The document discusses budgets and the budgeting process. It defines a budget as a quantitative plan for a future period that includes both financial and non-financial aspects. Budgets help managers communicate goals, measure performance, and motivate employees. The budgeting process involves strategic planning, developing operating and financial budgets, and comparing actual results to the budget. The master budget is the core document and includes an operating budget with schedules for revenues, production, costs, and an income statement, as well as a financial budget.
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A budget is the quantitative expression of a proposed plan of action by management for a specified period, and also works as an aid to coordinating what needs to be done to implement that plan. A budget generally includes the plan’s both financial and nonfinancial aspects.
Budgets serve many purposes for firms including those seen here:
Communicate directions and goals to different departments of a company to help them coordinate the actions they must pursue to satisfy customers and succeed in the marketplace.
Measure performance by comparing financial results against planned objectives, activities, and timelines to learn about potential problems.
Motivate employees to achieve their goals.
Strategy specifies how an organization matches its capabilities with the opportunities in the marketplace to accomplish its objectives.
A company can have a strategy of providing quality products or services at a low price, or a strategy of providing a unique product or service that is priced higher than the products or services of competitors. Budgeting is most useful when it is integrated with a company’s strategy.
As managers work to develop successful strategies, they must consider various questions including the risks and opportunities of alternative strategies, contingency plans if the preferred plan fails, how the economy, industry and competitors affect the business as well as, and in addition to, the questions shown here:
To develop successful strategies, managers must consider questions such as the following:
What are our objectives?
How do we create value for our customers while distinguishing ourselves from our competitors?
Are the markets for our products local, regional, national, or global?
What trends affect our markets?
How do the economy, our industry, and our competitors affect us?
What organizational and financial structures serve us best?
What are risks and opportunities of alternative strategies and what are our contingency plans if our preferred plan fails?
This slide shows an illustrated of view of the relationship among strategy, planning, and budgets.
These three steps describe the ongoing budget-related processes. The working document at the core of this process is called the master budget. In the next slide, we’ll take a closer look at the master budget.
The master budget is the initial plan of what the company intends to accomplish in the period and evolves from both the operating and financing decisions managers make as they prepare the budget.
When administered thoughtfully by managers, budgets do the following:
Promote coordination and communication among subunits within the company
Provide a framework for judging performance and facilitating learning
Motivate managers and other employees
There are several challenges in administering a budget. Among them is the time commitment a thoughtfully administered budget requires.
The motive for creating a budget should guide a manager in choosing the period for the budget.
As an example, if the purpose for the budget is cash-flow, you may look at a 6-month horizon whereas if you are looking at profitability of a new product line, you may need to look 3-years into the future.
The operating budget begins with the Revenues budget, includes multiple schedules and concludes with the Budgeted Income Statement.
The financial budget is made up of the Capital Expenditure budget, the Cash budget, the Budgeted Balance Sheet, and the Budgeted Statement of Cash Flows.
The revenue budget is usually based on expected demand because demand for a company’s products is invariably the limiting factor for achieving profit goals.
The logical next step is to plan the production so that the product is available when customers need it.
The number of units to be produced is the key to computing the usage of direct materials in both quantity and dollars. This will be based on quantity required for each unit to be produced from the production budget.
To create the budget for direct manufacturing labor costs, managers estimate wage rates, production methods, process and efficiency improvements and hiring plans.
The next schedule to be created (schedule #5) is the manufacturing overhead costs budget. Managing overhead costs is both challenging and important because of the required understanding of the activities required for production and the cost driver of those activities.
Inventories are essential for proper customer service and play an important role in the determination of the budget. Recall that the production budget included a determination of the target ending finished goods inventory.
Cost of Goods Sold is calculated by adding additional production costs to beginning finished goods inventory and then subtracting ending finished goods inventory.
Non-manufacturing costs are included in the operating expense budget.
Formats differ for the budgeted income statement but generally, information from schedules 1, 7, and 8 are used to generate the budgeted income statement.