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Master Budgets and Performance Planning
Managers must ensure that activities of employees and departments contribute to meeting the company’s
overall goals. This requires coordination and budgeting.
Budgeting, the process of planning future business actions and expressing them as formal plans, helps to
achieve this coordination. A budget is a formal statement of a company’s plans, expressed in monetary
terms. Unlike long-term strategic plans, budgets typically cover shorter periods such as a month, quarter, or
year. Budgets are useful in controlling operations. The budgetary control process refers to management’s
use of budgets to see that planned objectives are met.
The budgetary control process involves at least four steps: (1) develop the budget from planned objectives,
(2) compare actual results to budgeted amounts and analyse any differences, (3) take corrective and
strategic actions, and (4) establish new planned objectives and prepare a new budget.
When a company is in its first years of activity, it starts to think about the identification of the strategy and
the missions and goals. The long-term plan must be splitted in annual plans the budgeting; then it needs
to be transformed to actual activities to put in practice. Finally the company needs to monitor the results to
see if they coincide with the expectations. If they don’t meets them the companies need to reconsider the
activities put in practice in order to understand which are the problems and which are the activities that
needs to be modified. The plans can be modified also based on the situation in the market (crisis,
pandemic,…) that can affect the results foreseen and the actions put in place.
Budgets provide standards for evaluating performance and can affect the attitudes of employees evaluated
by them. Budgeted levels of performance must be realistic to avoid discouraging employees. Employees
who will be evaluated should help prepare the budget to increase their commitment to it. Performance
evaluations must allow the affected employees to explain the reasons for apparent performance
deficiencies, rather than assigning blame.
Why do we produce budgets?
To aid the planning of actual operations: by forcing managers to consider how conditions might
change and what steps should be taken now and by encouraging managers to consider problems
before they arise.
To co-ordinate the activities of the organization: by compelling managers to examine relationships
between their own operation and those of other departments.
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To communicate plans to various responsibility centre managers: everyone in the organization
should have a clear understanding of the part they are expected to play in achieving the annual
budget, by ensuring appropriate individuals are made accountable for implementing the budget.
To motivate managers to strive to achieve the budget goals: by focusing on participation and by
providing a challenge/target.
To control activities: by comparison of actual with budget (attention directing/management by
exception).
To evaluate the performance of managers: by providing a means of informing managers of how
well they are performing in meeting targets they have previously set.
Stages in the budgeting process:
1. Communicate details of budget policy and guidelines to those people responsible for preparing the
budget.
2. Determine the factor that restricts output.
3. Preparation of the sales budget.
4. Initial preparation of budgets.
5. Negotiation of budgets with higher management.
6. Co-ordination and review of budgets.
7. Final acceptance of budgets.
8. Ongoing review of the budgets.
A bottom-up process is usually more useful than a top-down approach in which top management passes
down the budget without input.
Benefits of written budgets include:
Planning: A budget focuses on the future opportunities and threats to the organization. This focus
on the future is important because the daily pressures of operating an organization can divert
management’s attention from planning. Budgeting makes managers devote time to plan for the
future.
Control: The control function requires management to evaluate (benchmark) operations against
some norm. Because budgeted performance considers important company, industry, and economic
factors, a comparison of actual to budgeted performance provides an effective monitoring and
control system. This comparison assists management in identifying problems and taking corrective
actions if necessary.
Coordination: Budgeting helps to coordinate activities so that all employees and departments
understand and work toward the company’s overall goals.
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Communication: Written budgets effectively communicate management’s specific action plans to
all employees. When plans are not written down, conversations can lead to uncertainty and
confusion among employees.
Motivation: Budgets can be used to motivate employees. Budgeted performance levels can provide
goals for employees to attain or even exceed. Many companies provide incentives, like cash
bonuses, for employee performance that meets or exceeds budget goals.
Budgets can be a positive motivating force when: affected employees are consulted; goals are challenging
but attainable; and evaluations offer opportunities to explain differences between actual and budgeted
amounts.
Managers must be aware of potential negative outcomes of budgeting. Some employees might understate
sales budgets and overstate expense budgets to allow themselves a cushion; sometimes pressure to meet
budgeted results leads employees to engage in unethical behaviour or commit fraud; and some employees
might always spend their budgeted amounts, even on unnecessary items, to ensure their budgets aren’t
reduced for the next period.
Budget Reporting and Timing
The budget period usually coincides with the company’s fiscal year. To provide specific guidance to help
control operations, the annual budget usually is separated into quarterly or monthly budgets. These short-
term budgets allow management to periodically evaluate performance and take corrective action.
Many companies apply continuous budgeting by preparing rolling budgets. In continuous budgeting, a
company continually revises its budgets as time passes. In a rolling budget, a company revises its entire set
of budgets by adding a new quarterly budget to replace the quarter that just elapsed.
The rolling budget reflects an annual budget composed of four quarters, prepared four times per year using
the most recent information available. When continuous budgeting is not used, the fourth-quarter budget
is nine months old and perhaps out of date when applied.
Master Budget Components
The master budget is composed by many budgets: the master budgeting process typically begins with the
sales budget and ends with a cash budget and budgeted financial statements. The master budget includes
individual budgets for sales, production (or purchases), various expenses, capital expenditures, and cash.
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