Profit Planning: Budgeting

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Session 30

• Profit Planning Budgeting
• May 10 2002

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Functions of Budgets--1

• Formally communicates management objectives and
  priorities in financial terms
• Represents authorization and approval to
  undertake activities
• Guide to action by others both internal and
  external to the firm

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Functions of Budgets--2

• Establishes expectations in quantitative terms
• The planning process forces and facilitates
  communication among functional and operating
  groups

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Functions of Budgets--3

• 6. Budgets form a basis on which to evaluate both
  the effectiveness and efficiency of the
  achievement of agreed upon goals and objectives
• 7. Forces us to identify potential or likely
  problem areas and challenges to goals and targets

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Benefits of Effective Budgets

• The benefits of profit planning depend on
• The environment in which the organization
  operates
• The time and effort devoted to the planning
  process
• The extent to which management goals and
  objectives are reflected in the plans
• The extent to which management utilizes the plans

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Benefits of Effective Budgets

• Improved performance relative to goals
• Improved performance evaluation processes
• Improved coordination communication
• Lower risk and lower cost of capital

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Perceived Costs of Budgeting

• Executive time and effort
• Management time and effort away from more
  valuable activites
• Cost of staff time and software
• Constraints on management
• Reveals problems weaknesses etc.

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Steps in Budgeting Process

• Forecast the markets for goods services
• Plan revenues (prices quantities)
• Prepare production budget in units
• Prepare materials requirements budget
• Prepare materials purchases budget
• Prepare labor requirements budget
• Prepare labor acquisition budget

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Steps in Budgeting Process

• Prepare cost budgets for other expense categories
• Determine billing and cost rates
• Prepare more detailed sales and inventory budgets
  based on matching sales plans with production
  plans
• Prepare cost of goods sold budgets
• Prepare budgeted financial statements

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Risk factors

• The predictability of demand is a key factor in
  the usefulness of financial budgets. Demand
  drives action.
• Stability of suppliers employees and facilities
  influence risk
• Financial health is key to the achievement of
  other objectives

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Other Considerations

• Different budgets of the same areas may exist for
  different purposes. The revenue budget used for
  cash flow and financing purposes may be more
  conservative than the sales buggets (targets)
  given to the sales force.

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Misuse of Budgets

• Budgets get a bad name because they can be used
  by management to brow-beat subordinates and
  justify non-support of projects etc.
• I believe in open communication of budgets and
  fair honest treatment of managers. People tend
  to be more suspicious than selfish!

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