Planning for Operations

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Planning for Operations
Lecture 1

• Annual Activity and Financial Budgets

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Agenda

• What is Operating Budget?
• Objective of Budget
• Types of Budgeting Process
• Budget Procedure

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Business Planning Time Period
Business Strategy

• Long-term capital budgets

Operating budgets
Time Period
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What is Budget?

• The quantitative expression of a proposed plan of
  action by management for a specified period
• An aid to coordinating what need to be done to
  implement that plan.

It is a plan that has been translated into dollar
amounts.
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Tactical-level Planning

• Operating budgets focus on near term (short-term)
  work activities
• Break down the strategic-level planning into
  yearly targets
• More detailed than long-term strategic plan

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Operating Budget is

• Called by many names
• Annual budget
• Profit plan
• Financial plan
• Targeting (HP)
• Proforma Financial Statements

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The Stages

• Context
• Preparation Review
• Feedback

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Annual Budget Overview

• Context Phase
• Link between strategy and operation
• Preparation Phase
• estimates work activities, resources required and
  resource prices
• Review and Approval Phase

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Example

• Charles Corp. plans to replace old machine. The
  new machine is expected to generate 400,000
  revenue and 10 of profits.

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Interrelated Budgets
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2. Budget Preparation Activities

• 1. Forecast sales and prepare a sales budget
• Communicate sales budget to all support areas to
  use to estimate their required level of activity.
• 2. Estimate costs necessary to achieve sales
  targets

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2. Budget Preparation Activities

• 3. Analyze and breakdown resource requirements by
  
• Capital versus operating items
• Expense (GAAP) versus cash flows
• 4. Consolidate (activity) budgets into profit and
  cash flow budgets

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3. Review and Approval Activities

• 1. Review consolidated operating and cash flow
  budget against targets set for the annual budget

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3. Review and Approval Activities

• 2. Devise action plans to resolve problem areas
• 3. Ask for budget revisions or approve budget

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Mid-year revisions

• Only highly unusual circumstances result in
  budget revision during year

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Getting startedBudget Preparation Questions

• What information do I need?
• How is data compiled reported?
• What work activities does my unit have to perform
  to meet budget objectives?
• What resources will these activities consume?
• What is the financial impact of these resources?

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Objectives of Operating Budget
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Budgeting plays roles of

• Planning
• Short-term goal
• Coordination

• Controlling
• Communication
• Motivating

• Judgment
• Performance measurements
• Evaluation

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Balancing three objectives is the issue
Planning
Budgeting
Performance Measurement
Controlling/ Incentive
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Budgeting is a GAME between Top Managers and
Employees

• Employees (or Branch Managers)
• Better knowledge in field, reality, or practice
• Easy works

• Top Managers
• Better knowledge in strategy
• Higher Goal

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Types of Budget

• Time Coverage
• Basis
• Initiation

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Time Coverage

• Annual budget (one year) is common
• Subdivided into
• Semi-annual,
• Quarterly,
• Monthly
• Prepare budget once a every year
• usually at the beginning of the year
• or at the end of previous year

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Perpetual Budgeting

• Updated monthly so there is always a plan for the
  next 12 months
• Updating period could be quarterly up to next 5
  to 6 quarter
• Prepare budget every month.
• Also called continual budget or rolling budget

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Empirical evidence

• Rolling forecasts
• Used in some form by fewer than 20 of
  multinational corporations
• Viewed as valuable by 65 of CFOs but only 15
  report using them extensively
• Companies that use rolling forecasts plan 5 to 6
  quarters ahead (more often than 4 quarters)

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Incremental vs Zero-based

• Incremental budgets
• Extremely common
• Start with last years budget
• Assumption that total will similar to last year
• Consider elements that need change

• Zero-based budgeting
• Start from scratch
• Each item must be justified each year

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Incremental vs Zero-based

• Incremental budgets
• Less time consuming that starting from scratch
• Inefficiencies of previous budget probably
  replicated in new budget
• Innovative solutions may not be considered

• Zero-based budget
• Innovative solutions can be considered
• Very time consuming
• Not practical especially for items that you KNOW
  will be included
• Police dept. in city budget
• Utilities for factory

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Where does budget begin?

• Top-down vs. Bottom-up
• Participative vs. Non-Participative

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Top-Down Budgeting

• Advantages
• Top-level managers have strategic focus and
  knowledge of entire companys operations
• Fewer people are involved so it is less time
  consuming than bottom-up process

• Disadvantages
• Lower-level managers employees have less
  buy-in and commitment
• Top executives may not have working knowledge of
  daily activities needed for detailed budgets

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Bottom-up Budgeting

• Advantages
• Better information makes budget more realistic
• More commitment to goals set by themselves
• Makes lower-level managers plan and think
  strategically

• Disadvantages
• More people involved, more iterations and more
  time consumed
• Targets may be set at levels too easily achieved
• Budget games
• Slack created

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Traditional budgeting is an iterative process

• It is often back to the drawing board
• First draft may identify problems to be resolved
• Cycles back through the various
  departments/activities for changes
• Compiled and reviewed again and again until
  workable plan is achieved

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Accounting Terms
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Before we budget . . .

• Review of cost accounting terms
• Review of how product costs are determined
• Reason?
• Budgets are prepared consistent with companys
  accounting and reporting system

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Accounting Terms

• Ill give you some sets of accounting terms that
  you should know.
• Some of them youll see at multiple choice
  problems in Exam 2 (more than 25).
• Right now, just briefly review commonly used
  accounting terms.

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Decision making in operation budgeting is more
related with

• Cost

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Cost Tracing Allocation
Cost Assignment
Indirect Costs
Direct Costs
Allocate
Trace
Cost Object
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Examples

• Direct costs
• Raw Material Cost
• Unit material cost
• of raw material used
• Direct Manufacturing Labor Cost
• Unit labor cost
• of labor used

• Indirect costs
• Salary of supervisor, Staff, Secretary, etc.
• RD
• Depreciation Amortization

Remember If a company has one products, this
classification doesnt matter. But, usually a
company has more than two products.
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Cost-Behavior Patterns
Fixed Cost
Variable Cost
Trace
Allocate
Cost Object
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Examples

• Variable costs
• Raw Material Cost
• Direct Manufacturing Labor Cost

• Fixed costs
• Building Rent
• Salary of supervisor, Staff, Secretary, etc.
• RD
• Advertising

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Manufacturing Cost Classification
Manufacturing Cost
Indirect manufacturing Costs (Overhead)
Direct Material Costs
Direct manufacturing labor Costs
Allocate
Trace
Trace
Cost Object
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Examples
Direct Manufacturing Cost
Overhead
Variable OH
Fixed OH

• Raw Material Cost
• Direct Manufacturing Labor Cost

• Plant rent, insurance
• Property tax
• Plant depreciation

• Plant maintenance
• Cleaning labor
• Machine set Up Costs

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Examples of terms to review

• Direct vs. indirect costs
• Product vs. period costs
• Fixed vs. variable costs
• Traditional breakdowns of product costs such as
• Prime costs
• Conversion costs
• Full absorption costing vs. variable or direct
  costing
• Incremental and opportunity costs