SUMMARY OF CHAPTER 9 - ASSIGNMENT 7

Budgeting and Financial Performance Target

BY : DINI RAHMADIANTI (1610531008) – GROUP 5

NATURE OF BUDGET

Budgets are unimportant tool for effective short term planning and control in organization.
An operating budget usually covers 1 year and states the revenues and expense planned for
that year.
A. Budget Characteristics :
 A budget estimates the profit potential of the business unit
 It is stated in monetary terms, although the monetary amounts may be backed up by
non monetary amounts
 Generally covers a period of 1 year. In business that are strongly influenced by
seasonal factors, there may be two budgets per year
 It is management commmitment ; managers agree to accept responsibility for
attaining the budgeted objectives
 The budget proposal is reviewed and approved by an authority higher than the
budgetee
 Once approved, the budget can be changed only under specified condition
 Periodecally, actual financial performance is compared to budget, and variance are
analyzed and explained.

B. The Relation to Strategic Planning :

Strategic planning is the process of deciding the nature and size of several programs that must be
implemented in order to implement various organizational strategies. Both strategic and budget involve
planning, but the types of planning activities are different. The difference lies in the process, the focus
budget is 1 year while the strategic is above 1 year. Strategic planning precedes budgeting and provides
a framework in the use of budget and budget is one piece of the organization's strategic framework.

C. Contrast with Forecasting :

A budget is a management plan, with the implicit assumption that positive steps will be taken by the
budget maker to make real activities according to plan, a prediction is only an estimate of what might
happen, but does not imply that predictors will attempt to shape events so that the predictions will be
realized. As contrasted with a budget, a forecast has the following characteristics :
 A forrecast may or may not be stated in monetary terms
 It can be for anytime period
 The forecaster doesnt except responsibility for meeting the forecasted result
 Forecasts are not usually approved by higher authority
 A forecast is update as soon as new information indicates there is a change in conditions
 Variances from forecast are not analyzed formally or periodically

D. Use of Budget
1. Fine Tuning the Strategic Plan
Budgets that are completed before the beginning of the fiscal year, provide an opportunity to
use the latest available information and are based on the assessment of managers at all levels
of the organization.
2. Coordination
 Every central manager of responsibility in the organization participates in budgeting.
Furthermore, when staff assembles the pieces into an overall plan, inconsistencies arise. During
the budget preparation process, various inconsistencies were identified and solutions sought.
The budget functions as a tool to coordinate plans and actions of various units within the
organization to work according to purpose.
3. Assigning Responsibility
The budget authorizes central managers to be responsible for spending a certain amount of
money for certain purposes that have been previously determined without the need for approval
from higher authorities.
4. Basis for Performance Evaluation
The budget reflects a commitment by the manufacturer to his boss. Therefore, the budget
becomes a benchmark against which actual performance can be assessed. This commitment can
change if the underlying assumptions also change. However, the budget is the best starting point
in assessing performance. The budget assigns responsibility to each center of organizational
responsibility.

E. Content of An Operating Budget

 For organization as a whole aim for each business unit
 Classified by responsibility center
 Typically includes : revenues, production cost and cost of sales, marketing expense, logistic
expense, general and administrative, research and development, income tax, net income
 Expense may be : flexible, dicrectionary, comitted
 For one year divided into months or quarters
 Total reconciles to strategic plan

F. Operating Budget Categories

a) Revenue budgets
Contains projected sales of units multiplied by the estimated selling price. Of all the elements
of the profit budget, the income budget is the most important, but also an element that is
influenced by the greatest uncertainty. Income budgets are usually based on predictions of some
conditions for which the sales manager cannot be held responsible.
b) Budgeted Production Cost and Cost of Sales
Standard raw material and labor costs for planned volume levels from the standard mix of
products are displayed on the budget. The cost budget developed by the production manager
may not only be for the same product quantity as indicated in the sales budget.
c) Marketing Expense
Marketing expenses are expenses incurred to obtain sales. Most of the amount contained in the
budget may have been committed before the year began. Adverts must be prepared months in
advance before launch, and contracts with the media too.
d) General and Administrative Expenses
All expenses of staff units. Overall, these expenses are discretionary costs, although some of
the components are engineered costs. This post is a policy fee, so the right amount to be
authorized is often debated.
e) RnD Expenses
The RnD budget uses either of two approaches, or a combination of them. In one approach,
total amount is the focus.Another approach, aggregating the planned spending on each
approved project, plus an allowance for work that is likely to be undertaken eventhough it is
not currently identified.
f) Income Tax
Some companies do not consider income tax in preparing budgets for business. This is because
the income tax policy is set at the head office.
 OTHER BUDGETS

A. Capital Budget

Stating that capital projects have been approved, plus a number of at the same time for small projects
that do not require higher level approval. At the time of the budget, the project has been assembled into
a single package in total and checked in total. For projects that are retained (not deleted or reduced in
size), an estimated cash that will be issued every quarter is compiled. This is important to prepare a cash
flow statement.

B. Budgeted Balance Sheet

Show the balance sheet implications of decisions included in the operating budget and capital budget.
Some balance sheet parts are useful for controlling.

C. Budgeted Cash Flow Statement

Indicates how much money is needed during the year which will be supplied by retained earnings and
which must be borrowed from other outside sources, if any. This is important for financial planning.
The treasurer also needs an estimate of the monthly cash requirements as a basis for planning the type
of credit and short-term loans.

BUDGET PREPARATION PROCESS

A. Organization
Budget Department
The Budget dept., which normally reports to the corporate controller, administers the information
flow of the budgetary control system. Budget dept functions :
 Publishes procedures forms the preparation of the budget
 Coordinates and publishes each year the basic corporatewide assumption that are to be the
basis for the budgets
 Makes sure that information as properly communicated between interrelated organization
units
 Provides assistance to budgetees in the preparaion 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 years
 Coordinate the work of budget departements in lower echelons
 Analyzes reported performanced against budget, interprates the result and prepares
summary report for senior management
The Budget Committee
Consists of senior management members In some companies, CEOs make decisions without
committees. The committee reviews and approves or adjusts each budget. In large, diversified
companies, budget committees may only meet with senior operating executives to review budgets
from a business unit or group of business units.
B. Issuance of Guidelines
In the development of a strategic plan does not involve the central manager of responsibility at a
lower level. The first step in the budgeting process is to develop guidelines that regulate the
distribution of budgets to all managers. The guidelines are stated implicitly in the strategic plan,
modified according to the developments that have occurred since it was approved. The contents of
the guidelines, for example general inflation assumptions and inflation for certain items such as
wages; corporate policy on how many employees can be promoted; compensation at each level of
wages and salaries, including benefits; and the possibility to freeze recruits.
C. Initial Budget Proposal
Most responsibility centers will start the fiscal year with the same facilities, employees, and other
resources as they currently have. Then this budget is based on existing levels, which are then
modified according to the guidelines.
D. Negotiation
Many budget makers tend to budget somewhat lower incomes and somewhat higher expenses, from
their best estimates of these amounts. Therefore, the budget generated, is a target that is easier for
them to achieve. The difference between the budget amount and the best estimate is called slack. In
checking the budget, superiors try to find and eliminate slacks.
E. Review and Approval
The budget proposal is submitted through several levels that are tiered in the organization. When the
proposal reaches the top of the business unit, the analyst collects the pieces together and checks the
total.
F. Budget Revisions
One of the main considerations in preparing the budget is the procedure for revising the budget after
approval. Two general types of budget revisions:
- Procedures that allow systematic budget updating.
- Procedures that allow for revisions under certain (special) circumstances
G. Contingency Budgets
Some companies routinely prepare contingency budget that identify management actions to be taken
if there is a significant decrease in the sales volume from what was anticipated at the time of
developing the budget. The contingency budget provides a way of quickly adjusting to changed
conditions if the situations arises. If sales volume declines by 20 %, business unit managers can
determine for themselves, according to the predetermined contingency budget, actions to be taken.

BEHAVIORAL ASPECTS

Some motivational considerations in the preparation of the operating budget are explained below:

A. Participation in the Budgetary Process

Research has shown that budget participation has positive effects on managerial motivation for 2
reasons :
1. There is likely to be greater acceptance of budget goals if they are preceived as being under
managers’ personal control, rather than being imposed externally
2. Participative budgeting results in effective information exchanges. The approved budget
amounts benefit from the expertise and personal knowledge of the budgetees, who are closest to
the product/market environment.
B. Degree of Budget Target Difficulty
The ideal budget is a challenging but achievable budget. In statistical terms, this can mean that a
manager who performs well enough has a chance of at least 50% to achieve the number of goals.
One limitation of the target that can be achieved is the possibility that the business unit manager
does not do a satisfactory business when the budget is reached. This can be overcome by providing
actual working bonus payments that exceed the budget.
C. Senior Management Involvement
It is necessary that any budget system be more effective in motivating budget makers. Without
their active participation in the approval process, there will be a great temptation for budget makers
to "play around" with the system - that is, some managers will submit budgets that are easily
accessible or that contain excessive allowances for possible contingencies.
D. The Budget Department
The budget department has very difficult behavioral problems. This department must analyze the
budget in detail, and must be sure that the budget is adequately prepared and the information is
accurate. To carry out their duties effectively, members of the budget department must have a
reputation as impartial and fair people. Also have the skills needed to deal effectively with others.

QUANTITATIVE TECHNIQUES

There are several quantitative techniques in budget preparation, they are:

Simulation
Simulation is a method that makes a model according to the actual conditions, and changes the
model to develop some conclusions from the actual conditions. Budget preparation and review
is a simulation process.
Probability Estimates
Each amount of the budget is a point estimate. For example, the estimated sales are stated in a
certain amount of each type of product sold. This point estimate is necessary for supervision.

FINANCIAL PERFORMANCE TARGET

Financial performance targets can be distinguished in a number of ways. 3 important ways are in
terms of whether the targets are :

i. Model based, historical and negotiated targets

- Model-based targets provide a prediction of the performance that should ensue in the
upcoming measurement periods. When model-based targets are used in areas where
activities are programmable, they are said to be engineered targets.
- Historical Targets are derived directly from performance in prior periods.
- Some performance targets are negotiated between superioirs and subordinates such as when
division managers negotiate their profit center budgets with corporate.
ii. Fixed versus flexible targets
- Fixed targets do not vary over a given time period
- Flexible targets are changed according to the conditions faced during the period.
iii. Internal versus external targets
Almost all planning and budgeting processes involve target setting approaches that are
internally focused. Managers consider what is possible within the organization and focus
on period over period, continous improvements. But planning and budgeting processes can
also involve target setting approaches that are externally focused.