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A Budget charts a course for a business by outlining the plans of the business in financial terms. Like a road map, the budget can help a company navigate through the year and reduce negative outcomes. Budgeting involves 1) establishing specific goals, 2) executing plans to achieve goals, and 3) periodically comparing actual results with the goals. These goals include both the overall business goals as well as the specific goals for the individual units within the business. Establishing specific goals for future operations is part of the planning function of the management, while executing actions to meet the goals is the directing function of the management. Periodically comparing actual results with these goals and taking appropriate action is the control function of management.
Planning not only motivates employees to attain goals, but also improves overall decision making. During the planning phase of the budget process, all viewpoints are considered, options identified, and cost reduction opportunities assessed. This effort leads to better decision making for the organization. As a result, the budget process may reveal opportunities or threats that were not known prior to the budget planning process.
Once the budget plans are in place, they can be used to direct and coordinate operations in order to achieve the stated goals. The budgetary units of an organization are called responsibility centers. Each responsibility center is led by a manager who has authority over and responsibility for the unit's performance. If there is a change in the external environment, the budget process can also be used by unit managers to readjust the operations.
As time passes, the current performance of an operation can be compared against the planned gaols. This provides prompt feedback to employees about their performance. If necessary, employees can use such feedback to adjust their activities in the future. Comparing the actual results against the plan also helps prevent unplanned expenditures. The budget encourages employees to establish their spending priorities.
Budgeting systems vary among businesses because of such factors
as organizational structure, complexity of operations, and management
philosophy. The budgetary period for operating activities
normally includes the fiscal year of a company. However, to achieve
effective control, the annual budgets are usually subdivided into
shorter time periods, such as quarters of the year, months or weeks.
budgets for the next fiscal year usually begins several months prior to
the end of the year. This responsibility
is normally assigned to a budget committe. Such committee
normally consists of the budget director and such high-level executives
as the controller, the treasurer, the production manager, and the sales
the budget has been approved, the budget process is monitored and
summarized by the Accounting Department, which reports to the committe.
A static budget shows the expected results of a
responsibility center for only one activity level. Once
the budget has been determined, it is not changed, even if the activity
is changing. The static budget is
used in many service companies and for some administrative functions of
manufacturing companies, such as purchasing, engineering and accounting.
example, the Assembly Department manager for Colt Manufacturing Company
the static budget for the upcoming year, shown in the table below:
disadvantage of static budgets is that these do not adjust for changes
in activity levels. For example, assume that the actual amounts
spent by the Assembly department of the company Colt Manufacturing,
$72,000, which is $12,000 or 20% ($12,000 / $60,000) more than
what was budgeted. Are these good or bad news? At
first you might think that this is a bad result, but this conclusion
may not be valid because the static budget may be difficult to
interpret. To illustrate, assume
that the assembly manager constructed the budget based on plans to
assemble 8,000 units during the year. However, 10,000
units were actually produced, representing a 25% (2000 / 8000) more
than expected. Then, should the additional $12,000 in spending
in excess of the budget be considered bad news? Maybe
not, because the Assembly department provided 25% more production with
only 20% additional cost.
static budgets, flexible budgets show the expected
results of a responsibility center for several levels of activity.
think of a flexible budget as a series of static budget for different
levels of activity. Such budgets are particularly useful in
estimating and controlling factory costs and operating expenses.
constructing a flexible budget, we first identify the relevant activity
the above example there are 8,000, 9,000, and 10,000 units of
production. Alternative activity bases, such as machine
hours or direct labor hours, may be used in measuring the volume of
activity. Second, we identify
the fixed and variable cost components of the costs being budgeted.
example, in the table, the cost of electricity is separated into its
fixed cost ($1,000 per month) and variable cost ($0.50 per unit).
we prepare the budget for each activity level by multiplying the
variable cost per unit by the activity level and then adding the
monthly fixed cost.
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