Financial Decision and Budget

¶ … budget process, "make" or "buy" decisions, and non-financial performance measures. The initial budget process starts with the existing budget, and the information in this budget should be verified, and reconciled against actual performance. You have to know that your starting point is accurate. The second step in the budgeting process is to determine the information flows and measures that will be used to create the budget. A budget depends on having accurate information, and this step is necessary to ensure that the information is accurate.

The third step in the budgeting process is to determine a methodology that will be used. When you have an existing budget and an ongoing business, that is usually the starting point, but there are still several different choices of methodology that can be used. Choose the one that is optimal for the type of business and its situation. The final step is to make the projections for the coming year, quarter or month. The budget variances report shows that there was a direct materials variance, mainly reflecting the efficiency.

The price was static, the efficiency, however, was not, and the direct materials overage reflects that efficiency was lower than expected. A larger variance was direct labor. The cost of labor was lower, but the efficiency was significantly lower. One possible explanation for this is that the company has less experienced workers. These tend to cost less, but they tend to be less efficient as well. Further, they might make more mistakes, leading to less efficiency in the use of raw materials.

This is the most likely cause of the variance, at least worth investigating. Alternately, the variance could be process-related, meaning that something in the process has changed to make it less efficient. Though, that would not reflect in the per unit cost of labor. It's probably also worth considering that the company might have made more product because it sold more product -- the variance isn't clear on if that is the case or not, so it is assumed that this isn't what happened.

If the cause of the variance is related to onboarding, then in the short-run there is nothing to be done. Those workers are probably getting up to speed and their efficiency reaching peak. Onboarding is often a long process, and the company has to be cautious about making changes that affect the long-run, based on short-run results. However, in the long-run the company might want to look at whether the onboarding process can be improved.

If there are ways to get new workers up to speed faster, that will help to eliminate the sort of waste that occurred here. And again, if this was process-related, then the company will need to re-evaluate what changed in the process and either adjust the budget to the new norm, or re-adjust the process back to the optimal. There are always ethical issues that can arise when dealing with budget variances.

First, the budget analyst has a duty to the owners of the firm to try to perform to the highest level. What this means is that the budget analyst has to be fully honest in the assessment of the issue. Maybe the onboarding process is slow because the company hired the wrong people and they need to be let go. There are a lot of hypotheticals here. But the recommendation given was to hold, on the idea that if the cause has been correctly identified the performance will average out.

So there are no ethical considerations with this -- the budget process simply did not accommodate for onboarding, and maybe this was unexpected. In general, decisions to do things like fire people are not the budget analyst's call; that is a decision to be made by someone else, so the ethical directive of the budget analyst is to be as accurate and honest as possible in the reporting of the budget variances and their causes. The buy or make decision usually takes into account a few different factors.

First, the company has to look at cost, and it has to consider cost in the long run, not the short run. But more than that, the company has to look at the reliability of the supplier, and what alternate suppliers there might be as a backup plan. The decision should be made carefully because the best financial decision for the short-run might be different than the best financial decision in the long-run.

Not going to shoehorn ethics into this -- it's a business decision so as long as the data used is honest and correct, the decision will be, too. As for the impact on efficiency -- that has to be priced into the decision, including risk factors like being able to get a reliable supply of the part. Most companies have non-financial performance measures. Those don't really come into budget analysis, but companies will often use measure relating to.