master budget best.docx

8/17/2019 Master Budget best.docx

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Budgeting is the process of identifying, gathering, summarizing, and

communicating nancial and nonnancial information about an

organization’s future activities. It is an essential part of the continuous is the

process of identifying, gathering, summarizing, and planning that an

organization must do to accomplish its long-term goals and intermediate

objectives

Careful planning is vital to the health of any organization. ailure to plan,

either formally

or informally, can lead to nancial disaster. !anagers of businesses, "hether

small or

large, must #no" their resource capabilities and have a plan that details the

use of these

resources.

Budgeting plays a crucial role in planning and control. $lans identifyobjectives and the

actions needed to achieve them. Budgets are the %uantitative e&pressions

of these plans,

stated in either physical or nancial terms or both. 'hen used for planning, a

budget

is a method for translating the goals and strategies of an organization into

operational

terms. Budgets can also be used in control. Control is the process of setting

standards,receiving feedbac# on actual performance, and ta#ing corrective action

"henever actual

performance deviates signicantly from planned performance. (hus, budgets

can be used

to compare actual outcomes "ith planned outcomes, and they can steer

operations bac#

on course, if necessary.

Advantages of Budgeting

)rganizations realize many benets from budgeting, including*

Budgets communicate management’s plans throughout the organization.

Budgets force managers to think about and plan for the future. In the

absence of the

necessity to prepare a budget, many managers "ould spend all of their

time dealing "ith day-to-day emergencies.


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(he budgeting process provides a means of allocating resources to those

parts of the

organization "here they can be used most e+ectively. (he budgeting process can uncover potential bottlenecks before they

occur. Budgets coordinate the activities of the entire organization by integrating

the plans of its various parts. Budgeting helps to ensure that everyone in

the organization is pulling in the same direction. Budgets dene goals and objectives that can serve as benchmarks for

evaluating subse%uent performance.

budget is a nancial plan of the resources needed to carry out tas#s and

meet nancial goals

Types of Budgets

(he master budget is a comprehensive nancial plan for the year and is

made up of various individual departmental and activity budgets. master

budget can be divided into

operating and nancial budgets. Operating budgets are concerned "ith

the income generating activities of a rm* sales, production, and nished

goods inventories. (he


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ultimate outcome of the operating budgets is a pro forma or budgeted

income statement.

ote that pro forma/ is synonymous "ith budgeted/ and estimated./ In

e+ect, the

pro forma income statement is done according to form/ but "ith estimated,

not historical, data. Financial budgets are concerned "ith the in0o"s and

out0o"s of cash and "ith

nancial position. $lanned cash in0o"s and out0o"s are detailed in a cash

budget, and

e&pected nancial position at the end of the budget period is sho"n in a

budgeted, or pro

forma, balance sheet

(he master budget is usually prepared for a one-year period corresponding

to the

company’s scal year. (he yearly budgets are bro#en do"n into %uarterly

and monthly

budgets. (he use of shorter time periods allo"s managers to compare actual

data "ith

budgeted data as the year unfolds and to ma#e timely corrections. Because

progress can

be chec#ed more fre%uently "ith monthly budgets, problems are less li#ely

to become

too serious.


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!ost organizations prepare the budget for the coming year during the last

four or

ve months of the current year. 1o"ever, some organizations have

developed a continuous budgeting philosophy. continuous (or rolling)

budget is a moving 23-month

budget. s a month e&pires in the budget, an additional month in the future


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is added so

that the company al"ays has a 23-month plan on hand. $roponents of

continuous budgeting maintain that it forces managers to plan ahead

constantly.

Strategic planning

Companies generally start the strategic planning process by stating their

critical success factors, "hich are the most important things for the company

to do to be successful. or e&ample, 4outh"est irlines relies on several

factors to maintain its competitive edge. It uses a point-topoint net"or# of

routes instead of the hub and-spo#e system used by most 5.4. airlines, hase6cient gate turnaround, and uses only one type of plane. (hese factors

#eep costs lo" and ma#e 4outh"est a price leader.

Companies build on these critical success factors to e&pand operations. or

e&ample, !c7onald’s has developed e&pertise in the fast-food business over

many years. !c7onald’s management has realized that its e&pertise and

"orld"ide reputation could be used to successfully e&pand throughout the

"orld. (he company continues to use its competitive advantages 8e.g., name

recognition, value, and consistency9 to succeed in areas outside the 5nited

4tates.

master budget is part of an overall organization plan for the ne&t year,

made up of three components*

)rganizational goals* are the broad objectives management

establishes and company employees "or# to achieve. 4uch broad

goals indicate management’s philosophy about the company. (he strategic long-range prot plan* lthough a statement of goals is

necessary to guide an organization, it is important to detail the specic

steps re%uired to achieve them. (hese steps are e&pressed in astrategic long-range plan. Because the long-range plans loo# into the

intermediate and distant future, they are usually stated in rather broad

terms. 4trategic plans discuss the major capital investments re%uired

to maintain present facilities, increase capacity, diversify products

and:or processes, and develop particular mar#ets


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(he master budget 8tactical short-range prot plan9* ;ong-range plans

are achieved in year-by-year steps. (he guidance is more specic for

the coming year than it is for more distant years. (he plan for the

coming year is called the master budget. (he master budget is also

#no"n as the static budget, the budget plan, or the planning budget.

(he income statement portion of the master budget is often called the

prot plan. (he master budget indicates the sales levels, production

and cost levels, income, and cash 0o"s anticipated for the coming

year. In addition, these budget data are used to construct a budgeted

statement of nancial position 8balance sheet9

Budgeting is a dynamic process that ties together goals, plans, decision

ma#ing, and employee performance evaluation.

The Human Element in Budgeting

number of factors, including their personal goals and values, a+ect

managers’ beliefs about the coming period. lthough budgets are often

vie"ed in purely %uantitative, technical terms, the importance of this human

factor cannot be overemphasized

Budget preparation rests on human estimates of an un#no"n future. $eople’s

forecasts are li#ely to be greatly in0uenced by their e&periences "ith various

segments of the company. or e&ample, district sales managers are in ane&cellent position to project customer orders over the ne&t several months,

but mar#et researchers are usually better able to identify long-run mar#et

trends and ma#e macro forecasts of sales.

(he use of inputs from lo"er- and middle-management employees is often

called participative budgeting or grassroots budgeting. It has an obvious

cost< it is time consuming. But it also has some benets< it enhances

employee motivation and acceptance of goals, and it provides information

that enables employees to associate re"ards and penalties "ith

performance. $articipative budgeting can also yield information thatemployees #no", but managers do not.

4ome studies have sho"n that employees provide inaccurate data "hen

as#ed to give budget estimates. (hey might re%uest more money than they

need because they e&pect their re%uest to be cut. =mployees "ho believe


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that the budget "ill be used as a standard for evaluating their performance

may provide an estimate that "ill not be too hard to achieve

Characteristics of a Good Budgetary System

n ideal budgetary system is one that achieves complete goal congruence

and simultaneously creates a drive in managers to achieve the

organization’s goals in an ethical manner. 'hile an ideal budgetary system

probably does not e&ist, research and practice have identied some #ey

features that promote a reasonable degree of positive behavior. (hese

features include fre%uent feedbac# on performance, monetary and

nonmonetary incentives, participation, realistic standards, controllability of

costs, and multiple measures of performance.

Freuent Feedbac! on "erformance

!anagers need to #no" ho" they are doing as the year unfolds. $roviding

them "ith fre%uent, timely performance reports allo"s them to #no" ho"

successful their e+orts have been and gives them time to ta#e corrective

actions and change plans as necessary. re%uent performance reports can

reinforce positive behavior and give managers the time and opportunity to

adapt to changing conditions.

(he use of 0e&ible budgets allo"s management to see if actual costs andrevenues are

in accord "ith budgeted amounts. 4elective investigation of signicant

variances allo"s

managers to focus only on areas that need attention. (his process is called

management

by exception

#onetary and $onmonetary %ncenti&es

sound budgetary system encourages goal-congruent behavior. %ncenti&esare the

means that are used to encourage managers to "or# to"ard achieving the

organization’s

goals. Incentives can be either negative or positive. egative incentives use

fear of punishment to motivate< positive incentives use re"ards. Both


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incentives can be used by an

organization.

"articipati&e Budgeting

>ather than imposing budgets on subordinate managers, participati&ebudgeting allo"s

subordinate managers considerable say in ho" the budgets are established.

(ypically,

overall objectives are communicated to the manager, "ho helps develop a

budget that "ill accomplish these objectives. In participative budgeting, the

emphasis is on the accomplishment of the broad objectives, not on individual

budget items

$articipative budgeting communicates a sense of responsibility to

subordinate managers and fosters creativity. 4ince the subordinate managercreates the budget, it is more li#ely that the budget’s goals "ill become the

manager’s personal goals, resulting in greater goal congruence. In addition

to the behavioral benets, participative budgeting has the advantage of

involving individuals "hose #no"ledge of local conditions may enhance the

entire planning process.

(he advantages of participative budgeting are as follo"s*

Improved %uality of forecasts to use as the basis for the budget* !anagers

"ho aredoing a job on a day-to-day basis are li#ely to have a better idea of "hat

is achievable,

"hat is li#ely to happen in the forthcoming period, local trading

conditions, etc. Improved motivation* Budget holders are more li#ely to "ant to "or# to

achieve a

budget that they have been involved in setting themselves, rather than

one that has been

imposed on them from above.

Better results* being the e&ecutor of the budget the applicant can controlthe costs

better than any other manager.

$articipative budgeting has t"o potential problems that should be

mentioned*

2. Building slac# into the budget 8often referred to as padding the budget 9


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3. $seudo participation

(he rst problem "ith participative budgeting is the opportunity for

managers to

build slac# into the budget. Budgetary slac! e&ists "hen a manager

deliberately underestimates revenues or overestimates costs. =itherapproach increases the li#elihood that the manager "ill achieve the budget

and conse%uently reduces the ris# that the manager

faces. $adding the budget also unnecessarily ties up resources that might be

used more productively else"here.

(he second problem "ith participation occurs "hen top management

assumes total control of the budgeting process, see#ing only supercial

participation from lo"er-level managers. (his practice is termed pseudo

participation. (op management is simply obtaining formal acceptance of

the budget from subordinate managers, not see#ing real input. ccordingly,none of the behavioral benets of participation "ill be realized.

#ultiple #easures of "erformance

)ften, organizations ma#e the mista#e of using budgets as their only

measure of managerial performance. )veremphasis on this measure can

lead to a form of dysfunctional

behavior called milking the rm or myopia. #yopic beha&ior occurs

"hen a manager

ta#es actions that improve budgetary performance in the short run but bringlong-run

harm to the rm.

(here are numerous e&amples of myopic behavior. (o meet budgeted cost

objectives

or prots, managers can reduce e&penditures for preventive maintenance,

advertising,

and ne" product development. !anagers can also fail to promote deserving

employees

to #eep the cost of labor lo" and can choose to use lo"er-%uality materials toreduce the

cost of materials. In the short run, these actions "ill lead to improved

budgetary performance, but in the long run, productivity "ill fall, mar#et

share "ill decline, and capable

employees "ill leave for more attractive opportunities.


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(he best "ay to prevent myopic behavior is to measure the performance of

managers on several dimensions, including some long-run attributes.

$roductivity, %uality, and

personnel development are e&amples of other areas of performance that

could be evaluated. inancial measures of performance are important, but

overemphasis on them can

be counterproductive.

master budget best.docx

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