Welcome everyone to the sixth, final week of accounting course. This week, we will study another very important facet of major accounting, namely budgets and budgeting. And as always, we will, first of all, discuss why this is an important topic. Then, I will give you a comprehensive example of preparation of operating budget that will go over a series of episodes here. And then, we will wrap up, and we will see how budgets, in particular, and how major accounting in general, contributes to our goal of valuing companies and projects better. Well, so now, we just start talking about budgets and responsibility accounting. I will first talk about what is a budget. Well, I think that all of you heard about budgets. And, strictly speaking, a budget is a plan. And there are just very few differences between a normal plan and the budget because, basically, budget is a sort of quantified plan. It's expressed in numbers. But in general, the idea here, is that budget is viewed more broadly. So this is a tool for planning. No question. This is the key story here. But then, also, this is the tool for control. Because if we have a plan to do something, it's important to see what happens if for any reason our plan is not implemented in the way we have planned to do so. And that might have serious repercussions for our managerial decisions, because we would like to know why we did not reach the goals that we had planned to. And what can be done, if any, to sort of fix the situation. And again, the definition goes that the budget is a quantitative expression of plan of actions. I'll put it this way. So, the best example to illustrate that is to analyze not the company as a whole, but their project within this company. You know that project manager is quite a popular area of overall management right now, and many companies are organized as sort of combinations of projects. This goes well beyond this global discourse, but this is the area in which we can mention that. So, let's say that we plan to build a bridge. And this is an important, and big project, and long term project for a company. And we start to plan how we will achieve this goal, because we have to have the designed project, then blueprints, and then, you have to accumulate financing, then prepare all the materials, then hire a proper qualified labor force. Then get all the necessary licenses, and the necessary permissions. Then you go right ahead, and prepare the site. But again, the goal is to connect two banks of the river. And you know that in this project, there are important components. First of all, this bridge must be built, so it should connect the two banks. For example, if you completed that 99 percent that there is a gap somewhere in the middle of the river, that is not what you want. And not only that, but you'd like to complete this construction with a proper quality, so that if cars start to run over the bridge doesn't break, and these cars don't fall in the river. So this is a quality component. Then, you have some time component, you cannot keep building this bridge forever. You have to do that by a certain date. And, there is another very important area, this is a budget, so you cannot spend limitless amount of resources to build this bridge. You can see that in order to achieve these goals, you have to properly plan all your actions. You have to quantify them. And in this process, you have to ensure certain important things that at the first glance seem to be more difficult to quantify. But let's see what we have here. We have goals, well that is kind of clear. But in order to reach these goals, keeping in mind is date, quality, and money, we have to have instruments of control. What if, let's say, our cost starts to go beyond the limit, what would we do? How can we control this cost? How can we bring it back under control? Then, this is also the tool for evaluation, because we have to know what it means to have a successful completion of this project. Let's say, we may have a perfect quality bridge, but it would be built for twice as long period of time compared to what we had planned, or it can cost double. And you can see that neither of the last two is probably appropriate. So here, the important thing is that this plan that leads to actions, and that in itself. So these actions might be not immediately linked to all these numbers. For example, you have to somehow ensure communication, you have to ensure coordination, you have to ensure of the process by which, if some people made a mistake then, we have to analyze whose fault it is, and if it's they fault, they have to be punished for that. But if that was beyond their control then, we cannot keep them as scapegoats. So, you can see that we are sort of entering the big area, and not only that, now, I will put a diagram of that sort of as I quoted the budget cycle. Because the important thing in budgeting is that this is a process, this is not a one time thing that you do, and then you forget about that. So, you start with planning. But like I said, in this planning there're certain quantifiable things, and others that are not so easily quantifiable. But then, remember, we talked about control, so the next thing is, so this is a reference frame. So we have to somehow compare what we observe in reality in the future to our plans. And if they go array, then, the next thing is from here, we go to investing deviations, output variations. Well, and if we successfully invested them, and we know what caused them, then the next thing is, as you can see, this is planning again, so here, we have to keep in mind things like feedback, then evaluation and some other things, and again that proceeds. So we can see that this is clearly a process, that is very important, and it's very important for the management itself. But at the same time, this process is very important for valuation, because you can see that each of these plans, and if these plans are implemented sort of okay, this is one story. That is again, not very easily quantifiable but that attest to the fact that the measurement does their job great. And if we have deviations that does not immediately point at to the fact that there is where there is not qualified, maybe there are some factors that are beyond their control that did not exist, or were not clearly seem at the moment that we had prepared this plan, but then later on, they started to show themselves more acutely, and in a more pronounced way. So we can see that this cycle, we have a great tool of combining the needs of the organization, the needs of this project, its whole vision of the future, its strategy, we'll talk about that in the next episode, and the actual actions that the company is about to undertake. So again, that was just an introduction. And as always, when you talk about something really important but comprehensive and company wide, then, we will sort of narrow this down first, and then later, I will provide a comprehensive example that pours some light on how this is actually done.
