1 Budgeting Planning for Future Success Through Effective Resource Allocation

2 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

3 Linking Operations to Strategy Business Strategy Product, Market Strategies Multi-Year Profit plans Long-Term Capital Budgets Annual Operating Budgets Variance Analysis

4 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

5 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

6 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

7 Annual Budget Process Sales Budget Production Budget Materials Budget Overhead Budget Labor Budget Cash Budget Pro-Forma Financial Statements S&A Budget Capital Budget

8 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

9 Annual Budget Process Consolidate individual budgets into master budget Prepare cash flow budget Prepare pro forma financial statements

10 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

11 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

12 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

13 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

14 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

15 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

16 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

17 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

18 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

19 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

20 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 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

21 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?

22 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

23 Budgets for Performance Evaluation 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

24 Budgets for Performance Evaluation Evaluations must be done carefully  Budgets are based on estimates, guesses, assumptions and lies  Actual results are based on reality