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Chapter 2: Strategic Planning and Budgeting—Process, Preparation, and Control

OVERVIEW

Although it differs among companies, planning charts the direction of the company over a period of time to accomplish a desired result, such as improving profitability. Budgeting is simply one portion of the plan, and the annual budget should be consistent with the long-term goals of the business. Planning should link short-term, intermediate-term, and long-term goals. Plans are interrelated, and the annual plan may be based on the long-term plan. The objective is to make the best use of the company's available resources over the long term.

In planning, management selects long-term and short-term goals and draws up plans to accomplish those goals. Planning is more important in long-run management. The objectives of a plan must be continually appraised in terms of degree of accomplishment and how long implementation will take. There should be feedback as to the plan's progress. It is best to concentrate on accomplishing fewer targets so proper attention will be given to them. Objectives must be specific and measurable. For example, a target to increase sales by 20 percent is definite and specific. The manager can quantitatively measure progress toward meeting this target.

The plan is the set of details implementing a strategy. The plan of execution typically is explained in sequential steps, including costs and timing for each step. Deadlines are set.

The planning function includes all managerial activities that ultimately enable an organization to achieve its goals. Because every organization needs to set and achieve goals, planning often is called the first function of management. At the highest levels of business, planning involves establishing company strategies—that is, determining how the resources of the business will be used to reach its objective. Planning also involves the establishment of policies—the day-to-day guidelines used by managers to accomplish their objectives. The elements of a plan include objectives, performance standards, appraisal of performance, action plan, and financial figures.

All management levels should be involved in preparing budgets. There should be a budget for each responsibility center. Responsibility in particular areas should be assigned for planning to specific personnel. At MillerCoors Company, planning is ongoing, encouraging managers to assume active roles in the organization.

A plan is a predetermined action course. Planning has to consider the organizational structure, taking into account authority and responsibility. Planning is determining what should be done, how it should be done, and when it should be done. The plan should specify the nature of the problems, reasons for them, constraints, contents, characteristics, category, alternative ways of accomplishing objectives, and information required. Planning objectives include quantity and quality of products and services, as well as growth opportunities.

A plan is a detailed outline of activities to meet desired strategies to accomplish goals. Such goals must be realistic. The assumptions of a plan must be specified and appraised as to whether they are reasonable. The financial effects of alternative strategies should be noted, and planning should allow for creativity. Planning involves analyzing the strengths and weaknesses of the company and each segment therein. It requires analysis of the situation and is needed to allocate various resources to organizational units and programs. The plan should specify the evaluative criteria and measurement methods.

Long-term plans should consider new opportunities, competition, resources (equipment, machinery, staff), diversification, expansion, financial strength, and flexibility. In planning, consideration has to be given to noncyclical occurrences, such as a new product or service introduction, modification of manufacturing processes, or discontinuance of a product or service. Strategic budgeting is a form of long-range planning based on identifying and specifying organizational goals and objectives. The strengths and weaknesses of the organization are evaluated, and risk levels are assessed. The influences of environmental factors are forecasted to derive the best strategy for reaching the organization's objectives.

Several planning assumptions should be made at the beginning of the budget process. Some of these assumptions are internal factors; others are external to the company. External factors include general economic conditions and their expected trend, governmental regulatory measures, the labor market in the locale of the company's facilities, and the activities of competitors, including the effects of mergers.

Planning is facilitated when the business is stable. For example, a company with a few products or services operating in stable markets can plan better than one with many diverse products operating in volatile markets. Planning should take into account industry and competing company conditions.

A description of products, facilities, resources, and markets should be noted in the plan. The emphasis should be on better use of resources, including physical facilities and personnel. In summation, a plan is a detailed outline of activities and strategies to satisfy a long-term objective. An objective is a quantifiable target. The objective is derived from an evaluation of the situation. A diagram of the strategic planning process appears in Exhibit 2.1.

BUDGETING

Budgeting is a form of planning and policy development considering resource constraints. It is a profit-planning mechanism that may look at what-if scenarios. Budgets are detailed and communicate to subunits what is expected of them. Those responsible for expenditures and revenue should provide budget information. Planning should be by the smallest practical segment. Budgeting is worthwhile if its use makes the company more profitable than without it.

Budgets are quantitative expressions of the yearly profit plan and measure progress during the period. The shorter the budgeting period, the more reliable the budget will be. A cumulative budget may drop the prior month and add the next month.

Probabilities may be used in budgeting. Of course, the total probabilities must add up to 100 percent.

Exhibit 2.1: Strategic Planning Process

Example 1

The sales manager assigns these probabilities to expected sales for the year:

Probability	Expected Sales	Probable Sales
50%	$3,000,000	$1,500,000
30%	2,000,000	600,000
20%	4,000,000	800,000
100%		$2,900,000

The probabilities are based on the manager's best judgment. The probabilities may be expressed in either quantitative terms (percentages) or relative terms (high or low probability of something happening).

A typical department budget appears in Exhibit 2.2. A typical checklist for the budgeting system appears in Exhibit 2.3.

Exhibit 2.2: XYZ Company Department Budget Report

 Open table as spreadsheet

Department______
Department Administrator______
	Dollar Amount	Over or Under	Percent Realized Current Month	Moving Average
Classification	Budget	Actual	Current Month	Cumulative to Date		Current	Prior
Direct Labor
1
2
3
4
5
Total Direct Labor
Indirect Labor
Indirect Salaries
Supervisor Salaries
Cleaning
Holidays and Vacations
Idle Time
Other Salaries
Subtotal
Other Department Costs
Operating Supplies
Tools
Telephone
Travel
Consultants
Memberships
Misc. Department Expenses
Subtotal
Total Department Expenses

Exhibit 2.3: A Budgetary Checklist

 Open table as spreadsheet

Schedule	Who Is Accountable?	Date Required	DateReceived
1. Establish overall goals 2. Set division and department objectives 3. Estimate a. Capital resource needs b. Personnel requirements c. Sales to customers d. Financial status 4. Preparation of budgets for: a. Profitability b. Revenue c. Production Direct material Direct labor Factory overhead d. Marketing budget Advertising and promotion Sales personnel and administration Distribution Service and parts e. Cash budget f. Budgeted balance sheet g. Capital facilities budget h. Research and development budget 5. Prepare individual budgets and the master budget 6. Review budgets and prepare required changes 7. Prepare monthly performance reports 8. Determine difference between budget and actual costs (revenue) 9. Prepare recommendations to improve future performance

STRATEGIC PLANNING

Strategic plans are long-term, broad plans ranging from 2 to 30 years, with 5 to 10 years being most typical. Strategic planning is continuous and looks where the company is going. It is done by upper management and divisional managers. Most of the information used is external to the company.

The strategic plan is the mission of the company and looks to existing and prospective products and markets. Strategic plans are designed to direct the company's activities, priorities, and goals in order to position the company to accomplish objectives. Strategic goals are for the long term, considering the internal and external environment, strengths, and weaknesses.

Strategy is the means by which the company uses its capital, financial, and human resources to achieve its objectives. It shows the company's future direction and rationale and looks at expected costs and return. Strategic planning provides detailed plans to implement policies and strategies. Risk-taking decisions are made. Strategies may be implemented at different times. Strategic planning should take into account the company's financial position, the economy, the political environment, social trends, technology, risks, markets, competition, product line, customer base, research support, manufacturing capabilities, labor, product life cycle, and major problems.

Strategic planning is a prerequisite to short-term planning. There should be a linkage between the two. There is considerably more subjectivity in a strategic plan than in a short-term plan.

The strategic plan is formulated by the chief executive officer (CEO) and his or her staff. It considers acquisitions and divestitures. Financial policies, including debt position, are determined. The plan must consider economic, competitive, and industry factors. It establishes direction, priorities, alternatives, and tasks to be performed. The strategic plan is the guideline for each business segment and the needed activities to accomplish the common goals.

Strategic planning is irregular. Further, strategic planning problems are unstructured. If a strategy becomes unworkable, abandon it.

The elements of a strategic plan are:

· The company's overall objectives, such as market position, product leadership, and employee development

· The strategies necessary to achieve the objectives, such as engaging in a new promotion plan; enhancing research, product, and geographical diversification; and eliminating a division

· The goals to be met under the strategy

· The progress to date of accomplishing goals such as sales, profitability, return on investment, and market price of stock

In summation, strategic planning is planning for the company as a whole, not just combining the separate plans of the respective parts; there must be a common thread. The strategic plans look to the long term and are concerned with the few key decisions that determine the company's success or failure. They provide overall direction and indicate how the long-term goals will be achieved. A strategic plan is a mission policy statement and must deal with critical issues.

SHORT-TERM PLANS

Short-term plans are typically for one year (although some are for two years). The plans examine expected earnings, cash flow, and capital expenditures. Short-term plans may be for a period within one year, such as a month or a week. Short-term planning relies primarily on internal information and details tactical objectives. It is structured, fixed, foreseeable, and continually determinable. The short-term profit plan is based on the strategic plan. It is concerned with existing products and markets.

There should be a short-term profit plan by area of responsibility (product, service, territory, division, department, project, function, and activity). Short-term plans usually are expressed on a departmental basis, such as sales, manufacturing, marketing, management (administration), research, and consolidation (integration) plans. Short-term planning has more lower-level managers involved in providing input. The line manager typically is involved with short-term rather than long-term plans. In making the short-term plan, the line manager should consider the company's objectives and targets as outlined in its long-term plan. The manager's short-term plan must satisfy the long-term objectives of the company.

LONG-TERM PLANS

Long-term planning is usually of a broad, strategic (tactical) nature to accomplish objectives. A long-term plan is typically 5 to 10 years (or more) and looks at the future direction of the company. It also considers economic, political, and industry conditions. Long-term plans are formulated by upper management. They deal with products, markets, services, and operations, and aim to enhance sales, profitability, return on investment, and growth. Long-range plans should be constantly revised as new information becomes available.

Long-range planning covers all major areas of the business, including manufacturing, marketing, research, finance, engineering, law, accounting, and human resources. Planning for these areas should be coordinated into a comprehensive plan to attain corporate objectives.

A long-term plan is a combination of the operating and developmental plans. It should specify what is needed, by whom, and when. Responsibility should be assigned to segments. Long-term goals include increased market share, new markets, expansion, new distribution channels, cost reduction, capital maintenance, and reduction of risk. The characteristics of sound long-term objectives include flexibility, motivation, measurability, consistency and compatibility, adequateness, and flexibility. Long-range plans may be used for growth, market share, product development, plant expansion, and financing.

Long-term plans are details of accomplishing the strategic plans. Compared with strategic planning, long-range planning is closer to planning current operations of all units of the business. It includes evaluating alternatives, developing financial information, analyzing activities, allocating resources, product planning, market analysis, human resources planning, analyzing finances, research and development planning, and production planning.

The time period for a long-term plan depends on the time required for product development, product life cycle, market development, and construction of capital facilities. More alternatives are available in long-term plans than in short-term plans. When there is greater uncertainty in the economic and business environment, long-range plans become more important. However, it is more difficult to plan long term than short term because of the greater uncertainties that exist. An illustrative long-term plan appears in Exhibit 2.4.

Exhibit 2.4: Long-Term Plan

 Open table as spreadsheet

		Amount
Contract acquisitions	—Customer
	—Division
	—Company
Sales backlog	—Customer
	—Division
	—Company
Total sales
Profit margin
Return on investment
Capital expenditures	—Assets
	—Leases

CHOOSING A BUDGET PERIOD

The budget period depends on the objective of the budget and the reliability of the data. Most companies budget yearly, month by month. For example, a seasonal business should use the natural business year, beginning when accounts receivable and inventory are at their lowest level.

The time period for a plan should be as far as is useful. The period chosen depends on many factors: the time to develop a market, production period, the time to develop raw material sources and to construct capital facilities, product development, and product life cycle. The time period also should take into account the type of industry, reliability of financial data and the use to which the data will be put, seasonality, and inventory turnover. Shorter budgeting cycles may be called for when unpredictable and unstable events occur during the year. Short-term budgets have considerably more detail than long-term budgets.

Operating budgets ordinarily cover a one-year period corresponding to the company's fiscal year. Many companies divide their budget year into four quarters. The first quarter is then subdivided into months, and monthly budgets are developed. The last three quarters may be carried in the budget as quarterly totals only. As the year progresses, the figures for the second quarter are broken down into monthly amounts, then the third-quarter figures are broken down, and then the fourth. This approach has the advantage of requiring periodic review and reappraisal of budget data throughout the year.

ADMINISTERING THE PLAN

A committee of senior operating and financial executives should be involved in administering a budget. The administration plan involves human resource planning for the various functions to be carried out, technological resource planning, and organizational planning.

PROFIT PLAN

A profit plan is the premise on which management charts an action course for the upcoming year. It is good for planning and control. Alternatives must be evaluated, and the profit plan should be flexible to adjust for contingencies. Profit planning includes a study of appraising profits relative to investment. A profit budget may be used to supplement a cost budget. Profit budgets may be by customer, territory, or product.

The profit plan must set forth selling price, sales volume, sales mix, per-unit cost, competition, advertising, research, market potential, and economic conditions. Profit may be improved through a closer correlation of manufacturing, selling, and administrative expense budgeting to sales and earnings objectives. Cost-reduction programs will lower expenses.

Continuous profit planning is used when planning should be for short time periods and where frequent planning is needed. The yearly or quarterly plan may be revised each month.

OPERATIONAL PLAN

The preliminary operational plan is an important part of the strategic plan. It examines alternative strategies to select the best one. The final operational plan is much more detailed and is the basis to prepare the annual budgets and evaluate performance. It also acts as the basis to integrate and communicate business functions. It is concerned with short-term activity or functions of the business. The operational plan typically includes production, marketing (selling), administration, and finance. It examines properly serving product or service markets.

The operational plan summarizes the major action programs and contains this information: objective, program description, responsibility assignments, resource needs (e.g., assets, employees), expected costs, time deadlines for each stage, input needed from other business segments, and anticipated results.

DEVELOPMENT PLAN

The development plan typically includes research and development, diversification, and divestment. It relates to developing future products, services, or markets. The development plan mostly applies to new markets and products. Bonuses should be given for new ideas.

The corporate development plan is concerned with:

· Discovering or creating new products

· Identifying financially lucrative areas and those having growth potential

· Ascertaining what resources are required in terms of assets, staffing, and so on

· Determining the feasibility of expanding operations into new areas

CONTINGENCY PLANNING

Contingency planning is anticipating in advance unexpected circumstances, occurrences, and situations so that there can be a fast response to a crisis. All possible eventualities should be considered. Contingency planning involves identifying the possible occurrence, ascertaining warning signs and indicators of a problem, and formulating a response.

Contingency planning can be in the form of flexible (bracket) budgets. The plan should be modified if needed to generate the best results. There should be flexibility in the plan to adjust to new information and circumstances and to allow for the resolution of uncertainties.

BUDGET PROCESS

In one company we are familiar with, the financial planning department issues guidelines to department managers. The manager then submits his or her plan to financial planning. The plan is returned to the manager if guidelines have not been adhered to. Financial planning coordinates the plan from the bottom up. The budget goes down to the supervisory level. The company also uses program budgeting, which involves the allocation of resources. The budgeting process requires good, timely communication. Upper management must make its budget goals clear to departmental managers. In turn, the managers must explain departmental operating conditions and limitations.

DEPARTMENTAL BUDGETS

The decision units in the plan must be identified, and the labor and dollar support at each decision unit must be noted. Department managers should plan for specific activities. They should put their budgets and trends in perspective relative to other departments in the company, to competing departments in other companies, and to industry norms. The manager should list problems needing solutions and opportunities to be further capitalized on.

BUDGET ACCURACY

The accuracy of budget preparation may be determined by comparing actual numbers to budget numbers in terms of dollars and units. Budget accuracy is higher when the two figures are closer to each other. Ratios showing budget accuracy include:

Example 2

A manager budgeted sales for 2 million but the actual sales were 2.5 million. This favorable development might be attributed to one or more of these reasons:

· Deficient planning because past and current information were not properly considered when the budget was prepared

· The intentional understatement of expected sales so the manager would look like a hero when actual sales substantially exceeded the anticipated sales

· Higher revenue arising from better economic conditions, new product lines, improved sales promotion, excellent salesperson performance, or other reasons

A significant deviation between budget and actual amounts may indicate poor planning. Is the planning unrealistic, optimistic, or due to incompetent performance? However, the problem may be with wasteful spending or inefficient operations.

REPORTS

A typical report for manufacturing cost analysis is presented in Exhibit 2.5. Performance reports typically are issued monthly.

BUDGET REVISION

A budget should be revised when it no longer acts as a useful planning and control device. Budgets should be revised when a major change in processes or operations occurs or when there are significant changes in salary rates. For example, additional competitors may enter the market with a product that sells at a lower price and is a good substitute for the company's product. This competition may make meeting the budgeted market share and sales unlikely. If management recognizes that even with increased promotional expenditures, budgeted sales are not realistic, all budgets affected should be revised. These revisions are preferable to using unattainable budgets. Budgets that are repeatedly revised are more informative as a control measure. For a one-year budget, budget estimates may be revised quarterly. Budget revisions should be more frequent in unstable businesses.

Exhibit 2.5: Manufacturing Cost Analysis

 Open table as spreadsheet

				Overhead		Average
Product Line	Units Produced	Material	Labor	Variable	Fixed	Total Cost	Unit Cost	Selling Price	Gross Margin

PERFORMANCE MEASURES

Performance measures also should be directed at the lower levels. Specific task performance for each employee should be measured. Employee performance may be measured by computing revenue per employee, man-hours per employee, and production volume to man-hours.

CONTROL AND ANALYSIS

Control is important in budgeting. Budget figures may be checked for reasonableness by looking at relationships. The budgeted costs must be directly tied to planned production output. The manager must be able to strongly defend the initial budget figure and to obtain needed facts. Budget comparisons may be made by current-year month to last-year month, current-year quarter to last-year quarter, and cumulative year to date. A comparison is therefore made to similar time periods.

Costs should be examined by responsibility. Cost reduction is different from cost control. Cost reduction attempts to lower costs by improving manufacturing methods and procedures, work assignments, and product or service quality. Cost control includes cost reduction. Cost control attempts to obtain cost objectives within the operational setting. Value analysis is an evaluation of cost components in an operation so as to minimize them to achieve higher profits.

Compare the company's segments with similar segments in competing companies. Variations from the plan should be studied and controlled. The integrated (consolidated) plan usually is prepared yearly. A change in one department's plan is likely to affect another department's plan.

SUMMARY

An objective of planning is to improve profitability. Plans are interrelated. Planning should link short-term, intermediate-term, and long-term goals. Budgeting is simply one portion of the plan. The annual plan may be based on the long-term plan. The annual budget should be consistent with the long-term goals of the business. There should be a climate conducive to planning and friendly relationships.