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CHAPTER 4

DEVELOPING A BUSINESS PLAN:

BUDGETING

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Chapter Overview

How does a budget contribute toward

helping a company achieve its goals?

Do the activities of a company have a

logical order that drives the organization

of a budget?

What is the structure of the budgeting

process, and how does a company begin

that process?

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What are the similarities and differences between a retail company’s and a service company’s master budget?

After a company begins the budgeting process, is there a strategy it can use to complete the budget?

How can a manager use a budget to evaluate a company’s performance and then use the results of that evaluation to influence the company’s plans?

Chapter Overview

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Budgeting and Budgets

Budgeting is a formal part of the ongoing planning process.

A budget is a report that gives a financial description of one part of a company’s planned activities for the budget period.

As an example, a budget might show how many products a company plans to sell in the next year, the dollar amount of the sales, and when the company will collect the cash from the sales.

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The Benefits of Budgeting

Budgeting improves the planning, operating, and evaluating processes by helping to:

1. Add discipline, or order, to the planning process.

2. Recognize and avoid potential operating problems.

3. Quantify plans.

4. Create a benchmark for evaluating the company’s performance.

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A retail company’s operating cycle is the average time it takes the company to use cash to buy goods for sale (called inventory), to sell these goods to customers, and to collect the cash from its customers.

Retail Company Operating Cycle

Purchaseinventory

Sell tocustomers

Collectcash

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Sweet Temptation’s Operating Cycle

Exhibit 4-1

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A service company’s operating cycle is the average time it takes the company to use cash to acquire supplies and services, to sell the services to customers, and to collect the cash from its customers.

Service Company Operating Cycle

Acquiresupplies and services

Sell tocustomers

Collectcash

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Hasty Transfer’s Operating Cycle

Exhibit 4-2

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Master Budgets

The master budget is the overall structure a

company uses to organize its budgeting

process.

The master budget shows the relationships

among company goals, activities,

resources, and expected financial results.

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Retail CompanyMaster Budget

A retail

company’s

master budget

might include

these related

components

Sales budget.

Purchases budget.

Selling expenses budget

General & administrative expenses budget.

Cash budget (projected cash flow statement.

Projected income statement.

Projected balance sheet.

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Master Budget RelationshipsExhibit 4-3

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Retail Sales Budget The budgeting process begins with the sales budget

because product sales or service contracts affect all of the other operating activities of a company.

A typical sales budget for a retail company would include the following items:

1. Budgeted total sales revenues by month (unit sales X selling price).

2. Budgeted cash sales versus credit sales by month.

3. Expected cash collections by month.

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Sweet TemptationsSales Budget

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Retail Purchases Budget

Once the units sales are budgeted, the next logical step is the timing and amounts of inventory purchases to meet the budgeted sales forecast. Determining the timing and amounts of inventory is important.

Inventory on hand

Out of stock;

high cost of fast

delivery

Too low

Ties up cash

resources; high

storage costs

Too highJust-in-time on customer demand

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ReflectionHow would I factor inventory level into

my purchases budget?

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Retail Purchases Budget The purchases budget begins with budgeted unit sales

from the sales budget, adding in desired ending inventory.

This approach helps to minimize risks of underestimating actual sales or overestimating the inventory that should be on hand.

Jan Feb MarBudgeted total unit sales 720 1,200 540Add: desired ending inventory 600 270 450Total merchandise to purchase 1,320 1,470 990Less: beginning inventory (360) (600) (270)Budgeted units to purchase 960 870 720

Note how the ending inventory in one month becomes the beginning inventory in the next.

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Sweet TemptationsPurchases Budget

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Retail Selling Expenses Budget

The selling expenses budget shows the expenses and related cash payments associated with planned selling activities.

A typical selling budget for a retail company would include the following items:

1. Budgeted selling expenses such as salaries, advertising and depreciation on store equipment by month.

2. Budgeted cash payments for selling expenses by month.

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Sweet TemptationsSelling Expenses Budget

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Retail G&AExpenses Budget

The general and administrative (G&A) expenses budget shows the expenses and related cash payments associated with expected activities other than selling.

A typical G&A expenses budget for a retail company might include the following items:

1. Budgeted G&A expenses such as rent, salaries, consulting expenses, supplies, and utilities by month.

2. Budgeted cash payments for G&A expenses by month.

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Sweet TemptationsG&A Expenses Budget

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Retail Cash Budget

Once the sales, purchases, and expenses budgets are completed, the company can put together its cash budget.

Like the amount of inventory, a company needs to manage its cash so it does not keep too much or too little on hand.

Cash on hand

Too low: can’t fund operations; no buffer;

unanticipated borrowings

Too high: idle resources not

invested in operations

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Projected Cash Flow Statement

This statement summarizes the cash receipts and payments by operating, investing, and financing activities. It is the cash budget of the company’s planned activities.

Operating activities

Financingactivities

Investingactivities

Cash receipts and payments from

planned operations

Cash receipts and payments from planned

investing activities

Cash receipts and payments from planned

financing activities

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Sweet TemptationsCash Budget

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Projected Income Statement

This statement summarizes the company’s expected revenues and expenses for the budget period, based on the planned activities.

The data is derived from the sales budget, purchases budget, and the expenses budget.

In order to provide more useful information for management to monitor and evaluate the planned activities, the projected income statement categorizes expenses into variable and fixed costs.

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Sweet Temptations Projected Income Statement

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Projected Balance Sheet

This statement summarizes the company’s expected financial position on a particular date, based on the planned activities.

Like other projected financial statements, its purpose is to project a future result.

In this case of Sweet Temptations, the projected balance sheet summarizes the projected assets, liabilities, and owners’ equity of the company at the end of the budget period.

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Evaluating Results

By analyzing differences between the company’s budgeted results and actual results, managers can monitor and evaluate results on an interim basis and implement corrective action if necessary.

FavorableBudgeted Actual (Unfavorable)Amount Amount Variance

Supplies expense 90$ 110$ (20)$

Why is supplies expense $20 more than expected? What strategies should we implement to monitor this expense?

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Sweet Temptations Budget to Actual Cost Report