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Profit PlanningProf. Pamela GonzalezSource: Cornerstones of Managerial Accounting, 5eBudgets help business owners and managers to plan ahead, and later, exercise control by comparing what actually happened to what was expected in the budget.Budgets formalize managers expectations regarding sales, prices, and costs.Planning is looking ahead to see what actions should be taken to realize particular goals.Control is looking backward, determining what actually happened and comparing it with the previously planned outcomes.Budgets are financial plans for the future and are a key component of planning. Before preparing a budget, an organization should develop a strategic plan. Strategic plan plots a direction for an organizations future activities and operations; it generally covers at least 5 years.

Budgeting The master budget is the comprehensive financial plan for the organization as a whole.A continuous budget is a moving 12-month budget. Most organizations prepare the master budget for the coming year during the last 4 or 5 months of the current year. The budget committee:reviews the budgetprovides policy guidelines and budgetary goalsresolves differences that arise as the budget is preparedapproves the final budgetmonitors the actual performance of the organization as the year unfolds.Operating BudgetsFinancial BudgetsDescribe the income-generating activities of a firm: sales, production, and finished goods inventories.Detail the inflows and outflows of cash and the overall financial position.

Operating BudgetsThe sales budget is approved by the budget committee and describes expected sales in units and dollars. The sales budget is the basis for all of the other operating budgets and most of the financial budgets.

Operating BudgetsThe production budget tells how many units must be produced to meet sales needs and to satisfy ending inventory requirements.Units to be produced = Expected unit sales + Units in desired ending inventory (EI) Units in beginning inventory (BI)

Operating BudgetsThe direct materials purchases budget tells the amount and cost of raw materials to be purchased in each time period.

Operating BudgetsThe direct labor budget shows the total direct labor hours and the direct labor cost needed for the number of units in the production budget.

Operating BudgetsThe overhead budget shows the expected cost of all production costs other than direct materials and direct labor.

Operating BudgetsThe ending finished goods inventory budget:Supplies information needed for the balance sheetServes as an important input for the preparation of the cost of goods sold budget.

Operating BudgetsThe cost of goods sold budget reveals the expected cost of the goods to be sold.

Operating BudgetsThe selling and administrative expenses budget outlines planned expenditures for nonmanufacturing activities.

Budgeted Income Statement

Financial BudgetsThe usual financial budgets prepared are:cash budgetbudgeted balance sheetbudget for capital expendituresThe basic structure of a cash budget includes cash receipts, disbursements, any excess or deficiency of cash, and financing as shown below:

Cash available consists of the beginning cash balance and the expected cash receipts. Expected cash receipts include all sources of cash for the period being considered. Financial Budgets

Financial BudgetsThe cash disbursements section lists all planned cash outlays for the period.All expenses that do not require a cash outlay are excluded from the list (e.g., depreciation is never included in the disbursements section).

Financial BudgetsSome companies expand the basic cash budget format by adding lines to show any borrowing or repayment necessary to achieve a minimum desired cash amount. When this is done, the preliminary ending cash balance is called cash excess or deficiency.

Borrowings and Repayments: If a company converts its preliminary cash balance line to a cash excess (deficiency) line, it may be borrowing or repaying money. If there is a deficiency, this section shows the necessary amount to be borrowed. When excess cash is available, this section shows planned repayments, including interest expense.Ending Cash Balance: The last line of the cash budget is the ending cash balance.

Budgeted Balance SheetThe budgeted balance sheet depends on information contained in the current balance sheet and in the other budgets in the master budget. Explanations for the budgeted figures are typically provided in the footnotesUsing Budgets for Performance EvaluationBudgets are often used to judge the performance of managers. Bonuses, salary increases, and promotions are all affected by a managers ability to achieve or beat budgeted goals.Positive behavior occurs when the goals of each manager are aligned with the goals of the organization and each manager has the drive to achieve them. The alignment of managerial and organizational goals is often referred to as goal congruence. If the budget is improperly administered, subordinate managers may subvert the organizations goals.Dysfunctional behavior is individual behavior that is in basic conflict with the goals of the organization.

Budgets are often used to judge the performance of managers. Bonuses, salary increases, and promotions are all affected by a managers ability to achieve or beat budgeted goals. Positive behavior occurs when the goals of each manager are aligned with the goals of the organization and each manager has the drive to achieve them. The alignment of managerial and organizational goals is often referred to as goal congruence. If the budget is improperly administered, subordinate managers may subvert the organizations goals. Dysfunctional behavior is individual behavior that is in basic conflict with the goals of the organization.

22Positive BehaviorKey features that promote a reasonable degree of positive behavior include:frequent feedback on performancemonetary and nonmonetary incentivesparticipative budgetingrealistic standardscontrollability of costsmultiple measures of performanceKey features that promote a reasonable degree of positive behavior include:frequent feedback on performancemonetary and nonmonetary incentivesparticipative budgetingrealistic standardscontrollability of costsmultiple measures of performance

23Frequent FeedbackFrequent, timely performance reports allow managers to know how successful their efforts have been, to take corrective actions, and to change plans as necessary.Monetary and Nonmonetary IncentivesMonetary incentives are used to control a managers tendency to shirk and waste resources by relating budgetary performance to salary increases, bonuses, and promotions.Nonmonetary incentives, including job enrichment, increased responsibility and autonomy, and recognition programs can be used to enhance a budgetary control system.

Participative BudgetingParticipative budgeting allows subordinate managers considerable say in how the budgets are established.problems:setting standards that are either too high or too lowbuilding slack into the budget (often referred to as padding the budget)pseudoparticipation

Realistic StandardsBudgets should reflect operating realities, including the following,Actual Levels of Activity: Flexible budgets are used to ensure that budgeted costs can be realistically compared with costs for actual levels of activity.Seasonal Variations: Interim budgets should reflect seasonal effects. Realistic StandardsEfficiencies: Budgetary cuts should be based on planned increases in efficiency and not simply arbitrary across-the-board reductions. General Economic Trends: General economic conditions also need to be considered. Controllability of CostsControllable costs are costs whose level a manager can influence.Multiple Measures of PerformanceOften, organizations make the mistake of using budgets as their only measure of managerial performance.

While financial measures of performance are important, overemphasis can lead to a form of dysfunctional behavior called milking the firm or myopia.

Myopic behavior occurs when a manager takes actions that improve budgetary performance in the short run but bring long-run harm to the firm.Exercises

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