Budget Preparation

[Pages:38]Budget Preparation

Nature of a Budget

? Budgets are an important tool for effective short-term planning and control

? in organizations.

? An operating budget usually covers one year and ? states the revenues and expenses ? planned for that year.

The budget has these characteristics:

A budget estimates the profit potential of the business unit. It is stated in monetary terms,

? may be backed up by nonmonetary amounts

? (e.g., units sold or produced).

? It generally covers a period of one year. ? In businesses that are strongly influenced by seasonal factors, there may be two

budgets per year--

? for example, apparel companies typically have a fall budget and a spring budget.

It is a management commitment; ? managers agree to accept responsibility for attaining the budgeted objectives. The budget proposal is reviewed and approved by an authority higher than the budgetee. Once approved, the budget can be changed only under specified conditions. ? actual financial performance is compared to budget, and variances are analyzed

and explained

Relation to Strategic Planning

? Strategic planning,

? is the process of deciding on the nature and size of the several programs that are to be undertaken in implementing an organization's strategies.

? Both strategic planning and budget preparation involve planning,

? but the types of planning activities are different in the two processes

A budget is, a one-year slice of the organization's strategic plan, ? although the budgeting process involves more than simply carving

out a slice.

Contrast with Forecasting

? A budget is a management plan ? a forecast is merely a prediction of what will most likely happen ? From management's point of view, ? a financial forecast is exclusively a planning tool, ? whereas a budget is both a planning tool and a control tool.

? All budgets include elements of forecasting

Use of a Budget

Preparation of an operating budget has four principal purposes: ? (1) to fine-tune the strategic plan; ? (2) to help coordinate the activities of the several parts of the

organization; ? (3) to assign responsibility to managers, to authorize the amounts

they are permitted to spend, and to inform them of the performance that is expected of them;

? (4) to obtain a commitment that is a basis for evaluating a manager's actual performance.

Fine-Tuning the Strategic Plan

The strategic plan has the following characteristics: ? it is prepared early in the year, ? it is developed on the basis of the best information

? available at that time,

? its preparation involves relatively few managers, The budget provides an opportunity to use the latest available information and

is based on the judgment of managers at all levels throughout the organization.

Coordination

? Every responsibility center manager in the organization participates in the preparation of the budget.

? Then, when the staff assembles the pieces into an overall plan, inconsistencies may show up.

? The most common is the possibility that the plans of the production organization are not consistent with the planned sales volume,

? in total or in certain product lines

? During the budget preparation process, these inconsistencies are identified and resolved.

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