7 budget and financial planning

8/8/2019 7 Budget and Financial Planning

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CHAPTER 7

BUDGETING AND

FINANCIAL PLANNING


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Strategic Planning

Critical success factorsCritical success factors - Strengths ofthe company that enable it to

outperform competitors.

StrategicStrategic

PlanPlan

Critical

Success

Factors

Incorporated IntoIncorporated Into


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Strategic Long-Range Plan

The master budget is part of an overallThe master budget is part of an overallorganizational plan made up of threeorganizational plan made up of three

components . . .components . . .

Organizational goalsOrganizational goals managements broadmanagements broadobjectives that employees work to achieve.objectives that employees work to achieve.

The strategic longThe strategic long--range profit planrange profit plan steps tosteps to

be taken to achieve organizational goals.be taken to achieve organizational goals.The master budgetThe master budget tactical shorttactical short--rangerange

profit plan.profit plan.


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Key Purposes of the Budgeting

SystemThe five primary purposes are:The five primary purposes are:

1.1. Planning.Planning.

2.2. Facilitating Communication andFacilitating Communication andCoordination.Coordination.

3.3.Allocating Resources.Allocating Resources.

4.4. Managing Financial and OperationalManaging Financial and OperationalPerformance.Performance.

5.5. Evaluating Performance and ProvidingEvaluating Performance and Providing

Incentives.Incentives.


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Organizations Use Many Types of

BudgetsOrganization

goals

Individual goals

and values

Long-range

strategic plan

Anticipated

conditions

M

asterM

asterbudgetbudget

Actual period

results

Individual

beliefs

Performance

evaluation

Strategic

evaluation

OrganizationOrganization IndividualIndividual


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The Master Budget as a Planning

ToolAfter organization goals, strategies and long-rangeplans have been developed, work begins on the

master budget.

The master budget is a detailed budget for thecoming fiscal year.

2006


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Sales Budget: The Starting

Point Sales StaffSales Staff close to customer needs. Market ResearchMarket Research can predict long-term

trends in attitudes and the effects of social

and economic changes on the companyssales, potential markets and products.

Sales ForecastingSales Forecasting the process ofpredicting sales of services or goods.

Lets look at some forecasting tools.Lets look at some forecasting tools.


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Forecasting Tools

Delphi TechniqueDelphi Technique individual forecasts ofgroup members are submittedanonymously and evaluated by the group

as a whole. Econometric ModelsEconometric Models statistical method

of forecasting economic data using

regression analysis.


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Operational Budgets Manufacturing firmsManufacturing firms A production budget isdeveloped from budgets for direct materials, direct

labor, and overhead. A budget for selling, general,and administrative (SG&A) expenses is alsoprepared.

Merchandising firmsMerchandising firms Instead of a productionbudget, a budget of merchandise purchased isdeveloped. The SG&A budget is also prepared.

ServiceService--industry firmsindustry firms Based on the salesbudget for its services, a service industry firmdevelops a set of budgets that show how it willmeet the demand.


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Operational Budgets

Every business prepares a . . .

1.1. Cash budgetCash budget

2.2. Capital expenditures budget, and aCapital expenditures budget, and a3.3. Summary of operational budgetsSummary of operational budgets


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International Aspects of Budgeting

Firms with international operations face a variety ofFirms with international operations face a variety ofadditional challenges in preparing their budgets . . .additional challenges in preparing their budgets . . .

1.1. Translation of foreign currencies into localTranslation of foreign currencies into local

currency.currency.2.2. Budget preparation is difficult when inflation (orBudget preparation is difficult when inflation (or

deflation) is high or unpredictable.deflation) is high or unpredictable.

3.3. The economies of all countries fluctuate inThe economies of all countries fluctuate interms of consumer demand, availability ofterms of consumer demand, availability ofskilled labor, and laws affecting commerce.skilled labor, and laws affecting commerce.


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Activity-Based BudgetingActivity-based budgeting (ABB) is the process of

developing a master budget using information obtainedfrom an activity-based costing (ABC) analysis

ResourcesResources

ActivitiesActivities

Forecast of products andForecast of products andservices to be produced,services to be produced,and customers served.and customers served.


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Illustrating the Master BudgetSchedule Title of Schedule

1 Sales Budget

2 Production Budget

3 Direct-Materials Budget

4 Direct-Labor Budget

5 Manufacturing Overhead Budget6 Selling, General, and Administrative Expense Budget (SG&A)

7 Cash Receipts Budget

8 Cash Disbursements Budget

9 Cash Budget

10 Budgeted Schedule of Cost of Goods Manufactured and Sold11 Budgeted Income Statement

12 Budgeted Balance Sheet


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The Sales Budget

Detailed schedule showing expectedsales for the coming periods expressed

in units and dollars.


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Sales Budget of Collegiate

Apparel Collegiate Apparel Company is preparingCollegiate Apparel Company is preparingbudgets for the year ending December31, 20x1.budgets for the year ending December31, 20x1.

Budgeted sales are:Budgeted sales are:

First quarterFirst quarter 15,000 units15,000 unitsSecond quarterSecond quarter 5,000 units5,000 unitsThird quarterThird quarter 10,000 units10,000 unitsFourth quarterFourth quarter 20,000 units20,000 units

The selling price is $12 per unit.The selling price is $12 per unit.


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Sales Budget of Collegiate Apparel


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Production Budget

SalesSalesBudgetBudget

ProductionProduction

BudgetBudget

Planofresourcesneededto meetcurrentPlanofresourcesneededto meetcurrent

salesdemandandensureinventorylevelssalesdemandandensureinventorylevels

aresufficientforfuturesales.aresufficientforfuturesales.


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Forecasting Production

Rearrange the basic inventory formula asfollows . . .

Units in

beginninginventory

Required

productionin units

Sales

inUnits

Units in

endinginventory++ ==

Now,solveforrequired production...

Unitsto be

Produced==

Salesin

Units++

Units inending

inventory

Expectedbeginninginventory


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The Production Budget

Collegiate Apparel wants units in endingfinished goods inventory to be 10% of thenext quarters expected sales in units.

At the beginning of the year, 1,500completed units were on hand.

During the first quarter of 20x2, 15,000 units

are expected to be sold.

Lets prepare the production budget.Lets prepare the production budget.


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The Production Budget

5,0005,000 10% = 500 units10% = 500 units


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Direct-Materials Budget

Direct materials needed for the budgetDirect materials needed for the budgetperiod can be determined as follows . .period can be determined as follows . .

..RequiredRequiredmaterialsmaterials

purchasespurchases==

MaterialsMaterialsused inused in

productionproduction++

EndingEndingmaterialsmaterialsinventoryinventory

BeginningBeginningmaterialsmaterialsinventoryinventory


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Direct-Materials Budget At Collegiate Apparel 1.5 yards of fabric areAt Collegiate Apparel 1.5 yards of fabric are

required per unit of product.required per unit of product.

Management wants fabric on hand at the end ofManagement wants fabric on hand at the end ofeach quarter to be 10% of next quarters raweach quarter to be 10% of next quarters rawmaterials required. On January 1materials required. On January 1stst, 2,100 yards of, 2,100 yards offabric are onfabric are on--hand. During the first quarter of 20x2,hand. During the first quarter of 20x2,Collegiate expects 21,000 yards of fabric to beCollegiate expects 21,000 yards of fabric to berequired.required.

Each yard of fabric cost the company $2.Each yard of fabric cost the company $2.

Lets prepare the direct materials budget.Lets prepare the direct materials budget.


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Direct-Materials Budget

8,2508,250 10% = 825 units10% = 825 units


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Direct-Labor Budget

At Collegiate Apparel, each unit producedrequires 0.20 hour (12 minutes) of directlabor.

Workers earn a wage rate of $10 per hourregardless of the hours worked. CollegiateApparel can hire workers as needed to meetproduction.

Lets prepare the direct labor budget.Lets prepare the direct labor budget.


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Direct-Labor Budget


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Manufacturing-Overhead

BudgetCollegiate Apparel uses activityCollegiate Apparel uses activity--based budgeting.based budgeting.

At the unitAt the unit--level, each unit produced requires $0.25 of indirectlevel, each unit produced requires $0.25 of indirectmaterials and $0.15 of electricity.materials and $0.15 of electricity.

At the batchAt the batch--level, the company expects the followinglevel, the company expects the followingproduction runs:production runs:

11stst quarterquarter 2828 22ndnd quarterquarter 1111

33rdrd quarterquarter 2222

44thth quarterquarter 3939

At the productAt the product--level, the company expects two new stylelevel, the company expects two new styledesigns each quarter with each new Tdesigns each quarter with each new T--shirt design costingshirt design costing$500.$500.

Details of the facilitiesDetails of the facilities--level overhead costs are shown on thelevel overhead costs are shown on the

manufacturingmanufacturing--overhead budget.overhead budget.


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BudgetUnitUnit--, Batch, Batch--, and Product, and Product--level Portions of the Budgetlevel Portions of the Budget


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BudgetProductProduct--, Facilities, Facilities--level and Total Overhead Budgetlevel and Total Overhead Budget

$5,600 + $8,400 + $1,000 + $36,500 = $51,500$5,600 + $8,400 + $1,000 + $36,500 = $51,500


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SG&A Expense Budget

At Collegiate Apparel, salescommissions and freight-out are unit-level SG&A.

Customer-level SG&A expensesinclude licensing fees for use of namesand logos.

Facilities-level SG&A expense includesales salaries, advertising, and clericalwages.


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SG&A Expense Budget

$ $ $ $


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Cash Receipts Budget

At Collegiate Apparel all sales are madeon account.

The company collects 80% of its billings in

the quarter of the sale, 18% in thefollowing quarter. The remaining twopercent of each quarters sales areexpected to be uncollectible.

Sales in the last quarter of 20x0 were$240,000.


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Cash Receipts Budget

$240,000$240,000 18% = $43,20018% = $43,200

$180,000$180,000 2% = $3,6002% = $3,600

$180,000$180,000 18% = $32,40018% = $32,400


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Cash Payments for Direct-

Materials At Collegiate Apparel all purchases of rawmaterials are made on account.

The company pays for60% of its purchases in the

quarter of the purchase and the remaining 40% inthe following quarter.

Purchases in the last quarter of 20x0 were$56,850.

Lets prepare the Cash Receipts Budget.


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Cash Payments for Direct-

Materials

$18,150$18,150 60% = $10,89060% = $10,890

$39,450$39,450 40% = $15,78040% = $15,780


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Other Cash Disbursements


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Cash Budget

Collegiate Apparel started the year with acash balance of $10,000, and borrows$100,000 at the beginning of 20x1 to financeplant expansion.

The loan is repaid in the amount of $25,000at the end of each quarter with interest onthe unpaid balance at 10%.

Payments for the plant expansion were: 1st quarter = $45,000

2nd quarter = $15,000

3rd quarter = $5,000

4th uarter = $35,000


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Cash Budget

$100,000$100,000 10%10% = $2,500 = $2,500


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Calculation of Absorption Unit

Cost


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Cost of Goods Manufactured

and Sold Budget

1,5001,500 $9$9

$13,500$13,500

2,1002,100 $2$2

$4,200$4,200


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Budgeted Income Statement


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Budgeted Balance Sheet The balance in the building account on December31, 20x0

was $400,000, and the balance in the equipment accountwas $320,000. Total accumulated depreciation was$240,000. Depreciation expense is recorded at the rate of$60,000 per year.

At December31, 20x1, the company had a long-term,noninterest-bearing note payable of $200,000. The note isdue on December31, 20x3.

The balance in the owners equity account at December

31, 20x0, was $330,160.

Supplies on hand at December31, 20x1 were $2,000.


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$330,16056,750

$386,910

$240,000$240,000 18%18%

$43,200$43,200

$56,850$56,850 40%40%

$22,740$22,740


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How It All Fits Together

SalesforecastProduction

budget

SG&Abudget


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budget

SG&Abudget

Requireddirect

materials,labor

and mfg.overhead

budgets

Budgeted

income

statement


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budget

SG&Abudget

Requireddirect

materials,labor

and mfg.overhead

budgets

Budgetedcost

ofgoods mfg.

andsold

Budgeted

income

statement


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budget

SG&Abudget

Requireddirect

materials,labor

and mfg.overhead

budgets

Budgetedcost

ofgoods mfg.

andsold

Budgeted

income

statement

Cashbudget

Budgetedbalance

sheet


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Responsibility for BudgetAdministration

Budget CommitteeBudget Committee Consists of key seniorexecutives who may advise the budget director

during the preparation of the budget.

The authority to give final approval to the budgetusually rests with the board of directors.


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Budgetary Slack: Padding theBudget

Padding the budgetPadding the budgetmeans intentionallymeans intentionallyunderestimating revenues or overestimatingunderestimating revenues or overestimatingcosts.costs.

The difference between the revenue or costThe difference between the revenue or costprojection that a person provides and aprojection that a person provides and arealistic estimate of the revenue or cost isrealistic estimate of the revenue or cost is

calledcalled budgetary slackbudgetary slack..


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Participative Budgeting

Participative BudgetingParticipative Budgeting the use ofinput from lower- and middle-

management employees.The process is time consuming but

enhances employee motivation andacceptance of goals.


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Ethical Problemsin Budgeting

Much of the information for the budget isprovided by persons whose performance isthen compared with the budget they help

develop.

I think sales

will increase by

10% next year.

Lets prepare the

sales forecast with a

4% increase, so we

will really look good!


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Zero-Based Budgeting forDiscretionary Costs

A system of establishing financial plansbeginning with an assumption of no activityand justifying each program or activity level.

After some initial success, zero-based budgetingwas found to be impractical.

Massive amounts of timeMassive amounts of time were required toimplement and update the budget.


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Flexible Overhead Budget

A flexible budget is a budget that is valid for aA flexible budget is a budget that is valid for arelevant range of activity. It is not based on onlyrelevant range of activity. It is not based on onlyone level of activity as we have seen with theone level of activity as we have seen with the

static budget.static budget.

St t

t

t ty ( )

t t ty t $ $ $ $

F

t

Includes severalpossible activity

levels.

Based ononly oneactivitylevel.


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Advantages of Flexible Budgets

Actual

Electricity

Cost

Budgeted

Electricity

Cost

Cost

Variance

1,050 1,200 150 Favorable

A manager is faced with the following information from theA manager is faced with the following information from thestatic budget for June when the level of activity was 4,500static budget for June when the level of activity was 4,500machine hours. Was there good control of electric costs?machine hours. Was there good control of electric costs?

Actual

Electricity

Cost

Budgeted

Electricity

Cost

Cost

Variance

1,050 900 150 Unfavorable

After preparing a flexible budget, the managerAfter preparing a flexible budget, the managerobtained the following information about cost controlobtained the following information about cost control

at 4,500 machine hours.at 4,500 machine hours.


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Activity Measure: Based on Input orOutput?

The number of units of output usually is not aThe number of units of output usually is not ameaningful measure in a multiproduct firmmeaningful measure in a multiproduct firm

because it requires the addition of numbers ofbecause it requires the addition of numbers of

dissimilar products. Output should be measureddissimilar products. Output should be measuredin terms of thein terms of the standard inputstandard inputallowed givenallowed given

actual output.actual output.


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Formula Flexible Budget

Total budgetedmonthly

overhead cost

Budgeted variableoverhead cost per

activity unit

Totalactivityunits

Budgeted fixedoverhead cost

per month= +


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Illustrated

$2.15$2.15 6

,000 = $12,9

006

,000 = $12,9

00


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Illustrated


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Illustrated

$24,360 + $16,550 = $40,910$24,360 + $16,550 = $40,910


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IllustratedManufacturing OverheadManufacturing OverheadActual

OverheadAppliedOverhead

ActualActual

activityactivity

PredeterminedPredetermined

overheadrateoverheadrate

Manufacturing OverheadManufacturing Overhead

ActualOverhead

AppliedOverhead

StandardStandard

allowedactivityallowedactivity

PredeterminedPredetermined

overheadrateoverheadrate

The difference lies in the quantity of hours used

Normal costing Standard costing


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Choice of Activity Measure

1.1. The activity measure should be one thatThe activity measure should be one thatvaries in a similar pattern to the way thatvaries in a similar pattern to the way thatvariable overhead varies.variable overhead varies.

2.2. As automation increases, many companiesAs automation increases, many companiesare using measures such as machine hoursare using measures such as machine hoursor process time for their flexible overheador process time for their flexible overheadbudget.budget.

3.3. Dollar measures are subject to priceDollar measures are subject to price--levellevelchanges and fluctuate more than physicalchanges and fluctuate more than physicalmeasures.measures.


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End of Chapter7

7 budget and financial planning

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