At the beginning of the master budgeting process, the budget director alerts all segments of the company to the need for gathering budget information. The data used to create the budget come from many sources. Historical data are one possibility. For example, last year’s direct materials costs may give the production manager a good feel for potential materials costs for next year. Still, historical data alone cannot tell a company what to expect in the future.
Forecasting Sales
The sales forecast is the basis for the sales budget, which, in turn, is the basis for all of the other operating budgets and most of the financial budgets. Accordingly, the accuracy of the sales forecast strongly affects the soundness of the entire master budget. Creating the sales forecast is usually the responsibility of the marketing department. One approach is for the chief sales executive to have individual salespeople submit sales predictions, which are aggregated to form a total sales forecast. The accuracy of this sales forecast may be improved by considering other factors such as the general economic climate, competition, advertising, pricing policies, and so on. Some companies supplement the marketing department forecast with more formal approaches, such as time-series analysis, correlation analysis, econometric modeling, and industry analysis.
To illustrate an actual sales forecasting approach, consider the practices of a company that manufactures oil field equipment on a job-order basis. Each month, the finance and sales departments’ heads meet to construct a sales forecast based on bookings. A booking is a probable sales order submitted by sales personnel in the field; it is meant to alert the engineering and manufacturing departments to a potential job. Past experience has shown that bookings are generally followed by sales/shipments within 30 to 45 days. Exhibit 8-3, shows the short-term bookings forecast for the company. Notice that the dollar amount of each booking is multiplied by its probability of occurrence to obtain a weighted dollar amount. The sum of weighted amounts is the forecast for sales for the month. The probability estimate requires additional explanation. The probability is determined jointly by the salesperson and the controller. Each probability is initially set at 50 percent. Then, it is adjusted upward or downward based on any additional information about the sale. The probability is really a prediction of a compound event, the prediction of both getting the order and determining the month in which it will happen. The sales department tends toward overconfidence both in terms of getting the order
Forecasting Sales
The sales forecast is the basis for the sales budget, which, in turn, is the basis for all of the other operating budgets and most of the financial budgets. Accordingly, the accuracy of the sales forecast strongly affects the soundness of the entire master budget. Creating the sales forecast is usually the responsibility of the marketing department. One approach is for the chief sales executive to have individual salespeople submit sales predictions, which are aggregated to form a total sales forecast. The accuracy of this sales forecast may be improved by considering other factors such as the general economic climate, competition, advertising, pricing policies, and so on. Some companies supplement the marketing department forecast with more formal approaches, such as time-series analysis, correlation analysis, econometric modeling, and industry analysis.
To illustrate an actual sales forecasting approach, consider the practices of a company that manufactures oil field equipment on a job-order basis. Each month, the finance and sales departments’ heads meet to construct a sales forecast based on bookings. A booking is a probable sales order submitted by sales personnel in the field; it is meant to alert the engineering and manufacturing departments to a potential job. Past experience has shown that bookings are generally followed by sales/shipments within 30 to 45 days. Exhibit 8-3, shows the short-term bookings forecast for the company. Notice that the dollar amount of each booking is multiplied by its probability of occurrence to obtain a weighted dollar amount. The sum of weighted amounts is the forecast for sales for the month. The probability estimate requires additional explanation. The probability is determined jointly by the salesperson and the controller. Each probability is initially set at 50 percent. Then, it is adjusted upward or downward based on any additional information about the sale. The probability is really a prediction of a compound event, the prediction of both getting the order and determining the month in which it will happen. The sales department tends toward overconfidence both in terms of getting the order
Also read preparing financial budget
and in landing it sooner rather than later. As a result, the controller takes a more pessimistic view and modifies the forecast. The end result is the form shown in the exhibit.
Forecasting Other Variables
Of course, sales are not the only concern in budgeting. Costs and cash-related items are critical. Many of the same factors considered in sales forecasting apply to cost forecasting. Here, historical amounts can be of real value. Managers can adjust past figures based on their knowledge of coming events. For example, a 3-year union contract takes much of the uncertainty out of wage prediction. (Of course, if the contract is expiring, the uncertainty returns.) Alert purchasing agents will have an idea of changing materials prices. In fact, large companies such as Nestlé and The Coca-Cola Company have entire departments devoted to the forecasting of commodity prices and supplies. They invest in commodity futures to smooth out price fluctuations, an action that facilitates budgeting. Overhead is broken down into its component costs; these can be predicted using past data and relevant inflation figures. The cash budget is a critically important part of the master budget, and some of its components, especially payment of accounts receivable, also require forecasting.
and in landing it sooner rather than later. As a result, the controller takes a more pessimistic view and modifies the forecast. The end result is the form shown in the exhibit.
Forecasting Other Variables
Of course, sales are not the only concern in budgeting. Costs and cash-related items are critical. Many of the same factors considered in sales forecasting apply to cost forecasting. Here, historical amounts can be of real value. Managers can adjust past figures based on their knowledge of coming events. For example, a 3-year union contract takes much of the uncertainty out of wage prediction. (Of course, if the contract is expiring, the uncertainty returns.) Alert purchasing agents will have an idea of changing materials prices. In fact, large companies such as Nestlé and The Coca-Cola Company have entire departments devoted to the forecasting of commodity prices and supplies. They invest in commodity futures to smooth out price fluctuations, an action that facilitates budgeting. Overhead is broken down into its component costs; these can be predicted using past data and relevant inflation figures. The cash budget is a critically important part of the master budget, and some of its components, especially payment of accounts receivable, also require forecasting.
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