QAIS ALEFAN

B.Pharm, R.Ph., M.Pharm, PhD

Developing a budget is a critical step in planning any economic activity We all must budget our money to meet day-to-day expenses

Pharmacy businesses must make financial plans to:

carry out routine operations plan for major expenditures help in making financial decisions

A budget is a detailed plan, expressed in quantitative terms, that specifies how resources will be acquired and used during a specified period of time The procedures used to develop a budget constitute a budgeting system

Budgeting systems have primary purposes:

1. 2. 3. 4. 5. Planning Facilitating Communication and Coordination Allocating Resources Controlling Profit and Operations Evaluating Performance and Providing Incentives

Different types of budgets serve different purposes A master budget, or profit plan, is a comprehensive set of budgets covering all phases of a pharmacy organizations operations for a specified period of time Budgeted financial statements, often called pro forma financial statements, show how the pharmacy organizations financial statements will appear at a specified time if operations proceed according to plan Budgeted financial statements include:
a budgeted income statement a budgeted balance sheet a budgeted statement of cash flows

A capital budget is a plan for the acquisition of capital assets A financial budget is a plan that shows how the pharmacy business will acquire its financial resources, such as through the issuance of stock or incurrence of debt Short-range budgets cover a year, a quarter, or a month, whereas long-range budgets cover periods longer than a year Rolling (revolving or continuous) budgets are continually updated by periodically adding a new incremental time period, such as a quarter, and dropping the period just completed

The master budget, the principal output of a budgeting system, is a comprehensive profit plan that ties together all phases of a pharmacys operations

The master budget consists of many separate budgets, or schedules, that are interdependent

The starting point for any master budget is a sales revenue budget For many pharmacy departments, this budget begins with a sales forecast for prescription drug spending

A pharmacy manager would need to keep abreast of how changes in government expenditures (e.g., Medicare prescription drug coverage) might change the distribution of drug spending among payers and affect collective spending

Sales forecasting is a critical step in the budgeting process, and it is very difficult to do accurately Many pharmacy corporations have a market research staff whose job is to coordinate the corporations sales forecasting efforts Typically, everyone from key executives to the firms sales personnel will be asked to contribute sales projections In many pharmacy organizations, elaborate econometric models are built to incorporate all the available information systematically Statistical methods, such as regression analysis and probability distributions for sales, are often used

Major factors considered when forecasting sales include the following:

1. 2. 3. Past sales levels and trends General economic trends (Is the economy growing? How fast?) Economic trends in the pharmaceutical industry (customers getting older?) 4. Other factors expected to affect sales in the industry (cold winter expected?) 5. Political and legal events (OTC switches by the FDA?) 6. The intended pricing policy of the pharmacy 7. Planned advertising and product promotion 8. Expected actions of competitors 9. New services contemplated by the pharmacy or other pharmacies (For example, drug stores are continuing to develop value-added services, which may increase the demand for certain categories of prescriptions.) 10. Market research studies

Based on the sales budget, a pharmacy organization develops a set of operational budgets that specify how its operations will be carried out to meet the demand for its goods or services A pharmacy organization that conducts manufacturing operations develops a production budget, which shows the number of product units to be manufactured Coupled with the production budget are ending inventory budgets for raw material, work in process, and finished goods From the production budget, the organization develops budgets for the direct materials, direct labor, and overhead that will be required in the production process A budget for selling and administrative expenses is also prepared

The operational portion of the master budget is similar in a pharmacy organization with merchandising, but instead of a production budget for goods, a merchandiser develops a budget for merchandise purchases For example, a chain drug store pharmacy will not have a budget for direct material because it does not engage in production However, the chain drug pharmacy will develop budgets for labor (or personnel), overhead, and selling and administrative expenses

Based on the sales budget for its services, a service oriented pharmacy organization develops a set of budgets that show how the demand for those services will be met Pharmacy departments in hospitals are focusing their efforts on improving the efficiency of product-related functions mainly through automation and redeploying staff to value-added clinical functions

Services added under these transformations include intravenous-to-oral conversion, dosage adjustments for patients with renal impairment, medication therapy management (MTM) services, and participation in rounds in all areas of the hospital
The introduction of clinical pharmacy services as part of hospital-wide reengineering programs has been associated with positive benefit-cost ratios and a substantial net cost savings

This budget shows expected cash receipts as a result of selling goods or services and planned cash disbursements to pay the bills incurred by the pharmacy Pharmacies prepare cash budgets to allow them to anticipate changes in cash flows over a period of time

Operational budgets differ because they are adapted to the operations of individual pharmacies in various industries However, operational budgets are also similar in important ways
In each pharmacy, they encompass a detailed plan for using the basic factors of productionmaterial, labor, and overhead-to produce a product and/or provide a service

The final portion of the master budget, includes a budgeted income statement, a budgeted balance sheet, and a budgeted statement of cash flows These budgeted financial statements show the overall financial results of the pharmacy organizations planned operations for the budget period

The master budget for a nonprofit organization includes many of the components shown in the earlier figure However, there are some important differences Many provide services F.O.C. Hence there is no sales budget

However, they do begin their budgeting process with a budget that shows the level of services to be provided
They also prepare budgets showing their anticipated funding A free clinic budgets for revenue from:
public (e.g., support from government agencies) private sources (e.g., donations)

The process of constructing a master budget can be significantly enhanced if the concepts of activity-based costing (ABC) are applied ABC uses a two-stage cost assignment process:
In stage 1, overhead costs are assigned to cost pools that represent the most significant activities (prescription processing) In stage 2, the overhead costs are allocated from each activity cost pool to cost objects (e.g., prescriptions, value-added services) in proportion to the amount of activity consumed

Applying ABC concepts to the budgeting process yields activity-based budgeting (ABB) Under ABB
The 1st step is to specify the products or services to be produced and the customers to be served Then the activities that are necessary to produce these products and services are determined Finally, the resources necessary to perform the specified activities are quantified

Conceptually, ABB takes the ABC model and reverses the flow of the analysis

The process of constructing a master budget requires the pharmacy manager to use 13 different schedules Pharmacy managers must make assumptions and predictions in preparing budgets because pharmacies, like any other business or organization, operate in a world of uncertainty One way of coping with that uncertainty is to supplement the budgeting process with a financial planning model

A financial planning model is a mathematical expression of all the relationships expressed in the flowchart in Fig. 18-1 Then software programs (e.g., Microsoft Excel) are used to determine the impact of different combinations of unknown variables What if questions can be answered about such unknown variables as inflation, interest rates, the value of the dollar, demand, competitors actions and a host of other factors

In small organizations, the procedures used to gather information and construct a master budget are usually informal In contrast, larger organizations use a formal process Such organizations usually designate a budget director or chief budget officer The budget director specifies the process by which budget data will be gathered, collects the information, and prepares the master budget

To communicate budget procedures and deadlines to employees throughout the organization, the budget director often develops and disseminates a budget manual

The budget manual states who is responsible for providing various types of information, when the information is required, and what form the information is to take For example, the budget manual for a pharmacy retail chain might specify that each regional director is to send an estimate of the following years sales, by product line, to the budget director by September 1 A budget committee, consisting of key senior executives, often is appointed to advise the budget director during preparation of the budget

The authority to give final approval to the master budget usually belongs to the board of directors or a board of trustees in many nonprofit organizations

As more pharmacy organizations operate globally, the Internet is playing an important role in the budgeting process e-Budgeting is an increasingly popular Internet-based budgeting tool that can help to streamline and speed up an organizations budgeting process Employees throughout an organization and at all levels can submit and retrieve budget information electronically via the Internet

Budgeting software is used and made available on the Web so that budget information submitted electronically from any location is in a consistent organization-wide format In the past, these organizations have compiled their master budgets on hundreds of spreadsheets, which had to be collected and integrated by the corporate controllers office

Examples of budgeting software include OutlookSoft, Cognos, and WebFOCUS

Zero-base budgeting is used in a wide variety of organizations Under zero-base budgeting, the budget for virtually every activity in the organization is initially set to zero To receive funding during the budgeting process, each activity must be justified in terms of its continued usefulness The zero-base-budgeting approach forces management to rethink each phase of an organizations operations before allocating resources

Some organizations use a base-budgeting approach without going to the extreme of zero-base budgeting Under this approach, the initial budget for each of the organizations departments is set in accordance with a base package, which includes the resources required for the subunit to exist at an absolute minimal level Base budgeting has been effective in many organizations because it forces managers to take an evaluative, questioning attitude toward each of the organizations programs

Firms with international operations face a variety of additional challenges in preparing their budgets

First, a multinational firms budget must reflect the translation of foreign currencies into a single currency (i.e., U.S. dollars)
Since almost all the worlds currencies fluctuate in their values relative to each other, this makes budgeting for those translations difficult Second, it is difficult to prepare budgets when inflation is high or unpredictable Predicting such high inflation rates is difficult and further complicates a multinationals budgeting process Finally, the economies of all countries fluctuate in terms of consumer demand, availability of skilled labor, laws affecting commerce, and other factors

A recent focus of the budgeting process is to plan for all the costs that will be incurred during the introduction of a new product into the marketplace The introduction of a new product may involve unanticipated costs during the following five phases:
1. 2. 3. 4. 5. Product planning and concept design Preliminary design Detailed design and testing Production Distribution and customer service

For example, for a pharmaceutical manufacturer to justify a new drugs introduction, the sales revenues it will generate must be sufficient to cover all these costs

A budget affects virtually everyone in an organization The human reactions to the budgeting process can have considerable influence on an organizations overall effectiveness Two key issues that a pharmacy manager should clearly understand are:
budgetary slack participative budgeting

The information on which a budget is based comes largely from people throughout an organization For example, the sales forecast for a retail pharmacy chain relies on market research and analysis by market research staff but also incorporates the projections of sales personnel If a territorial sales managers performance is evaluated on the basis of whether the sales budget for the territory is exceeded, what is the incentive for the sales manager in projecting sales? The incentive is to give a conservative, or cautiously low, sales estimate The sales managers performance will look much better in the eyes of top management when a conservative estimate is exceeded than when an ambitious estimate is not met

Budget padding means underestimating revenue or overestimating costs The difference between the revenue or cost projection that a person provides and a realistic estimate of the revenue or cost is called budgetary slack

Why do people pad budgets with budgetary slack?

There are three primary reasons:
First, people often perceive that their performance will look better in their superiors eyes if they can beat the budget Second, budgetary slack often is used to cope with uncertainty Third reason is that budgetary cost projections are often cut by others in the resource-allocation process

The idea of participative budgeting is to involve employees throughout an organization in the budgetary process It can give employees the feeling that this is our budget rather than the all-too-common feeling that this is the budget you imposed on us Too much participation and discussion can lead to vacillation and delay When those involved in the budgeting process disagree in significant and conflicting ways, the process of participation can highlight those differences Finally, the problem of budget padding can be severe unless incentives for accurate projections are provided

The budget is a key tool for planning, control, and decision making in virtually every organization Since budgets affect almost everyone in an organization, they can have significant behavioral implications and can raise difficult ethical issues

One common problem in budgeting is the tendency of people to pad budgets

The resulting budgetary slack makes the budget less useful because the padded budget does not present an accurate picture of expected revenue and expenses