©2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Chapter 9 The Use of Budgets in Planning and Decision Making

Budgeting for Planning, Operating, and Control Activities

The Budget Development Process Budgeting is much more than a number crunching exercise. It is a management task that requires a great deal of planning and input from a broad range of managers in a company. While it is time-consuming, the use of spreadsheets, such as Microsoft Excel, makes the process much simpler.

The Budget Development Process Zero-based budgets require managers to build budgets from the ground up each year rather than just add a percentage increase to last year’s numbers. Companies often use rolling budgets. As the oldest month rolls off the analysis, the newest month is added. Budgets are more than crunching numbers.

Participatory Budgeting Participatory budgeting starts with departmental managers and then flows up through middle management and ultimately to top management. At each level, budget estimates are prepared and then submitted to the next level of management, which has responsibility for reviewing the budget and negotiating any changes that need to be made. Departmental Managers Middle Managers Top Management

Defines goals and objectives as standards of performance Increases coordination and goal congruence Helps identify bottlenecks and constraints Encourages a future focus Encourages communication throughout the organization Advantages of Budgeting

Master Budget- Manufacturing Company

Master Budget- Merchandising Company

The Sales Budget

Sales Forecasting Factors Other factors, such as political and legal events The impact of new products or changes in product mix Anticipated marketing or advertising plans Anticipated price changes for purchasing and sales costs Regional and local factors expected to affect sales General economic trends or factors Historical data, such as sales trends

Production Budget For manufacturing companies, the next step in the budgeting process is to complete the production budget. Once the sales volume has been projected, companies must forecast how many units of product to produce in order to meet the sales projections.

Material Purchases Budget Because many traditional companies desire to keep materials on hand at all times in order to plan for unforeseen changes in demand, the desired ending inventory for materials must be added to the projected production needs for materials to arrive at the total expected needs for materials,. Then an adjustment is made for any raw materials inventory on hand at the beginning of the month.

Direct Labor and Manufacturing Overhead Budgets Preparation of the manufacturing overhead budget involves estimating overhead costs (using plantwide or departmental predetermined overhead rates or activity-based costing). For example, a company might use a plantwide cost driver like machine hours. The direct labor budget starts with the production budget and is prepared by multiplying the units to be produced by the number of direct labor hours required to produce each unit.

Cash Budgets Cash budgeting forces managers to focus on cash flow and to plan for the purchase of materials, the payment of creditors, and the payment of salaries. Many managers consider managing cash flow to be the single most important consideration in running a successful business.

Budgeted Financial Statements The set of operating budgets and budgeted financial statements form an interrelated set of planning tools that are vital for managers’ decisions affecting: (1)the number of units to produce, (2)the amount of materials to purchase, (3)how many employees to schedule for a particular time period (and when to schedule training, for example), (4)the timing of major acquisitions and sales of equipment, and (5)the overall management of cash.

Budgets for Merchandising and Service Companies The budgeting process for merchandising and service companies is similar to that of manufacturing companies, with a few important differences. The key areas of budgeting for service companies is the labor budget and detailed budget of expected overhead expenditures (like rent, utilities, insurance, etc.).

Merchandising Companies While merchandising companies will prepare a sales budget, they will not prepare budgets for production, direct material purchases, direct labor, or manufacturing overhead. They will prepare a purchases budget (for goods to be sold to customers) based on the projections in the sales budget. In addition, many merchandising companies hold some level of merchandise inventory and will need to estimate desired inventory balances and adjust sales projections accordingly. The preparation of selling and administrative expense budgets, cash budgets, and budgeted financial statements in merchandising companies is similar to that in manufacturing companies.

Static budgets are established at the beginning of the period for one activity level. Static Versus Flexible Budgets Static budgets are useful for planning and operating, but not for control. Flexible budgets take differences in cost owing to volume differences out of the analysis. This allows comparison of budgeted amounts to actual results so causes can be found for differences.

End of Chapter 9