Strategic plans specify long term (5 years or more) strategic orientations for the company;
Capital budgets forecast cash flows for specific assets over their useful life;
Operational budgets are financial syntheses of company’s operations for the next year.
Budgeting process
Sales budget: sales volume forecast, revenues, cash sales, sales on accounts, collection,
accounts receivable;
Production and purchasing budget: volume of production, inventory consumption,
production costs, cash purchases, purchases on account, inventories, payments, accounts
receivable;
Administrative budget: cash purchases, purchases on account, payments, accounts
receivable;
Pro-forma financial statements: budgeted income statement, balance sheet, and cash flow
statement.
Criticism of budgets
- Time consuming
- Obsolete even before it is completed
- Foster inertia and a mechanical renewal of past actions and expenses
- Provide an incentive to lie to build slack and cheat to meet targets
Budget Base Zero (BBZ) prevents mechanical renewal of past expenses by starting from
scratch every year;
Activity-Based Budgeting (ABB) improves accuracy and make the process faster by relying
on the knowledge of resource consumption built in Activity-Based costing systems;
Balanced Scorecards complements financial metrics with non- financial metrics informing
about long-term performance drivers.
Beyond Budgeting techniques simplify the process, maintain a constant 12-month window
with rolling forecasts, use external benchmarks rather than negotiated targets, and
disconnect capital budgeting from operational budgeting.
Volume variances are changes in profit due to differences between actual and budgeted
(sales) volumes;
Usage variances are changes in profit due to differences between actual and budgeted
consumption of resources per unit (material, labor);
Price variances are changes in profit due to differences between actual and budgeted prices
of products or resources.
Flexible budget variance: Qa * ((Pa-Vca)-(Pb-Vcb)) – (FCa-FCb)
, Favourable -> Increases profit = -
Unfavourable -> Decreases profit = +
Investigation of the sources of variances:
- Variances are not evidences, but ambiguous cues: you need to investigate further;
- Make hypotheses explaining not only isolated variances, but the overall pattern of
variances;
- Collect more information to disambiguate the variance report, supporting some
hypotheses and dis-confirming others.
The company performed better (worse) than expected because:
- Budgeted standards and targets were not ambitious enough (unrealistic);
- Employees were more (less) motivated;
- Employees were (not) well trained;
- Employees had better (worse) working conditions, tools, or materials to work with;
- The environment was more (less) favorable; employees sacrificed (worked on)
performance dimensions not captured by the budget.
Differential analysis is a method to compute quickly the short-term economic impact of a
decision to make the best possible use of available resources from the decision-maker’s
perspective.
A cost or benefit is only relevant if it is a potential future cash flow, affected by the decision
and affecting the person of interest.
Capital budgets forecast cash flows for specific assets over their useful life;
Operational budgets are financial syntheses of company’s operations for the next year.
Budgeting process
Sales budget: sales volume forecast, revenues, cash sales, sales on accounts, collection,
accounts receivable;
Production and purchasing budget: volume of production, inventory consumption,
production costs, cash purchases, purchases on account, inventories, payments, accounts
receivable;
Administrative budget: cash purchases, purchases on account, payments, accounts
receivable;
Pro-forma financial statements: budgeted income statement, balance sheet, and cash flow
statement.
Criticism of budgets
- Time consuming
- Obsolete even before it is completed
- Foster inertia and a mechanical renewal of past actions and expenses
- Provide an incentive to lie to build slack and cheat to meet targets
Budget Base Zero (BBZ) prevents mechanical renewal of past expenses by starting from
scratch every year;
Activity-Based Budgeting (ABB) improves accuracy and make the process faster by relying
on the knowledge of resource consumption built in Activity-Based costing systems;
Balanced Scorecards complements financial metrics with non- financial metrics informing
about long-term performance drivers.
Beyond Budgeting techniques simplify the process, maintain a constant 12-month window
with rolling forecasts, use external benchmarks rather than negotiated targets, and
disconnect capital budgeting from operational budgeting.
Volume variances are changes in profit due to differences between actual and budgeted
(sales) volumes;
Usage variances are changes in profit due to differences between actual and budgeted
consumption of resources per unit (material, labor);
Price variances are changes in profit due to differences between actual and budgeted prices
of products or resources.
Flexible budget variance: Qa * ((Pa-Vca)-(Pb-Vcb)) – (FCa-FCb)
, Favourable -> Increases profit = -
Unfavourable -> Decreases profit = +
Investigation of the sources of variances:
- Variances are not evidences, but ambiguous cues: you need to investigate further;
- Make hypotheses explaining not only isolated variances, but the overall pattern of
variances;
- Collect more information to disambiguate the variance report, supporting some
hypotheses and dis-confirming others.
The company performed better (worse) than expected because:
- Budgeted standards and targets were not ambitious enough (unrealistic);
- Employees were more (less) motivated;
- Employees were (not) well trained;
- Employees had better (worse) working conditions, tools, or materials to work with;
- The environment was more (less) favorable; employees sacrificed (worked on)
performance dimensions not captured by the budget.
Differential analysis is a method to compute quickly the short-term economic impact of a
decision to make the best possible use of available resources from the decision-maker’s
perspective.
A cost or benefit is only relevant if it is a potential future cash flow, affected by the decision
and affecting the person of interest.
