2.1. Introduction to Budgets and Preparing the Master Budget Flashcards
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What are budgets and how do budgets facilitate planning and organization?
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- budgets are condensed business plans for the forthcoming year (or less)
- are much more than simply limiting spending
helps managers to:
1. understand, plan and control organizations
2. allocate resources most efficiently
3. measure and reward performance
4. communicate about progress and developments
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Q
What are four advantages of budgeting?
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- FORMALIZATION OF PLANNING compels managers to think ahead
- EARLY WARNINGS AND OPPORTUNITIES: evaluation of existing and new activities highlights potential problems and opportunities early
- aid managers in communicating objectives and coordinating actions across the organization and provides an IMPORTANT TWO WAY COMMUNICATION CHANNEL
- provide benchmarks to EVALUATE SUBSEQUENT PERFORMANCE
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What are the Potential Problems in Implementing Budgets?
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- low level of participation in budget process and lack of acceptance of responsibility for final budget
- incentives to lie and cheat
- difficulties of obtaining accurate sales forecast
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Potential Problems in Implementing Budgets | What are the main factors affecting budget acceptance?
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- perceived attitude of top management
- level of participation
- degree of alignment between budget & other performance goals
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Potential Problems in Implementing Budgets | What can we say about incentives to lie and cheat? What can be done to stop it?
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- lying can arise if budget process creates incentives for managers to bias budget information
- increase of resources allocated to a managers department in order to reach output targets and receive higher rewards/ bonus
- “budgetary slack” or “ budgeting padding”: overstating budgeted costs or understating budgeted revenues to create budgeted profit level that is easier to achieve
- cheat: to make results appear better than they actually are
- Lying and cheating create cynicism about the budget process and culture of unethical behavior
- Reward good budget forecast and motivate managers to take personal responsibility to avoid lying and cheating.
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Potential Problems in Implementing Budgets | What are important factors to include in the sales forecast?
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- past patterns of sales
- estimates made by sales force
- general economic conditions
- competitors actions
- changes in firms prices
- changes in product mix
- market research studies
- advertising and sales promotion plans
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What types of budgets are there?
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- strategic plan
- long range plan
- capital budget
- master budget (pro forma statements)
- continuous or rolling budget
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Explain the budget:
- strategic plan
- long range plan
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- most forward looking budget; sets overall goals and objectives of the organization
- results from strategic plan; produces forecasted financial statements for five to ten year periods
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Explain the budget:
- capital budget
- continuous or rolling budget
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- coordinate long range plan; details planned expenditures for facilities, equipment, new products and other long term investments
- common form of master budgets that add a month (or quarter) in the future as the month (or quarter) just ended is dropped; budgeting as ongoing process
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Explain the budget:
Master Budget
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- Detailed and comprehensive analysis of first year of long range plan
- Summarizes planned activities of all subunits (e.g. sales, production, distribution and finance) of an organization
- Quantifies targets for sales, cost driver activity, purchases, production, net income and cash position, and any other objective that management specifies
- Links to both long range plans and short therm budgets
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Master Budget | What is the Operating budget (also: profit plan) and the financial budget?
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- two major parts of master budget
- OB: focus on income statement and its supporting schedules (in organization with no sales revenues on budgeted expenses)
- FB: focuses on effects that the OB and other plans (e.g. capital expenditures) will have on cash balances
- distinction important bc of distinction between profitability and financial position
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What can be said regarding strategy and the master budget?
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- MB is important management tool for evaluating and revising strategy
- integral part of the management process itself
- budgeting is planning and communicating in re-iterative steps and cyclic process
- essential to determine and secure (initial) funding
Examples: - (impact of) different timing of earnings in cash in- and outlfows
- detection of large cash deficiency in april
- consider new sales strategies to generate more demand
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What is the (Fully-Integrated) Financial Planning Model and what does it reflect?
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- mathematical model of master budget (often in form of connected spreadsheets)
- reflects: a. impact of all input paramteres on and b. relationship among all operating and financial activities
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What are some key aspects in what the (Fully-Integrated) Financial Planning Model can do? Possible advantages?
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- allows managers to assess predicted impacts of various alternatives before making decision
- allows making sensitivty and/ or scenario analyses
- shortens reaction time of managers dramatically
- essential tool in asset valuation
- (financial) models are only as good as assumptions and inputs used
- garbage in, garbage out: financial planning with accurate calculations but faulty assumptions or inputs
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