You are on page 1of 64

15

Budgeting and Financial Planning


McGraw-Hill/Irwin Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

15-2

Learning Objective 1

15-3

Strategic Planning
Critical success factors - Strengths of the company that enable it to outperform competitors.
Critical Success Factors

Incorporated Into

Strategic Plan

15-4

Strategic Long-Range Plan


The master budget is part of an overall organizational plan made up of three components . . .
Organizational goals managements broad objectives that employees work to achieve. The strategic long-range profit plan steps to be taken to achieve organizational goals. The master budget tactical short-range profit plan.

15-5

Learning Objective 2

15-6

Key Purposes of the Budgeting System


The five primary purposes are:
1. 2. 3. 4.
Planning. Facilitating Communication and Coordination. Allocating Resources. Managing Financial and Operational Performance. 5. Evaluating Performance and Providing Incentives.

15-7

Organizations Use Many Types of Budgets


Organization Individual

Organization goals

Long-range strategic plan Anticipated conditions


Master budget

Individual goals and values Individual beliefs

Strategic evaluation

Actual period results

Performance evaluation

15-8

Learning Objective 3

15-9

The Master Budget as a Planning Tool


After organization goals, strategies and longrange plans have been developed, work begins on the master budget.

The master budget is a detailed budget for the coming fiscal year.
2008

15-10

Sales Budget: The Starting Point


Sales Staff close to customer needs. Market Research can predict long-term trends in attitudes and the effects of social and economic changes on the companys sales, potential markets and products. Sales Forecasting the process of predicting sales of services or goods.

Lets look at some forecasting tools.

15-11

Forecasting Tools

Delphi technique the elicitation of forecasts from individual group members, for anonymous evaluation by the group as a whole, in a search for convergence. Econometric modeling the use of various economic indicators and market factors to predict future sales, by means of regression analysis.

15-12

Operational Budgets

Manufacturing firms A production budget is developed from budgets for direct materials, direct labor and overhead. A budget for selling, general and administrative (SG&A) expenses is also prepared. Merchandising firms Instead of a production budget, a budget of merchandise purchased is developed. The SG&A budget is also prepared. Service-industry firms Based on the sales budget for its services, a set of budgets is developed for the resources to be used in providing the services.

15-13

Operational Budgets
Every business prepares a . . . 1. Cash budget 2. Capital expenditures budget, and a 3. Summary of operational budgets

15-14

International Aspects of Budgeting


Firms with international operations face a variety of additional challenges in preparing their budgets . . . 1. Translation of foreign currencies into local currency. 2. Budget preparation is difficult when inflation (or deflation) is high or unpredictable. 3. The economies of all countries fluctuate in terms of consumer demand, availability of skilled labor, and laws affecting commerce.

15-15

Activity-Based Budgeting
Activity-based budgeting (ABB) is the process of developing a master budget using information obtained from an activity-based costing (ABC) analysis
Resources Activities Forecast of products and services to be produced, and customers served.

15-16

Illustrating the Master Budget


Schedule 1 2 3 4 5 6 7 8 9 10 11 12 Sales Budget Production Budget Direct-Materials Budget Direct-Labor Budget Manufacturing Overhead Budget Selling, General, and Administrative Expense Budget (SG&A) Cash Receipts Budget Cash Disbursements Budget Cash Budget Budgeted Schedule of Cost of Goods Manufactured and Sold Budgeted Income Statement Budgeted Balance Sheet Title of Schedule

15-17

The Sales Budget


Detailed schedule showing expected sales for the coming periods expressed in units and dollars.

15-18

Sales Budget of Collegiate Apparel


Collegiate Apparel Company is preparing budgets for the year ending December 31, 20x1. Budgeted sales are: First quarter 15,000 units Second quarter 5,000 units Third quarter 10,000 units Fourth quarter 20,000 units The selling price is $12 per unit.

15-19

Sales Budget of Collegiate Apparel

15-20

Production Budget
Sales Budget Production Budget

Plan of resources needed to meet current sales demand and ensure inventory levels are sufficient for future sales.

15-21

Forecasting Production
Rearrange the basic inventory formula as follows . . .
Units in beginning inventory + Required production in units Sales in Units = Units in ending inventory

Now, solve for required production . . .


Units to be Produced = Sales in Units + Units in ending inventory Expected beginning inventory

15-22

The Production Budget


Collegiate Apparel wants units in ending finished goods inventory to be 10% of the next quarters expected sales in units. At the beginning of the year, 1,500 completed units were on hand. During the first quarter of 20x2, 15,000 units are expected to be sold.

Lets prepare the production budget.

15-23

The Production Budget

5,000 10% = 500 units

15-24

Direct-Materials Budget
Direct materials needed for the budget period can be determined as follows . . .
Required materials purchases = Materials used in production + Ending materials inventory Beginning materials inventory

15-25

Direct-Materials Budget
At Collegiate Apparel 1.5 yards of fabric are required per unit of product. Management wants fabric on hand at the end of each quarter to be 10% of next quarters raw materials required. On January 1st, 2,100 yards of fabric are onhand. During the first quarter of 20x2, Collegiate expects 21,000 yards of fabric to be required. Each yard of fabric cost the company $2.

Lets prepare the direct materials budget.

15-26

Direct-Materials Budget

8,250 10% = 825 units

15-27

Direct-Labor Budget
At Collegiate Apparel, each unit produced requires 0.20 hour (12 minutes) of direct labor. Workers earn a wage rate of $10 per hour regardless of the hours worked. Collegiate Apparel can hire workers as needed to meet production.

Lets prepare the direct labor budget.

15-28

Direct-Labor Budget

15-29

Manufacturing-Overhead Budget
Collegiate Apparel uses activity-based budgeting. At the unit-level, each unit produced requires $0.25 of indirect materials and $0.15 of electricity. At the batch-level, the company expects the following production runs:
1st quarter 28 2nd quarter 11 3rd quarter 22 4th quarter 39

At the product-level, the company expects two new style designs each quarter with each new T-shirt design costing $500. Details of the facilities-level overhead costs are shown on the manufacturing-overhead budget.

15-30

Manufacturing-Overhead Budget
Unit-, Batch-, and Product-level Portions of the Budget

15-31

Manufacturing-Overhead Budget
Product-, Facilities-level and Total Overhead Budget

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

15-32

SG&A Expense Budget


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

Customer-level SG&A expenses include licensing fees for use of names and logos.
Facilities-level SG&A expense include sales salaries, advertising and clerical wages. Lets prepare the SG&A expense budget.

15-33

SG&A Expense Budget

15-34

Cash Receipts Budget


At Collegiate Apparel all sales are made on account.

The company collects 80% of its billings in the quarter of the sale and 18% in the following quarter. The remaining two percent of each quarters sales are expected to be uncollectible.
Sales in the last quarter of 20x0 were $240,000.

Lets prepare the Cash Receipts Budget.

15-35

Cash Receipts Budget

$240,000 18% = $43,200

$180,000 18% = $32,400

$180,000 2% = $3,600

15-36

Cash Payments for Direct-Materials


At Collegiate Apparel all purchases of raw materials are made on account.

The company pays for 60% of its purchases in the quarter of the purchase and the remaining 40% in the following quarter.
Purchases in the last quarter of 20x0 were $56,850.

Lets prepare the Cash Disbursements Budget.

15-37

Cash Payments for Direct-Materials

$39,450 40% = $15,780

$18,150 60% = $10,890

15-38

Other Cash Disbursements

15-39

Cash Budget
Collegiate Apparel started the year with a cash balance of $10,000, and borrows $100,000 at the beginning of 20x1 to finance plant expansion.

The loan is repaid in the amount of $25,000 at the end of each quarter with interest on the unpaid balance at 10%. Payments for the plant additions were:
1st quarter 2nd quarter 3rd quarter 4th quarter = $45,000 = $15,000 = $5,000 = $35,000

Lets prepare the Cash Budget.

15-40

Cash Budget

$100,000 10% = $2,500

15-41

Calculation of Absorption Unit Cost

15-42

Cost of Goods Manufactured and Sold Budget


At Collegiate Apparel the production cycle is short enough that it has no work-in-process inventory at any time. From Schedule 3 in the text, we know there are 2,100 yards of fabric at $2.00 per yard in beginning raw material inventory. And from Schedule 2 we know there are 1,500 units in ending finished goods inventory. We just computed the absorption cost per unit at $9.00. Lets prepare the Cost of Goods Manufactured and Sold Budget.

15-43

Cost of Goods Manufactured and Sold Budget


2,100 $2 $4,200

1,500 $9 $13,500

15-44

Budgeted Income Statement

15-45

Budgeted Balance Sheet


The balance in the building account on December 31, 20x0 was $400,000, and the balance in the equipment account was $320,000. Total accumulated depreciation was $240,000. Depreciation expense is recorded at the rate of $60,000 per year. At December 31, 20x1, the company had a long-term, noninterest-bearing note payable of $200,000. The note is due on December 31, 20x3. The balance in the owners equity account at December 31, 20x0, was $330,160.

Supplies on hand at December 31, 20x1 were $2,000.


Lets prepare the Budgeted Balance Sheet.

15-46

$240,000 18% $43,200

$56,850 40% $22,740 $330,160 56,750 $386,910

15-47

How It All Fits Together


Production budget Sales forecast SG&A budget

15-48

How It All Fits Together


Production budget Sales forecast SG&A budget

Required direct materials, labor and mfg. overhead budgets

Budgeted income statement

15-49

How It All Fits Together


Production budget Sales forecast SG&A budget

Required direct materials, labor and mfg. overhead budgets

Budgeted cost of goods mfg. and sold

Budgeted income statement

15-50

How It All Fits Together


Production budget Sales forecast SG&A budget

Required direct materials, labor and mfg. overhead budgets

Budgeted cost of goods mfg. and sold

Budgeted income statement

Cash budget Budgeted balance sheet

15-51

Learning Objective 4

15-52

Responsibility for Budget Administration


Budget Committee Consists of key senior executives who may advise the budget director during the preparation of the budget. The authority to give final approval to the budget usually rests with the board of directors.

15-53

Learning Objective 5

15-54

Budgetary Slack: Padding the Budget


Padding the budget means intentionally underestimating revenues or overestimating costs. The difference between the revenue or cost projection that a person provides and a realistic estimate of the revenue or cost is called budgetary slack. A solution: reward managers for making accurate estimates.

15-55

Participative Budgeting
Participative Budgeting the use of input from lower- and middle-management employees.

The process is time consuming but enhances employee motivation and acceptance of goals.

15-56

Ethical Problems in Budgeting


Much of the information for the budget is provided by persons whose performance is then compared with the budget they help develop.
Lets prepare the sales forecast with a 4% increase, so we will really look good! I think sales will increase by 10% next year.

15-57

Zero-Based Budgeting for Discretionary Costs


A system of establishing financial plans beginning with an assumption of no activity and justifying each program or activity level.

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


Massive amounts of time were required to implement and update the budget.

15-58

Learning Objective 6

15-59

Contemporary Trends in Budgeting and Financial Planning

The emerging concept of financial planning is gradually replacing a budgeting process in which remote sales projections drive decisions and push costs onto inventory. The process is more customer-driven, not by largescale sales statistics but by specific orders. The budgeting process is adapting to this sales model. In cost management, costs dont just happen but are actively managed with techniques such as activity-based management. Activities are reviewed for the value they add to products and services.

15-60

Beyond Budgeting

A break from the budgeting process already shown, based on the growing need to satisfy customers and relying on a companys intellectual assets. This approach emphasizes:

rolling forecasts and optimization of resources no evaluation on meeting specific targets decentralized decision making and teams a climate based on sustained competitive success transparent and open information systems

15-61

Learning Objective 7

15-62

Inventory Management Economic Order Quantity

How much inventory to keep on hand? Inventory decisions involve a delicate balance between these classes of cost:

ordering costs holding costs shortage costs

EOQ is a mathematical tool to determine the order quantity that minimizes the ordering and holding costs:

15-63

Inventory Management under JIT

Under JIT, there would be no inventories at all! Inventory cost would be wasteful. In fact, as inventory holding costs are reduced, so is EOQ. So, order as needed. There is no ideal order quantity.

15-64

End of Chapter 15

You might also like