ities. For example, there may be dual parent companies (as in the case of Royal
Dutch/Shell); there may be affiliates reporting directly to the parent company; or, for
one product line, the company may be organized geographically, but for another
product line, a functional organization may be more suitable.
In the following discussion, we will assume that the parent company, operating di-
visions, and regions use the U.S. dollar to express financial results, regardless of the
physical location of operations and affiliates. To designate the parent company ori-
entation, the letters PCwill be applied when referring to the parent company’s and
other management levels’ U.S. dollar accounting.
The affiliates, on the other hand, operate, of course, in their respective local cur-
rencies, referred to as “LC.”
25.4 BASIC APPROACHES TO CAPITAL BUDGETING AND PROFIT PLANNING
(a) Basic Approaches. When examining the methods and procedures used for capi-
tal budgeting and profit planning, we find two basic approaches: top-down and bot-
tom-up.
If the corporate level determines the perimeter of the capital budget, the total
amount of dollars to be spent, and then allocates portions to division, regions, and af-
filiates, this constitutes a top-down approach. If, conversely, the corporate level asks
the affiliates to determine their capital requirements and proposed net income, and
the regions and divisions merely aggregate the affiliates’ proposal, we refer to this
process as a bottom-up approach.
(b) Guidance. In practice, these two approaches are frequently combined. At the
corporate level, the overall perimeters will be determined. In discussions with the
next level of organization—the divisions—”guidance” will be given, suggesting to
the divisions the total budgets to be given to the regions, as well as the net income
expected to be generated by each region. In the meantime, the affiliates have prepared
their own capital requirements, together with net profit and cash generation assump-
tions. The only firm guidance the affiliates receive are the assumptions regarding ex-
change rates to be used so that local plans can be converted into U.S. dollars.
(c) Local Conditions. After the affiliates’ plans have been completed, taking into ac-
count local needs and operating conditions, negotiations between affiliate manage-
ments and regional managements take place to determine the final budgets and net
profits to be proposed by the affiliates to the divisions and corporate management.
The process will be described in more detail as we separate the capital budgeting pro-
cedures from those used for profit planning.
25.5 BUILDING THE CAPITAL BUDGET
(a) Objectives. Prior to the establishment of a capital budget, it is important that the
company determine its long-range objectives and prepare a strategic plan that speci-
fies timing horizons and overall capital requirements. In a multinational company,
objectives and capital needs are then suggested for each country and each major af-
filiate or function within the countries.
25.5 BUILDING THE CAPITAL BUDGET 25 • 5