Budgets and the Budgeting Cycle

Learning Objective 1 Describe the master budget and explain its benefits

• the master budget is the initial budget prepared before the start of a period 
• benefits include planning, coordination, and control

A budget is (1) the quantitative expression of a proposed plan of action by management for a specified period and (2) an aid to coordinate what needs to be done to implement that plan. The budget generally includes both the plan’s financial and nonfinancial aspects and serves as a road map for the company to follow in an upcoming period. A financial budget quantifies managers’ expectations regarding a company’s income, cash flows, and financial position in a future period via a budgeted income statement, a budgeted statement of cash flows, and a budgeted balance sheet. Managers develop financial budgets using supporting information from nonfinancial budgets for, say, units manufactured or sold, number of employees, and number of new products being introduced to the marketplace.

Strategic Plans and Operating Plans

Budgeting is most useful when it is integrated with a company’s strategy. Strategy specifies how an organization matches its capabilities with the opportunities in the marketplace to accomplish its objectives. To develop successful strategies, managers must consider questions such as the following:

• What are our objectives?
• What set of integrated choices can we make along the value chain (for example, in product and service design, operations, and marketing) to create value for our customers while distinguishing ourselves from our competitors?
• What organizational and financial structures serve us best?
• What are the risks and opportunities of alternative strategies, and what are our contingency plans if our preferred plan fails?

A company, such as Home Depot, can have a strategy of providing quality products or services at a low price. Another company, such as Porsche or the Ritz-Carlton, can have a strategy of providing a unique product or service that is priced higher than the products or services of competitors. Exhibit 6-1 shows that strategic plans are expressed through long-run budgets and operating plans are expressed via short-run budgets. But there is more to the story! The exhibit shows arrows pointing backward as well as forward. The backward arrows show that budgets can lead to changes in plans and strategies. Budgets help managers assess strategic risks and opportunities by providing them with feedback about the likely effects of their strategies and plans. Sometimes that feedback prompts managers to revise their plans and possibly their strategies.

Boeing’s experience with the 747-8 program illustrates how budgets can help managers rework their operating plans. Boeing believed that utilizing some of the design concepts it was implementing in its 787 Dreamliner program would be a relatively inexpensive way to reconfigure its 747-8 jet. However, continued cost overruns and delays undermined that strategy: In early 2012, the 747-8 program was already $2 billion over budget and a year behind schedule. As a result, the company expected to earn no profit on any of the more than 100 orders for 747-8 planes it had on its books. And with the budget revealing higher-than-expected costs in design and production, Boeing postponed production plans for the 747-8 program until it could rework its plans.