Strategic Planning and Budgeting Process

Strategic planning setting long-term goals that may extend 5 to 10 years into the future. Long-term loosely detailed budgets are often created to reflect expectations for these long-term goals. After the goals are set, management designs key strategies for attaining these goals. Companies usually prepare a budget for every month of the fiscal year.

·A rolling budget is a budget that is continuously updated so that the next 12 months of operations are always budgeted.

Who is Involved in the Budgeting Process?

·Participative budgeting involves the participation of many levels of management. It helps create more realistic budgets and it has more acceptance by managers. It also has some disadvantages, such as higher complexity and it involves more time consumption. Managers may also build slack into the budget for their areas of operation by overbudgeting expenses or underbudgeting revenue.

·In the end, a budget committee will review the submitted budgets, remove unwarranted slack, and revise and approve the final budget.

Starting Point for Developing the Budgets

·Prior year’s budgeted figures or actual results modified to reflect

• New products, customers, or geographical areas
• Changes in the marketplace caused by competitors
• Changes in labor contracts, raw materials, and fuel cost
• General inflations
• Any new strategies

·Zero-based budgeting
oBeginning with a budget of zero and must justify every dollar. It is very time consuming and labor intensive.

The master budget is the comprehensive planning document for the entire organization. It consists of all of the supporting budgets needed to create the company’s budgeted financial statements.

master budget: operation budget, capital expenditures budget, financial budget

The operating budgets are the budgets needed to run the daily operations of the company. The starting point is the sales budgets because it affects other components of the master budget.

The financial budgets include the capital expenditures budgets and the cash budgets. The capital expenditures budget shows the company’s plan for purchasing, property, plant, and equipment. The cash budget projects the cash that will be available to run the company’s operations. The budgeted balance sheet forecasts the company’s position at the end of the budget period.

Gross book value is the historical cost of the assets. The net book value is the historical cost of the assets less accumulated depreciation.

The transfer price is the price charged for the internal sale of product between two different divisions of the same company.

Vertical integration is the practice of purchasing other companies within one’s supply chain

PV = Amount of each cash inflow x (Annuity PV factor for i=14%, n=5)

The accounting rate of return capital budgeting method uses accrual

Management minimum desired rate of return on an investment is discount rate

Performance report: compares actual revenues with budgeted

Direct materials budget: Manufacturing

Management by exception: look at the size of the variances of actual and budgeted results

Profit center: financial result that compares Favorable and Unfav in the variances

The Payback Period

provides management with valuable information on how fast the cash invested in the asset will be recouped.

The Accounting Rate of Return

indicates the profitability of the investment with respect to its impact on operating income. uses accrual accounting income

Net Present Value and Internal Rate of Return

factor in the time value of money, so they are more appropriate for longer-term capital investments.

oFocus on Cash Flows

GAAP is based on accrual accounting, but capital budgeting on cash flows. The desirability of a capital asset depends on its ability to generate net cash inflows—that is, inflows in excess of outflows—over the asset’s useful life.