Study Guide

I. Allocating Resources
A. Strategy defines how the organization spends money and
allocates resources. In fact, the organization's strategy
(intentional or not) can be observed in how it spends its
money and allocates its resources (i.e., positions its
assets).
B. That said, the real work of spending money and
positioning assets is carried out in the day-to-day
decisions taking place during the organization's period of
operations. These decisions are planned, controlled, and
evaluated as a core aspect of budgeting.
II. Budgeting Time Frames
A. Budgets are built working backwards from a long-run view
based on the organization's strategy. Conversely, budgets
are achieved working forwards using a short-run focus on
operations.
1. Beginning with the three-to-five year focus of the
strategy plan, budgets are typically designed by
working backwards from the strategy to design one-
to-three-year targets, followed by quarterly targets,
monthly targets, and perhaps weekly targets.
2. When actually operating with the budget,
performance is achieved by focusing on short-run
operations (weekly or monthly), and working forward
to achieve more long-run objectives in the quarterly
and annual budgets.
3. As organizations work through each operating
period, the budget is continuously built forward to
always maintain a one-to-three-year operating plan.
This is the process of a “rolling” budget.
B. Remember, the time frame of operating budgets always
needs to tie back to the long-run focus of the
organization's strategy, which will be closer to the three-
to-five-year time span.
III. Communication and Performance Evaluation
A. Budgeting should be one of the key tools in the
organization to facilitate communication and coordination
between individuals and divisions within the organization.
 1. The bigger and more complex the organization, the
more crucial it is to develop clear budgets to support
communication and coordination.
2. Budgets help divisions know what resources they
can expect to receive, and what deliverables they
are expected to provide.
B. Budgets serve multiple purposes, and sometimes those
purposes can conflict. Another key deliverable of budgets
is to support performance evaluation.
1. When evaluating performance by comparing actual
results to the planned budget, the concept of
controllable costs is crucial.
2. Successful budgeting requires accurate estimates of
costs, which managers help provide. However, some
planned costs are not controllable (e.g., property
taxes, certain salaries, etc.). Managers should be
responsible to help accurately plan (i.e., forecast) all
costs, but their performance should be evaluated
only on costs they can control.
3. When managers are held responsible for costs they
cannot control, the incentive is strong to
overestimate costs in order to build slack into these
cost estimates. Budgetary slack provides cushion for
the manager in the event uncontrollable costs are
higher. However, budgetary slack reduces the
accuracy and usefulness of budget plans for the
whole organization.
IV. Roles in the Budgeting Process
A. The diagram shown below illustrates the traditional
budgeting cycle.
1. The process begins with the formation of a budget
committee. In some organizations, the committee is
not limited to executive leadership, but will also
involve directors of selected strategic business units
(SBUs) and other managers.
2. Budget guidelines are established by the budget
committee and include strategic objectives, major
organization goals, and incentives.
3. To the extent the organization values significant
participation in the budgeting process by lower-level
managers, initial budget proposals are submitted
 “bottom up” by managers (rather than “top down”
by executives).
4. As budget proposals are submitted across the
organization, an iterative process of negotiation and
revision begins as the organization works out
expectations and the sharing of limited resources
between divisions across the organization.
5. The negotiation and revision continues in the final
step as the budget committee reviews and provides
feedback. Eventually, the budget is completed and
presented to the organization's leadership
(executives, board of directors, etc.).

B. The actual process of building a budget will illustrate a

key aspect of the organization's culture—employee
participation.
1. Organizations make important choices regarding the
extent of top-down versus bottom-up budgeting,
which effectively describe how different levels of
 employees will participate in the management of the
organization.
2. Bottom-up (participating) budgeting involves more
time and resources, but results in a more informed
budget with higher ownership by the employees.
3. Top-down (authoritative) budgeting takes less time
and resources and doesn't exhaust the employees
as much, but the budget may have blind spots and
may be resisted by the employees.
V. Best Practice Guidelines
A. Link the budget to strategy. This linkage is critical since
budgets determine how resources will be allocated and
what measures will be used to evaluate progress.
B. Design budgeting processes that allocate resources
strategically. Every business unit needs funding for both
capital investment and operating expenses, and funding
needs usually exceed available resources. Hence,
competition for resources within the organization is
inevitable. Tradeoff decisions must be based on long-run
strategy.
C. Establish budget targets based on realistic
expectations and based on stretch goals. Budgets are
used for both planning purposes and motivation
purposes, and these purposes can conflict. Budgets needs
to carefully balance these two purposes.
D. Reduce budget complexity and budget cycle time.
Organizations need to constantly strive to reduce budget
complexity and streamline budgeting procedures. Overly
complex budgets that take too much time and resources
to complete will disrupt the organization's core activities.
E. Develop flexible budgets that accommodate
change. Organizations should review budgets regularly
and make adjustments if needed. Knowing that budgets
have some flexibility frees managers from the need to
build slack into budget estimates to cover unexpected
and uncontrollable developments.

Practice Question
Assume that you've been employed as a consultant to help a
growing organization establish an effective budgeting process.
Describe for the executive team an effective budgeting process that
involves department managers throughout the organization.
Indicate important qualities that will be demonstrated by a
successful master budget.
Answer
An effective budgeting process begins with guidance from a budget
committee that represents both executive leaders and division
managers. That guidance should establish the strategic objectives,
primary goals, and employee incentives that need to be
incorporated into each department budget. Each department
manager then prepares and submits an initial budget. To the extent
these budgets need to coordinate and share resources across
departments, the managers should negotiate these issues with each
other. Once all of the department budgets are revised and
reconciled, then the set of budgets are submitted back to the
budget committee for feedback, and likely more revision.
Eventually, the budgets are approved, and the master budget plan
is presented to the organization's executive leadership (and board
of directors, if relevant).
A successful master budget needs to clearly connect to and support
the organization's strategy by effectively allocating scarce resources
to accomplish the strategy over the long run. The budget should
balance realistic expectations with stretch goals that motivate
employees. The budgeting process itself should be efficient in order
to not use too much time and exhaust participants. Once deployed,
the budget should be periodically reviewed and adjusted if
necessary to accommodate changing circumstances.
Summary
Budgets are, hopefully, an intentionally strategic effort to tie short-
run spending and asset deployment decisions to long-run strategy.
The time frame of an operational budget typically rolls out across
weeks, months, quarters, and then years. Effective budgets are used
by employees and divisions to communicate and coordinate with
each other. When budgets are also used to motivate performance, it
is important that only controllable costs are used in the evaluation
process. The budget process traditionally follows a cycle of budget
proposals that are submitted, negotiated, and revised until the final
budget is established and approved by the organization's
leadership. Best practices in the budget process include clear
linkage to the organization's strategy, budget targets that are
realistic and stretch the employees, budget processes that are fast
and efficient, and periodic reviews to adjust budgets as needed
based on changing circumstances.