Week 5 Budgets
An important management objective in large companies is to ensure that activities of all departments
contribute to meeting the company’s overall goals. This requires coordination. Budgeting helps to
achieve this coordination. The budgeting process coordinates the activities of various departments to
meet the company’s overall goals.
Budget-is a formal statement of a company’s future plans. It is usually expressed in monetary terms
because the economic or financial aspects of the business are the primary factors driving management’s
decisions. All managers should be involved in budgeting, which is the process of planning future
business actions and expressing them as formal plans. Managers who participate in a budgeting process
increase the likelihood of both personal and company success.
Benefits of Budgeting-
The focus on the future opportunities or threats. It formalizes planning process and demands
input.
Control. Requires managers to evaluate operations against some norm. helps identify problems
(Benchmarking).
Ensures all departments are pulling their weight.
Communicates management priorities to employees.
Motivates employees with budgeted performance levels.
Budgeting Human behavior
This process can have both positive impacts on TM development and performance, and negative
impact on tm ethics. Performance evaluations must allow the afftected employees to explain the
reasons for apparent performance deficiencies. The budgeting process has three important
guidelines:
1. Employees afftected by a budget should be consulted when it is prepared
(Participatory Budgeting)
2. Goals reflected in a budget should be attainable.
3. Evaluations should be made carefully with opportunities to explain differences
between actual and budgeted amounts.
Managers must also be aware of potential negative outcomes of budgeting. Under participatory
budgeting, some employees might understate sales budgets and overstate expense budgets to
allow themselves a cushion, or budgetary slack, to aid in meeting targets. For some businesses,
pressure to meet budgeted results might lead employees to engage in unethical behavior or
commit fraud. Finally, some employees might always spend their budgeted amounts, even on
unnecessary items, to ensure their budges aren’t reduced for the next period.
Budget Reporting and Timing
The budget period usually coincides with the accounting period. Most companies prepare at
least an annual budget, which reflects the ojectives for the next year. To provide specific
guidance, the annual budget usually is separated into quarterly or monthly budgets. These short-
term budgets allow management to periodically evaluate performance and take corrective
action.
Continuous Budgeting and Rolling Budgets- as each month or quarterly budget period goes by,
these companies revise their entire set of budgets for the month or quarters remaining and add
new monthly or quarterly budgets to replace the ones that have lapsed. Thus, at any point in
time monthly or quarterly budgets are available for the next 12 months or four quarters.
Rolling budget prep:
Budget Calendar- many companies use long-range budgets. For large companies, three groups usually
determine or influence the budgets: creditors, directors, and management. All three are interested in the
companies’ future cash flows and earnings. The annual budget process often begins six months or more
before the budget is due to the board of directors. When rolling budgets are used, directors must be
aware that managements updated budgets might be used to mask poor performance.
Budget Committee- The task of preparing a budget should not be the sole responsibility of any one
department. Similarly, the budget should not be simply handed down as top management’s final word.
Instead, budget figures and budget estimates developed through a bottom-up process usually are more
useful. This includes for instance involving the sales department in preparing sales estimates. Likewise
the production department should have initial responsibility for preparing it’s own expense budget.
Without active employee involvement in preparing budget figures, there is a risk these employees will
feel that the numbers fail to reflect their special problems and needs.
Although most budgets should be developed using a bottom up process, the budgeting system requires
central guidance. This guidance is supplied by a budget committee of department heads and other
executive responsible for seeing that budgeted amounts are realistic and coordinated . If a department
submits initial budget figures that do not reflect efficient performance, the budget committee should
return them with explanatory comments on how to improve them. Then the originating department
must either adjust its proposals or explain why they are acceptable. Communication between the
originating department and the budget committee should continue as needed to ensure that both
parties accept the budget as reasonable, attainable, and desirable.
Strategic Planning- most companies allocate dollars based on budgets submitted by department
managers. The managers verify numbers and monitor the budgets. Managers must remember that a
budget is judged by its success in helping achieve co. vision. Like a hiker making a plan and making
progress to top, not how well shoes are holding up.
Master Budget- is a formal comprehensive plan for a company’s future. It contains several individual
budgets that are linked with each other to form a coordinated plan. Includes individual budgets for sales,
productions (or Purchases), various expenses, capital expenditures, and cash.
Master Budget Process
Sales budget
Cash budget
Budgeted financial statements.
The usual number and types of budgets included in a master budget depend on the company’s size and
complexity. A manufacturers master budget should include, at a minimum, several operating budgets, a
capital expenditures budget, and a cash budget. Some budgets can’t be made before others, or require
input from others
Operating Budgets- consist of the sales budget, production and manufacturing budgets, selling expense
budget, and general and administrative expense budget.
Sales Budget- The first step in preparing the master budget is the sales budget, which shows the
planned sales units and the expected dollars from these sales. The sales budget is the starting
point in the budgeting process because plans for most departments are linked to sales.
The sales budgets should emerge from a careful analysis of forecasted economic and market
conditions, business capacity, proposed selling expenses (like advertising), and predictions of
unit sales. A company’s sales personnel are usually asked to develop predictions of sales for each
territory and department. To illustrate, in September 2015, TSC sold 700 hockey sticks at $60 per
unit. After considering sales predictions and market conditions, TSC prepares its sales budget for
the next three months. Note that the sales budget below includes forecasts of both unit sales
and unit prices. Some sales budgets are expressed only in total sales dollars. But most are more
detailed. Management finds it useful to know budgeted units and unit prices for many different
products, regions, departments, and sales reps.
Production Budget a manufacturer prepares a production budget, which shows the number of
units to be produced in a period. The production budget is based on the unit sales projected in
the sales budget, along with inventory considerations. Manufacturers often determine a certain
amount of safety stock, a quantity of inventory that provides protection against lost sales caused
by unfulfilled demands from customers or delays in shipments from suppliers. Below shows the
general computation of the production required for a period. A Production budget does not
show costs! It is always expressed in units of product.
Safety stock- in a safety stock inventory system, companies maintain sufficient inventory to
reduce the risk and cost of running short. This practice requires enough production or purchases
to satisfy the budgeted sales amounts. To illustrate, after assessing the cost of keeping inventory
along with the risk of cost of inventory shortages, TSC decided that the number of units in its
finished goods inventory at each month-end should equal 90% of budgeted November sales, and
so on. This information along with knowledge of 1,010 units in inventory at September 30 allows
the company to prepare the production budget shown below.
Pence
Cee
September
30,2015
Cash...
os
'$
20,000
‘Accounts
receivable
..
mae
25,200
Raw
materials
inventory
(178
pounds
@
$20)
.
3,560
Finished
goods
inventory
(1,010
units
@
$17)
. :
17,170
Equipment...
$200,000
Less:
Accumulated
depreciation
.
36,000
_164,000
Total
assets.
Liabilities
and
Equity
Liabilities
‘Accounts
payable
$
7,060
Income
taxes
payable
(due
10/31/2015)
.
20,000
‘Note
payable
$
37,060
Stockholders’
equity
‘Common
stock
...
150,000
Retained
earnings
42870
_192,870
Total
liabilities
and
equity
$229,930
*
Equipment
is
depreciated
ona
straight-line
basis
over
10
years
(salvage
value
is
$20,000).
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