Strategy and the Master Budget

1
Strategy and the Master Budget
Chapter Eight
2
Basic Terminology

• A budget
• is a financial or nonfinancial expression of a
  plan of action for a specified period
• identifies the resources and commitments required
  to achieve the organizations goals for an
  upcoming period
• Budgeting
• The process of preparing a budget is called
  budgeting

3
Strategic Goals and Long-term Objectives

• The starting point in the budget-preparation
  process is specification of the organizations
  strategy
• An organization expresses its strategic goals and
  long-term objectives in its capital and master
  budgets
• Long-range planning often entails capital
  budgeting, which is a process for evaluating,
  selecting, and financing major projects, such as
  purchases of new factory equipment and
  construction of a new factory

4
The Master Budget

• The master budget
• Represents the grand plan of action for an
  upcoming period
• Translates the organizations short-term
  objectives into action steps
• Culminates in the preparation of a set of
  pro-forma financial statements
• Communicates to employees and managers alike the
  expectations of top management
• Helps coordinate subunit activities

5
The Master Budget (continued)

• The master budget is made up of operating and
  financial budgets
• Operating budgets are plans that identify
  resources needed to carry out the budgeted
  activities, such as sales and services or
  production
• Operating budgets include production, purchase,
  personnel, and marketing budgets
• Financial budgets identify sources and uses of
  funds for the budgeted operations
• Financial budgets include the cash budget,
  budgeted statement of cash flows, the budgeted
  balance sheet, and the capital expenditures budget

6
The Budgeting Process

• The budget committee is the highest authority in
  an organization for all matters related to the
  budget
• Determination of the budget period
• Generally, a fiscal year with sub-period budgets
  prepared for each quarter or month
• A continuous (rolling) budget is a budget system
  that has a budget for a set number of months,
  quarters, or years at all timesas one period
  ends another is added

7
Preparing Individual Budgets

• Three-step process
• Define the bottom-line information contained in
  the budget (e.g., sales for the upcoming period)
• Determine what this information is a function of
  (e.g., budgeted unit sales, budgeted selling
  price/unit)
• Put together information in a user-friendly way

8
Sales Budget

• The sales budget is often referred to as the
  cornerstone of the entire master budget
• The sales budget has two components
• Forecasted sales volume
• Budgeted selling prices

9
Production Budget

• After the sales budget, we prepare a production
  budget, which shows planned production for a
  given period
• Budgeted production can be calculated through use
  of the following formula

10
Direct Materials Budgets

• The direct materials usage budget
• Shows the amount (and cost) of direct materials
  required for budgeted production
• The last line of the production budget first
  line of the direct materials usage budget

11
Direct Materials Budgets (continued)

• The direct materials purchases budget
• Contains budgeted purchases, in units and
  dollars, of direct materials for the upcoming
  period
• Is needed to complete the direct materials usage
  budget (i.e., provides unit cost data)
• Is a function of materials required for
  production (from materials usage budget), target
  ending inventory of materials, beginning-of-period
  materials inventory, budgeted purchase price per
  unit of raw material

12
Direct Labor Budget

• Enables the personnel department to plan for
  hiring repositioning of employees, based on
  production needs
• Is prepared for each class (type) of labor,
  e.g., skilled and semi-skilled
• Is a function of
• Budgeted output (from production budget)
• Standard labor hours per unit of output
• Standard wage rate per hour

13
Direct Labor Budget (continued)

• Kerry uses 0.5 hours of semiskilled labor and
  0.2 hours of skilled labor per unit _at_ standard
  wage rates of 8 and 12 per hour, respectively

14
Cost of Goods Manufactured CGS Budgets

• The cost of goods manufactured and CGS budgets
  are prepared after the factory overhead budget is
  prepared
• The income statement budget and the balance sheet
  use information from this budget

15
Selling Administrative Expense Budget

• The selling and general administrative expenses
• budget is now prepared
• This budget includes all the planned expenditures
  for selling and general administrative activities
• Many of the expenses included in this budget are
  considered discretionary and are a likely place
  for spending cuts
• Managers must be careful not to focus solely on
  short-term affects when making cuts in these
  areas (e.g., customer-service expenditures)

16
Cash Budget

• The cash budget brings together the cash effects
  of all budgeted activities--to ensure that the
  firm has adequate cash on hand
• This budget generally has three sections
• Cash available
• Cash disbursements, and
• Financing
• Preparation of this budget involves careful
  review of all other budgets to identify cash
  inflows and outflows

17
Budgeted I/S and B/S

• The budgeted income statement (I/S) and
• budgeted balance sheet (B/S) can then be
• prepared using all the aforementioned budgets
• The budgeted I/S describes the expected operating
  income for the upcoming period
• The budgeted B/S, the last budget in the
  budget-preparation process, incorporates the
  effects of all operations and cash flows during
  the budget period and shows projected ending
  balances in asset, liability, and equity accounts

18
Alternative Budgeting Approaches

• Zero-base budgeting (ZZB) is a budgeting process
  that requires managers to prepare budgets from a
  zero base
• This type of budgeting allows no activities or
  functions to be included in the budget unless
  managers can justify their needs
• In-depth reviews and analyses of all budget items
  make managers aware of activities and functions
  that have outlived their usefulness
• Can be a difficult and time-consuming process

19
Alternative Budgeting Approaches (continued)

• Activity-based budgeting (ABB) is a budgeting
  process based on activities and cost drivers of
  operations
• Starts with the budgeted output and segregates
  costs required for the budgeted output into
  homogeneous cost pools
• Can be a simple extension of a firms ABC system
• Kaizen (Continuous improvement) budgeting
• Incorporates continuous improvement expectations
  into the budgets
• Promotes active engagement in reforming and
  altering business practices and processes

20
Behavioral Issues in Budgeting

• Budgetary slack, or padding the budget, is the
  practice of managers knowingly including a higher
  amount of expenditures or a lower amount of
  revenue in a budget
• Spending the budget is another issue managers
  often feel if they do not use all the resources
  they receive, next years budget may be cut
• Goal congruence is a term that refers to the
  degree of consistency between goals of the firm,
  its subunits, and its employees
• Involving employees in the budgeting process
  fosters goal congruence

21
Behavioral Issues in Budgeting (continued)

• Difficulty level of the budget target?
• An easy budget may fail to encourage employees to
  give their best efforts, while a very difficult
  target can be discourage managers from even
  trying
• A highly achievable target is suggested with
  incentives for exceeding the budgeted figures
• Authoritative or participative budgeting?
• Top-down budgeting is referred to as
  authoritative budgeting
• Bottom-up budgeting is referred to as
  participative budgeting
• Effective budgeting processes often combine the
  two types