Using Budgets to Achieve Organizational Objectives

1
Chapter 11 Using Budgets to Achieve
Organizational Objectives
2
Chapter Objectives To be able to 1. Identify
the primary role of budgets and budgeting in
organizations. 2. Demonstrate the importance of
each element of the budgeting proces. 3. Explain
the different types of operating budgets and
financial budgets and their interrelationships. 4
. Describe the way that organizations effectively
use and interpret budgets. 5. Use
cost-volume-profit analysis to evaluate the
operating and financial consequences of
alternative decisions. 6. Undertake what-if and
sensitivity analyses - two important budgeting
tools used by budget planners. 7. Identify the
role of budgets in service and not-for-profit
organizations 8. Recognize the behavioral effects
of budgeting on an organizations employees.
3
The budgeting process The budgeting process The
process that determines the planned level of
most flexible costs. Budget A
quantitative expression of the money inflows and
outflows that predicts the consequences of
current operating decisions and reveals
whether a financial plan will meet
organizational objectives. Planning and
control and the role of budgets Exhibit 11-1
4
Purpose of the Budgeting Process The budgeting
process forces the organization to do the
following 1. Identify its long-term objectives
and short-term goals and be specific in setting
goals and evaluating performance relative to
those goals. 2. Recognize the need to view the
organization as a system of interacting
components that must be coordinated. 3. Communic
ate the organizations goals to all organization
members and involve them in the budgeting
process. 4. Anticipate problems, thereby
handling them proactively rather than reactively.
5
The Master Budget Budgets are prepared for
specific time periods to allow managers to
compare actual results for the period with
planned results. Differences between actual
results and the budget plan are called
variances. Variances The difference between
planned and actual costs. Operating
budgets The document that forecasts revenues and
expenses during the next operating period
including monthly forecasts of sales,
production and operating expenses. Financial
budgets Those budgets that identifiy the
expected financial consequences of the
activities summarized in the operating
budgets. Exhibit 11-2
6
The Operating Budget Typical content 1. Sales
plan 2. Capital spending 3. Production plan 4.
Materials purchasing plan 5. Labor hiring and
training plan 6. Administrative and discretionary
spending plan
7
The Financial Budget Typical content 1. Plan
when excess cash will be generated so that they
can undertake short- term investments. 2.
Organize how to meet any cash shortages.
8

• The process, page 1 of 4
• Demand forecast (detail level, etc.)
• The production plan (inventories, capacities
  etc)
• Aggregate planning (The process that compares
  the production plan with the amount
• of available productive capacity this
  comparison assesses the feasibility of the propo-
• sed production plan)
• The spending plan (acquiring plan for requiring
  raw materials and supplies as
• marketing, RD, IT etc.)

9

• The process, page 2 of 4
• Choosing the capacity levels (exhibit 11-7)
• Flexible resources that the organization can
  acquire in the short term.
• Capacity resources that the organization must
  acquire for item for the intermediate term.
• Capacity resources that the organization must
  acquire for the long term.
• Determine
• Activities that create the need for resources
  and, therefore, resource expenditures in the
  short
• term.
• Activities undertaken to acquire capacity for
  the intermediate term.
• Activities undertaken to acquire capacity that
  must be acquired for the long-term.
• Efficiency and effectiveness
  considerations, short-term
• Is this expenditure necessary to add value to
  the product from the customers perspective?
• Can the organization improve the execution of
  this activity?
• Would changing the way this activity is done
  provide more customer satisfaction?

10

• The process, page 3 of 4
• Efficiency and effectiveness considerations,
  intermediate- and long-term
• Are alternative forms of capacity available that
  are less expensive?
• Is this the best approach to achieve our goals?
• How can we improve the capacity selection
  decision to make capacity less expensive or more
  flexible?
• Handling infeasible production plans (resource
  or capacity constrains)
• Interpreting the production plan (bottlenecks,
  adjusting sales or capacities,
• exhibit 11-8)
• The financial plans
• Cash-flows (exhibit 11-9)
• Projected balance sheet (exhibit 11-10)
• Projected income statement (exhibit 11-11)
• The cash flow statement

11

• The process, page 4 of 4
• Using the financial plans
• (relationships to shareholders, banks and other
  investors)
• Using the projected results
• (Identify borad resource requirements,
  identify potential problems, compare projected
• operating and financial results)

12
Cost-Volume-Profit Analysis (CVP), page 1 of
2 Definition The process of combining cost
behavior information with revenue information to
project revenues, cost and profits for different
levels of volume. Assumptions - Costs are either
pure flexible or capacity related. - Units made
equal units sold. - Revenue per unit does not
change as volume changes. Profit
calculations Profit Revenue - Costs Profit
Revenue - Flexible Costs - Capacity-related
Costs Profit (Units sold x Revenue per unit) -
(Units sold x Flexible cost per unit) - Capacity
related Costs Profit Units sold
(Revenue per unit - Flexible Cost per unit) -
Capacity-related Costs Profit (units sold x
Contribution Margin per unit) - Capacity-related
Costs
13
Cost-Volume-Profit Analysis (CVP), page 2 of
2 Breakeven Calculation Units sold to breakeven
Capacity-related costs / Contribution Margin
per unit Exhibit 11-15 Unit revenue and cost
information Profit (62.40 x units sold) -
205.200 Breakeven quantity 205.200 / 62,40
3288 units Exhibit 11-16 Cost-Volume-Profit
Chart Multiproduct organizations versus
Single-product organizations Exhibits 11-17,
11-18, 11-19
14
What-if Analysis What-if A type of analysis
that explores the effect of a change in a
parameter on an outcome. Example What if I
decrease prices 5 and sales then increase by
10? Sensitivity The analysis of
the effect of a change in a parameter on a
decision rather than on an outcome. Example
How much many can Euro fall compared to USD
before we reach breakeven?
15
Managing the Budgeting Process, page 1 of 2 Who?
Who is involved an to what extent? How? How
should budgets be determined and at what level of
difficulty should the budget be set to have the
greatest positive influence on peoples motivation
and performance? Authoritative budgeting A
budget-setting method in which a superior tells a
subordinate what the budget will be. Stretch
budgeting A budgeting method that attempts to
reach much higher goals than the current
performance Participative budgeting A method of
budget setting that uses a joint decision-making
process in which all parties agree about
setting the budget targets. Consultative
budgeting A method of budget setting used when
managers ask subordinates to discuss their
ideas about the budget, but no joint decision
making occurs.
16
Managing the Budgeting Process, page 2 of
2 Manipulation Budgeting games A process in
which managers attempt to manipulate
infor- mation and targets to achieve as high a
bonus as possible. Budget slack Involve the
acts of requiring excess resource and distorting
performance information.
17

• Other Subjects
• Comparison of actual and planned results.
• Periodic versus continuous budgeting.
• Controlling descretionary expenditures.
• Incremental budgeting. Bases a periods
  expenditure level for a discretionary
• itemon the amount spent for that item during
  the previous period.
• Zero-based budgeting. Requires that proponents
  of discretionary expenditures
• continually justify every expenditure.
• Activity-based budgeting. A budgeting approach
  based on the insights of
• activity-based costing.
• Project funding. A proposal for discretionary
  expenditures with a specific time
• horizon or sunset provision.