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Budget Process

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A. Identify the stages of the budgeting process and evaluate their effectiveness.

b. Evaluate the level and validity of detailed assumptions used to create budget estimates.

c. Discuss the role of the budget as an analytic tool that can be used to evaluate organizational performance.

d. Explain how the budget can be used to find and eliminate inefficiencies in an organization's performance.

e. Explain the role of the budget in the business control cycle.

f. Analyze internal and external control mechanisms that can be put in place to monitor and evaluate the budget.

g. Describe how the budget can be used in the performance accountability and reward process.

h. Identify a major business initiative in any organization that was approved last year as a result of the budget process, and explain how the budget was used in the approval process.

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Please see response attached (also below). I hope this helps and take care.

RESPONSE:

Budget Assignment

a. Identify the stages of the budgeting process and evaluate their effectiveness.

A Budget is a plan that outlines an organization's financial and operational goals. So a budget may be thought of as an action plan; planning a budget helps a business allocate resources, evaluate performance, and formulate plans. While planning a budget can occur at any time, for many businesses, planning a budget is an annual task, where the past year's budget is reviewed and budget projections are made for the next three or even five years. The basic process of planning a budget involves listing the business's fixed and variable costs on a monthly basis and then deciding on an allocation of funds to reflect the business's goals. (For more on fixed and variable costs, see Breakeven Analysis.) Businesses often use special types of budgets to assess specific areas of operation. A cash flow budget, for instance, projects your business's cash inflows and outflows over a certain period of time. It's main use is to predict your business's ability to take in more cash than it pays out. And if you're planning on starting a business, planning a budget plays an important role in determining your start up and operating costs. The Financial Plan Section of the Business Plan provides information on calculating your start up and operating expenses. http://sbinfocanada.about.com/od/management/g/budget.htm

1. Planning - Schedule key dates, establish consultation forums, review previous processes

2. Strategizing - Review IDP, set service delivery and objectives for next 3 years, consult on tariffs, indigent, credit control, free basic services, etc and consider local, provincial and national issues, previous years performance and current economic and demographic trends etc

3. Preparing - Prepare budget, revenue and expenditure projections, draft budget policies, consult and consider local, provincial and national priorities

4. Tabling - Table draft budget, IDP and budget related policies before council, consult and consider formal local, provincial and national inputs or responses

5. Approving - Council approves budget and related policies

6. Finalizing - Publish and approve SDBIP and annual performance agreements and indicators

However, different types of budgets engage in slightly different steps (see Budgetary Approaches or visit http://nces.ed.gov/pubs2004/h2r2/ch_3.asp). However, taken together, the above steps should be effective.

To show this effectiveness, let's look at an example of stages in one budget process, which will help to analyze the effectiveness of each step. It is lengthy, but it provided an excellent idea of what goes into the budget process:

Example: Municipal Finance Management Act No. 56 of 20

Step 1: Planning - Coordination of the budget preparation process

Section 21 of the MFMA is the primary provision relating to the municipal budget process. It requires the mayor to coordinate the processes for preparing the annual budget and for reviewing the Integrated Development Plan (IDP) and budget related policies. The mayor must table in council by 31 August (10 months before the start of the budget year) a schedule of key deadlines for various budget related activities as spelled out in section 21. The accounting officer is tasked by section 68 of the MFMA with assisting the mayor in developing and implementing the budgetary process. The process should provide for both internal (within municipality) and external (local community and other stakeholder) consultations.

An example schedule of key deadlines that may be tabled before council by the mayor is posted on the MFMA web site (see last page for contact details). Municipalities may adopt this example or adapt it by inserting the actual dates of planned meetings and include more detail. Please note that where a specific time frame is shown in the example schedule, it is a deadline requirement of the MFMA and must be complied with. Municipalities are advised to make public a simplified version of the schedule to ensure the
community is aware of the timelines, process and opportunities and to have input to the budget and IDP. A simplified version of the schedule should be placed in local newspapers, newsletters and the municipal website alerting the public that more information on the budget process is available on the municipal website and offices, including how the public can make an input into the budget process.

Review of previous budget process - budget evaluation checklist

While the MFMA does not explicitly require a review of the previous budget process, it is strongly recommended that this undertaken in early August by the mayor and municipal manager before determining the new schedule of key deadlines. Such a review can provide information about what worked well, what didn't, where to improve and issues to address for legislative compliance.

A Budget Evaluation Checklist (BEC) template has been developed and will assist municipalities evaluate the budget process to facilitate eventual compliance with the MFMA, including previous budget preparation, tabling, approval and implementation. The BEC is available on the MFMA web site. When completing the checklist if a municipality answers "No" next to one of the items, this will serve as an indication of where more effort is needed to ensure compliance in the future. Immediate compliance with all provisions is not expected for the 2005/06 Budget, given that this is the first year of implementation of the new budget process. National Treasury will also use BEC information submitted by municipalities to monitor the progress of implementation across the country and target assistance where required. Instructions for completing the BEC are as follows: answers must only be selected from the drop down list; all questions must be answered; for questions with multiple requirements, all requirements must be satisfied before scoring a "Yes"; each answer should be referenced to a page number in the supporting documentation; some questions require an answer for the tabled budget and the approved budget. Once completed please email to lgdatabase@treasury.gov.za with a subject heading of "Demarcation Code - Municipality Name - Budget Evaluation Checklist 2005".

Many of the municipalities piloting the municipal finance management and budget reforms have already submitted this checklist after the approval of the 2004/05 Budget. Other municipalities may find that their 2004/05 Budget does not comply with many of the questions. This is not cause for concern as these municipalities will generally have longer to comply with the MFMA and should utilize the checklist as a tool to identify areas for improvement. We request all municipalities that have not already submitted the BEC to submit it by 30 November 2004. Municipalities that have not as yet tabled their schedule of key deadlines, or wish to revise or improve their existing schedule, should ensure that they do so by 30 November.

Entities and the budget process

Municipalities with entities will have a slightly more complex budget process and must ensure that the municipal budget process includes the budget process for each of its entities. The entity budget processes must be shaped by, and be within the framework of, the municipality's budget process. In particular, it will be necessary to ensure that the entities strategic plan and budget is consistent with the direction of the parent municipality's IDP and budget. The mayor of the parent municipality must therefore coordinate the overall budget process including that of its entities.

Step 2: Strategizing - Review of IDP and budget related policies

The amendment to the Municipal Systems Act (MSA) and chapter 4 of the MFMA require that a revised IDP be adopted at the time of adopting the budget. Therefore, the process leading to the adoption of the 2005/06 budget and IDP must be incorporated into one process, together with the process for approving taxes, levies, user charges and budget related policies. This will ensure credible plans and budgets that are realistic and implementable. Furthermore, the IDP should be informing the entire budget, not just the capital budget, which has traditionally been the case. Budget related policies include but are not limited to policies on: tariff setting; credit control / debt collection; indigents; cost recovery; investment; borrowing; cash management; spending delegations or authorizations; other supply chain considerations such as purchasing limits for sole supplier versus quote or tender; and so on. Some of these are required to be passed as a by-law and may require significant planning before changes can be made.

Internal consultations within the municipality

The Budget process is consultative and the collective product of all within a municipality. If treated as an accounting exercise only, the mayor and accounting officer will have failed in their obligations to the municipality and the community. The budget process must involve all the senior managers and, importantly, it must be guided by the strategic priorities of the municipality. The budget process should be preceded by a number of strategic and consultation processes within the municipality, involving the mayoral/executive committee and councillors. These processes are not legislated and are left to the discretion of each municipality. The consultation proposals outlined in this circular may not all be possible for the 2005/06 budget, but municipalities should strive to consider such consultations to the extent that these are still possible.

The internal strategic consultation should commence around September/October, with the mayor convening a meeting of the mayoral or executive committee and senior managers. The purpose is to determine the priorities of the municipality for the coming budget, taking into account the financial and political pressures facing the municipality. It should also consider what revisions should be considered to its current IDP. This process need not involve any non-executive councillors at this stage. The above process ideally would culminate in a major council strategic workshop around the beginning of October involving the entire council (or if the council is too large, at least the chairpersons of all council committees). The purpose of the workshop is to gain understanding of budgetary pressures and to win the support of councillors to the budget priorities proposed by the mayor. It should be noted that at this stage the mayor and mayoral/executive committee determine the budget priorities - the council should not be asked to vote on such priorities and the mayor should strive to only win the broad support of the council. The actual priorities will be approved by the council when it approves the budget and revisions to the IDP
at the end of the process. The budget priorities are tentative at this stage and offer a basis for consulting with the community and stakeholders. It may be necessary for the mayor to revise the priorities following the consultation process.

External consultations with the community and other stakeholders

There are two external consultation processes envisaged in the MFMA and Municipal Systems Act. The first external consultation process is informal, and open-ended, which begins around October and includes the following:

1. Public meetings with residents and small businesses in local communities - to identify and prioritize the greatest local needs (e.g. housing, water, electricity, recreation facilities, schools, clinics, streets and street lighting, refuse removal, social services and related issues, crime and functioning of local police stations, etc). To obtain the views of the community the council should consider the use of ward committees to gain an understanding of the issues in each ward;

2. Meetings with key stakeholders (e.g. residents associations, NGOs, business organizations) - to identify community and business needs and concerns, including the level of municipal tariffs and charges.

3. Consultations between the municipality and other municipalities, provincial and national departments and entities.

This first phase of informal or open-ended consultations ends when the mayor tables the budget and revisions to the IDP around the end of March. The second external consultation process is more formal and takes place after the tabling of the draft budget, when the council convenes hearings on the draft budget and revisions to the IDP. The municipality must invite the public and stakeholder organizations to submit comments and submissions in response to the draft budget and revised IDP. Since specific proposals are contained in the draft budget and revised IDP the public comments and responses tend to be more directed to these proposals. It should be noted that since municipalities are the closest interface between the community and government (all three spheres), they are best placed to consult communities on matters of a national and provincial function, such as policing, schools, clinics and housing - in a sense they are the eyes and ears of national and provincial governments. In this respect, it is important the municipalities and/or councillors act as a channel between local communities and the relevant national and provincial government departments and entities feeding information into the relevant department's budget process.

The IDP is a co-ordinating tool that includes the needs of the community with respect to local services provided by all three spheres of government. It follows that the IDP of a municipality should differentiate between two sections - one part related to municipal functions and responsibilities and a second part relating to national and provincial responsibilities. The budget of the municipality can only fund the first part of the IDP related to municipal functions and services. The second part of the IDP requires the municipal manager to co-ordinate with national and provincial departments advocating on behalf of the local community.

Step 3: Preparing

The preparation of the budget is a lengthy process spanning many months. It can be said to start in August at the time the mayor tables the schedule of key deadlines and conclude in June or early July when the mayor approves the Service Delivery and Budget Implementation Plan (SDBIP) and annual performance agreements with senior managers. In practice however, the budget preparation process is an ongoing function where processes and budget years will overlap. There are generally three different budget processes operating in parallel all the time - reporting on the past year (e.g. annual reports and audited financial ...

Solution Summary

This solution describes aspects of the budget process e.g. identifies the stages of the budgeting process and evaluate their effectiveness; evaluates the level and validity of detailed assumptions used to create budget estimates, discusses the role of the budget as an analytic tool that can be used to evaluate organizational performance; explains how the budget can be used to find and eliminate inefficiencies in an organization's performance; explains the role of the budget in the business control cycle; analyzes internal and external control mechanisms that can be put in place to monitor and evaluate the budget; describes how the budget can be used in the performance accountability and reward process and identifies a major business initiative in any organization that was approved last year as a result of the budget process; and explains how the budget was used in the approval process. Many examples and links are provided.

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See Also This Related BrainMass Solution

Finance Case Study: River Beverages' Budgeting Process

River Beverages is a food and soft-drink company with worldwide operations. The company is organized into five regional divisions with each vice president reporting directly to the CEO, Cindy Wilkins. Each vice president has an R&D department, controller, and three divisions; carbonated drinks, juices and water, and food products. Management believes that the structure works well for River Beverages because different regions have different tastes and the division's products complement each other. River Beverages' company wide and divisional organization charts are shown here.

CEO

Vice President Vice President Vice President Vice President Vice President

Strategic research Team

Controller

Division Manager, Division Manager, Division Manager,
Carbonated Drinks Juices & Water Food Products

Division Manager

Controller

Plant Manager

Operations Manager. Maintenance Manager. Quality Control Manager.

Division Sales Manager

District Manager. Distrcit Manager. Distrcit Manager.

NOTE: Plant Manager and Divisional Sales Manager are side by side in actual.

Industry

The US beverage industry has become mature with its growth matching population growth. In one recent year alone, consumers drank about 50 billion gallons of fluids. Most of the industry growth has come from the nonalcoholic beverage market, which is growing by about 1.1 percent annually. In the nonalcoholic arena, soft drinks are the largest segment, accounting for 53.4 percent of the beverages consumed. Americans consume about 26 billion gallons of soft drinks, ringing up retail sales of $50 billion every year. Water (bottled and tap) is the next largest segment, representing 23.7 percent of the
market. Juices represent about 12 percent of the beverages consumed. The smallest but fastest-growing segment is ready to-drink teas, which is growing by more than 91 percent in volume but accounts for less than 1 percent of the beverages consumed.

Sales Budgets

Susan Johnson, plant manager at River Beverages' non-carbonated drink plant in St. Louis, recently completed the annual budgeting process. According to Johnson, division managers have decision-making authority in their business units except for capital financing activities. Budgets keep the division managers focused on corporate goals. At the beginning of December, division managers submit a report to the vice president for the region summarizing capital, sales, and income forecasts for the upcoming fiscal year beginning July 1. Although the initial report is not prepared with much detail, it is prepared
carefully because it is used in the strategic planning process.

Next, the strategic research team begins a formal assessment of each market segment in its region. The team develops sales forecasts for each division and compiles them into a company forecast. The team considers economic conditions and current market share in each region. Management believes the strategic research team is effective because it is able to integrate division products and more accurately forecast demand for complementary products. In addition, the team ensures
continuity of assumptions and achievable sales goals.

Once the corporate forecast has been completed, the district sales managers estimate sales for the upcoming budget year. The district sales managers are ultimately responsible for the forecasts they prepare. The district sales forecasts are then compiled and returned to the division manager. The division manager reviews the forecast but cannot make any revisions without discussing the changes with the district sales managers. Next, the strategic research team and the division controller review the district sales forecasts. Finally, top management reviews each division's competitive position; including plans to increase market share, capital spending, and quality improvement plans.

Plant Budgets

After top management approves the sales budget, it is separated into a sales budget for each plant. Plant location is determined by product type and where the product needs to be distributed. The budget is broken down further by price, volume, and product type. Plant managers budget contribution margins, fixed costs, and pretax income using information from the plant sales budget.

Budgeted profit is determined by subtracting budgeted variable costs and budgeted fixed costs from the sales forecast. If actual sales fall below forecasts, the plant manager is still responsible for achieving the budgeted profit. One of the most important aspects of the plant budgeting process is that plant managers break the plant budget down into various plant departments.

Operations and maintenance managers work together to develop cost standards and cost-reduction targets for all departments. Budgeted cost reductions from productivity improvements, unfavorable variances, and facility-level costs are developed for each department, operation, and cost center in the plant. Before plant managers submit their budgets, a member of the strategy team and the regional controller visit the plant to keep corporate management in touch with what is
happening at the plant level and to help corporate management understand how plant managers determine their budgets. The visits also allow corporate management to provide budget preparation guidance if necessary. The visits are especially important because they force plant management to keep in touch with corporate-level managers. The final budgets are submitted and consolidated by April 1. The vice president reviews them to ensure that they are in line with corporate objectives. After all changes have been made by the vice presidents and the chief executive officer (CEO), the budgets are submitted to the board of directors for approval. The board votes on the final budget in early June.

Performance Measurement

The corporate office generates variance reports monthly. River Beverages has a sophisticated information system that automatically generates reports based on input downloaded daily from each plant. Managers in the organization also can manually generate the reports. Most managers generate variance reports several times during the month, allowing them to solve problems before the problems get out of control. Corporate management reviews the variance reports, looking
closely at over budget variance problems. Plant managers are questioned only about over budget items. Management believes that this ensures that the plant managers are staying on top of problem areas, and that this keeps the plants operating as efficiently as possible.

One week after the variance reports are generated, plant managers are required to submit a response outlining the causes of any variances and how they plan to prevent the problems in the future. If a plant manager has repeated problems, corporate management might send a specialist to the plant to work with the plant manager to solve the problems.

Sales and Manufacturing Relations

"We are expected to meet our approved budget," remarked Kevin Greely, a division controller at River Beverages. "A couple years ago, one of our major restaurant customers switched to another brand. Even though the restaurant sold over one million cases of our product annually, we were not allowed to make revisions to our budget." Budgets are rarely adjusted after approval. However, if sales decline early in the year, plant managers might file an appeal to revise the budgeted profit for the year. If sales decline late in the year, management usually does not revise the budgeted amounts but asks plant managers to cut costs wherever possible and delay any unnecessary expenditure until the following year. Remember that River Beverages sets budgets so it is able to see where to make cuts or where it can find any operating inefficiencies. Plant managers are not forced to meet their goals, but they are encouraged to cut costs below budget.

The sales department is primarily responsible for product price, sales volume, and delivery timing while plant managers are responsible for plant operations. As you might imagine, problems occur between plant and regional sales managers from time to time. For example, rush orders could cause production costs to be higher than normal for some production runs. Another problem could occur when a sales manager runs a promotional campaign that causes margins to shrink. In both
instances, a plant manager's profit will be affected negatively while a sales manager's sales will be affected positively. Such situations are often passed up to the division level for resolution; however, the customer is always the primary concern.

Incentives

River Beverages' management has devised what it thinks is an effective system to motivate plant managers. First, plant managers are promoted only when they have displayed outstanding performance in their current position. Second, monetary incentives reward plant managers for reaching profit goals. Finally, charts produced monthly display budgeted items versus actual results. Although not required to do so, most plant managers publicize the charts and use them as a motivational tool. The charts allow department supervisors and staff to compare activities in their department to similar activities in other plants around the world.

CEO's Message

Cindy Wilkins, CEO of River Beverages, looks to the future and comments, "Planning is an important aspect of budget preparation for every level of our organization. I would like to decrease the time spent on preparing the budget, but I believe that it keeps people thinking about the future. The negative aspect of the budgeting process is that sometimes it over controls our managers. We need to stay nimble enough to react to customer demands while staying structured enough to achieve corporate objectives. For the most part, our budget process keeps our managers aware of sales goals and alerts
them when sales or expenses are off track."

Required

a. Discuss each step in River Beverages' budgeting process. Begin with the division manager's initial reports and end with the board of directors' approval. Is each step necessary? Explain.

b. Evaluate River Beverages' responsibility-accounting system. Specifically, should the plant managers be held responsible for costs or profits? Why?

c. Write a report to River Beverages' management stating the advantages and disadvantages of the company's budgeting process. Start your report by stating your assumption(s) about what River Beverages' management wants the budgeting process to accomplish.

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