Budgeting Process [Cost & Management Accounting]

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Budgeting

Planning for Future Success Through

Effective Resource Allocation

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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

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Linking Operations to Strategy

Business

Strategy

Product,

Market

Strategies

Multi-Year

Profit

plans

Long-Term

Capital

Budgets

Annual

Operating

Budgets

Variance

Analysis

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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

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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

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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

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Sales Budget

Production Budget

Materials

Budget

Overhead

Budget

Labor

Budget

Cash

Budget

Pro-Forma

Financial

Statements

S&A

Budget

Capital

Budget

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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

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Consolidate individual budgets into master

budget

Prepare cash flow budget

Prepare pro forma financial statements

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Review and approve

Review for consistency with goals

Revise if necessary

Approve budget after final revisions

Communicate to operating units

Release resources

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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

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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

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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

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Budget should help develop process understanding

What is done, and why?

Understand the interdependencies among activities

Identify resource drivers

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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

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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

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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

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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

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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

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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

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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?

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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

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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

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Evaluations must be done carefully

Budgets are based on estimates, guesses,

assumptions and lies

Actual results are based on reality

Budgeting Process [Cost & Management Accounting]

Business

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