Budgeting and Profit Planning: Special Studies - Part 17

11.9 SPECIAL STUDIES

Often a budget manager can develop a better budget when he has a more perfect understanding of the resources he controls.  This includes understanding the cause and effect nature of various activities, controllable and uncontrollable variables, variable and fixed cost relationships, and market economics.  Examples of items that are popularly studied, include

•     The effect of advertising on sales.
•     How product demand is affected by seasonality, environmental factors, or particular leading economic indicators.
•     How the layout of work centers the shop floor affects work-in-process inventory levels.
•     The effect of different financing alternatives on cash flow.
•     Product life cycle projections.

Developing an improved understanding of these items is not something that is generally considered to be part of the budgeting process.  However, the results of studying these areas can greatly improve the accuracy and usefulness of the budget, not to mention the manager's grasp of underlying business process.  For example, knowing how advertising affects sales can help determine a worthwhile level of advertising expenses, for a given sales budget.
Special analyses such as these are usually performed outside the budgeting cycle when sufficient time is available.  Sometimes the effort required to conduct a special study of this nature can be significant.  Moreover, special expertise may be required to manage the technical aspect of the study.  The techniques applied usually come from a field of study called Operations Research and involve an understanding of mathematical processes such as statistics, Monte Carlo simulation, regression, correlation analysis, and linear programming.  But many times the simpler techniques tend to be the most popular.  For example, a simple spreadsheet and a personal computer typically serve as the primary tool for the data evaluation in a special study.  Often the general ledger system's only role here is to serve as the repository for available financial data and not as a tool for data evaluation. 

SPECIAL STUDY EXAMPLE— MARKET ANALYSIS FOR A ROOFING CONTRACTOR

A roofing contractor sells roofing material and installs roofs in a specific area of Houston, Texas. 80 of the contractor's revenue comes from two specific markets in the area:

•     New residential homes.
•     Revenues from existing homes. 

The remaining 20 comes from similar work in other geographic areas.
Data for historical sales for each of these two markets is as follows:

In performing some research and analysis, the vice president of marketing postulated that sales in each of these markets were driven by two external factors: (1) the number of residential building permits issued in the previous year and (2) the number of homes that became 20 years old during that year.  If either or both of these were true, knowing this correlation could provide a way to predict next year's sales for these business segments.  Along with a technical assistant, he conducted a special study to determine if his theory was really correct.

The assistant obtained data from the city indicating how many residential building permits were issued in each of the preceding 30 years.  For each of the last six years, he separated this data into two classes:

•     Residential building permits that were issued for the previous year.
•     Residential building permits that were issued 20 years ago. 

He was able to construct the following information:

NEXT MONTH'S TOPIC: SPECIAL STUDIES, CONTINUED

Material in this chapter has been adapted and reprinted with the permission of Warren, Gorham & Lamont, Inc., from Chapter 43, “Automated Budget Systems,” in Budgeting and Profit Planning Manual, 2nd edition, by James D. Willson.  Copyright 1983, 1989 by Warren, Gorham & Lamont, Inc. 210 South Street, Boston, MA 02111. All rights reserved.