Operational Budgeting

This lesson deals with preparing and using budgets. When preparing budgets managers won’t be looking at specifics, they will look at the big picture.

They won’t look at something like the route a delivery driver takes each day. They will be more concerned with the total monthly fuel costs for all the delivery trucks. The manager in charge of delivery trucks and drivers will be responsible for controlling delivery costs and working within the fuel budget for the month.

Any single budget will benefit a company. Several budgets can help even more. This lesson shows how to prepare a number of monthly budgets that fit together into a unified set. They give management the ability to manage various aspects of the business on both a short term and long term basis.

Operating busiest are very short term, and deal with production and costs over the coming month. Capital budgets deal with the purchase of land, buildings and major machinery. These things don’t happen every day, so capital budgets might span over many years. Budgets will span a time period relevant to the type of decision that relates to that budget. Short term decisions will use short term budgeting; long term decisions will use long term budgeting.

The monthly budget should be prepared in a certain order. This order follows a logical sequence to manage production and delivery of goods.

• Sales forecast
• Production schedule
• Manufacturing cost budget
• Cost of Goods Sold and ending inventory budgets
• Operating expense budget

The logical order should be clear to see. The sales department must forecast the demand for the company’s products. Now that they know how much to make, the production schedule and manufacturing cost budget can be prepared. The production schedule budgets labor, machinery and materials into the production process in terms of units, not dollars. The manufacturing cost budget shows the cost of the inputs calculated in the production schedule.

The COGS budget shows how much gross profit the company can expect to be generated by the month’s production. The ending inventory budget shows the reserve of products that will be on hand to start the next month. Finally the operating expense budget will examine all the other monthly costs of running the factory.

After preparing the short term budget, managers can update the capital expenditures budget, and update the budgeted financial statements.

There are three elements to the budgeting process:

1. planning and budgeting before production,
2. overseeing production and operations during the month, and
3. month end budget to actual analysis, and review of the month’s
   results

Flexible Budgeting

There are two basic types of budgeting: static and flexible. A static budget assumes a set level of production. A flexible budget uses standard costs, and is adjusted relative to actual production. A flexible budget is a much better analysis tool. Static budgets rarely produce reliable results. Static budgets are widely used in government accounting, where results are less important, but staying within a legal budget is mandatory.

Flexible budgeting starts with standard costs. After estimating sales and preparing a production schedule, the flexible budget can be prepared.
The manufacturing and operating cost budgets can be prepared using flexible budgeting. The sales forecast can also be prepared using flexible budgeting.

The critical thing about flexible budgeting is the reporting that happens at the end of the month. After production, a budget to actual cost analysis is prepared, adjusted for the actual production that month. Favorable and unfavorable variances are identified and can be analyzed.

Computer spreadsheet programs are a great tool for preparing flexible budgets. Once a budget template is created, the same format and formulae can be used over and over again, by simply updating a few pieces of information. A set of flexible budget worksheets can be combined, and linked together, so beginning and ending amounts automatically flow from one month to the next.