A budget is a realistic plan for the future that is expressed in quantitative terms.
A budget is many tools in one; it is a planning tool, a control tool, a communication tool, and a motivational tool.
As such, the area of budgeting, as tested on the CMA exam, is a composite of theory and calculations.
Some of the calculations have many steps, thus making budgeting problems among the most-missed questions on the exam.
Alternatively, budgeting should not be viewed as a difficult area; the concepts are easy, but you need to pay close attention to detail as you work numerical questions.
This study unit is the first of two on planning, budgeting, and forecasting. The relative weight assigned to this major topic in Part 1 of the exam is 30%.
The two study units are:-
Study Unit 5: Budgeting Concepts and Forecasting Techniques.
Study Unit 6: Budget Methodologies and Budget Preparation.
The main outline and titles
5.1 Roles of Budgets
5.2 The Budgeting Process
5.3 Budgeting and Standard Costs
5.4 Correlation and Regression
5.5 Learning Curve Analysis
5.6 Time Series Analysis
5.7 Expected Value
5.8 Sensitivity Analysis
5.9 Core Concepts
5.10 Essay Question
ROLES OF BUDGETS
1. The Budget as a Tool
a. The budget is a planning tool.
1) A budget is a written plan for the future.
2) Companies that prepare budgets anticipate problems before they occur.
a) EXAMPLE: If a company runs out of critical raw material, it may have to shut down. At best, it will incur extremely high freight costs to have the needed materials rushed in. The company with a budget will have anticipated the shortage and planned around it.
3) A firm that has no goals may not always make the best decisions. A firm
with a goal in the form of a budget will be able to plan.
b. The budget is a control tool.
1) A budget helps a firm control costs by setting cost guidelines.
2) Guidelines reveal the efficient or inefficient use of company resources.
3) A manager is less apt to spend money for things that are not needed if …(s)he knows that all costs will be compared with the budget.
a) (S)he will be accountable if controllable costs exceed budgeted amounts.
4) Budgets can also reveal the progress of highly effective managers.
…Consequently, employees should not view budgets negatively. A budget is just
as likely to provide a boost to a manager's career as it is to be detrimental.
5) Managers can also use a budget as a personal self-evaluation tool.
6) Budgetary slack (overestimation of expenses) must be avoided, however, if a budget is to have its desired effects.
…The natural tendency of a manager is to negotiate for a less stringent measure of performance so as to avoid unfavorable variances from expectations.
7) For the budgetary process to serve effectively as a control function, it must be integrated with the accounting system and the organizational structure.
…Such integration enhances control by transmitting data and assigning variances to the proper organizational subunits.
c. The budget is a motivational tool.
1) A budget helps motivate employees to do a good job.
a) Employees are particularly motivated if they help prepare the budget.
b) A manager who is asked to prepare a budget for his/her department will
work hard to stay within the budget.
2) A budget must be seen as realistic by employees before it can become a
good motivational tool.
3) Unfortunately, the budget is not always viewed in a positive manner. Some
managers view a budget as a restriction.
4) Employees are more apt to have a positive feeling toward a budget if some
degree of flexibility is allowed.
d. The budget is a means of communication.
1) A budget can help tell employees what goals the firm is attempting to
2) If the firm does not have an overall budget, each department might think
the firm has different goals.
3) For example, the sales department may want to keep as much inventory as
possible so that no sales will be lost, but the company treasurer may want to
keep the inventory as low as possible in order to conserve cash reserves.
If the budget specifies the amount of inventory, all employees can work toward the same objectives.
2. The Budget as a Formal Quantification of Management's Plans
a. Corporations have goals for market share, profitability, growth, dividend payout, etc.
…Not-for-profit organizations also have goals, such as increased number of free meals served, lowered recidivism rate among offenders, etc.
…These goals cannot be achieved without careful planning about the allocation of resources and the expected results.
b. A budget lays out in specific terms an organization's expectations about the
consumption of resources and the resulting outcomes.
3. Budgeting's Role in the Overall Planning and Evaluation Process
a. Planning is the process by which an organization sets specific goals for itself and sets about pursuing those goals.
Planning is an organization's response to the saying "If you don't know where you're going, any path will take you there."
1) The starting point for any organization's planning process is the formulation of its mission statement.
The mission statement, formulated by the board and senior management, embodies the organization's reason for existing.