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Budgets and budgetting

7 important questions on Budgets and budgetting

What are the three planning cycles?

Strategic planning
- long range: setting a vision, a mission, and objectives & how we achieve the objective, i.e., stratgies

Capital budgeting (programming
- middle range: resource allocation

Operational budgeting
- annual: preparation of a short term financial plan =budget

What are the purposes of budgeting?

1) planning
- promotes forward thinking
- controls cash flow and identifies financial needs

2) communication & coordination
- knowledge transfer: vertical and horizontal
- ensure that expectations and assumptions are consistent

3) motivation
- can act as targets and are linked to performance evaluation and reward systems. Goal theory

4) contracting
- often budgets are negotiated. Problems arise, are investigates, strategies adjusted. Etc.

Why is budgeting criticized?

- time consuming (20% management time)
- sticky (incremental thinking, minor changes 2 last budget)
- assumptions needed
- lack of flexibility and agility
- encouraging short termism (current year / quarter focus)
- encourage gaming, dishonesty and politicking

What is Jensen's compensation system?

Traditionally there are kinks. Because of the kinks/steps they are motivated if they can reach past the hurdle up untill the 'cap'. If they cant or surpass they do nothing.

Jensen suggests taking out any kinks to remove gaming but
- dishonest managers lie about performance
- often weaker incentives
- non monetary tewards also have to be independent of budget targets

Who should set the target?

Budgets can be used for decision management. In ideal scenario is fully reveals knowledge about conditions. However, managers make biased budget forcasts to look better.

Top-down budgeting. Begin with aggregated for the firm and disaggregate down. Providing more control but being less informative for decision making.

Bottom up. Lower level have more knowledge. Managers are held responsible for meeting target they propose. And thus more commited.

What are flexible, static targets and budgets?

Flexible targets: may not be taken serious.
Fixed: hit target and lose motivation. Move sales to periods.

Static budget: do not vary with sales volume. Preps for one level activity.
Flexible budget are a function of some volume measure

What is target ratcheting?

Target ratcheting incentivizes store managers to reduce the sales they make in the final quarter of the year in order t make their next year sales target more achievable.

Remove by:
- eliminating targets
- zero based budgetting
- job rotation
- relative targets