Chapter 6
Financial Forecasting and Budgeting
Steps in Projecting a Business Enterprise’s Needs
1. Project sales
2. Project additional variable (such as expenses)
3. Estimate the level of investment in current plant and
assets the business enterprise will need to make to
support the projected sales
4. Calculate the business enterprise’s financing needs
Percent-of-Sales Method – most widely used method for
projecting the business’s financing needs
- Requires to estimate future expenses, assets and
liabilities as a percent of sales for the period
- Construct forecasted statement of financial position
- Major advantage: simple and inexpensive to use
- Assumes that business is operating at full capacity,
does not have sufficient productive capacity to absorb
a projected increase in sales
- Must be used with extreme caution if excess capacity
exists in certain asset accounts
Budget – represents a business’s annual financial plan
- Tool for both planning and control
- Beginning of period: plan or standard vs end of period:
control device by which management measure its
success in achieving the goal outlined and plan to
improve future performance
- Two broad categories
1. Operating Budget – consist of:
Sales Budget
Production Budget
Direct Material Budget
Direct Labor Budget
Factory Overhead Budget
Selling and Administrative Budget
Pro Forma Income Statement
2. Financial Budget – consist of:
Cash Budget
Pro Forma Statement of Financial Position
Comprehensive (Master) Budget – formal statement of
management’s expectation for sales, expenses, volume and
other financial transaction
- Consist of:
1. Pro forma (projected/planned) Income
Statement
2. Pro forma Statement of Financial Position
3. Cash Budget
Steps in Preparing the Budget
1. Prepare a sales forecast
2. Determine expected production volume
3. Estimate the manufacturing costs and operating
expenses
4. Determine the cash flow and other financial
statements
5. Formulate projected financial statements
Sales Forecast – gives the expected level of sales
- Instrumental in planning and budgeting functions
- Two Approaches
1. Qualitative Approach – includes:
Forecast based on judgement and opinion
(executive opinion and Delphi technique)
Sales Force Pooling
Consumer Surveys
2. Quantitative Approach
Forecast based on Historical Data
 Naïve methods
 Moving averages
 Exponential smoothing
 Trend analysis
Associative (casual) Forecast
 Simple regression
 Multiple Regression
 Economic Modelling
Sales Budget – starting point in preparing master budget
- Indicates the quantity in units of each product the
business enterprise expects to sell
- Includes computation of expected cash collections from
credit sales (also used later for cash budgeting)
Production Budget – developed by determining the units
expected to be manufactured in order to meet budgeted sales
and inventory requirement
Expected Volume of Production = determined by subtracting
the estimated inventory at the beginning of the period from the
sum of the units expected to be sold and the desired inventory
at the end of the period
= planned sales PLUS (desired ending MINUS beginning
inventory) inventory
Direct Material Budgeted – show how much material will be
required and how much must be purchased to meet
production requirements
- Usually accompanied by a computation of expected cash
payments for materials
 = Purchase in units = usage PLUS desired ending inventory - Budget can be divided into quarters to keep tight control
in units MINUS beginning inventory units over its operation
Budgeted Statement of Financial Position – developed by
Direct Labor Budget adjusting the statement of financial for the year just ended
* Direct Labor Requirement = expected production volume for - Must be prepared because:
each period X direct labor hours required to produce units  Might disclose some unfavorable financial
* Budgeted Direct Labor Cost = direct labor requirement X conditions
direct labor hours  Serves as final check on the mathematical
accuracy of schedules
Factory Overhead Budget – provides a schedule of all  Helps management perform a variety of ratio
manufacturing cost other than direct material and direct labor calculations
- It is important to remember that depreciation does not  Highlights future resources and obligations
entail a cash outlay and therefor must be deducted from
the total factory overhead when you compute cash
disbursement for factory overhead
Ending Inventory Budget – provides the information required
for the construction of budgeted financial statement
- Helps compute Cost of Goods Sold on budgeted income
statement and the peso value of the ending materials and
finished goods inventory that appears on budgeted
statement of financial position
Selling and Administrative Expense – list the operating
expenses incurred in selling the products and in managing the
business

* To complete budgeted income statement, variable selling and

administrative expenses must be computed per unit

Cash Budget – helps managers anticipate:

 expected cash inflow and outflow for a designated
time period
 keep cash balances in reasonable relationship to
needs
 avoid both unnecessarily idle cash and possible
cash shortage
- Four Major Sections:
1. Receipt Section – beginning cash balance, cash
collections from customer, and other receipts
2. Disbursement section – cash payments that are
planned during the budget period
3. Cash Surplus or Deficit Section – differences
between the cash receipt section and the cash
disbursements section
4. Financing Portion – provides a detailed account of
the borrowings and repayments expected during
the budgeting period

Budgeted Income Statement – summarizes projections for the

various components of revenue and expenses for the budget
period