Guillermo Furniture Store Needs to

Guillermo Furniture Store needs to produce its budgets for the coming year. The flex budget helps to bridge the gap between the forecast budget and the actual budget. The flex budget is essentially a revised version of the forecast budget given sales figures more in line with those of the actual budget. The flex budget is used to help determine key sources of variance between the forecast budget and the actual budget (Caplan, 2006). The Guillermo Furniture Store example illustrates the risk inherent in forecast budgets.

Forecast budgets are created based on sets of assumptions. The degree to which these assumptions are realistic will determine in large part the accuracy of the forecast budget. Some budget conditions may be difficult to determine in advance, so it is likely that the actual financial results will differ from the projections in the forecast budget. The likelihood of such variance and the size of the variance both factor into the risk associated with the forecast budget.

There are a couple of ways in which to mitigate the risk of the forecast budget. The first is to gather the best information. The revenue forecast, in essence, describes the best-known information about the uncertainty of the revenues for the period (Bretschneider & Schroeder, 1984). As such, this uncertainty can be reduced by gathering more information. Past figures often provide a baseline for forecasts, as do past variance figures -- historical variance levels from forecast can help to understand the likelihood of future variance against forecasts.

Other techniques can also be used as well. Today, sophisticated modeling is typically used in order to analyze historical variance levels against forecasts. This variance, however, gives rise to ethical considerations. When setting forecast budgets, managers may utilize a number of approaches. In a static environment, the previous years' sales may be a reasonable approximation of the next years' sales. However, most environments are dynamic and therefore the manager will have significant control over the forecast budget.

The budget could be produced in an unethical manner to secure greater funding, to retain funding levels or to mask manager underperformance. Reputation and ethics are the two most likely causes of ethical lapse in the budgeting process (Stevens, 2002). Therefore, senior management needs to implement controls on the budgeting process in order to decrease the risk of unethical behavior and increase the quality of the budget as a result.

These controls can include having a standardized procedure for the preparation of the forecast budget or through the application of budgetary slack. The lower the slack management allows in the forecast budget, the greater the lower the variance that can be expected, in particular when the manager making the forecast has reputation at stake on the variance (Ibid). Reputation is an external driver, while ethics are an internal driver (Ibid).

Therefore, a code of ethics should be implemented as a control to help define the ethical expectations that the company has for its financial managers. In the Guillermo Furniture Store situation, the variance from the budget forecast last year left the company with losses instead of profits. Consumers purchased more of the mid-grade product and less of the high-grade product than anticipated; the latter having much higher margins than the former.

For the next year's budget, Guillermo senior management should approach the budget hoping to reduce the variance between forecast and actual results. For the next year, the budget should incorporate controls that force it to have a starting point of declining sales in the high-end product, as that has been the trend over the past year. Increasing sales of the mid-end product should also be included. Management can.