BUDGET PREPARATION

NATURE OF A BUDGET
BUDGET- important tool for effective short-term planning and control in organizations
Operating budget- usually covers one year and states the revenues and expenses planned
for that year.
CHARACTERISTICS
It estimates the profit potential of the business unit.
It is stated in monetary terms
It generally covers a period of one year.
It is a management commitment; managers agree to accept responsibility for
attaining the budgeted objectives.
Budget proposal is reviewed and approved by an authority higher than the
budgetee.
Can only be changed once approved under a specified condition.
Periodically compared to actual financial performance where variances are analyzed
and explained.
STRATEGIC PLANNING BUDGET
-process of deciding on the nature and
size of several programs that are to be
undertaken in implementing and
RELATIONSHIP

organizations strategies.
Involves planning
Focuses on activities that extend over a Focuses on a single year
period of several years
It precedes budgeting and provides One year slice of organizations
framework where annual budget is strategic plan
developed.
Essentially structured by product lines or Structured by responsibility
other programs centers

FORECASTING BUDGET
Merely a prediction of what will most likely happen. Management plan
Usually made by the treasurers office to help in ( prepared by budgetee-
cash planning. manager)
May or may not be stated in monetary forms
It can be for any time period
Forecaster does not accept responsibility for
meeting forecasted results.
Not usually approved by higher authority
CONTRAST

Is updated as soon as new information indicates

that there is change in conditions
Its Variances are not formally or periodically
analyzed.
Examples are estimates of revenues, expenses and Includes elements of
other items that affect cash flows forecasting
Is not cleared by top management, may change
weekly or even daily without approval from higher
authority, its variances are not systematically
analyzed.
Exclusively a planning tool Both a planning and control
tool
It cannot be used for evaluation and control.
USES OF BUDGET

1. FINE TUNING THE STRATEGIC PLAN

The budget which is completed just prior to the beginning of the budget year, provides
an opportunity to use the latest available information and is based on the judgment of
managers at all levels throughout the organization. Budget preparation also provides an
opportunity to make decisions that will improve performance before a commitment is made
to a specific way of operating during the year.
2. COORDINATION

FINANCING EDUCATIONAL SYSTEM BUDGET PREPARATION ALLAN

JAYSON P. DALAWAMPU
 Every responsibility center manager in the organization participates in the preparation
of the budget. Inconsistencies during the budget preparation process are also identified and
resolved by the entire team from manager to staffs- production organization, line
organization, etc.
3. ASSIGNING RESPONSIBILITY
Approved budget should make clear what each manager is responsible for. Budget also
authorizes responsibility center managers to spend specified amounts of money for certain
designated purposes without seeking the approval of higher authority.
4. BASIS FOR PERFORMANCE EVALUATION
The budget represents a commitment by the budgetee to his or her superior. It is
therefore a benchmark against which actual performance can be judged.
Budget also assigns responsibility to each responsibility center in the organization:
Top Level individual profit centers functional areas (marketing)individual responsibility centers
(regional sales offices)

CONTENT OF AN OPERATING BUDGET

STRATEGIC PLAN
Revenue and expense for For organization as a whole and
each major program for each business unit
Not necessarily by
responsibility centers
Not as much detail as
operating budget
More expenses are variable
For several years
Total reconciles to operating
budget
OPERATING BUDGET CAPITAL BUDGET
Each major capital
project listed
separately
Classified by responsibility
centers
Typically includes:
Revenues
Production cost and cost of
sales
Marketing expense
Logistic expense (sometimes)
General and administrative
Research and development
Income taxes (sometimes)
Net income
Expenses may be:
Flexible
Discretionary
Committed
For one year divided into months
or quarters
Total reconcile to strategic plan Total project
(unless revised) expenditures by
quarters

Cash Forecast
Budgeted Balance
OPERATING BUDGET CATEGORIES Sheet

Revenue Budgets - consists of unit sales projection multiplied by expected selling prices
- Most critical of all the elements of a profit budget
- Based on forecast of some conditions for which the sales manager cannot be held
responsible
Budgeted Production Cost and Cost of Sales - standard material and labor costs of the planned
volume level of a standard mix of products are shown in the budget.
- The budgeted cost developed by the production managers may not be for the same
quantities of products as shown in the sales budget; the difference represents additions
to or subtractions from finished goods inventory.
- Cost of sales reported in the summary budget is the standard cost of the products
budgeted to be sold.
Marketing Expenses - expenses incurred to obtain sales. Considerable fraction of the amounts for
opening or closing offices and for hiring and training new personnel (or for laying off
personnel) must be well under way before the year begins including the advertising and
contracts with media.
Logistics Expenses- usually reported separately from order getting expenses and
include order entry, warehousing and order picking, transportation to the customer, and
collection of accounts receivable.

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JAYSON P. DALAWAMPU
General and Administrative Expenses- these are the G & A expenses of staff units, both at
headquarters and at business units.
- Considered as discretionary expenses- the appropriate amount to authorize is subject to
much debate.
Research and Development Expenses - not geared to short run changes in sales volume
- R&D budget uses either of two approaches:
One approach - total amount is the focus which may be the current level of spending,
adjusted for inflation, may be a larger amount
Alternative Approach- aggregating the planned spending on each approved project, plus
allowance for work that is likely to be undertaken even though it is not currently
identified.
Income Taxes- although the bottom line is income after income taxes, some companies do not take
income taxes into account in preparing the budgets for business units because income tax
policies are determined at corporate headquarters.

OTHER BUDGETS

Capital Budget- states the approved capital projects plus a lump sum amount for small projects that do
not require high level approval.
- Usually prepared separately from the operating budget and by different people.
Budgeted Balance Sheet- shows the balance sheet implications of decisions included in the operating
and capital budget.
Budgeted Cash Flow Statement- shows how much of the cash needs during the year will be supplied
by retained earnings and how much, if any, must be obtained by borrowing or from other
outside sources.
- Shows the inflows and outflows of cash during the year, usually by quarters.
Management by Objectives- a quarterly review system that makes employees accountable to
themselves. Objectives of each responsibility center are set forth in the quantitative terms
whenever possible and are accepted by the responsible manager. If nonfinancial objectives
can be stated as numbers, they may serve a useful purpose in motivating managers and in
appraising their performance.

BUDGET PREPARATION PROCESS

ORGANIZATION- Budget Department administers the information flow of the budgetary control
system. The department performs the ff functions:
Publishes procedures and forms for the preparation of the budget.
Coordinates and publishes each year the basic corporate wide assumptions that are to be the
basis for the budgets
Make sure that information is properly communicated between interrelated organization units.
Provides assistance to budgetees in the preparation of their budgets.
Analyzes proposed budgets and makes recommendations, first to the budgetee and
subsequently to senior management
Administers the process of making budget revisions during the year.
Coordinates the work of budget departments in lower echelons such as business unit and
budget departments.
Analyzes reported performance against budget, interprets the result, and prepares summary
reports for senior management.
- Budget Committee consists of members of senior management, such as CEO, COO, and
CFO. It also reviews and either approves or adjusts each of the budgets
ISSUANCE OF GUIDELINES- whether or not there is a strategic plan, guidelines must be developed
(by budget staff)initially for dissemination to all managers. It includes assumed inflation in general
and specific items such as wages, corporate policies on how many persons can be promoted,
compensation at each wage and salary level, including employee benefits, and a possible hiring
freeze.
INITIAL BUDGET PROPOSAL- using the guidelines, budget request is developed by responsibility
center managers assisted by their staffs. Budget is based on existing levels which are then
modified in accordance with the guidelines. Changes from current level of performance can be
classified as:
Changes in External Forces
Changes in general level of economic activity as it affects the volume of sales.
Expected changes in the price of purchased materials and services.
Expected changes in labor rates.
Expected changes in the cost of discretionary activities
Changes in selling prices.
Changes in Internal Policies and Practices
Changes in production costs, reflecting new equipment and methods.
Changes in discretionary costs, based on changes in anticipated workload

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JAYSON P. DALAWAMPU
 Changes in market share and product mix
NEGOTIATION - the budgetee discusses the proposed budget with his or her superior. It is considered
to be the heart of the process. The superior recognizes that he/she will become the budgetee at
the next level of the budget process and therefore, must be prepared to defend the budget that is
finally agreed to.
Slack- the difference between the budget amount and the best estimate. Many budgetees tend to
budget revenues somewhat lower, and expenses somewhat higher than their best estimates of
these amounts.
REVIEW AND APPROVAL the examination asks whether the budget will produce a satisfactory
profit. Final approval is recommended by the budget committee to CEO and is then submitted
once approved to the board of directors for ratification. It happens in December just prior to the
beginning of the budget year.
BUDGET REVISIONS if the budget assumptions turn out to be so unrealistic that the comparisons of
actual numbers are meaningless, revisions are desirable. Two types of budget revisions:
1. Procedures that provide for a systematic updating of the budget
2. Procedures that allow revisions under special circumstances.
Budget revisions should be limited to those circumstances in which the approved
budget is so unrealistic that it no longer provides a useful control device.
CONTINGENCY BUDGETS- identifies management actions that to be taken if there is a significant
decrease in the sales volume from what was anticipated at the time of developing the budget.
It also provides a way of quickly adjusting to changed conditions if the situation arises

BEHAVIORAL ASPECTS
One of the purposes of a management control system is to encourage the manager to be
effective and efficient in attaining the goals of the organization.

PARTICIPATION IN THE BUDGETARY PROCESS- a process in which the budgetee is both involved
in and has influence over the setting of a budget amount. Beneficial for responsibility centers
that operate in dynamic and uncertain environment.
Either:
Top-Down Budgeting- senior management sets the budget for the lower levels.
- Leads to lack of commitment on part of budgetees which endangers the
plans success.
Bottom-Up Budgeting- lower level managers participate in setting the budget amounts
- Generates commitment to meeting the budgeted objectives.
An effective budget preparation process prepares the first draft of the budget which is
bottom up and do so within guidelines established at higher levels which is top down.
2 Reasons for Positive Effects of Managerial Motivation
1. There is likely to be greater acceptance of budget goals if they are perceived as being under
managers personal control, rather than being imposed externally. This leads to higher personal
commitment to achieve the goals.
2. Participative budgeting results in effective information exchanges. Budgetees have a clearer
understanding of their jobs through interactions with superiors during the review and approval phase.

DEGREE OF BUDGET TARGET DIFFICULTY

Merchant and Manzoni concluded that business unit budget achievability in practice is
usually considerably higher than 50 percent. Several reasons senior management approves
achievable budgets for business unit are:
If the budgeted target is too difficult, managers are motivated to take short term actions
that may not be in the long term interests of the company.
Achievable budget targets reduce the motivation for managers to engage in data
manipulation to meet the budget.
If business unit profit budgets represent achievable targets, senior management can, in
turn, divulge a profit target to security analysts, shareholders and other external
constituencies with a reasonable expectation of being correct.
A profit budget that is very difficult to attain usually implies an overly optimistic sales
target which may lead to an overcommitment of resources to gear up for the higher
sales activity.
When business unit managers are able to meet and exceed their targets, there is a
winning atmosphere and positive attitude within the company.

SENIOR MANAGEMENT INVOLVEMENT- necessary for any budget system to be effective in

motivating budgetees

THE BUDGET DEPARTMENT- has a particularly difficult behavioral problem. It must analyze the
budgets in detail, and it must be certain that budgets are prepared properly and that the
information is accurate by acting in ways that line managers perceive as threatening or hostile.
(ex. Ensuring that budget does not contain excessive allowances). To perform effectively,
members of the department must have a reputation for impartiality and fairness.
FINANCING EDUCATIONAL SYSTEM BUDGET PREPARATION ALLAN
JAYSON P. DALAWAMPU
QUANTITATIVE TECHNIQUES

SIMULATION- a method that constructs a model of real situation and then manipulates this
model in such a way as to draw some conclusions about the real situation. (ex. Preparation and
review of budget). Computer simulation with computer software programs can be used to know
the effect of different types of changes and receive almost instantaneous answers.
PROBABAILITY ESTIMATES- Each number in a budget is a point estimate that is the single
most likely amount which are necessary for control and planning purposes
Monte Carlo Process- after a budget has been tentatively approved, substitution of a
probability distribution in each major point estimate shall be done with a computer model. The
model is then run a number of times, and a probability distribution of the expected profits can be
calculated and used for planning purposes.

FINANCING EDUCATIONAL SYSTEM BUDGET PREPARATION ALLAN

JAYSON P. DALAWAMPU