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A standard costing system involves estimating the required costs of a production process. But before the start of the accounting period, determine the standards and set regarding the amount and cost of direct materials required for the production process and the amount and pay rate of direct labor required for the production process. In addition, these standards are used to plan a budget for the production process.

Standard costing compares the standard costs and revenues with the actual results of the process, finds the reasons for the variances, provides information about deviations to management for taking steps to improve it.

Standard costing is the practice of substituting an expected cost for an actual cost in the accounting records. Subsequently, variances are recorded to show the difference between the expected and actual costs. This approach represents a simplified alternative to cost layering systems, such as the FIFO and LIFO methods, where large amounts of historical cost information must be maintained for inventory items held in stock.

Standard costing involves the creation of estimated (i.e., standard) costs for some or all activities within a company. The core reason for using standard costs is that there are a number of applications where it is too time-consuming to collect actual costs, so standard costs are used as a close approximation to actual costs.

At the end of the accounting period, use the actual amounts and costs of direct material. Then utilize the actual amounts and pay rates of direct labor to compare it to the previously set standards. When you compare the actual costs to the standard costs and examine the variances between them, it allows managers to look for ways to improve cost control, cost management, and operational efficiency.

There are both advantages and disadvantages to using a standard costing system. The primary advantages to using a standard costing system are that it can be used for product costing, for controlling costs, and for decision-making purposes.

Whereas the disadvantages include that implementing a standard costing system can be time consuming, labor intensive, and expensive. If the cost structure of the production process changes, then update the standards.

Since standard costs are usually slightly different from actual costs, the cost accountant periodically calculates variances that break out differences caused by such factors as labor rate changes and the cost of materials. The cost accountant may periodically change the standard costs to bring them into closer alignment with actual costs.

Standard costs of these inputs:

1. Direct materials
2. Direct labor
3. Manufacturing overhead

• Variable manufacturing overhead
• Fixed manufacturing overhead

Uses of Standard Costing

Though most companies do not use standard costing in its original application of calculating the cost of ending inventory, it is still useful for a number of other applications. In most cases, users are probably not even aware that they are using standard costing, only that they are using an approximation of actual costs. Here are some potential uses:

Inventory costing. It is extremely easy to print a report showing the period-end inventory balances (if you are using a perpetual inventory system), multiply it by the standard cost of each item, and instantly generate an ending inventory valuation. The result does not exactly match the actual cost of inventory, but it is close. However, it may be necessary to update standard costs frequently, if actual costs are continually changing. It is easiest to update costs for the highest-dollar components of inventory on a frequent basis, and leave lower-value items for occasional cost reviews.

Budgeting. A budget is always composed of standard costs, since it would be impossible to include in it the exact actual cost of an item on the day the budget is finalized. Also, since a key application of the budget is to compare it to actual results in subsequent periods, the standards used within it continue to appear in financial reports through the budget period.

Price formulation. If a company deals with custom products, then it uses standard costs to compile the projected cost of a customer’s requirements, after which it adds a margin. This may be quite a complex system, where the sales department uses a database of component costs that change depending upon the unit quantity that the customer wants to order. This system may also account for changes in the company’s production costs at different volume levels, since this may call for the use of longer production runs that are less expensive.

Overhead application. If it takes too long to aggregate actual costs into cost pools for allocation to inventory, then you may use a standard overhead application rate instead, and adjust this rate every few months to keep it close to actual costs.

A flexible budget performance report is used to compare actual results for a period to the budgeted results generated by a flexible budget. This report varies from a traditional budget versus actual report, in that the actual sales figure is plugged into the budget model, which then uses formulas to alter the budgeted expense amounts. This approach results in budgeted expenses that are significantly more relevant to the actual performance that an organization experiences.

If the flexible budget model is designed to adjust to actual sales inputs in a reasonable manner, then the resulting performance report should closely align with actual expenses. This makes it easier to spot anomalies in the report, which should be rare. Management can then focus on the significant variances to see if any actions should be taken to ensure that actual results remain close to expectations.

The flexible budget model and its related reports are a significant improvement over the more common static model, where there is only one version of a budget, and that budget does not change. When a static model is the basis of comparison, the likely outcome is large favorable variances or unfavorable variances for many line items, since the static model may have been based on a sales level that is no longer relevant to actual conditions.

There are three common types of flexible budgets as follows:

Intermediate Flexible Budget: There are some expenses that do not vary with revenue, instead, they vary based on some other measure such as electricity expense based on the number of units consumed. An intermediate flexible budget takes into account changes in expenses based on such other activity measures as well.

Basic Flexible Budget: In this budget, those expenses that vary with revenue are expressed as a percentage of sales or as cost per unit and adjusted as the output level changes.

Advanced Flexible Budget: Further there are expenses that remain the same in a certain level of activity and beyond such a level they change. An advanced flexible budget takes into account the change in expenses based on the change in such levels.

The flexible budget responds to changes in activity, and may provide a better tool for performance evaluation. It is driven by the expected cost behavior. Fixed factory overhead is the same no matter the activity level, and variable costs are a direct function of observed activity. When performance evaluation is based on a static budget, there is little incentive to drive sales and production above anticipated levels because increases in volume tend to produce more costs and unfavorable variances. The flexible budget-based performance evaluation provides a remedy for this phenomenon.

Flexible Budgets for Planning

The flexible budget illustration for Mooster’s Dairy was prepared after actual production was known. While this tool is useful for performance evaluation, it does little to aid advance planning. But flexible budgets can also be useful planning tools if prepared in advance. For instance, Mooster’s Dairy might anticipate alternative volumes based on temperature-related fluctuations in customer demand for ice cream. These fluctuations will be very important to production management as they plan daily staffing and purchases of milk and cream that will be needed to support the manufacturing operation.

A rolling budget is continually updated to add a new budget period as the most recent budget period is completed. Thus, the rolling budget involves the incremental extension of the existing budget model. By doing so, a business always has a budget that extends one year into the future.

It’s is a new, revised set of financial plans for the next accounting period used to replace the prior one in a continuous budgeting system. In other words, it’s a newly updated budget that takes the place of the old version when it expires.

A rolling budget calls for considerably more management attention than is the case when a company produces a one-year static budget, since some budget updating activities must now be repeated every month. In addition, if a company uses participative budgeting to create its budgets on a rolling basis, the total employee time used over the course of a year is substantial. Consequently, it is best to adopt a leaner approach to a rolling budget, with fewer people involved in the process.

Advantages and Disadvantages of the Rolling Budget

This approach has the advantage of having someone constantly attend to the budget model and revise budget assumptions for the last incremental period of the budget. The downside of this approach is that it may not yield a budget that is more achievable than the traditional static budget, since the budget periods prior to the incremental month just added are not revised.

Types:

Sales Budget/Revenue Budget

Sales Budget the very first budget that an enterprise has to prepare because all other budgets depend on the revenue budget. In this budget, enterprises are forecasting their sales in terms of Value and Volume. In preparing the sales budget below, factors have been considered by the sales manager.

Master Budget

A master budget is a summary of all the above budget, which is verified by top management after taking inputs from various functional heads. It also shows the profitability of the business.

Capital Expenditure Budget

It contains forecasting of capital expenditure like expenditure on Plant & Equipment, Machinery, Land & building, etc.

Financial Budget

In the financial budget, the enterprise has to forecast the requirement of funds for running the business, whether it is long term or short term. In this budget, the company is also planning to invest their excess cash in that manner so that they can get a maximum return, or if the money is required for business, then they can pull out that money from the investment easily.

Overhead Budget

In this budget, enterprises are estimating the cost of indirect material, indirect labor, operational cost like rent, electricity, water, traveling, and many others. The overhead budget is divided into two parts one is fixed overhead, and one is variable overhead. It is also known as the expense budget.

Production Budget

The production budget purely depends upon the sales budget. In the production budget product manager estimates the monthly volume production according to the demand and also maintains the inventory level. In this budget, the cost of production is also estimated. Below are the factors of the production budget.

• Labor
• Raw Material
• Plant & Machinery

Factors:

Fixed Expenses

Fixed expenses are easy to forecast. It has most compelling evidence. As an illustration, office or factory rent is easy to predict. There is a remote possibility that it will change.

Variable Expenses

Variable expenses vary based on the volume of the production and sales. Hence, variable expenses can be updated regularly. The volume of sales and production is decided on the external factors and internal factors.

Other Expense

Following expenses are also considered:

• Interests paid on loan from the bank.
• Payment to shareholders by way of dividends
• Any other non-operational expenses

Zero-based budgeting (ZBB) is a method of budgeting in which all expenses must be justified for each new period. The process of zero-based budgeting starts from a “zero base,” and every function within an organization is analyzed for its needs and costs. Budgets are then built around what is needed for the upcoming period, regardless of whether each budget is higher or lower than the previous one.

3 primary things that a budget must meet:

• Expenses determination: How much will you spend?
• Revenue from the project: How much will you earn?
• Profit prediction: The target profit you will require after all expenses?

As the name says “Zero-based budgeting” is an approach to plan and prepare the budget from the scratch. Zero-based budgeting starts from zero, rather than a traditional budget that is based on previous budgets.

With this budgeting approach, you need to justify each and every expense before adding it to the actual budget. The primary objective of zero-based budgeting is the reduction of unnecessary cost by looking at where costs can be cut.

To create a zero base budget involvement of the employees is required. You can ask your employees what kind of expenses the business will have to bear and figure out where you can control such expenses. If a particular expense fails to benefit the business, the same should be axed from the budget.

Differences between Traditional Budgeting and Zero Base Budgeting

• In traditional Budgeting, the previous year’s budget is taken as a base for the preparation of a budget. Whereas, each time the budget under zero-based budgeting is created, the activities are re-evaluated and thus started from scratch.
• The emphasis of the traditional budgeting is on the previous expenditure level. On the contrary, zero-based budgeting focuses on forming a new economic proposal, whenever the budget is set.
• Traditional Budgeting works on cost accounting principle, thereby, it is more accounting oriented. Whereas the zero-based budgeting is decision oriented.
• In the traditional budgeting, justification of the line items and expenses are not at all required. On the other hand, in zero-based budgeting, proper justification is required, taking into account the cost and benefit.
• In traditional budgeting, the top management take decisions regarding any amount that will be spent on a particular product. In contrast, in zero-based budgeting, the decision regarding the spending a specific sum on a particular product is on the managers.
• Zero-based budgeting is better than traditional budgeting when it comes to clarity and responsiveness.
• Traditional budgeting follows a monotonous approach. On the contrary, zero-based budgeting follows a straightforward approach.

Steps to create a Zero based budget

• Identifying the decision units that need a justification for every line item of expenditure in the proposed budget.
• Preparing Decision Packages. Each decision package is an identifiable and separate activity. These decision packages are connected with the objectives of the company.
• The next step in ZBB is to rank the decision packages. This ranking is done on the basis of cost-benefit analysis.
• Finally, funds are allocated on the basis of the above findings by following a pyramid ranking system to ensure maximum results.

Zero Based Budgeting Advantages

• Accuracy: Against the traditional budgeting method that involves mere some arbitrary changes to the earlier budget, this budgeting approach makes all departments relook every item of the cash flow and compute their operation costs. This methodology helps in cost reduction to a certain extent as it gives a true picture of costs against the desired performance.

• Efficiency: Zero-based Budgeting helps a business in the allocation of resources efficiently (department-wise) as it does not look at the previous budget numbers, instead looks at the actual numbers.

• Budget inflation: As mentioned above every expense is to be justified. Zero-based budget compensates the weakness of incremental budgeting of budget inflation.
• Reduction in redundant activities: This approach leads to identify optimum opportunities and more cost-efficient ways of doing things by eliminating all the redundant or unproductive activities.

• Coordination and Communication: Zero-based budgeting provides better coordination and communication within the department and motivation to employees by involving them in decision-making.

Although this concept is a lucrative method of budgeting, it is also important to know the disadvantages as listed below:

Zero Based Budgeting Disadvantages

• Time-Consuming: This Zero-based budgeting approach is a highly time-intensive for a company to do annually as against incremental budgeting approach, which is a far easier method.

• High Manpower Turnover: The foundation of zero-based budgeting itself is a zero. Budget under this concept is planned and prepared from the scratch and require the involvement of a large number of employees. Many departments may not have adequate human resource and time for the same.
• Lack of Expertise: Providing an explanation for every line item and every cost is a problematic task and requires training for the managers.

The Project Budget is a tool used by project managers to estimate the total cost of a project. A project budget template includes a detailed estimate of all costs that are likely to be incurred before the project is completed.

A project budget is the total projected costs needed to complete a project over a defined period of time. It’s used to estimate what the costs of the project will be for every phase of the project.

Large commercial projects can have project budgets that are several pages long. Such projects often have a large number of costs associated with them, such as labor costs, material procurement costs, and operating costs. The Project Budget itself is a dynamic document. It is continuously updated over the course of the project.

Some tools and techniques for estimating cost:

Vendor bid analysis: Sometimes you will need to work with an external contractor to get your project done. You might even have more than one contractor bid on the job. This tool is about evaluating those bids and choosing the one you will accept.

Determination of resource cost rates: People who will be working on the project all work at a specific rate. Any materials you use to build the project (e.g., wood or wiring) will be charged at a rate too. Determining resource costs means figuring out what the rate for labour and materials will be.

Cost of quality: You will need to figure the cost of all your quality-related activities into the overall budget. Since it’s cheaper to find bugs earlier in the project than later, there are always quality costs associated with everything your project produces. Cost of quality is just a way of tracking the cost of those activities. It is the amount of money it takes to do the project right.

Reserve analysis: You need to set aside some money for cost overruns. If you know that your project has a risk of something expensive happening, it is better to have some cash available to deal with it. Reserve analysis means putting some cash away in case of overruns.

Creating a Project Budget

As noted above, there are many components necessary to build a budget, including direct and indirect costs, fixed and variable costs, labor and materials, travel, equipment and space, licenses and whatever else may impact your project expenses.

To meet all the financial needs of your project, a project budget must be created thoroughly, not missing any aspect that requires funding. To do this, we’ve outlined seven essential steps towards creating and managing your project budget:

1. Use Historical Data

Your project is likely not the first to try and accomplish a specific objective or goal. Looking back at similar projects and their budgets is a great way to get a headstart on building your budget.

2. Reference Lessons Learned

To further elaborate on historical data, you can learn from their successes and mistakes. It provides a clear path that leads to more accurate estimates. You can even learn about how they responded to changes and kept their budget under control. Here’s a lessons learned template if you need to start tracking those findings in your organization.

3. Leverage Your Experts

Another resource to build a project budget is to tap those who have experience and knowledge be they mentors, other project managers or experts in the field. Reaching out to those who have created budgets can help you stay on track and avoid unnecessary pitfalls.

4. Confirm Accuracy

Once you have your budget, you’re not done. You want to take a look at it and make sure your figures are accurate. During the project is not the time to find a typo. You can also seek those experts and other project team members to check the budget and make sure it’s right.

5. Baseline and Re-Baseline the Budget

Your project budget is the baseline by which you’ll measure your project’s progress once it has started. It is a tool to gauge the variance of the project. But, as stated above, you’ll want to re-baseline as changes occurs in your project. Once the change control board approves any change you need to re-baseline.

Advantages of budgeting in a business:

Establishing Guidelines: Project budget allows you to establish the main objectives of a project. Without proper budgeting, a project may not be completed on time. It allows the project manager to know how much he can spend on any given aspect of the project.

Cost Estimating: Once a budget is in place, the project manager can determine how much money can be spent on each component of the project. Hence it also determines what percentage of the available funds can be allocated to the remaining elements of the project. It gives the chance to decide whether or not the project can be completed in the available budget.

Prioritizing: Another advantage of having a project budget is that it helps you to prioritize the different tasks of the project. Sometimes it might seem to be completed at once, but it doesn’t happen due to some inefficiency. A budget will allow you to prioritize which parts of the project can be completed first.

Expected value (also known as EV, expectation, average, or mean value) is a long-run average value of random variables. It also indicates the probability-weighted average of all possible values.

Expected value is a commonly used financial concept. In finance, it indicates the anticipated value of an investment in the future. By determining the probabilities of possible scenarios, one can determine the EV of the scenarios. The concept is frequently used with multivariate models and scenario analysis. It is directly related to the concept of expected return.

Formula for Expected Value

The first variation of the expected value formula is the EV of one event repeated several times (think about tossing a coin). In such a case, the EV can be found using the following formula:

EV = P(x) *n

Where:

EV: The expected value

P(X): The probability of the event

N: The number of the repetitions of the event

The expected value (EV) is an anticipated value for an investment at some point in the future. In statistics and probability analysis, the expected value is calculated by multiplying each of the possible outcomes by the likelihood each outcome will occur and then summing all of those values. By calculating expected values, investors can choose the scenario most likely to give the desired outcome.

EV=∑P(Xi)×Xi

Example:

Examples of using expected value

It turns out that all events have some aspect of risk and value. Insurance companies use this to determine how much to charge you for your premiums. They add up everyone in your reference class, and determine how much it costs them on average in payouts. They then add a little on the top to make a profit, which makes buying insurance net negative (the costs minus the benefits to you) on expectation, just like buying a lottery ticket. However, this doesn’t mean getting insurance is a bad idea! A lot of people don’t like taking on excessive risk (a small chance of becoming bankrupt feels much worse than paying up for insurance you might never need), so buying insurance is rational. Another way to put this is that we have diminishing marginal returns to extra money (or concave utility functions, for the mathematically inclined).

Pascal’s wager is also an example of using expected value to think about the world. Humans all bet with their lives either that God exists or that he does not. Pascal argues that a rational person should live as though God exists and seek to believe in God. If God does actually exist, such a person will have only a finite loss (some pleasures, luxury, etc.), whereas they stand to receive infinite gains (as represented by eternity in Heaven) and avoid infinite losses (eternity in Hell).

The Budget Must Have the Support of Management

The budget must undeniably have the support of management at all levels of the organization. The support of both the top-level managers and the lower-level managers is crucial to garner the support of the employees of the enterprise.

The Budget Must be a Motivating Tool

The budget should motivate and inspire all the people in the enterprise to work toward attaining the enterprise’s goals. Furthermore, the budget must encourage everyone to work together for the improvement of the organization. The budget should not be viewed as a rigid plan, or as a device for top management to use in assessing blame.

The Budget Must Address the Enterprise’s Goals

Essentially, a budget must begin with the enterprise’s short and long-term plans and goals. The budget should not just to recreate the enterprise’s previous year’s results with slight changes. It must include valuable input from planning so that the budget becomes a powerful guiding tool.

The Budget Should be Coordinated

The budget must be coordinated to smoothly operate within the different business units of an enterprise. For example, the sales manager will strive to increase the sales of the enterprise. However, the credit manager will be extremely keen in limiting bad debt write-offs.

The Budget Should be a Correct Representation

The budget should accurately represent what is expected to happen. An inaccurate budget will not have the support of managers and employees directly affected by it and will encourage managers of an enterprise to fabricate “budgetary slack” into their budgets.

The Budget Should be Flexible

A key factor in the success of a budget is whether it is flexible or not. Most successful budgets are flexible. A flexible budget permits an enterprise in going ahead with plans that are strategically important to the enterprise. However, a rigid budget becomes an excuse for not executing strategically important plans.

Budgets are most commonly prepared for the company’s fiscal year, but often three-, five-, and ten-year budgets are planned, as well as budgets of shorter duration. A different year basis other than fiscal year is possible, but is not recommended, because fiscal year financial statements can be easily compared to the budget. Budgets are often further broken down into monthly or quarterly sub-periods, or a continuous or rolling budget is used. A continuous budget has a month, quarter, or year basis, and as each period ends the upcoming period’s budget is revised and another period is added to the end of the budget. Software is available for implementing this type of budget.

Budget Process

Methods of budget preparation differ between companies, but all fall somewhere on a continuum between entirely authoritative and entirely participative. In an authoritative budget (top-down budget), top management sets everything from strategic goals down to the individual items of the budget for each department and expects lower managers and employees to adhere to the budget and meet the goals. In a participative budget (bottom-up or self-imposed budget), managers at all levels and certain key employees cooperate to set budgets for their areas, and top management usually retains final approval.

Characteristics of a Successful Budget

• Should be flexible.
• Must be realistic.
• Should be evaluated regularly.
• Should have a financial format.
• Must be well planned and clearly communicated.

Operations Goals

Operational goals define the routine tasks that are necessary to run an organization. When a company functions efficiently, employees are more productive and can reach their full potential. Profits can be made. Setting operational goals lets you manage a business, allowing it to grow in a scalable manner.

Regardless of the phrases you use, operational goals are items an organization wants to accomplish over the course of one to two years. They are (typically) defined by these characteristics:

• Limited to a single department or division
• Associated with a budget
• Tracked to see “what you get” with the budget you have
• Measurable and actionable
• Shorter time frames

Linking Operational Goals to Strategic Goals

A strategy is a high-level plan to accomplish items of key importance for your organization over the course of three to five years. Strategic goals are the building blocks of a strategy. They can be organized in multiple ways: by perspectives (financial, customer, internal process, and people) or by division and department.

Operational goals should be ingrained in every area of your strategic plan. You won’t be able to achieve your strategy otherwise. If you have too many operational goals tied to one strategic goal and not enough (or any) tied to another, consider shifting resources and prioritizing your operational goals differently.

Also, you may have operational goals and plans aligned by department, such as a marketing operations plan, customer success plan, product development plan, etc. Check all your work plans to make sure they cover all your strategic goals.

Setting Goals Vs. Setting Targets

An important distinction to make here is that goals are different than targets. We’ve established that operational goals specify (in a measurable way) the short-term tactics an organization will take to achieve its strategy. Targets are tools that allow you to define expected progress in even smaller steps that align with the details and deadlines of operational goals. More specifically, targets are typically set by quarter throughout the one- to two-year time span of an operational goal.

Operational Goals and Projects

A strategic plan has clearly defined goals, measures, and projects. Your strategic projects contribute to your goals so you can improve your measures. When you’re doing operations planning, operational goals and projects will be intermixed—and that’s perfectly normal. Similar to how goals and targets can overlap, so can goals and projects. Sometimes you’ll measure a longer term operational goal, like improving miles and miles of paved roads; and sometimes you’ll track and measure a shorter project, like widening a bridge. From a strategy standpoint, the bridge widening will look like a project, but from an operations perspective, it’s both a goal and a project. Ultimately, a lot of your activities will directly or indirectly link to your strategic goals.

Operational budgets are usually consumed by projects, so those projects start to have goal-like “symptoms.” Because of this fluidity of terminology, it’s important to regularly evaluate operational goals and projects to ensure they are on track and aligned with the organization’s strategy. This helps you be continually aware of how the progress you’re achieving is helping the company, all the way up to the strategic level.

Your strategy won’t be effective if you don’t have those operational goals in place and on track. Operational tactics and strategic vision have a reciprocal relationship. Plus, if you’re in a cost-cutting environment, it will be easier to defend your budget or work plan if it links closely to the strategy. You’ll be able to clearly show that you’re thinking strategically and using resources in a way that supports the strategy.

• These goals are focused on the monetary aspects of the business such as reducing costs or improving revenues.
• These goals tend to focus on improving productivity or quality so as to differentiate the company from its competitors.
• Cultural/Workforce. These goals are designed to improve the workforce’s capabilities, commitment, and discretionary effort.

Strategic Goals

Strategic goals let executives and upper management determine where they want to go. Basically, you want to get from your current state to a future enhanced position. Strategic goals are the outcome that you desire.

Perhaps you want to produce more products. You might want to reduce overhead. Maybe you want to enter new markets. Setting strategic goals allows you to evaluate where you are and challenge yourself to end up at a better place.

Some examples of strategic goals include:

• Increase customer conversion rates
• Launch a new product
• Increase revenues
• Improve training programs
• Diversify your revenue streams

Tactical Goals

Once you set strategic goals, you can build up your tactical goals. These further define your strategic objectives. You can plan tactical goals in advance by breaking down your strategic goals.

For example, let’s say that your strategic goal is to boost sales by 15 percent by the end of the quarter. Tactical goals would be the campaigns that you set up in each department to increase sales. One strategic goal should have multiple short-term tactical goals that create the momentum to achieve the overarching objectives.

Tactical goals can build on one another. You may have to accomplish certain tactical goals before you can take on more to produce a consequence. On the other hand, tactical goals can also be independent of one another. You can have several separate tactical goals that you can work on at once to bring about a result. Think of them as the action steps that provide a direct line to your strategic goals.

Performance goals

Performance goals are short-term objectives that an employee is expected to achieve within a set period of time. These goals are usually attached to specific job positions and are determined after considering the tasks and duties an employee is required to perform in that position. Performance goals are often a subset of and add up to overall company goals. They let employees know what is expected from their position, so it is important to define performance goals as clearly as possible and make them easily measurable.

Performance goals are what employees work to achieve. They are based on the goals and priorities of an organization and are tied to specific job positions. They focus on the job duties and productivity of an employee, and are designed to integrate an employee’s achievement with the overall goals of the company.

Development goals

Development goals, on the other hand, are set for the professional development of an employee. They focus on the areas the employee wants to develop for growth and advancement in their career. They encourage enhancement in performance through learning and development. Development goals are chosen and set by the employee, but they often involve active support from management. The employee usually looks up to the organization to help fulfill their professional development goals, such as through skill-based training and financial sponsorship.

How to set performance goals

Setting performance goals for employees is an important responsibility of a manager. Use the following steps to set measurable goals to improve the performance of your team and drive growth in your organization:

Invite employees to participate

Encourage employees to identify and suggest their own job-specific goals. Employees will be more motivated to achieve the goals that they set rather than those imposed by the management. Discuss with each employee their individual goals for a given performance period. Ensure that the goals align with the company objectives. Once you finalize the goals, develop an action plan for their achievement.

Review company objectives

Consider your company’s goals to connect performance goals for each employee with the mission and strategy of the company. Performance goals become effective when employees know how they contribute to the company’s growth. Start with an overall company goal and divide it into smaller goals for each employee. For example, if the management wants to grow sales by 4%, find out how each individual can contribute toward that achievement.

Use the SMART method

You can use the SMART method of setting goals to ensure that employee performance goals are specific, measurable, achievable, relevant and time-bound. Each goal should clearly tell the employees what they are expected to achieve and within what time frame. Quantify the achievement to make it measurable, and try to keep the target challenging but within the attainable range.

Specific

You should clearly define goals in specific terms as to what is to be achieved. For example, saying “start publishing a monthly newsletter” is better than making a generic statement like “improve communication with team members.”

Measurable

Goals should be measurable, making it easy to track their achievement. For example, “reduce process time by 10%.” In addition to a numeric quantity, you can also measure goals through a change in behavior, quality, cycle or processing time and efficiency.

Achievable

Goals should be achievable with a reasonable amount of effort. You should set realistic goals that can be achieved within the pre-determined timeframe with sincere efforts and available resources.

Relevant

All goals should be pertinent to the main objective, such as achieving company goals.

Time-bound

You should clearly specify a timeframe to achieve goals. For example, if you want to increase productivity by 10%, you should also state whether it should be achieved in one year, two years or by a certain date.

Operating budgets include the sales budget, production budget, direct materials budget, direct labor budget, overhead budget, cost of goods sold budget, selling and administrative budget, and pro forma (or budgeted) income statement.

Financial budgets include the capital budget, pro forma balance sheet, pro forma statement of cash flow, and cash budget.

Operating Budget

The operating budget contains the expenditure and revenue generated from the daily business functions of the company. The operating budget concentrates on the operating expenditures, including cost of produce sold in the market or popularly known as cost of sold goods (COGS) and the revenue or income. COGS is the cost of direct labor and direct materials that are tied to production.

The operating budget also depicts the overhead and administration costs tied directly to manufacturing the goods and providing services. However, the operating budget will not contain capital expenditures and long-term loans.

An operating budget consists of all revenues and expenses over a period of time (typically a quarter or a year) which a corporation, government, or organization uses to plan its operations.  An operating budget is prepared in advance of a reporting period as a goal or plan that the business expects to achieve. Below is an example of a downloadable budget template and an explanation of how to prepare one.

Components of an Operating Budget

The main components of an operations budget are outlined below. Each business is unique and every industry has its nuances, but these items are general enough to apply to most industries.

Revenue

Revenue is usually broken down into its drivers and components. It’s possible to forecast revenue on a year-over-year basis, but usually, more detail is required by breaking revenue down into its underlying components.

Revenue drivers typically include:

• Volume (units, contracts, customers, products, etc.)
• Price (average price, per unit price, segment price, etc.)

Variable costs

After revenue, variable costs are determined. These costs are called “variable” because they depend on revenue, and are often calculated as a percentage of sales.

• Variable costs often include:
• Cost of goods sold
• Direct selling costs
• Sales commissions
• Payment processing fees
• Freight
• Certain aspects of marketing
• Direct labor

Fixed costs

After variable costs are deducted, fixed costs are usually next. These expenses typically do not vary with changes in revenue and are mostly constant, at least within the time frame of the operating budget.

Examples of fixed costs include:

• Rent
• Head office
• Insurance
• Telecommunication
• Management salaries and benefits
• Utilities

Non-operating expenses

Non-operating expenses are those that fall below Earnings Before Interest and Taxes (EBIT) or Operating Income.  Examples of expenses that may be included in a budget are:

• Interest
• Gains or Losses
• Taxes

Non-cash expenses

An operating budget often includes non-cash expenses, such as depreciation and amortization.  Even though these expenses don’t impact cash flow (other than taxes), they will impact financial reporting performance (i.e the figures a company reports at the end of the year on their income statement).

Capital costs in an operating budget

Capital costs are usually excluded from an operating budget. The term operating refers to a statement of operations (income statement) which does not include capital expenditures.

Financial Budget

A budget helps an organization allocate the resources of the company to different departments and activities and manage the cash flows of the business in an effective way. There are many types of budgets. One of them is a financial budget.

The financial budget is one part of a business’s master budget. The second part of the firm’s master budget is the operating budget. The master budget is the financial portion of the business’s strategic plan for the near future. The strategic plan for the business maps out the firm’s planned financial activities for the next five years.

The purpose of the financial budget is to estimate the firm’s cash budget, capital expenditures, and balance sheet line items like assets, liabilities, and owner’s investment. The financial budget is the last budget to be developed by the firm every year since all other budgets, like the individual budgets in the operating budget, are necessary first. The financial budget helps the firm by allowing it to calculate net profit when the budget process is complete.

The capital expenditures budget is the first budget of these three budgets to be prepared within the framework of the financial budget. The information from this budget is needed for both the cash budget and the budgeted balance sheet.

Capital expenditures are fixed asset expenditures. Fixed assets are equipment or facilities needed for a business to operate. These expenditures also include maintenance for these items. While there are businesses that purchase larger amounts of fixed assets, most smaller businesses do not.

Small businesses tend to be more conservative in their capital expenditures since these types of purchases can be very costly. Many do not own the facilities they operate in, reducing capital expenditures.

While an expenditures plan for maintenance of the equipment is likely, a smaller business may lease, rather than own, their equipment. Consider depreciation and standard lifetimes of your equipment when designing your capital budget if you own your plant and equipment.

Different Sections of a Financial Budget

Budgeted Balance Sheet

The budgeted balance sheet comprises many other budgets. The major component of this budget includes the production budget and its associated budgets.

Cash Budget

The cash budget contains information on the inflows and outflows of the business. On the other hand, the cash flow of the business continues changing and with that, the cash budget should also change. Making a cash budget is a dynamic process, not a static one. There must be an immediate reflection of any change in the cash flow in the cash budget of the business.

Capital Expenditure Budget

As the name suggests, the capital expenditure budget relates to expenses related to plant and machinery or any capital asset of the business. This budget determines the expenses that would be incurred if an existing plant is replaced or any new machinery is bought. Factors like depreciation, cost of the plant, life of the machinery, etc. are taken into account when preparing the capital expenditure budget.

Financial Budget Plan

The financial budget plan is comprised of the following steps:

• Calculate the expected outflow
• Calculate the expected inflow
• Set the targets
• Keep track of components in the budget
• Divide the expenses into different categories
• Set up the ledger

Capital Budgets

Capital budgeting involves choosing projects that add value to a company. The capital budgeting process can involve almost anything including acquiring land or purchasing fixed assets like a new truck or machinery.

Capital budgeting is the process a business undertakes to evaluate potential major projects or investments. Construction of a new plant or a big investment in an outside venture are examples of projects that would require capital budgeting before they are approved or rejected.

Corporations are typically required, or at least recommended, to undertake those projects that will increase profitability and thus enhance shareholders’ wealth.

However, the rate of return deemed acceptable or unacceptable is influenced by other factors specific to the company as well as the project.

Objectives of Capital budgeting

Capital expenditures are huge and have a long-term effect. Therefore, while performing a capital budgeting analysis an organization must keep the following objectives in mind:

Capital expenditure control

Selecting the most profitable investment is the main objective of capital budgeting. However, controlling capital costs is also an important objective. Forecasting capital expenditure requirements and budgeting for it, and ensuring no investment opportunities are lost is the crux of budgeting.

Selecting profitable projects

An organization comes across various profitable projects frequently. But due to capital restrictions, an organization needs to select the right mix of profitable projects that will increase its shareholders’ wealth.

Finding the right sources for funds

Determining the quantum of funds and the sources for procuring them is another important objective of capital budgeting. Finding the balance between the cost of borrowing and returns on investment is an important goal of Capital Budgeting.

Cash flow forecasting is the process of estimating the flow of cash in and out of a business over a specific period of time. An accurate cash flow forecast helps companies predict future cash positions, avoid crippling cash shortages, and earn returns on any cash surpluses they may have in the most efficient manner possible.

Cash flow is the amount of money going in and out of your business. Healthy cash flow can help lead your business on a path to success. But poor or negative cash flow can spell doom for the future of your business.

If you want to predict your business’s cash flow, create a cash flow projection. A cash flow projection estimates the money you expect to flow in and out of your business, including all of your income and expenses.

Typically, most businesses’ cash flow projections cover a 12-month period. However, your business can create a weekly, monthly, or semi-annual cash flow projection.

Advantages of projecting cash flow

Projecting cash flows has many advantages. Some pros of creating a cash flow projection include being able to:

• See and compare business expenses and income for periods.
• Predict cash shortages and surpluses.
• Determine if you need to make adjustments. (e.g., cutting expenses)
• Estimate effects of business change. (e.g., hiring an employee)
• Prove to lenders your ability to repay on time.

Forecasting:

Determine Your Forecasting Objectives

To ensure you see actionable business insights from a cash flow forecast, you should start with determining the business objective that the forecast should support. We find that organizations most commonly use cash forecasts for one of the following objectives.

• Short-term liquidity planning: Managing the amount of cash available on a day-to-day basis to ensure your business can meet its short-term obligations.
• Interest and debt reduction: Ensuring the business has enough cash on hand to make payments on any loans or debt they’ve taken on.
• Covenant and key date visibility: Projecting your cash levels for key reporting dates such as year, quarter, or month-end.
• Liquidity risk management: Creating visibility into potential liquidity issues that could arise in the future so you have more time to address them.
• Growth planning: Ensuring the business has enough working capital on hand to fund activities that will help grow revenues in the future.

Choose Your Forecasting Period

Once you’ve determined the business objective you hope to support with a cash flow forecast, the next thing to consider is how far into the future your forecast will look.

Generally, there’s a trade-off between the availability of information and forecast duration. That means the further into the future the forecast looks, the less detailed or accurate it’s likely to be. So, choosing the right reporting period can have a big impact on the accuracy and reliability of your forecast.

• Short-period forecasts: Short-term forecasts typically look two to four weeks into the future and contain a daily breakdown of cash payments and receipts. As you might expect, short-term forecasts are often best suited for short-term liquidity planning, where day-to-day granularity is important to ensure a business can meet its financial obligations.
• Medium-period forecasts: Medium-term forecasts typically look two to six months into the future and are extremely useful for interest and debt reduction, liquidity risk management, and key date visibility. The most common medium-term forecast is the rolling 13-week cash flow forecast.
• Long-period forecasts: Longer-term forecasts typically look 6–12 months into the future and are often the starting point for annual budgeting processes. They’re also an important tool for assessing the cash required for long-term growth strategies and capital projects.
• Mixed-period forecasts: Mixed-period forecasts use a mix of the three periods above and are commonly used for liquidity risk management. For example, a mixed period forecast may provide weekly forecasts for the first three months and then on a month-to-month basis for the next six months after that.

Choose a Forecasting Method

There are two primary types of forecasting methods: direct and indirect. The main difference between them is that direct forecasting uses actual flow data, where indirect forecasting relies on projected balance sheets and income statements.

Choosing the right forecasting method depends on the cash flow forecasting window you selected above, as well as the kind of data you have available to build your forecasting model.

Source the Data You Need for Your Cash Flow Forecast

Direct forecasting provides the greatest accuracy and works for the majority of business objectives that companies build forecasts to support. Therefore, we’ll focus on where to find actual cash flow data for your forecast in this section.

The right places to source cash flow data for your forecast ultimately depends on how your business manages its finances. But, generally speaking, most of the actual cash flow data you’ll need to build your forecast can be found in bank accounts, accounts payable, accounts receivable, or the accounting software you use.

• Your opening cash balance for the forecasting period: This is normally taken from the most up-to-date and accurate reflection of current positions.
• Your cash inflows for the forecasting period: Anticipated sales receipts from within the forecasting period are usually the primary source of data for your cash inflows. Other types of cash inflows to consider including are intercompany funding, dividend income, proceeds of divestments, and inflows from third parties.
• Your cash outflows for the forecasting period: We recommend capturing wages and salaries, rent, investments, bank charges, and debt payments. But you can include anything that’s relevant to your business.