BUDGETING 209
expenses etc.). Senior managers set the revenue targets and spending limits that
they believe are necessary to achieve profits that will satisfy shareholders.Bottom-
up budgetsare developed by the managers of each department based on current
spending and agreed plans, which are then aggregated to the corporate total.
Top-down budgets can ignore the problems experienced by operational man-
agers. However, boards of directors often have a clear idea of the sales growth and
profit requirement that will satisfy stock market conditions. By contrast, the result
of the bottom-up budget may be inadequate in terms of ‘bottom-line’ profitability
or unachievable as a result of either capacity limitations elsewhere in the business
or market demand. Therefore, the underlying factors may need to be modified.
Consequently, most budgets are the result of a combination of top-down and
bottom-up processes. By adopting both methods, budget-holders are given the
opportunity to bid for resources (in competition with other budget-holders) within
the constraints of the shareholder value focus of the business.
The budgeting process...................................
Budgets are based on standard costs (see Chapter 9) for a defined level of sales
demand or production activity. The typicalbudget cycle–the period each year
over which budgets are prepared – will follow the sequence:
1 Identify business objectives.
2 Forecast economic and industry conditions, including competition.
3 Develop detailed sales budgets by market sectors, geographic territories, major
customers and product groups.
4 Prepare production budgets (materials, labour and overhead) by responsibility
centre managers in order to produce the goods or services needed to satisfy the
sales forecast and maintain agreed levels of inventory.
5 Prepare non-production budgets by cost centre.
6 Prepare capital expenditure budgets.
7 Prepare cash forecasts and identify financing requirements.
8 Prepare master budget (profit and loss, balance sheet and cash flow).
9 Obtain board approval of profitability and financing targets.
Good practice in budgeting at the level of each responsibility centre involves
looking at the causes of costs and the business processes in use. Bidding for funds
for capital expenditure or to fund new initiatives or projects is an important part
of budgeting because of the need to question past practice and continually seek
improvement. The process of budgeting is largely based on making informed
judgements about:
žhow business-wide strategies will affect the responsibility centre;
žthe level of demand placed on the business unit and the expected level of
activity to satisfy (internal or external) customers;
žthe technology and processes used in the business unit to achieve desired
productivity levels, based on past experience and anticipated improvements;