Chapter 08

Slide 8.
Chapter 8:
Planning and Budgeting
Merchant, Management Control Systems PowerPoints on the Web, 3rd edition, Pearson Education Limited 2012
Slide 8.2
Financial results controls
Three core elements

Financial responsibility centers
The apportioning of accountability for financial results within
the organization
Formal management processes

Planning and budgeting to define performance expectations
and standards for evaluating performance
Motivational contracts
To define the links between results and various organizational
incentives
Slide 8.3
Planning and budgeting
Produce written plans that specify:

Where the organization wishes to go
How it intends to get there
What results should be expected
Purposes of planning and budgeting processes

To enhance management control
To engage in long(er)-term thinking
To achieve coordination (top-down, bottom-up, sideways)
To establish challenging-but-achievable performance targets
Slide 8.4
and involving all organizational levels
Incrementally specific, detailed, short-term,
Planning cycle
Strategic
Planning
Programming
Capital
Budgeting
Operational
Budgeting
Relatively broad processes of thinking

about the missions, goals, and strategies
Normally a top-management process
Specification of specific action programs

to be implemented over the next few years
and specification of the resources each
will consume
It involves managers at different levels
(top-down/bottom-up)
Short-term financial planning
Budgets match the organizations
responsibility structure
Emphasis on quantitative data
Slide 8.5
Characteristics of a budget
It is usually stated in monetary terms
It generally covers a period of one year
It contains an element of management commitment,

that is, the managers agree to accept the responsibility
for attaining the budgeted objectives
The budget is approved by an authority higher than the

budgetee
Once approved, the budget can be changed only under

specified conditions
Periodically, actual financial performance is compared to

budget and variances are analyzed and explained
Slide 8.6
Budgeting and management control
Budgeting involves setting targets that are

commonly used as standards against which to
evaluate performance results controls
Planning and budgeting processes involve formal

reviews of plans and include the actions that are
felt to be good for the organization to take
action controls
Planning and budgeting processes provide the

needed information for decision making to the
relevant managers personnel controls
Slide 8.7
The budget preparation process

Budget Committee
ss
e
nc
ua
G
of
os
op
Pr
4. Approval
s
ne
eli
uid
Budget
Department
et
dg
Bu
al
Bottom-Up
I
1.
l
itia
In
2.
3. Negotiation
Top-Down
Business Managers
The budgeting process takes about 4 months in most firms

Slide 8.8
Types of financial performance targets
Model-based (engineered) / historical / negotiated
Internally / externally-derived
Information asymmetry
Target costing
Benchmarking
Fixed / Flexible
Should managers be held accountable for achieving their
plans regardless of the business conditions they face?
Relative performance targets
Slide 8.9
Budget participation
Top-down / bottom-up budgeting

The budgetee is both involved and has influence over
setting the budget
Leads to better acceptance of budget targets, and hence,
commitment to achieve them
Is an effective way of information sharing bringing
together corporate priorities and constraints with lowerlevel insights about business potentials and risks
But, potential for slack, bias, conservatism,
Slide 8.10
Motivation / Performance
Budget target difficulty
Easy
Goal Difficulty
Impossible
Slide 8.11
Budget target difficulty (continued)

In theory (lab experiments):
Probability
Good targets are about 2540% achievable
Target
Performance
Slide 8.12

In practice (field research)
Probability
Targets are about 8090% achievable
Target
Performance
Slide 8.13
Probability
Effective vs. ineffective management teams
Target
Performance
Slide 8.14
Probability
Low vs. high uncertainty
Target
Performance
Slide 8.15
Challenging but achievable ...
To minimize dysfunctional management actions

Myopic behavior, data manipulation
To increase managers commitment to budget targets
To reduce the cost of organizational interventions

Management-by-exception
To protect against the cost of optimistic revenue projections

Over-commitment of resources
To create a winning atmosphere and positive attitude
Slide 8.16
What is a good budget target?

Purpose of Budgeting
Motivation
Planning
Coordination
Cost control
Evaluation
Target Difficulty
Conservative
Best guess
Optimistic
Target should be after-the-fact assessment of what could

have been accomplished, not any of the three choices listed
Slide 8.17
Beyond Budgeting?
Some principles
Goals
Set relative goals for continuous improvement; not fixed performance contracts
Rewards
Reward success based on relative performance; not on meeting fixed targets
Planning
Make planning a continuous and inclusive process; not a top-down annual event
Coordination
Coordinate interactions dynamically; not through annual planning cycles
Resources
Make resources available as needed; not through annual budget allocations
Controls
Base controls on relative indicators and trends; not on variances against plan
Applicability in practice? Effectiveness? Problems?


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Slide 8.

Financial results controls

Three core elements

Formal management processes

Planning and budgeting

Produce written plans that specify:

Purposes of planning and budgeting processes

and involving all organizational levels

Incrementally specific, detailed, short-term,

Relatively broad processes of thinking

Specification of specific action programs

It is usually stated in monetary terms

It generally covers a period of one year

It contains an element of management commitment,

The budget is approved by an authority higher than the

Once approved, the budget can be changed only under

Periodically, actual financial performance is compared to

Budgeting and management control

Budgeting involves setting targets that are

Planning and budgeting processes involve formal

Planning and budgeting processes provide the

The budget preparation process

The budgeting process takes about 4 months in most firms

Types of financial performance targets

Model-based (engineered) / historical / negotiated

Top-down / bottom-up budgeting

Budget target difficulty

Budget target difficulty (continued)

Good targets are about 2540% achievable

Budget target difficulty (continued)

Targets are about 8090% achievable

Budget target difficulty (continued)

Effective vs. ineffective management teams

Budget target difficulty (continued)

Low vs. high uncertainty

Challenging but achievable ...

To minimize dysfunctional management actions

To increase managers commitment to budget targets

To reduce the cost of organizational interventions

To protect against the cost of optimistic revenue projections

To create a winning atmosphere and positive attitude

What is a good budget target?

Target should be after-the-fact assessment of what could

Applicability in practice? Effectiveness? Problems?

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