Riordan Case Study

Budgeting Assignment

A company's budget serves as a guideline in planning and committing costs in order to meet tactical and strategic goals. Tactical goals such as providing budgetary costs for daily operations, and strategic objectives that include R&D, production, marketing, and distribution are all part of the budgeting process. Serving as a guideline rather than being set in stone, the budget is a snapshot of manager's "best thinking at the time it is prepared." (Marshall, 2003, p.496) The budget is a method in which to reign-in discretionary spending, and will likely show variances between what costs have been anticipated and what costs are actually incurred.

The Budget Process

Budgetary planning may differ between organizations. Single-period budgets and rolling budgets have methodologies that provide advantages and disadvantages that may make one budget time frame better than another. A single-period may require less time in planning during a fiscal year, but is less accurate than a rolling budget that is continuously planned on a repetitive basis. In either case, budgets are planned in advance in order for a company to operate profitably, and less so to have "actual results equal budgeted results." (p. 496)

The budget process, according to Marshall, is to "develop and communicate" how an organization' economic, industry, and organizational strategies will be effected within the budgeted time frame. (p.497) People within the organization from planners, economists, and managers contribute facets of the strategic budget process in order to meet organizational needs. Upper management then typically approves those budgets. The operating budget is the forecast of activity that encompasses the results of the budget process. Within the operating budget, an organization may see:

* Forecasts for sales and revenues.

* Forecasts for purchases and production.

* Forecasts for operating expenses.

* Income, cash, and balance sheet budget statement forecasts. (p.498)

The budget process may start with a sales forecast that describes "expected revenues from groups of products." (p. 485) Total revenues can be calculated based on a number of factors that include both the product markup as well as a fluctuating commodity price.

As a first step in the budget process, sales forecasting allows for other budgets to be planned on sales activities. Purchases and production, for example, depend on the forecasted sales and subsequent inventory levels to be managed. The operating expenses are then budgeted as a result of the sales budget and expected costs of purchasing and production (materials, labor, manufacturing) as a measure of Cost of Good's Sold.

The budgeted income statement, cash flows, and balance sheet follow in order. The income budget relies on the revenue and expense forecast from the operating budget, while the budget cash flows are planned for financial and investment activities. A final component of the budget process, the projected balance statement, can be used to tie in all the budgeting dependencies. Once a budget has been prepared, evaluation can be expected before approval. Budgetary components may require several iterations before finalizing the organizational budget.

Budgetary Assumptions

There are many assumptions that planners, economists, and managers can make regarding the budgetary hierarchy and expected forecasts. It is important to understand how conclusions are drawn in order to make these forecasts, as well as the models used in all calculations.

The purchases and production budget, according to Marshall, is an example of how changes of the Cost of Goods Sold under a periodic inventory system can reflect different meanings. The Cost of Goods Sold is the beginning inventory + purchases less the goods available for sale - ending inventory. This model can be changed to reflect physical quantities (or units) rather than currency (or dollars). The contribution margin model ratio can replace the Cost of Goods Sold ratio to increase the accuracy of the cost of goods sold for manufacturing firms, for instance. In any event, this shows that managers must know the level of validity of models used for the budgetary process, and understood by those approving a company's budget.

It is also important to understand that operating managers may exaggerate budget estimates that go beyond what the forecasted costs may really be. This is done as a contingency plan for unexpected cost increases or unplanned expenses. Additionally, managers may spend money that was over-estimated (or unspent) in ways that are misleading in order to make budgetary spending goals. Knowing that these problems exist can help upper management target weaknesses in the budget problems.

The Budget as an Analytical Tool and Eliminating Efficiencies

A company's budget can be an important method of analyzing its performance. The budget addresses all aspects of costs and spending as well as the activities within the organization that increase revenue and profits. These activities, such as labor, can be measured to understand if there is too much or too little spent on a particular product or service. Labor is a good identifier when it comes to production because it will reflect in the Cost of Goods Sold budget. Too much labor will reflect in idle time and result in opportunity costs, while too little may increase overtime and effect the quality of goods and services.

Other budgetary concerns regarding performance may be less activity-based, such as leasing too much space as a fixed cost than what is needed for production. This again, can affect the cost of goods sold for expenditures that unnecessarily increase the cost or decrease the margin of goods and services.

A variance analysis as a control process can be helpful when determining how variable costs of both materials and labor are used. For example, if the variable cost of a raw material increases or decreases, and the budget remains unaffected, this can indicate that the budget process for determining the costs of the material was over- or under-exaggerated.

The same principle can be applied when labor fluctuates; benchmarks for performance can indicate flaws in the budget process when variances occur and performance does not meet the variance. Simply put, if labor fluctuates and performance does not, management has a tool to indicate that there is a problem with the budget. By the same token, if there are no variance and performance decreases, for instance, this

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