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  1. Budgeting Planning for Future Success Through Effective Resource Allocation

  2. Budgets • Quantitative and/or financial plans • Should focus activities/resources on goals • “What do we need to accomplish the goal?” • Not “How much are we allowed to spend?” • Focus should be on overall organizational goals, not local goals

  3. Linking Operations to Strategy Long-Term Capital Budgets Multi-Year Profit plans Business Strategy Product, Market Strategies Annual Operating Budgets Variance Analysis

  4. Annual Budget Process • Begins with a review of strategy, goals for the coming year • SWOT analysis • Respond to SWOT • Updating multiyear product/profit plans • Set budget targets • Communicate goals/assumptions to lower levels

  5. Annual Budget Process • Budget process flows from the top down to lower levels • Organizational goals must be determined • The goals are achieved through activities • Those activities must be supported with resources

  6. Annual Budget Process • Prepare operating (activity) budgets • Organizational goal, typically the sales budget, is communicated to lower levels • Process of estimating the resources needed to achieve the sales goal begins • Materials, labor, overhead, administrative, etc. • Trickle down process • Each area must estimate the resources needed to support the area above

  7. Annual Budget Process Sales Budget Production Budget Capital Budget S&A Budget Materials Budget Labor Budget Overhead Budget Cash Budget Pro-Forma Financial Statements

  8. Annual Budget Process • At the departmental level • Goals determine the activities to be conducted • The activities determine the resources required • Activity-based costing is very helpful • Focus should be on resources required, not on the cost of the resources • Cost should be determined by accounting, other areas

  9. Annual Budget Process • Consolidate individual budgets into master budget • Prepare cash flow budget • Prepare pro forma financial statements

  10. Annual Budget Process • Review and approve • Review for consistency with goals • Revise if necessary • Approve budget after final revisions • Communicate to operating units • Release resources

  11. Properties of a Good Budget Process • Should provide a common framework for discussion of objectives and strategies • Documents the operational plan to achieve the goals • Provides for an appropriate allocation of resources

  12. Properties of a Good Budget Process • Proactive, not reactive • Budget must be tied to strategy • Budget should be a plan for the attainment of needed resources, not for limiting amounts that can be spent • Critical success factors must receive adequate funding, regardless of financial condition • Improves allocation of resources

  13. Properties of a Good Budget Process • Should be collaborative, with free flow of information • Strategy, goals come from above • Upper management has better understanding of strategy • Resource requirements come from lower levels, based on assigned objectives • Operating managers have better understanding of resource needs

  14. Properties of a Good Budget Process • Budget should help develop process understanding • What is done, and why? • Understand the interdependencies among activities • Identify resource drivers

  15. Properties of a Good Budget Process • Focus on resources needed, not cost • Operating managers should identify the quantities of resources needed • Accounting should translate into monetary amounts • Managers may not know the cost of the resources requested

  16. Properties of a Good Budget Process • Budget should not be a reward/penalty system • Achievement of organization-wide goals must take precedence over empire-building • Appropriate funding of activities is more important than rewarding past success or penalizing past failures

  17. Properties of a Good Budget Process • Recognizes that planning, control, and evaluation are different, require different tools • Original budget is a plan for operations • Actual operations may deviate from plan, either intentionally or unintentionally • Usually cannot be used effectively for evaluation of results • Control and evaluation require “apples to apples” comparison • Flexible budget

  18. Properties of a Good Budget Process • Goals should be reasonable, attainable • Overly ambitious goals are detrimental • System can only produce to its capabilities • Negative impact on employees • “Stretch goals” are fine if attainable, and resources are provided

  19. Properties of a Good Budget Process • Should seek to minimize game playing • Padding the budget • Overestimation of resource needs • Results in misallocation of resources • Budget slack • Underestimating achievable goals • Goals are easily achieved • May not reach desired level of achievement • Surpassing goals may strain other areas

  20. Properties of a Good Budget Process • The budget should not be an end in itself • Budget should be used to guide operations • Avoid institutionalized budgeting • Mechanical, little thought given to the process • Lacks relevance to organization’s plan or problems • Serves no purpose other than to keep employees busy during budget preparation season • Okay to adjust prior year budget for expected changes

  21. Budgets for Performance Evaluation • “Static” budget is of little use • Conditions may change, requiring deviation from original plans • Pointless to compare initial plan to final results when determining appropriateness of resource use • Given what was achieved, what resources should have been consumed?

  22. Budgets for Performance Evaluation • Flexible budget is better for control, evaluation • Sets milestones • Can be tailored to actual operating results • Variances have more meaning when determining whether resource use was efficient or not • Still want explanations for deviations from plan

  23. Budgets for Performance Evaluation • Variances • Quantity variances • Evaluate reasonableness of the amount of resources consumed given the output achieved • Price variances • Evaluate the cost of the resources consumed • Both are needed for adequate understanding of results

  24. Budgets for Performance Evaluation • Evaluations must be done carefully • Budgets are based on estimates, guesses, assumptions and lies • Actual results are based on reality