Budgeting

Planning for Future Success Through

Effective Resource Allocation

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

Linking Operations to Strategy

Long-Term
Capital
Budgets

Business
Strategy

Product,
Market
Strategies

Multi-Year
Profit
plans

Annual
Operating
Budgets

Variance
Analysis
3

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

Annual Budget Process

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

Annual Budget Process

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

Annual Budget Process

Sales Budget
Production Budget

Capital
Budget
Materials
Budget

Labor
Budget

S&A
Budget
Overhead
Budget

Cash
Budget

Pro-Forma
Financial
Statements
7

Annual Budget Process

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

Annual Budget Process

Consolidate individual budgets into master

budget

Prepare cash flow budget

Prepare pro forma financial statements

Annual Budget Process

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

11

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

12

Properties of a Good Budget Process

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
13

Properties of a Good Budget Process

Budget should help develop process

understanding

What is done, and why?

Understand the interdependencies among

activities

Identify resource drivers

14

Properties of a Good Budget Process

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

15

Properties of a Good Budget Process

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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Properties of a Good Budget Process

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
17

Properties of a Good Budget Process

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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Properties of a Good Budget Process

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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Properties of a Good Budget Process

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 organizations 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
20

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?

21

Budgets for Performance Evaluation

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

22

Budgets for Performance Evaluation

Variances

Quantity variances

Price variances

Evaluate reasonableness of the amount of resources

consumed given the output achieved

Evaluate the cost of the resources consumed

Both are needed for adequate understanding of

results
23

Budgets for Performance Evaluation

Evaluations must be done carefully

Budgets are based on estimates, guesses,

assumptions and lies

Actual results are based on reality

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