Operational Budgeting and Profit Planning Essay

Introduction Why reckon? dapple a work out platformning is a laborious exploit it is crucial for the success of any c totallyer-out. The calculateing summons forces managers to be proactive in political platformning for the approaching while fostering communication and coordination within a company. Different parts mustiness work together in pitch to receive a proper figure. A properly formulated reckon willing aid to define a companys objectives and provides guidelines to reduce wasted actions. Also, run a risk can be mitigated when objectives and action send offs argon clarified through the calculateing process.This phrase will identify the key components of a reckon as intumesce as the methodologies involved in the cyphering process. The influences of counselling behavior will be discussed followed by a brief example of bad budgeting practices and its consequences. higher-up work outThe master budget is a summary of a companys plans that sets concrete ta rgets for sales, proceeds, diffusion and financing activities. Companies prep be cash budget not only for operating activities but also for drop and pecuniary activities. This is because management should be aw ar in advance of any borrowing needs and when loans can be repaid. Budgets are interdependent because the figures of one budget are conventionally utilized in the preparation of another. Budget fancys are dependent on the nature of the business, its products and services, processes, shaping, and management needs. It is a detailed model of the planetary houses operating cycle that includes all internal processes which is substantial into a cash budget, a budgeted income statement, and a budgeted balance sheet.AdvantagesThe keep in line Budget defines the organizations objectives and strategies. As well as allowing the company to realistically shed upcoming cash flows, it also smoo indeeds the functioning of organizations operating cycle.DisadvantagesDisadvantages o f developing a master budget is that it is both snip consuming and highly complex. However, it should be noted that the advantages of a proper Master Budget furthermost outweighs the disadvantages.Components of the Master BudgetThe Sales Budget includes the forecast of sales revenue, sale units and sales ingathering in the future market conditions.The Purchase budget would include purchase of merchandise for sale and raw material for manufacturing. It is convey in terms of sales dollars.The Selling Expense Budget presents expenses the organization plans to incur in connecter with sales and distribution.The General and Administrative Expense Budget presents the expenses the organization plans to incur in connection with superior general administration such as the accounts department, the IT department, law etc.The Cash Budget summarizes all cash return and disbursements expected to occur during the budgeting period. After a company makes sales predictions, an organization use s information regarding credit terms, collection policy, and prior collection experience to develop a cash collection budget. Other items included are an allowance for bad debt, cash sales, sales discount, allowance for volume discounts, and seasonal changes of sales prices and collections. The cash budget shows cash operations deficiencies and surplus expected to occur at the end of each month, which is employ to plan for borrowing and loan payments.Budgeted Financial Statements are pro forma statements that reflect the asif effects of the budgeted activities on the real(a) pecuniary position of the organization. It reflects the results of operations assuming the budget predictions.Budget Development in a Manufacturing makeupManufacturing organization converts the raw materials into finished goods and sells it to the customer for consumption. It prepares the master budget before production to make the organization successful and survive in a matched environment. For example, a Bicycle manufacturer will plan a Master Budget in the following fashionA Sales Budget will be habitationd on the anticipation of sales of the Bicycle and pricing policy, expected number of units to be sold and the revenue generated.Once the sales budget is completed the Production Budget will bring in the total volume of Bicycle units to be manufactured based on the targeted sales and inventory take to maintain sales. For example, if the expected number of sales of Bicylces for the month of January is 500 units, the production budget will plan for 650 units (Sales tolerateed (500) + inventory as per company s strategy (30%)).The Purchase budget will be obtained based on volume of Bi Cycles to be manufactured, material unavoidable to manufacture a angiotensin converting enzyme unit and the cost of materials. As per the above example, the material required for 650 units will be budgeted for the month of January.The Manufacturing equal Budget will be derived from the cost of ma king 650 units of bicycles using the design of product and process use to manufacture while considering the raw material cost, direct labor cost and manufacturing over headed cost.Finalizing the BudgetFor expeditious and effective budgeting two questions must be addressed Is the proposed budget feasible?Is the proposed budget acceptable?To be feasible the organization must be able to implement the proposed budget. Possible actions include obtaining equity financing, eff long-term debt, reducing the amount of inventory on hand, or obtaining a line of credit. Constraints for infeasibility are availability of merchandise and production capacity for a manufacturer. When evaluating the budget, management must consider various financial ratios such as return on assets, profit margins, etc. The company must compare the return provided by the proposed budget, the past budget and industry average as well as the organizations goals.Budgeting MethodologiesInput/Output ApproachCompanies using the Input/Output approach calculate the required commentary or resources through estimating the potential drop getup or exercise. For example, if a microchip manufacturing plant requires 5 grams of coat to create one microchip and each gram be $2, then each microchip costs $10 of material. Thus, a projected output of 1000 microchips would cost $10,000 and 5 kilograms of material. This approach is mainly used for industries with a measurable relationship in the midst of effort and return, such as manufacturing, service, and merchandising but is not compatible with industries that are inelastic to unit take changes.Activity-based ApproachThe Activity-based Approach is subset of the Input/Output which reduces the potential for error by determining cost through evaluating the cost of each activity in the manufacturing process rather than focusing on inputs such as machine or labor hours. Thus, the approach provides a more accurate picture of costs involved by providing costs at each level of production. It results in a more streamlined budget by allowing the identification of the optimal set of activities. However, it is far more time consuming to produce.Incremental ApproachA budget prepared using the preceding year budget as a base with roughly percentage increase or drop-off is called incremental budget. Budgetjustification is to be given only for the percentage change not for the base amount (previous years budget). This type of budget is best suited for non-profit organizations, government organizations or in organizations in which the amount of output is weakly correlated to the money spent. For example, the Boston Public School budget for FY12 increased by 1.2% from the FY 11 and for FY11 it increased by 0.4% of the FY 10 budgets (OBM 2011, 2012). The increase in both budgets was confirm as improving opportunities for English Language learners, arts and physical education, but not for their existing programs. The advantages of this budget are that it is easy to practice, quick preparation, stability and conflict avoidance between departments due to different budget approval. Some of the main disadvantages are at that place is no incentive to reduce expense as peopmsle are tempted to spend the allotted expense so that their future budget is not affected. Also, no room for ripe changes to the budget is given.Minimum Level ApproachIn this type of approach a minimum budget level is fixed for carrying out ongoing projects and activities and anything above the budget should be justified. For example, the R&D budget in a pharmaceutical company is fixed for ongoing projects and new projects must be okay by the management. Main advantages are ongoing projects will not be disturbed due to budget changes and last year budget will not be approved without revision as in the case of Incremental approach.The Minimum level approach is considered as Zero Level Budgeting in some organizations in which for every amount spent, justificat ion must be (TWF n.d.). For example if an R&D department of an Electronics manufacturer puts forth many project proposals to the management , based on the market trend and project feasibility, the management will approve the most profitable project. Advantages of this method are that allocation of resources is very efficient and detects inflated budgets. However, this method consumes a significant amount of time and resources.Manager BehaviorTop-down vs. bottom-upIn addition to macro methods of budgeting (Input/output, activity based, incremental, and minimum level) there is also a distinction between top-down/imposed and bottom-up/participative budgets. These two methods represent reverse extremes of a spectrum of which a companys budgeting procedure may fall on any point.As the name suggests, a Top-down Budget is formulated by a small number of high ranking managers who make all decisions regarding a companys objectives which are then received by the overturn managers who implem ent the plan. Because only a few people are involved in the decision making, it is quick and saves time. It also avoids the cushion that is lower management ladder to build into their budgets. However, because only a few people are involved in the decision-making process, those not involved may lack the motivation and commitment to properly implement the plan.On the opposite end of the spectrum is the Bottom-up process of budgeting. It begins at the lowest possible management level, whose budget plan is then integrated with the proposals at the next level. The process is continued until a comprehensive holistic budget is developed for the company. The Bottom-up process ensures that managers at each level clearly understand their roles in meeting company objectives. Therefore, budgets are usually far more accurate and employees are more committed to their self-made budget. However, inefficiencies tend to occur with a bottom-up process. Managers tend to provide a budgetary slack (und erstating revenues or overstating expenses) in order to provide a cushion against underperformance or unfavorable reviews. While this may cause wasteful spending, it can provide funds to reduce risky activities of which there is insufficient information.Budgeting PeriodsThere are terzetto types of budgeting periods used by companies Fixed-length, Life Cycle and Continuous/Rolling Budgets. The type of period used is rigid by the context of the budget. Most companies use fixed-length budgets determined at the beginning of a specified period. However, for individual projects, a Life Cycle budget is more attractive, where a companydetermines the budget for the entire project especially if the project occurs within a period or over multiple periods. A free burning budget may be more useful than a fixed-budget as it forces managers to be continually update their budget. Where a one-year budget plan is only available at the beginning of the year, a 4 quarter rolling budget requires ma nagers to continually incur a budget plan for a unharmed year at the beginning of each quarter, thus, sustaining the budgets relevancy.Forecasts, Ethics, and go around Book ManagementIn addition to deciding methodologies of budgeting, a manager must also consider company forecasts, ethics and employee support. A manager must allow for the development of various forecasts and consider them during the budgeting process. Industry forecasts, such as economic conditions, as well as internal forecasts, such as collection periods, should be factored into the budget.Because ethical issues regarding budgeting are rarely illegal, there is a strong incentive to either pad the budgetary slack or overstate performance. Organizations should be firm in their rules against unethical behavior as it is easy to fall into a moral colorise area.Finally, in order to properly motivate employees by gaining support for the budget, many companies present adopted an Open Book Management approach. The app roach involves interacting with employees by sharing information and teaching employees to understand the relevant financial information.Sample AnalysisA well formulated budget is crucial in order to promote a companys operations. However, when a companys budget is poorly formulated, it can have disastrous consequences. An example is OGX Petrleo e Gs Participaes S.A. owned by Eike Batista. At the companys peak in 2009, it achieved an IPO of $3 billion (Spinetto et al. 2013). However, the company filed for bankruptcy on Oct. 30, 2013 with debts of $5.11 billion with Batista being sued for violations of disclosure ruels (Fontevecchia 2013). While its failure was due to a variety of factors, we will deliberate that poor budgetingis a crucial factor.Within the petroleum industry, the exploration and production process is both a high risk and high expense venture where predicted outputs require complex calculations (Suslick et al. 2009). Even after production has begun, the projected o utput may change depending on a variety of variables (Katusa 2012). OGX had calculated potential output at 4.8 billion barrels and therefore invested heavily into the required infrastructure based on this estimate (Spinetto 2013). However, these decisions were made before the wells were operational which resulted in final outputs at roughly 50% of the initial amount (Katusa 2012).Management decisions at OGX were made by Bastista and a small group of managers and its inputs were based on an estimation of outputs (Katusa 2012, Spinetto 2013). In addition, performance was highly overstated due to Batistas tendency to shoot the messenger (Spinetto 2013).Therefore, OGX should have adopted a bottom-up minimum level approach of budgeting as well as adopting a policy of reporting performance after confirmation. A bottom-up approach would have generated a frequently more precise picture of performance and costs while a minimum-level approach would have required confirmation of projected out puts before beginning operations at the cost of time. In addition, reporting performance after confirmation would have avoided any overstatements of performance.ConclusionTo be successful in a competitive environment a company must develop proper Master Budget in order to promote proactive thought, communication and coordination within a company. It is also an important aide to planning and risk management. In order for a company to run smoothly, the Master Budget must balance all the variable constituents of a companys operational activities. In addition, methodologies used, while utilized at the managements discretion, should reflect the context of the companys operations. As illustrated in the OGX example, failure to properly develop a budget can have catastrophic consequences to a company.ReferencesCity of Boston Office of Budget Management (OBM). 2011. Summary Budget. Retrieved Oct. 2013 from http//www.cityofboston.gov/images_documents/02%20Summary%20Budget_tcm3-16341.pdfCity o f Boston Office of Budget Management (OBM). 2012. Summary of Budget. Retrieved Oct. 2013 from http//www.cityofboston.gov/images_documents/02%20Summary%20Budget%20A_tcm3-24767.pdfEaston, P.D., Halsey, R.F., McAnally, M.L., Hartgraves, A., & Morse, W.J. 2013. Financial & managerial Accounting for MBAs 3rd Ed. Cambridge Cambridge Business Publishers.Fontevecchia, A. 2013. Death of the brazil-nut treeian Dream Ex-billionaire Eike Batistas OGX Files for Bankruptcy. Forbes, Oct. 30. Available at http//www.forbes.com/sites/afontevecchia/2013/10/30/death-of-the-brazilian-dream-ex-billionaire-eike-batistas-ogx-files-for-bankruptcy/Katusa, M. 2012. Brazilian Oil Dreams Get a Sobering Reality Check. Casey Research, July 2012. Available at http//www.caseyresearch.com/cdd/brazilian-oil-dreams-get-sobering-reality-checkSpinetto, J.P., Millard, P., & Wells, K. 2013. How Brazils Richest Man Lost $34.5 Billion in a Year. Bloomberg Businessweek. (October) 60-65.Suslick, S.B., Schlozer, D., & Rodrigu ez, M.R. 2009. Uncertainty and Risk Analysis in Petroleum Exploration and Production. Terrae 6 (1) 30-41.