considerable influence on a company’s overall effectiveness. If a sales manager’s performance is evaluated on the basis of a sales budget, then he/she has incentive to give a conservative sales estimate. When a supervisor provides a departmental cost projection for the budget, there is an incentive to overestimate costs. l Padding the budget is the process of building budgetary slack into a budget by overestimating expenses and underestimating revenues.

Dealing with Budgetary Slack l A company can avoid relying on the budget as a negative evaluation tool. l Managers can be given incentives not only to achieve budgetary projections but also to provide accurate projections. See the article Tie a salesmen’s bonuses to their forecasts by Jacob Gonik for a comprehensive discussion of dealing with budgetary slack.