STRATEGIC COST MANAGEMENT

CHAPTER 5 - STRATEGY AND THE MASTER BUDGET

ROLE OF A BUDGET
Budget – financial plan of the resources needed to carry out tasks and meet financial goals.
- It is also a quantitative expression of the goals the organization wishes to achieve and the cost of
attaining these goals.

Budgeting – act of preparing a budget.

Budgetary control – use of budgets to control a firm’s activities.

 Budgets and the budgeting process are intertwined with all aspects of management.
 Budget plays an important role in allocating resources, coordinating operations, identifying
constraints and limitations, and communicating expected actions and results, authorizing
activities, motivating and guiding implementation, providing guidelines for control of operations,
managing cash flows, and serving as criteria in performance evaluations.
 Budgets help firms to run smoother operations to achieve better results.
 The objective of budgeting is to substitute deliberate, well-conceived business judgement for
accidental success in enterprise management.

IMPORTANCE OF STRATEGY IN BUDGETING

Formulation of Strategy – is the process of using a structured approach to form to ensure financial
resources are used effectively and determine the company’s direction towards its desired goal.

Development of a Firm’s Product Strategy – a high level plan that defines how a product will meet key
goals across its entire lifecycle. But, over time market conditions, technology, and customer preferences
change evolves from time to time.
Strategic Goals and Long-Term Objectives – strategic goals is a High level, long-term objectives that
overall aims to guide the organization’s direction and decision-making. Long term objectives is usually
include specific improvement need to be achieved to realize strategic goals.

Long Range Planning – long-range planning can be defined as a process used to envision a desired future
and translating this vision into defined goals coupled with the organization’s future plan.
Short-term Objectives and the Master Budget - the word itself short term objectives is a goal that you
want to do within a brief period, it can mean that it is today. Master budget is a comprehensive financial
planning document that consolidates various individual budgets of a business, projecting all financial
aspect over a specified period.

Relationship between Strategic Goals – a goal is defined as the result which an individual company plans
to accomplish while a strategy is defined as the method by which the goal is achieved. Strategic goals
within an organization are interconnected and should be developed and managed with an understanding
of their mutual impact.

THE MANAGEMENT PROCESS OF PREPARING THE MASTER BUDGET

Top Management Involvement – ensures that budget guidelines are being followed through the budget
review and approval process.

Organization for Budget Preparation – it is essential that the manager of an entity assigns the most
qualified personnel to the preparation of the budget.

 A budget committee with representation from the different functional areas is generally
considered an effective body to oversee preparation and administration.
 The controller may be selected to serve as head of the committee for two major reasons:
1. Controller’s position is independent from the operating parts of the organization.
2. He has the skills and experiences in coping with the intricacies of setting up a budget.
Budget Guidelines – set the tone for the budget and govern budget preparation.
The Budget Period - the period covered by a budget should be long enough to show the effect of
managerial policies but short enough so that estimates can be made with reasonable accuracy.

Different Types of Budgets

1. Master Budget – is an overall financial and operating plan for a coming fiscal period and the
coordinated program for achieving the plan.
2. Capital Budgets – is a long range budgets which incorporate plans for major expenditures for
plant and equipment or the addition of product lines.
3. Responsibility Budgets – which are segments of the master budget relating to the aspect of the
business that is the responsibility of a particular manager are often prepared monthly.
4. Cash Budgets – may be prepared on a day-to-day or monthly basis.

Continuous Budgeting Plan – budgets are constantly reviewed and updated.

The Initial Budget Proposal – in preparing an initial budget proposal, the following factors should be
considered by a budget unit.
Internal factors:
 Introduction of new products
 Adoption of new manufacturing processes
 Changes in availability of equipment or facilities
 Changes in product design or product mix
 Changes in expectations or operating processes of other budget units that the budget unit
relies on for its input materials or other operating factors
 Changes in other operating factors or in the expectation or operating processes in those
other budget units that rely on the budget unit to supply them components
External factors
 Competitor’s actions
 Changes in the labor market
 Availability of raw materials or components and their prices
 Industry’s outlook for the near term
Budget Negotiation, Review and Approval, Revision – the head of the budget units examines the initial
budget proposal to determine whether the proposal is within the budget guidelines.
Master Budget – a comprehensive budget for a specific period, it consists of many interrelated operating
and financial budgets.

Steps in developing a master budget:

1. Establish basic goals and long-range plans for the company.
2. Prepare sales forecast for the budget period.
3. Estimate the cost of sales and operating expenses.
4. Determine the effect of budgeted operating results on assets, liabilities, and ownership equity
accounts.
- The cash budget is the largest part of this step.
5. Summarize the estimated data in the form of a projected income statement for the budget
period.

Preparation of Comprehensive Master Budget

 Sales budget – foundation on which all other short-term budgets are built.
Sales forecast is made after consideration of the following factors:
1. Past sales volume
2. General economic and industry conditions
3. Relationship of sales to economic indicators
4. Relative product profitability
5. Market research studies and competition
6. Pricing advertising and other promotion policies
7. Production capacity
8. Quality of sales force
9. Seasonal variations
10. Long-term sales trends for various products
  Production budget – key factor in the determination of other budgets, including the direct
materials budget, the direct labor budget and the manufacturing overhead budget.

 Raw materials budget – after determining the number of units to be produced the raw materials
purchases can now be prepared.

 Direct labor budget

 Overhead costs budget

 Budgeted cost of sales

 Marketing and administrative expense budget

 Cash Budget
o Cash receipts
o Cash disbursements

 Budgeted income statement – prepared after the cash budget showing the net income that is to
be expected during the budget period.

 Budgeted statement of financial position – developed by beginning with the current statement
of financial position and adjusting it for the data contained in other budgets.

Budgeting in service industries – budgeting in service industries are similar to manufacturing and
merchandising firms. But, service industries don’t have tangible goods. Thus, budgeting in service
industries is centered around managing human resources efficiently, accurately forecasting revenue,
controlling operational cost, and ensuring client satisfaction to drive growth.

Budget in not-for-profit organization – not-for-profit organization primary focus is fulfilling the

organization’s mission rather than profit generation. Not-for-profit organization relies on donations,
fundraising events, and sometimes sales and service fees. Budgeting in no-for-profit organization
organizations is centered around mission fulfillment and efficient utilization of funds to maximize impact.

Budgeting in International setting – budgeting in international setting is complex because of multifaceted

challenges such as political risks, economic factors, cultural difference, risk management etc. each with
its unique economic, political, cultural environment. Proper research, flexibility, and risk management is
a must.
Alternative Approaches in Budgeting
1. Zero-Base Budgeting – is a budgeting process that requires managers to prepare budgets from a
zero base.
2. Activity-Based Budgeting – is a budgeting process based on activities and cost drivers of
operations.
3. Kaizen Budgeting – is a budgeting approach that explicitly demands continuous improvement in
operation processes and incorporates the improvements in the budget.

ETHICAL ISSUES IN BUDGETING

Ethical issues in budgeting:
Preventing concealment of information
Avoidance of having a higher budget goal
Inclusion of budget slack
Spending budget to avoid having it cut back

Goal congruence – is consistency between the goals of the firm with those of its employees.
- A budget that aligns the goal of the firm with those of its employees has much better chance of
leading to successful operations.

Authoritative budgeting – a top-down budgeting process, top management prepares budgets for the
entire organization including those for lower-level operations.
- Provides better decision-making control than participative budgeting.
- Lacks commitment on the part of the lower level managers and workers responsible for the
implementation of the budget.

Participative budgeting – a bottom-up approach that involves the people affected by the budget,
including lower-level employees in preparing the budget.
- A good communication device.
- More likely to gain the employees’ commitment to fulfill the budgetary goals.

An effective budgeting process usually combines both top-down and bottom-up budgeting
approaches.