Profit planning The steps taken by businesses to achieve their planned levels of profits Accomplished by preparing a number of budgets that together form an integrated business plan known as the master budget I The Basic Framework of Budgeting a Budget detailed plan for the future that is usually expressed in formal quantitative terms those goals i Planning developing goals and preparing various budgets to achieve ii Control gathering feedback to ensure that the plan is being properly executed or modified as circumstances change b Advantages of Budgeting organization i Budgets communicate management s plans throughout the ii Forces managers to think about and plan for the future iii Provides a means of allocating resources to those parts of the organization where they can be used most efficiently iv Can uncover potential bottlenecks before they occur v Coordinate the activities of the entire organization by integrating the plans of its various parts Ensures that everyone in the organization is pulling in the same direction vi Budgets define goals and objectives that can serve as benchmarks for evaluating subsequent performance c Responsibility Accounting i Responsibility accounting a manager should be held responsible for those items and only those items that the manager can actual control to a significant extent ii Each line in the budget is the responsibility of a manager who is held responsible for subsequent deviations between budgeted goals and actual results iii Personalizes accounting information by holding individuals responsible for revenues and costs d Choosing a Budget Period i Operating budgets ordinarily cover a one year period corresponding to the company s fiscal year Many companies divide their budget into four quarters ii Continuous Perpetual Budget 12 month budget that rolls forward one month or quarter as the current month or quarter is completed 1 One month is added to the end of the budget as each month comes to a close 2 Keeps managers focused at least one year ahead so they do not become to narrowly focused on short term results i Self Imposed Budget Participative Budget a budget that is prepared with the full cooperation and participation of managers at all levels e Self Imposed Budget ii Advantages 1 Individuals at all levels of organization are recognized as members of the team whose views and judgments are valued by top management 2 Budget estimates prepared by front line managers are often more accurate and reliable than estimates prepared by top iii Limitations managers who have less intimate knowledge of markets and day to day operations 3 Motivation is generally higher when individuals participate in setting their own goals than when the goals are imposed from above Self imposed budgets create commitment 4 A manager who is not able to meet a budget that has been imposed from above can always say that the budget was unrealistic and impossible to meet With a self imposed budget this excuse isn t available 1 Lower level managers may allow too much budgetary slack Because the manager who creates the budget will be held accountable for actual results that deviate for the budget the manager will have a natural tendency to submit a budget that is easy to attain 2 Most companies don t follow the budgeting process described a Top managers initiate the budgeting process by issuing profit targets but often times not in a position to know whether the targets are appropriate b Lower level managers are directed to prepare budgets that meet those targets which may be unrealistically high or low i ii If too high motivation suffers If too low waste will occur f Human Factors in Budgeting i If budget program is to be successful it must have the complete acceptance and support of the persons who occupy key management positions ii Purpose of the budget is to motivate people and to coordinate their efforts 1 Undermined if managers become preoccupied with the technical aspects of it the budget is used in a rigid and inflexible manner to control people 2 Should be highly achievable g Budget Committee i Budget Committee responsible for overall policy relating to the budget program and for coordinating the preparation of the budget itself Approves the final budget 1 President VPs in charge of various functions such as sales production and purchasing and the controller 2 Disputes can erupt over budget matters 3 Budgets allocate resources and sets the benchmarks budgeting process determines to a large extent which departments get more resources and which get less i Master Budget a number of separate but interdependent budgets that formally lay out the company s sales production and financial goals 1 Master budget culminates in a cash budget a budgeted income statement and a budgeted balance sheet h Master Budget Overview 2 ii Steps 1 Preparation of the Sales Budget a Detailed schedule showing the expected sales for the budget period b Accurate sales budget is the key to the entire budgeting process 2 Production Budget 3 Cash Budget a Used to determine the budgets for manufacturing costs including the direct materials budget the direct labor budget and the manufacturing overhead budget a Detailed plan showing how cash resources wil be acquired and used b Found when budgets from production budgets are combined with data from the sales budget and the selling and administrative expense budget c All of the operating budgets have an impact on the cash budget 4 Budgeted Income Statement 5 Budgeted Balance Sheet i Preparing the Master Budget i List of Documents that would be part of master budget 1 Sales Budget including a schedule of expected cash collections 2 Production Budget schedule of expected cash disbursements for purchases of materials 3 Direct Materials Budget including a schedule of expected cash disbursements for purchases of materials 4 Direct Labor Budget 5 Manufacturing Overhead Budget 6 Ending Finished Goods Inventory Budget 7 Selling and Administrative Expense Budget 8 Cash Budget 9 Budgeted Income Statement 10 Budgeted Balance Sheet II The Master Budget a Sales Budget budget iii i Sales Budget Budgeted Unit Sales x Selling Price ii A schedule of expected cash collections is prepared after the sales b The Production Budget i Lists the number of units that must be produced to satisfy sales needs and to provide for the desired ending inventory ii The total needs for the quarter is found by adding together the budgeted sales for the quarter and the desired ending
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