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No part of this book may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted.

359

23 Budgeting for Service Organizations: Special Features
A budget is important to meet goals and objectives. Most discussions of the budgetary process tend to focus on manufacturing firms. However, more businesses are becoming engaged in nonmanufacturing activities today, and such businesses can benefit greatly from a properly designed budgetary planning and control system. Budgeting may be used by a service business (which does not have merchandise inventory). For example, an airline may budget the average occupancy rate for seats and passenger miles. A hotel may budget the occupancy rate for rooms and the cost per room. For the most part, the budgeting methods and procedures described for manufacturing companies also apply to service businesses. Special attention should be devoted to budgetary planning and control techniques in the service industry for two reasons. First, planning and control are critical functions in all businesses, whether they produce and sell goods or provide services. Many service businesses have become more competitive in recent years. This increase in competition can be attributed to many things, such as the growth of the economy and the increase in demand for specialized services. When competition increases, planning and control become even more important. Second, the practice of budgeting is probably not as well developed in service companies as it is in manufacturing firms. In manufacturing industries, budgeting is forced on the business by the need to keep sales and production coordinated. A manufacturing firm's investment in inventory forces the company to plan. In service companies, however, the business activity largely requires human effort, and personal services generally are performed after the orders are received. The investment in inventory as we know it in manufacturing does not exist. There is no production activity. As a result, the management of a service company may not see the same need for planning and control. Because budgeting is a planning and control system, the techniques applied to service companies will be very similar to those applied to manufacturing companies. The service company must not only develop an overall budget or profit plan for the year but also must establish good budgetary control that follows a well-thought-out plan of organization. The major difference in budgeting nonmanufacturing activities relates to the types of costs incurred and therefore to the control techniques applied. In most service industries, the major cost element is that of personnel, reflected in salaries, wages, commissions, bonuses, and fringe benefits. Because of this fact, budgeting techniques are concerned primarily with planning the use of personnel and with controlling personnel effectiveness. A professional service business sells the employees' expertise. Emphasis is given to labor productivity and controlling overhead costs. Pricing policies are budgeted based on a daily rate, an hourly rate, a fixed rate for the job, or a contingent fee based on, for example, the dollar value of property sold, a court settlement, or sales price. Problems may occur if there are inadequate numbers of qualified workers or insufficient capital facilities to meet customer demand. It is important that employee time be used productively. A productivity report should be prepared of sales dollars generated per professional and the associated direct costs. The format of the report is:

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or advertising agency. however. A planned statement of financial position is developed and tested against selected standards. most service companies regard only receivables as an important current asset. The cash budget is established. by month. 6. such as a certified public accounting firm. 3. consulting business. Otherwise. 3rd Edition Page 2 of 7 . A profit or target for the company is established. No part of this book may be reproduced or transmitted without publisher's prior permission. However. 5. private use only. A service company must place a premium on defining the operations required to produce a service profitably and on assigning responsibility for planning and controlling such operations efficiently. A service business relies heavily on its reputation for fast and quality service. does not change. budgetary control should extend to profit centers. a common six-step pattern is observed while implementing a budgetary system: 1.COM>. It is best to grow at a steady. revenue dollars may be identified specifically to specific individuals. Rendering poor quality for short-term opportunities has disastrous long-term effects. Printing is for personal. quality rate. 2. For example. 4. Actual performance is measured against plan by specific levels of management position. In a professional service firm. where accountability for revenues as well as costs can be placed. Corrective action is taken as deemed necessary. customers will switch to competitors. So emphasis on points of cost control and specific balance sheet items may shift between the two types of business concerns. An annual plan is developed that indicates expected revenues and expenses by the organizational segments and in total. These businesses are labor intensive and have high variable cost structures.PRINTED BY: Genessa Nelson <GENESSA_NELSON@HOTMAIL. Indirect costs are budgeted separately and allocated based on revenue. 360 361 Budgeting Basics and Beyond. law practice. The underlying concept of budgeting. whereas receivables and inventories are two current asset areas for planning and control emphasis in a manufacturing company. The revenue and direct costs per individual may be determined. Service companies typically have prepared budgets for departmental expenses and have tracked these expenses against plan. Keeping personnel costs well within the limits set for planned revenues is critical in order to achieve net income objectives. For growing service companies. Violators will be prosecuted.

unstable governments. they also have no-shows. such as the economy. Otherwise. For hotels. Airlines Airlines face a problem of perishable services. it is very difficult to predict sales and average unit selling price. For example. such as transportation companies. Hotels have a maximum capacity of rooms each night and annually. If there are cancellations. can refuse potential business.PRINTED BY: Genessa Nelson <GENESSA_NELSON@HOTMAIL. new competitors. have customers staying different lengths of time. like a factory's production capacity. but the planning and control techniques still should extend to the statement of financial position so that acceptable financial ratios are maintained. taking into account that if the seat goes unsold. Hotels. investments in inventories. A hotel's reservation system does not function like an airline's. plant. however. However. and year to year. Historical data can be of some help. and leasing companies. and so on. Reservations forecasting is much more art (and luck) than a science. However. it will stop taking reservations or will stop selling highly discounted rates. it is difficult to control a business with high long-term capital investment. Airlines deal with one customer occupying one seat on a flight. One problem is that a hotel room is a perishable commodity. these rooms stand the chance of going unsold (not producing revenue). they have market segments. fluctuating currencies. the amount of discounted fares available will increase to stimulate sales. Hotels. and current travel trends. the number of each market segment is not adjusted automatically for yield maximization. the system will severely limit or eliminate discounted seats. Hotels do not have fare products like airlines. if a flight is selling slowly. taking a chance that Budgeting Basics and Beyond. staying longer than they have reserved. Printing is for personal. However. but an airline system will not work. If it is not sold one night. Violators will be prosecuted. it is a lost revenue opportunity. In service companies. and departing early. if future sales fall off. The goal of the yield management system is to maximize revenue. the inverse is also true. Hotels also try to maximize their revenues per room. like airlines. No part of this book may be reproduced or transmitted without publisher's prior permission. 3rd Edition Page 3 of 7 361 362 . If a hotel is projected to be full or near full. computer service business. but they do not take into account many environmental factors. the potential value for that time is lost forever. month to month. if an airline's Los Angeles-to-New York seats are selling very briskly. Airlines have systems known as yield management systems that constantly adjust what fares are available and the number based on sales. This chapter presents the budgeting aspects of certain airlines and hotels. The hotel's goal is to book as many of the next highest paying segments. Service businesses should make long-term commitments for salaries and facilities only if they are confident of future sales. The results of this can be a small number of rooms allocated to a low-paying market group. Hotels The calculation of sales volume and unit price is much more difficult for hotels than for manufacturers. aging facililties.COM>. Modern computer systems have done little to improve accuracy of hotel room sales. the high fixed costs will hurt profits. bad weather. Hotels also may refuse potential discounted reservations because they think they can sell the remaining rooms to full-paying clients. private use only. the demand for a hotel's rooms can vary greatly from day to day. and equipment typically are relatively small.

management will really push to try to sell these rooms.2 Sample Hotel Rate Structure Having estimated in the budget that Monday XX.PRINTED BY: Genessa Nelson <GENESSA_NELSON@HOTMAIL. A sample rate structure is presented in Exhibit 23. To estimate the gross sales. monthly. Projected sales are done on a daily. Often rates are reduced (especially on weekends. If a slow period is projected from reports and bookings. the projected room revenue is $29. It is hoped that this action will provide at least a minimal amount of revenue. Printing is for personal. these rooms will not sell at all.1. The sales are monitored very closely because they are selling a perishable commodity. hotels as well as airlines overbook. multiply the projected number of rooms in each category by the averaged rate paid by each market segment. For these reasons.2. 20XX.125 on a projected occupancy of 81 percent. They gamble that they will have a sufficient amount of no-shows and cancellations to accommodate everyone.COM>. when business travel is low) to try to stimulate sales. private use only.1 Hotel Projected Sales Budget 362 363 Exhibit 23. Violators will be prosecuted. A projected sales budget for hotels is presented in Exhibit 23. Exhibit 23. No part of this book may be reproduced or transmitted without publisher's prior permission. Budgeting Basics and Beyond. 3rd Edition Page 4 of 7 . and annual basis. which is not always the case. The notion of reducing rates is somewhat tricky when dealing with image.

this would not be appropriate for a service firm. Doing this is not as straightforward for a hotel as for a manufacturer. hotels can budget their expected labor costs. corporate. Rooms overhead 2. for most accounts of this type.g. A direct labor budget is probably one of hotel's most critical budgets. A hotel would do this a little differently. by check or cash. However. On the group's departure. After the charges have been processed. some companies. However. the direct materials budget would primarily be the food and beverage that it sells. However. they are selling a service (e. generally. When the actual budgeted period has begun. Anaheim. along with the sales budget. especially full-service luxury resorts. as service firms are not building anything. It can construct a direct materials budget. Overhead for a hotel is like a factory. Z percent in the third. This fact must be taken into consideration when projecting cash collections estimation. The next step for a manufacturer is to construct a production budget. and government accounts can all pay individually on departure. each individual amount is credited electronically to the hotel. they have terms such as net 30. and the company is billed monthly for charges the group has incurred during the period. hotels that are located in areas of high competition (i. 3rd Edition Page 5 of 7 363 364 . Most individual customers pay for their charges with a credit card. and overhead budget.PRINTED BY: Genessa Nelson <GENESSA_NELSON@HOTMAIL. are very labor intensive. the master account can be processed and billed to the company. one does not know exactly what percentage of guests will charge their accounts or pay some other way. One last monkey wrench in this whole system is advance deposits. Y percent in the second month. but it is somewhat difficult to estimate. Based on projected sales. or more likely. No part of this book may be reproduced or transmitted without publisher's prior permission. Groups. Violators will be prosecuted. Hotels. Each department seeks a target productivity. Any difference between the budgeted figure and the actual numbers will be investigated. can be very slow in paying their bills. The demand for the food and beverage is difficult to exactly estimate. these figures are watched very closely for any variations. As everyone knows. A hotel overhead can be broken down into two main categories: 1. When a manufacturer sells its finished goods to a retailer or wholesaler. Hotels have different cash collection patterns. lodging). there is a running total. Additionally. The sales budget and the production budget are identical for service businesses.. Many groups and individuals are required to leave advance deposits to guarantee space. This will make the estimation of cash collections even more difficult because one does not know where and when these deposits will occur. Printing is for personal. while leaving some percentage uncollected as bad debt. direct labor budget.e. Food and beverage overhead Budgeting Basics and Beyond. It knows from past experience that it will collect X percent one month after the sale.COM>. For a hotel. especially big corporations and the government. private use only. From the production budget a manufacturer then develops a direct materials budget. From the sales budget one can develop a projected cash collections schedule. This would occur when a group only has one function and does not have a running account. Any cost that is not direct labor or direct materials will be accounted for as overhead. but a ballpark figure can be calculated. California) use rates as one of their competitive weapons. all charges will go to a master account..

This is usually an annual budget. When competition increases. such as rooms and food and beverage. It can disclose potentially unfavorable financial conditions. In service companies. and fringe benefits. one will know when funds are available for investment growth or expansion. First.COM>. 3rd Edition Page 6 of 7 . Second. the practice of budgeting is probably not as well developed in service companies as it is in manufacturing firms. 2. All organizations need to know their selling expenses. commissions. This statement summarizes the various component projections of revenue and expenses for the budget period. This budget is very important. The next step for a manufacturer is to develop a cost of goods sold budget. Income taxes are subtracted to produce the goal: net income. a budgeted balance sheet can be compiled. It allows management to perform a number of different ratio calculations. this budget is helpful in setting prices and estimating gross income. for better control. however. Printing is for personal. This budget combines both fixed and variable S&A costs such as insurance. the business activity largely requires human effort. or when funds are needed just to pay the bills. or overhead. Violators will be prosecuted. remember. private use only. a company can go broke while making a profit. bonuses. they provide services. For a hotel. The budgeted balance sheet serves three primary purposes: 1. Now the selling and administrative (S&A) expense budget would be compiled. By having this budget available. There is a fine line between what costs can be direct labor or materials. 3. The major cost element is that of personnel. These two areas are the main revenue centers for most hotels. For a manufacturer. When all the budgets have been completed. The balance sheet is constructed by adjusting the balance sheet from the period that just ended. many service businesses have become more competitive in recent years. less interest expenses providing income before taxes.PRINTED BY: Genessa Nelson <GENESSA_NELSON@HOTMAIL. Special attention should be devoted to budgetary planning and control techniques in the service industry for two reasons. and personal services are generally performed after the orders are received. This budget subtracts variable expenses from sales to obtain a contribution margin. Because of this fact. Hotels do not produce products. as we all know. 364 365 Conclusion This chapter addresses the special features of the service industry. planning and control become even more important. This budget will signal when there will be cash surpluses or shortages. A cash budget also needs to be prepared. rent. The selling expenses are combined with general administrative costs. This budget is as helpful to a manufacturer as a hotel. Now different parts of the budget are combined into the budgeted income statement. sales salaries. Then it subtracts fixed expenses to arrive at operating income. it may be done quarterly or even monthly. A cost of goods sold budget would provide a hotel with the cost of major departments. It falls to management to classify each cost. Budgeting Basics and Beyond. and commissions. No part of this book may be reproduced or transmitted without publisher's prior permission. It highlights future resources and obligations. being reflected in salaries. wages. office salaries. this budget step would yield only minimal benefit.

PRINTED BY: Genessa Nelson <GENESSA_NELSON@HOTMAIL. 3rd Edition Page 7 of 7 . private use only.COM>. budgeting techniques are primarily concerned with planning the use of personnel and with controlling personnel effectiveness. 365 Budgeting Basics and Beyond. Printing is for personal. Violators will be prosecuted. No part of this book may be reproduced or transmitted without publisher's prior permission.