BUDGETING IS CORPORATE BUDGETING BROKEN Corporate budgeting is
BUDGETING
IS CORPORATE BUDGETING BROKEN? • “Corporate budgeting is a joke […] It consumes a huge amount of executive’s time, forcing them into endless rounds of dull meetings and tense negotiations. It encourages managers to lie and cheat, low-balling targets and inflating results, and it penalizes them for telling the truth. It turns business decisions into elaborate exercises in gaming […] And it distorts incentives, motivating people to act in ways that run counter to the best interests of their companies” (Jensen 2001)
WHAT IS A BUDGET? • A detailed plan of future operating activities • A financial model of future operations • A core component of an organization’s planning and control system • A critical way of providing information to managers • Regarded as short-term planning, typically for one year
PURPOSES OF BUDGETING • Planning • Expresses a plan of action in financial terms • Communication and coordination • Allocating resources • Sharing limited resources among competing users • Controlling profit and operations • The budget can serve as a benchmark • Evaluating performance/ incentives Actual/budget comparisons help managers Budget targets may be linked to cash rewards or profit sharing
RESPONSIBILITY ACCOUNTING • Budgets usually reflect managers’ areas of • responsibility • Responsibility accounting • Managers are held responsible for their area • Responsibility centers An organizational unit that a manager is held accountable for (its activities and performance) • • Managers of various departments • Develop budget estimates for their responsibility center • They are then held responsible for meeting those budget targets
THE ANNUAL BUDGET: A PLANNING TOOL • The annual budget (or master budget) is a comprehensive set of budgets that covers all aspects of a firm’s activities • Consists of several interdependent budgets • Operating budgets • Sales budgets and various cost budgets that are directly associated with the operating activities of the organization • Financial budgets • Budgeted income statement, budgeted balance sheet, cash budget and capital expenditure budget
COMPONENTS OF THE ANNUAL BUDGET
OPERATING BUDGET DETAILS: MANUFACTURING
OPERATING BUDGETS: SALES • A detailed summary of estimated sales units and revenues • Sales volume is based on the sales forecast • Sales forecasting is a critical early stage of the budgeting process • Market research may be used to estimate sales volume, selling price, etc.
OPERATING BUDGETS: PRODUCTION • Estimates units that must be produced to meet sales needs and ending inventory requirements.
OPERATING BUDGETS: DIRECT LABOUR • Total direct labour hours needed and associated cost for the amount of budgeted production
OPERATING BUDGETS DIRECT MATERIALS
OPERATING BUDGETS: MOH • Shows expected cost of all indirect manufacturing items
FINANCIAL BUDGETS • The cash budget • Expected cash receipts period and planned cash payments for the budget • Timing of all cash movements • Allows the business to plan its financial resources • Budgeted income statement • Shows expected revenues and planned expenses for the budget period • Budgeted balance sheet • Shows expected assets and liabilities at the end of the budget period
BUDGETING’S DARK SIDE • Performance incentives facilitate undesirable management • Padding: Pushing expenses into the future to meet cost/profit targets. • Bath: Bringing expenses forward/delaying revenues where targets are unattainable. • Smoothing: When nearing targets, delaying revenues/ bringing forward expenses. • Funding incentives encourage undesirable negotiation tactics • Sandbagger (budget slack), Magician, Lone agent, Visionary, Hostage taker
BEHAVIORAL CONSEQUENCES OF BUDGETING • The previous highlights: • Individuals’ reactions to the budgeting process may affect an organization’s effectiveness • Some things to consider Participative budgeting: Where managers develop their own initial budget estimates for their own area of operations • Budgetary slack: Managers intentionally underestimate revenues or overestimate costs • Budget difficulty: Ensuring employees are motivated to achieve the budget targets as their own • Goal congruence: Aligning manager incentives to organizational goals •
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