Chapter 5 Planning and Forecasting Unit 5 1 Planning and the Budgeting Process Strategic planning very broad and helps to identify the overall focus of an organization Tactical planning develops concrete actions that turn strategic plans into reality o Type of tactical plan budgeting process Budgeting process is a means of allocation organizational resources among various divisions projects or other subsets of an organization What is a Budget Budget an operating plan that s expressed primarily in financial terms in dollars Has its beginnings in the organization s strategic plan o As managers develop the steps required to implement a strategy they begin also to develop the budget which shows how resources will be used to operationalize those steps Preparing a budget allows managers to plan for the future reducing the need for kneejerk responses to unexpected situations Also helps divisions within the organization to communicate with one another getting them all going in the same direction toward overall corporate goals o As managers review divisional budgets they can assess whether the divisions strategic direction is in line with corporate strategy and request corrective action if needed The Budgeting Process Choices related to who created the budget or how standards are set may result in unintended consequences if managers aren t aware of how employees are affected by these choices Information Flows Information flows in 2 primary directions in the budgeting process In a top down budget environment executive management creates the budget and that budget is then pushed down through the rest of the organization o Sometimes called imposed budget because those who must implement the budget have no input into it The most efficient method of budget preparation since it involves the fewest people o o Also upper management has the best understanding of the organization s strategic direction and how to allocate resources to achieve the organization s goal Bottom up budget the budgeting process begins at the lowest levels of management and filters up through the organization o At each higher level of management the budget is reviewed and may be altered to satisfy the competing needs of various units within the organization As changes are made to the budget the best practice is for management to communicate the rational behind those changes to the affected units o Referred to as participative budgeting because those employees who ll be held accountable for meeting the budget participate in its creation Elicits more commitment to the budget from employees since they have had some input into its creation Time consuming More circular budgeting than linear unlike what the graph perceives Behavioral Issues Budgets should be used to guide employee actions and decisions throughout the year as part of an overall performance management plan Deviations from the budget can identify the need to correct a situation gone wrong Budget is part of managerial control As the year progresses actual results should be compared to budgeted results A problem that is common in a bottom up budget environment is one in which managers prepare the budget that they will eventually be evaluated against Often managers are tempted to include budgetary slack or budgetary padding in the budget o Budgetary slack causes consequences for the organization First resources may not be allocated in an optimal way The suboptimal allocation of resources may lead to the postponement or cancellation of projects that would be beneficial to the organization because resources don t appear to be available to fund them Second if managers receive bonuses based on their beating a padded budget they achieve additional compensation that they would not have earned had the budget been prepared realistically Top down budgets have behavioral issues as well Employees may feel that an imposed budget s unfair o If they re not committed to the budget they ll have no motivation to attempt to meet it o o As employees fail to control expenses or generate revenues the organizations resources may be wasted Starting Points 2 main ways to begin the budgeting process The more popular way is the incremental approach o o o The manager begins with the current year s budget and adds or subtracts funds for any anticipated changes in operations Perpetuates budget errors Ex if the manager padded this year s budget that padding will carry forward to the next year Programs won t be reviewed to ensure that they continue to meet corporate goals and objectives The 2nd way to budget is zero based budgeting under which the budget begins each year at 0 and each individual budget item must be justified o More time consuming and often used in governmental entities Time Frames The most common time frame is 1 year A typical approach to preparing an annual budget is to compile detailed monthly budgets To protect against uncertainties some organizations will begin the budget period by breaking down only the 1st quarter into month o As the 2nd quarter approaches managers review the budget and break it down into months Other companies prepare a rolling budget which always includes 12 months of data o As one month ends it s removed from the budget and the entire budget rolls forward 1 month Companies can revise budget estimates throughout the year 5 2 Performance Standards Standards specify the characteristics rules or guidelines that define a particular level of performance or quality Ideal versus Practical Standards Standards generally fall along a continuum based on the likelihood that they ll be achieved An ideal standard signifies perfection At the other end of the continuum are practical standards which represent a level of performance that can be attained with reasonable effort The type of standard adopted can have a behavioral impact on workers Product Standards Manufacturing companies often set standards for the maximum cost that should be incurred to produce a unit of product Such cost standards are useful in the planning budgeting process and can be helpful in evaluating how well manufacturing operations are managed In developing product standards managers much set a separate standard for each component of product cost direct materials DM direct labor DL variable manufacturing overhead VMO and fixed manufacturing overhead FMO o When the standards for all these cost components have been determined a standard cost representing the cost to produce 1 unit of product can be
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