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What is a budget?
A formalized plan describing the use and source of financial and operating resources over a given time period
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PURPOSES OF BUDGETING
• Forces management planning• Motivation• Evaluation and control• Communication• Coordination• Education
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FEATURES OF A SOUNDBUDGETARY SYSTEM
Participative budgeting Frequent feedback on performance Realistic standards Controllability Flexible budgeting Multiple measures of performance Monetary and nonmonetary
incentives
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Strategic Plan
Short-TermObjectives
Short-TermPlan
Budgets
FeedbackCorrective
Action
Investigation
Comparison ofActual &Planned
Monitoring ofActual
ActivityLong-TermObjectives
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The MASTER BUDGET is a collection of various types of
budgets
Sales Production Purchases (Direct materials) Labor Manufacturing overhead Administrative Cash
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OPERATING BUDGETS
Sales plan Production plan Materials purchasing plan Labor hiring and training plan Capital spending plan Administrative and
discretionary spending plan
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Sales BudgetThe sales budget represents
the expected quantity of each type of product/service
to be sold multiplied by its expected selling price.
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Generic budget format
Amount needed for current requirements
+ Amount desired for future needs
= Total needs - What is already on hand = Amount to be acquired
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Production
Predicted sales quantity + Desired ending inventory Total needed units - Amount already on hand
(beginning inventory) Units to be produced
Note the sales
budget figure will
be the starting
point for
this budget.
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Direct Materials (Purchasing)
This budget is for planning the acquisition of raw materials to support the organization’s production needs identified in the production budget.
Units to be produced x Raw material required per unit produced Total raw material needed for production + Desired ending inventory = Total raw material needed - Inventory on hand = Raw materials to be acquired
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CAPITAL BUDGET
Purpose is to plan for the acquisition of land, buildings, and capital equipment for expansion and/or replacement.
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FINANCIAL BUDGETS
Master Budget usually presented in three forms:
A statement of expected cash flows The projected balance sheet The projected income statement
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FLEXIBLE vs. STATIC BUDGETS
Flexible budgets - those that vary with the activity level in the firm
Static budgets - those that do not change with changes in activity levels
The use of the budget data determines which type of budget is most appropriate
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BUDGETING APPROACHES
Incremental budgeting– A budgeting approach that assumes the starting point
for each budget item is the amount spent on it in the previous budget
– The new budget is seen as last year’s +/- a specified increment
– Less costly but may not be strategically sound
Zero-based budgeting– A budgeting approach that assumes the starting point
for each budget item is zero– Essential feature is a review of the necessity of each
expenditure element/activity as part of the budgeting process
– More costly but more strategically sound
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DESIGNING THE BUDGET PROCESS
How should budgets be determined?
Who should be involved in the budgeting process?
At what level of difficulty should the budget be set to have the greatest positive influence on people’s motivation and performance?