Theory of Constraints Handbook - James Cox Iii [246]
Financial planning includes preparing a projection of what the company hopes to accomplish for the next period. The typical budget process begins with projected sales in units and in currency, on a monthly basis, for a 12-month period.15 Based on expected sales and certain information concerning desired inventory levels, production in units, material acquisition (in units and currency), labor costs, variable overhead elements, and other production fixed overhead amounts to be incurred are estimated, both in terms of cash outflows and overhead applied, for each month of the period. At this point, cost of sales, including materials, labor, and applied overhead, is computed for each month. Next, a schedule of general, selling, and administrative expenses, usually divided into variable and fixed components, is prepared.
Using the previous information, along with assumptions concerning collections from customers, payments to suppliers, asset acquisitions, and the timing of other cash inflows and outflows, a statement of changes in cash is prepared. Only then is sufficient information available for projected income statements and balance sheets. (See master budget relationships, in the diagrams, in Hilton, 2009, 350; Garrison et al., 2010, 375.)
Capital Budgets
One of the largest cash requirements involves acquisition of additional assets. In large, decentralized organizations, capital budget requests are prepared by investment centers that have responsibility for return on assets as well as profit and loss. These centers require additional resources in order to fulfill their stretch goals and do not (and probably cannot) predict the impact of their request on the entire organization. Therefore, executive committees usually schedule marathon sessions where managers come in and present their cases, using projected cash flows and net present values, for additional investment. The committee then must decide which proposals to fund16 based on logical analyses of short, compelling, and often competing presentations.
Due to the time required to achieve budget agreement on budgets of all sorts, management is frequently reluctant to revise budget numbers when original assumptions are invalidated. Thus, the data formulated during the fall for a calendar-year company may be used for the next 12 to 15 months.
Once the budget period begins, large organizations typically prepare periodic flexible budgets, which are based on actual results of the critical area of the organization on which a master budget is originated. For example, if a company has excess capacity, the first schedule in a master budget is sales units, followed by projected sales in the organization’s currency, followed by production schedules, material schedules, etc. Therefore, once sales are known, expected costs associated with those sales can be prepared. If a company has more demand than it has resources to fulfill, however, the master budget must begin with a production schedule featuring the desired product mix. Then sales, in currency and other supporting schedules can be derived. Later, actual production and sales of various products, along with expected costs, can be combined in a flexible budget. Flexible budgets present more meaningful interlocking data once actual critical area performance is known.
Use of Budget Data
In addition to their planning role, budgets frequently are used in performance evaluation. Because a master budget contains budgets for each area of an organization, it is easy to engage in performance to budget, where actual results for each area are compared with budgeted predictions