Introduction to Budgeting (Lecture 1) by JamieGribowicz


									  Lecture 1

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

   Budget Procedure
Business Planning & Time Period

          Business Strategy

            capital 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
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

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

   Preparation Phase
     estimateswork activities, resources
     required and resource prices
   Review and Approval Phase
   Charles Corp. plans to replace old
    machine. The new machine is expected to
    generate $400,000 revenue and 10% of
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
   Communicate    sales budget to all support
    areas to use to estimate their required level of
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
 3. Ask for budget revisions or approve
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
 What is the financial impact of these
Objectives of
Operating Budget
Budgeting plays roles of
   Planning                       Controlling
     Short-term goal                Communication
     Coordination                   Motivating

             Judgment
                Performance
                Evaluation
Balancing three objectives is the


  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

     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
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

                                                                  Changes to Assumptions or Numbers
        Submit to Upper Management

                                                                                                                                       Submit to Upper Management
                                                                                                       Dept Managers Revise Detailed

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

     Business Area
       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
   It is often “back to the drawing
   First draft may identify
    problems to be resolved
     Cycles back through the various
      departments/activities for
     Compiled and reviewed again
      and again until workable plan is
Accounting Terms
Before we budget . . .
 Review of cost accounting terms
 Review of how product costs are

   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 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

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
   Incremental and opportunity costs

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