Planning for the future Chapter 15 Additional material taken from “Cost Management”, by Hilton, Maher & Selto (McGraw-Hill), Indicated as “HM&S” Planning for the future Chapter 15 ME 2027 Performance and Cost Analysis ME 2605 Cost Management and Control (for IMIM) Håkan Kullvén, KTH, 2007 Hakan.kullven@indek.kth.se When we plan for the future, we primarily use budgetary control

The budgeting process Tactic Identify the objectives of the organization Identify potential strategies Evaluate alternative strategic options Select course of action Implement the long-term plan in the form of the annual budget Monitor actual results Respond to divergences Strategic Tactic Steps 1-4 are parts of the long-term planning process, steps 5-7 of the annual budgeting process. Operative

Stages in the process Figures 15.2 page 599 Communicate details of budget policy and guidelines to those people responsible for preparing the budget Determine the factor that restricts output Preparation of the sales budget Initial preparation of budgets Negotiation of budgets with higher management (see the picture) Co-ordination and review of the budgets Final acceptance of budgets Ongoing review of the budgets; also revised budgets, flexed budgets (based on e.g. changes in number of orders)

Focusing on participation Purpose 1. Aid for planning 3. Communicate Forcing managers 2. Co-ordinate 4. Motivate Encouraging managers Focusing on participation Planning and motivating are conflicting roles! 5. Control Cybernetic control Providing a challenge 6. Evaluate

Operational budgets Budgeted financial statements Master budget HM&S page 599 Sales budget Production budget Direct- material budget Direct- labour budget Manufacturing overhead budget Selling, general, and administrative expense budget Operational budgets Research and development budget Budgeted schedule of cost of products produced and sold Cash budget Marketing budget Capital budget Customer service budget Budgeted income statement The master budget is the main output of a budget system. It is comprised of many separate budgets that are interdependent. The sales budget is the first budget to be completed in the master budget. A set of operational budgets is developed next, based on the sales budget. The components of this set of budgets vary, depending on whether the company is a manufacturer (the picture + examples to follow), a merchandiser, or a service provider. A merchandising company uses purchases budget. Then, a budget for personnel, overhead, and selling and administrative expenses is prepared. A service provider must prepare a set of budgets showing how those services will be provided. A cash budget shows the amount and timing of expected cash receipts and cash disbursements. A capital budget details plans for major acquisitions and disposals of assets. Budgeted financial statements are the final piece of the master budget to be completed. The financial statements include budgeted (pro forma) balance sheet, income statement, and statement of cash flows. Non-profit organizations also use master budgets with the notable omission of the sales budget, since they do not obtain their financial resources from selling products or services. They usually begin with information showing planned services that will be provided and the expected funding. NOTE: Cost of goods manufactured and sold, and the statements following that (income & balance sheet) needs the calculation of Absorption unit cost on next page Budgeted financial statements Budgeted balance sheet Budgeted cash flows statement 13

Activity-Based Budgeting costing (ABC) Resources Resources Activities Activities Products sold and customers served Estimated demand on the market Activity-based budgeting (ABB)

Example on page 612ff Steps in ABB Estimate the production and sales volume by individual products and customers Estimate the demand for organizational activities Determine the resources that are required to perform organizational activities Estimate for each resource the quantity that must be supplied to meet the demand Take action to adjust the capacity of resources to match the projected supply 2. Process 5000 customers orders for the customer order processing activity 3. 0.5 hours per order = 5000x0,5 hours = 2500 labour hours for the customer processing activity must be supplied 4. Assume a step cost function with each person employed contracted to work 1500 hours per year so that quantity of resources required = 2500/1500 = 1.67 persons, meaning that 2 persons must be employed 5. If 3 persons are presently employed on the activity, resources must be reduced, or redeployed, by one person

Zero-Based Budgeting Decision packet 3:n N Cost in € Decision area 1 4. Available money Is distributed 1. Areas of decisions are defined Decision packet 3:n N Cost in € Decision area 1 e.g. Turning Decision area 2, e.g. Painting Decision packet 3:3 Repair garage €5.000 Decision packet 3:2 Truck maintenance €43.000 Decision area 3, e.g. Garage Decision area 4, e.g. Invoicing Also known as priority-based budgeting, as opposed to incremental budgeting Decision packet 3:1 Garage maintenance €52.000 2. Decision packets defined & 3. ranked

Next, we… will look at variance analysis, when the difference between the expected value, which often is named as the standard, and the actual outcome is analyzed in different ways Chapter 18