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Chapter 9
The Use of Budgets in
Planning and Decision
Making
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Budgeting for Planning, Operating,
and Control Activities
The Budget Development Process
• Budgeting is much more than a number
crunching exercise. It is a management
task that requires a great deal of planning
and input from a broad range of
managers in a company.
• While it is time-consuming, the use of
spreadsheets, such as Microsoft Excel,
makes the process much simpler.
The Budget Development Process
Budgets are more
than crunching
numbers.
Zero-based
budgets require
managers to
build budgets
from the ground
up each year
rather than just
add a percentage
increase to last
year’s numbers.
Companies often use rolling budgets. As the oldest
month rolls off the analysis, the newest month is
added.
Participatory Budgeting
Participatory budgeting starts with departmental
managers and then flows up through middle management
and ultimately to top management. At each level, budget
estimates are prepared and then submitted to the next
level of management, which has responsibility for
reviewing the budget and negotiating any changes that
need to be made.
Top
Management
Middle
Managers
Departmental
Managers
1
Advantages
of Budgeting
2
Encourages communication
throughout the organization
Encourages a future focus
3
Helps identify bottlenecks and
constraints
4
Increases coordination and
goal congruence
5
Defines goals and objectives as
standards of performance
Master Budget- Manufacturing Company
Master Budget- Merchandising Company
The Sales Budget
Sales Forecasting Factors
Historical data, such as sales trends
General economic trends or factors
Regional and local factors expected to affect sales
Anticipated price changes for purchasing and sales costs
Anticipated marketing or advertising plans
The impact of new products or changes in product mix
Other factors, such as political and legal events
Production Budget
• For manufacturing companies, the
next step in the budgeting process is
to complete the production budget.
Once the sales volume has been projected,
companies must forecast how many units
of product to produce in order to meet the
sales projections.
Material Purchases
Budget
• Because many traditional companies desire to
keep materials on hand at all times in order to
plan for unforeseen changes in demand, the
desired ending inventory for materials must be
added to the projected production needs for
materials to arrive at the total expected needs
for materials,.
• Then an adjustment is made for any raw
materials inventory on hand at the beginning of
the month.
Direct Labor and Manufacturing
Overhead Budgets
The direct labor budget starts with the production
budget and is prepared by multiplying the units to
be produced by the number of direct labor hours
required to produce each unit.
Preparation of the manufacturing overhead budget involves
estimating overhead costs (using plantwide or departmental
predetermined overhead rates or activity-based costing). For
example, a company might use a plantwide cost driver like
machine hours.
Cash Budgets
Many managers consider managing cash flow to
be the single most important consideration
in running a successful business.
Cash budgeting forces managers to
focus on cash flow and to plan for the
purchase of materials, the payment of
creditors, and the payment of
salaries.
Budgeted Financial Statements
The set of operating budgets and budgeted
financial statements form an interrelated set of
planning tools that are vital for managers’
decisions affecting:
(1) the number of units to produce,
(2) the amount of materials to purchase,
(3) how many employees to schedule for a
particular time period (and when to schedule
training, for example),
(4) the timing of major acquisitions and sales of
equipment, and
(5) the overall management of cash.
Budgets for Merchandising and
Service Companies
The budgeting process for merchandising and
service companies is similar to that of
manufacturing companies, with a few
important differences.
The key areas of budgeting for service
companies is the labor budget and detailed
budget of expected overhead expenditures
(like rent, utilities, insurance, etc.).
Merchandising Companies
• While merchandising companies will prepare a sales budget,
they will not prepare budgets for production, direct material
purchases, direct labor, or manufacturing overhead.
• They will prepare a purchases budget (for goods to be sold to
customers) based on the projections in the sales budget.
• In addition, many merchandising companies hold some level
of merchandise inventory and will need to estimate desired
inventory balances and adjust sales projections accordingly.
• The preparation of selling and administrative expense budgets,
cash budgets, and budgeted financial statements in
merchandising companies is similar to that in manufacturing
companies.
Static Versus Flexible
Budgets
• Static budgets are established at the
beginning of the period for one
activity level.
• Static budgets are useful for
planning and operating, but not for
control.
• Flexible budgets take differences in
cost owing to volume differences
out of the analysis.
• This allows comparison of budgeted
amounts to actual results so causes
can be found for differences.
End of Chapter 9