Introduction to Budgeting (Lecture 1) by JamieGribowicz

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									  Lecture 1




Planning for
Operations
Annual Activity and Financial
Budgets
Agenda
   What is Operating Budget?
     Objective of Budget
     Types of Budgeting Process



   Budget Procedure
Business Planning & Time Period

          Business Strategy


             Long-term
            capital budgets

             Operating
             budgets

               Time Period
What is Budget?

1.   The quantitative expression of a
     proposed plan of action by
     management for a specified period
2.   An aid to coordinating what need to be
     done to implement that plan.

 It is a plan that has been translated into dollar
 amounts.
Tactical-level Planning

   Operating budgets focus on near
    term (short-term) work activities
     Break  down the strategic-level
      planning into yearly targets
     More detailed than long-term
      strategic plan
Operating Budget is

   Called by many names
     Annual   budget
     Profit plan
     Financial plan
     “Targeting” (HP)
     Proforma Financial Statements
The Stages

Context
Preparation & Review
Feedback
Annual Budget Overview
   Context Phase
     Link   between strategy and operation


   Preparation Phase
     estimateswork activities, resources
     required and resource prices
   Review and Approval Phase
Example:
   Charles Corp. plans to replace old
    machine. The new machine is expected to
    generate $400,000 revenue and 10% of
    profits.
Interrelated Budgets
        Develop Sales Budget
                                          Estimate Cash Inflows

Develop Purchase or Production Budget


  Develop Other Expense Budgets
                                          Estimate Cash Outflows



   Combine for Income Budget


                                  Combine for Cash Budget
2. Budget Preparation Activities
1. Forecast sales and prepare a sales
  budget
   Communicate    sales budget to all support
    areas to use to estimate their required level of
    activity.
2. Estimate costs necessary to achieve
  sales targets
2. Budget Preparation Activities
   3. Analyze and breakdown resource
    requirements by
     Capital
            versus operating items
     Expense (GAAP) versus cash flows

   4. Consolidate (activity) budgets into profit
    and cash flow budgets
3. Review and Approval Activities

   1. Review consolidated operating and
    cash flow budget against targets set for
    the annual budget
3. Review and Approval Activities

 2. Devise action plans to resolve problem
  areas
 3. Ask for budget revisions or approve
  budget
Mid-year revisions
   Only highly unusual circumstances result
    in budget revision during year
Getting started:
Budget Preparation Questions
   What information do I need?
     How   is data compiled & reported?
 What work activities does my unit have to
  perform to meet budget objectives?
 What resources will these activities
  consume?
 What is the financial impact of these
  resources?
Objectives of
Operating Budget
Budgeting plays roles of
   Planning                       Controlling
     Short-term goal                Communication
     Coordination                   Motivating




             Judgment
                Performance
                 measurements
                Evaluation
Balancing three objectives is the
issue


                 Planning



                Budgeting
  Performance               Controlling/
  Measurement                Incentive
Budgeting is a GAME between Top
Managers and Employees

   Top Managers               Employees (or
                                Branch Managers)
     Better knowledge in        Better  knowledge in
      strategy                    field, reality, or
                                  practice


     Higher   Goal              Easy   works
Types of Budget

Time   Coverage
 Basis
 Initiation
Time Coverage

 Annual budget (one year) is common
   Subdivided   into
       Semi-annual,
       Quarterly,
       Monthly




     Prepare budget once a every year
       usually  at the beginning of the year
       or at the end of previous year
Perpetual Budgeting

 Updated monthly so there is always a
    plan for the next 12 months
     Updating  period could be quarterly up to next
      5 to 6 quarter


 Prepare budget every month.
 Also called continual budget or rolling
  budget
Empirical evidence
   Rolling forecasts
     Used  in some form by fewer than 20% of
      multinational corporations
     Viewed as valuable by 65% of CFOs but only
      15% report using them extensively
     Companies that use rolling forecasts plan 5 to
      6 quarters ahead (more often than 4 quarters)
Incremental vs Zero-based
   Incremental                  Zero-based
    budgets                       budgeting
     Extremely    common          Start  from scratch
     Start with last              Each item must be
      year’s budget                 justified each year
     Assumption that
      total will similar to
      last year
     Consider elements
      that need change
Where does budget begin?
   Top-down vs. Bottom-up



   Participative vs. Non-Participative
Top-Down Budgeting
   Advantages                    Disadvantages
     Top-level managers            Lower-level  managers
      have strategic focus           & employees have
      and knowledge of               less “buy-in” and
      entire company’s               commitment
      operations                    Top executives may
     Fewer people are               not have working
      involved so it is less         knowledge of daily
      time consuming than            activities needed for
      bottom-up process              detailed budgets
Bottom-up Budgeting
   Advantages                 Disadvantages
     Better  information        More   people
      makes budget more           involved, more
      realistic                   iterations and more
     More commitment to          time consumed
      goals set by               Targets may be set at
      themselves                  levels too easily
     Makes lower-level           achieved
      managers plan and               Budget games
      think strategically             Slack created
                                                                                                      Continued Iterations



                                     Management Reviews Numbers
                                                                                                                                                                    Senior Managers Review Numbers
                                                                                                                                                                                                     Multiple HQ
                                                                                                                                                                                                     Submissions




                                                                  Changes to Assumptions or Numbers
        Submit to Upper Management




                                                                                                                                       Submit to Upper Management
                                                                                                       Dept Managers Revise Detailed
                                                                                                                 Budgets




     START
Dept Managers Prepare
  Detailed Budgets
                                                                                                      Traditional Bottom-up Approach
                                                                                                           for Operating Budgets
              START
                    Senior Management
                                                                 Goal: Single
                      Sets High Level
                                                               Submission to HQ
                       Expectations




     Business Area
     Management
       Performs                                                                Target
        Target                                                                Validation
      Cascading                             Dept Managers
       Process                                Complete
                                           Worksheets Based
                                              on Targets

R. Harborne, “Power Planning!” Strategic
                                                              A Modern Top-Down
Finance, Oct 1999
                                                              Budgeting Approach
Traditional budgeting is an iterative
process
   It is often “back to the drawing
    board”
   First draft may identify
    problems to be resolved
     Cycles back through the various
      departments/activities for
      changes
     Compiled and reviewed again
      and again until workable plan is
      achieved
Accounting Terms
Before we budget . . .
 Review of cost accounting terms
 Review of how product costs are
  determined

   Reason?
     Budgets
            are prepared consistent with
     company’s accounting and reporting system
Accounting Terms
   I’ll give you some sets of accounting terms
    that you should know.

   Some of them you’ll see at multiple choice
    problems in Exam 2 (more than 25%).

   Right now, just briefly review commonly
    used accounting terms.
Decision making in operation
budgeting is more related with




         ~Cost~
Cost Tracing & Allocation

                  Cost Assignment




   Direct Costs                     Indirect Costs


       Trace                         Allocate


                   Cost Object
Cost-Behavior Patterns

                  Fixed Cost                                          Variable Cost




                                                      Total Dollars
  Total Dollars




                                                                         Volume (quantity)



                    Volume (quantity)




                   Allocate                                              Trace

                                        Cost Object
Manufacturing Cost Classification

                      Manufacturing Cost



                                                Indirect
Direct Material   Direct manufacturing     manufacturing Costs
    Costs              labor Costs            (Overhead)

      Trace                Trace                 Allocate


                         Cost Object
Examples of terms to review
   Direct vs. indirect costs
   Product vs. period costs
   Fixed vs. variable costs
   Traditional breakdowns of product costs such as
     Primecosts
     Conversion costs

   Full absorption costing vs. variable or direct
    costing
   Incremental and opportunity costs

								
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