| Operations
Budgeting |
What is Budgeting?
- budgeting defines the planning and forecasting of future
business operations in quantitative terms
- establishes objectives for revenue inflows and cost outflows
- provides guidelines for future operations
- serves as a basis for performance appraisal
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The 3 Goals of Budgeting
- provide organizational estimates
of revenues, expenses, human resource needs, and equipment requirements
- provides the basis to develop
coordinated management procedures
and policies for both the short term and the long term
- provides methods of control
for comparison and evaluation of actual operating
results
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Types of Budgets
- Capital Budget
- this budget considers balance sheet items and long-range
expenditures projected to improve operating capacity and efficiency
- Operating Budget
- projects sales revenues and operating costs over a
specified operating period
- note: this results in a projected income statement
also called pro forma income statement
- Departmental Budget
- forecasts revenues and operating expenses for a specific
profit center
- Master Budget
- comprehensive budget that includes all of the operating
departments or division of the organization
- Fixed Budget
- forecasts 1 level of activity and shows a static projection of estimates
forecasted
- main disadvantage of a fixed budget -- there is no plan
in place if actual revenues and costs differ from the forecast
- Flexible Budget
- forecasts several levels of operating activity for the
coming period
- Short Term Budget
- Long Term Budget
- greater than 1 year
- considers the major future plans of the organization
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Advantages and Disadvantages of Budgeting
- advantages
- encourages participation and enhances communication among
management, employees, and customers
- encourages the development of potential courses of action
for evaluation and consideration
- allows comparison between the standards developed and
actual results
- may provide a variety of different operating scenarios
- forces the organization to look into the future
- requires those involved to be aware of the internal and
external factors affecting the organization
- disadvantages
- the time and resulting costs in preparing the budget may
be considerable
- based largely on "unknown" information -- our best
"guesstimates"
- may require the use of confidential information
- there could be a tendency to "spend
to the budget"
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The Budgeting Cycle
- establish attainable and reasonable goals and objectives
- create a plan to reach those goals and objectives
- compare the actual results to the budgeted results
- identify problems areas and analyze the variances
- take action to correct unfavorable variances
- always seek new techniques and procedures that will improve
the effectiveness of the budgeting process (this creates a dynamic process)
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Limitations to Budget Forecasting Techniques
- the results are only as good as the forecasted data used
- mathematical approaches cannot substitute for individual
judgment and experience
- mathematical approaches may not consider certain variables
controllable by management
- the longer the time horizon budgeted the greater is the
chance for forecasting error
- historical data may not be a good predictor of future
activity levels
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Developing The Pro Forma Income Statement
- estimate revenue levels by department
- past revenue figures; anticipated trends; competitive
factors
- economic factors; limiting factors
- deduct direct operating expenses for each department
- usually based on historical %
- with labor, develop staffing schedules
- combine departmental operating incomes and deduct
undistributable expenses to arrive at net income
- many of these fixed costs are called discretionary
expenses
- distribute unallocated expenses as a ratio of revenues
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Zero Based Budgeting (ZBB)
- technique used to control undistributed expenses
- ZBB requires that each budgeted amount be justified
- key element is the decision unit process:
- establish decision unit
- determine unit’s objectives
- justification of the unit’s continuation
- list alternative ways to achieve goals
- recommend one alternative
- develop budget for different levels
- rank the different decision units
- advantages of ZBB
- concentrates on the $ cost and not broad %
- can reallocate funds to areas providing the greatest
benefit
- provides quality information to the operation
- obliges management to identify inefficient functions
- reduce areas of duplication or overlap
- disadvantages of ZBB
- implies that the traditional budgeting process is not
adequate
- time, effort, paperwork, and cost
- may be unfair to some department heads who are not as
capable as others in defending their budgets
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Variance Analysis
- process of analyzing variances in order to give management
more information about the causes of the variance
- a variance is the difference between budgeted and actual
results
- we can classify this difference as:
- the variance usually made up of 2 components
- price (or cost) variance
- quantity variance
- can be used for revenues and expenses
- variance analysis provides additional information that is
of help identifying causes of these differences
- 3 major types
- revenue variance analysis
- cost of goods sold variance analysis
- variable labor variance analysis
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Forecasting
- Moving Averages
- attempt to remove random variations
- gives equal weight to each of the periods
- a large number of periods (n) results in a forecast that
reacts slowly
- current forecast is based on past information
- Regression Analysis
- assumes a linear relationship between 2 variables
- Y = mX + b
- Y is called the dependent variable
- X is called the independent variable
- we use this relationship to forecast the value of the Y
variable
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