Chapter Three Lecture Notes

1. Chapter Three Lecture Notes Additional Budgeting Concepts

2. Line item or object of expense - e.g., salaries, benefits, supplies, rent, etc. • Responsibility Center - units for which individual managers are held accountable, e.g., custodial services, maintenance, public relations, development, ticket sales, etc. • Program Budgets include both revenues and expenses - ballet, opera, philharmonic, etc. • Generally, both Responsibility Center and Program budgets are supported by line item detail. Budgeting Formats

3. Revenue Net patient revenue Gift shop revenue Investment revenue on endowment Total revenue Expenses Salaries Supplies Bad debts Interest Rent Total expenses Profit/(loss) $ 97,980,000 120,000 50,000 $ 98,150,000 $ 78,900,000 15,400,000 2,200,000 400,000 3,100,000 $100,000,000 $ (1,850,000) Line Item Operating Budget

4. Responsibility Center Expense Budget

5. Program Budgets Program budgets include both revenue and expenses for the major activities of an organization. Helps managers focus on sources of profits and losses of programs that could be expanded or discontinued.

6. Functional Budgets focus on the major functions performed by an organization. This format is often used to report to outsiders. Note the line item detail. Functional Budgets

7. Flexible Budget • Organizations often experience more or less volume than budgeted. • Flexible budgets look at expected revenues, expenses, and net income under different volume assumptions. • The key to flexible budgeting is the identification of: • Fixed Costs - which do not change with volume. • Variable Costs - which do change with volume. • Flexible budget results are normally shown in a side-by-side columnar format. • A flexible budget is a form of "What if?" analysis.

8. Flexible Budget Example Charity Church sponsors a three-day youth camp in Bear Mountain Park. Charity provides a $500 grant for the event and collects $130 from each camper. The camp director expects 40 campers to attend and anticipates the following expenses: Campground fees $350 for 3 days Bus transportation $1,225 (60 rider capacity) Equipment rental $40 per camper Meals $65 per camper Provide a flexible budget assuming a 10% increase in the number of campers.

9. Budget10% Increase Revenue 40 campers44 campers Camp tuition $5,200 $5,720 Church subsidy 500 500 Total revenue $5,700$6,220 Less expenses Campground rental $ 350 $ 350 Bus transportation 1,225 1,225 Equipment rental 1,600 1,760 Meals 2,600 2,860 Total expenses $ 5,775$ 6,195 Surplus/loss $ (75)$ 25

10. Meals for Homeless Flexible Budget Example

11. Two Approaches to Budgeting • Centralized or Top Down Model - Priorities are set at the top of the organization and imposed on the operating units. More control but less staff involvement. • Decentralized or Bottom Up Model - Operating units prepare budgets based on their perceptions of needs. Less control but more involvement. Lots of negotiations. Risk of losing sight of overall objectives. • Most organizations use hybrid approaches incorporating elements of both methods.

12. Traditional Budgeting processes focus on resource negotiations and uni-dimensional output measurements (i.e. profit/loss). • Performance Budgeting asks managers to define goals, plan their resource needs, and measure the achievement of various goals and objectives. It is a “mission-related” budgeting format. • Choose your measures wisely. • Can simple measures tell the whole story? Performance Budgeting

13. Incremental Versus Zero-Based Budgeting • Incremental budgeting starts with current revenues and expenses and projects next year by adjusting for inflation, volume, efficiency, technology, etc. • Zero-Based Budgeting - calls for a total reevaluation of all programs and activities. - requires that “decision packages” be prepared for each separable activity or level of activity. - ranks the packages. - selects packages for adoption or rejection.

14. Governmental Budgeting Issues • Taxing authority – budget for tax revenues • Taxing/spending decisions often have policy implications. • Entitlements and mandates create spending patterns that must be built into budgets. • Governmental budgets generally have the force of law: • they restrict managers from spending more than is • allocated for their departments. • they limit a manager’s ability to move funds from one • account to another. • Governments must disclose their budgets to the public.

15. Forecasting • Three “formal” forecasting approaches: - Subjective methods (e.g., Delphi and nominal group) when there are no historical data. - Time Series methods when the future is expected to follow an historical trend. - Causal Modeling which tries to forecast based on statistical relationships among several factors. • Forecasting is an art, not a mathematical science. Models should be tested before use and experience should be brought to bear when appropriate.

16. Factors in Revenue Forecasts • Economic conditions • Endowment Investment Decisions • Price Setting - historical approach - what we always got. - market approach - what others charge. - Price elasticity and demand estimation

17. Regression Analysis for Forecasting • Independent/Dependent Variables • Ordinary Least Squares • Predictive Value • Goodness of Fit • Statistical Significance