Types of Budgets • A master budget is a comprehensive set of budgets that covers all phases of an organization’s operations for a specified period of time. • 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. • A capital budget shows planned acquisitions and disposal of assets, such as land and equipment. • A financial budget outlines how an organization will acquire financial resources during the budget period.
Budget Planning • The starting point for the master budget is a sales revenue budget based on forecast sales of services or goods. • 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 • 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 Total units needed Units to be started - =
Operational: Direct-Material Budget • A direct-material budget shows the amount of material needed during a budget period. Total raw materials needed Raw material needed for production Desired ending raw material inventory + = Expected beginning raw material inventory Total raw materials needed Raw material to be purchased = -
International Aspects of Budgets • A multinational firm’s budget must reflect the translation of foreign currency into U.S. dollars. • It is difficult to prepare budgets when inflation is high or unpredictable.
Behavioral Impact of Budgets • 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. • Padding the budget is the process of building budgetary slack into a budget by overestimating expenses and underestimating revenues.
Dealing with Budgetary Slack • A company can avoid relying on the budget as a negative evaluation tool. • 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.