BAFINMAX:

FINANCIAL
MANAGEMENT

Course Material No. 7:

FINANCIAL PLANNING and BUDGETING

Lawrence Zyril D. Lizardo, CPA, MAcc

Course Instructor
2 FINANCIAL PLANNING AND BUDGETING • NU LAGUNA

Financial Planning and

Budgeting 7
LEARNING OUTCOMES

After studying the material, you should be able to:

LESSON OUTLINE
• discuss the basic concepts of the financial planning process;
• differentiate the budget used in financial planning;
Financial
•
• explain the step-by-step procedure of budgeting;
Planning
• compute budget for sales, inventories, and variable and fixed expenses;
Unit Outline
• Master Budget
and
• prepare the pro-forma cash budget, balance sheet, and income statement.

RESOURCES NEEDED

For this lesson, you would need the following resources:

• Reference Book
• Course Material
FINANCIAL PLANNING AND BUDGETING • NU LAGUNA 3

TABLE OF CONTENTS

Starting Point
Pretest 3
Before you start, try answering the following Make it Real
questions. 4
1. What is a budget? Working Capital
5
_________________________________________
Post Test
2. What is a budgetary control?
21
________________________________________
3. Discuss some of the major benefits to be gained
from budgeting? 22 Instructor

________________________________________
22 Reference

Financial
Planning and
Budgeting
 4 FINANCIAL PLANNING AND BUDGETING • NU LAGUNA

What are the basic benefits and purposes of developing pro-forma statements and a
cash budget?
 FINANCIAL PLANNING AND BUDGETING • NU LAGUNA 5

Financial Planning and Budgeting

Financial Planning

• Financial planning covers the processes of setting the primary objective, identifying the alternative
courses of action, and choosing the best alternative to achieve the objective.
• Financial planning focuses on what the firm intends to do in the near future.
• It is a system that guides the top management to direct the actions of the different units of the
organization in accomplishing its objectives (Kolb & Demong, 1988).

Dimensions of Financial Planning

Short-range Plan
• A short-range plan usually covers the next twelve months.
• It focuses on the goals needed to be achieved in the coming year.
• A short-range plan requires forecasting all activities of the firm affecting its balance sheet, income
statement, and cash flow.

Long-range Plan
• This is a plan that has a time frame of two to five, or more, years and does not require a great
amount of detail.
• The long-range plan, as compared with the short-range plan, is more difficult and more prone to
errors because of the time frame involved.

Financial Plan

• A financial plan is also known as a budget.

• Budgeting is the process of transforming the planned courses of action into quantitative terms,
i.e., in the form of money.
• Thus, the financial plan becomes a formal statement prepared by the company with regard to
the expected sales, expenses, production, and other related financial transactions for a certain
period.
• The financial plan is used in directing the firm's operations and serves as a control device that
helps measure periodic or annual performance.

Approaches to Financial Planning

Basically, there are two approaches to financial planning. They are:

• Zero-based approach.

1. From the name itself, "zero" means the budget's baseline is zero.
2. The previous year's budget is irrelevant in allocating financial resources for the current year.
3. Managers preparing a zero-based budget are required to present and justify all the
required expenses included in the budget.
4. One common disadvantage of this approach is that it requires a lot of documentation.
6 FINANCIAL PLANNING AND BUDGETING • NU LAGUNA

5. Aside from the schedules required in the normal structure of the budget, it should identify
all activities and operations in decision packages ranked in accordance with relative
importance (Garrison, Noreen, & Brewer, 2006).
6. Other disadvantages of zero-based budgeting are its execution that normally rakes a long
period of time and its cost that is too expensive to justify on a yearly basis.

Example:

The previous year's budget on the firm's advertising expense was P15,000 which is 10% of the
budgeted sales of P150,000. Using the zero-based approach, a percentage of the budgeted sales will
not be applied. That is, if the current year's budgeted sales is P250,000, the advertising expense will not
follow the supposedly P25,000 budgeted expense but rather, the firm has to come up with a figure
based on certain conditions and assumptions.

• Incremental-based approach.
1. This is the traditional approach in budgeting.
2. The budget starts with the previous year's budget and then an amount is added or
subtracted according to the anticipated needs.
3. In this type of approach, an increment is always subject to justification.

Example:

Using the example from zero-based approach, the advertising expense for the current year in
incremental-based approach will be P25,000. The increase by P10,000 in the budgeted advertising
expense has to be justified in order to be approved.

Objectives of Financial Planning

Financial planning serves certain purposes. They are as follows:

• Planning. Financial planning helps the firm determine its objectives and courses of action. With the
clear set of objectives, the firm looks forward to placing itself as one of the major players in
the industry.

• Coordination. Financial planning creates a harmonious relationship among the different units of
the organization. Though departments are created with different functions with a clear set of
objectives, departments learn to coordinate, communicate, and work with each other.

• Control. A financial plan becomes an important tool in enhancing and measuring the performance
of the company. With the diligent preparation of summarized reports containing comparisons with
the planned objectives, differences are analyzed for improvements. It is also used as a basis to
evaluate individual performance.

Master Budget

• This budget is the combined budgets of the different units of the organization (Mejorada, 2000). It
is a control measure that helps the firm determine if the set objectives are attained. The master
budget is classified into two categories: the operating budget and the financial budget.
FINANCIAL PLANNING AND BUDGETING • NU LAGUNA 7

• Operating Budget

This budget shows the plan of operations where the details of sales, production, and expenses are
laid out. The operating budget takes the form of the budgeted income statement showing the
operating results of the firm in the coming year. It is composed of the following:

1. Sales budget. This refers to the planned volume of production that the company is expected
to sell based on forecasted sales.
2. Production budget. This identifies the number of units to be produced after the sales
budget has been established and the ending inventory has been set.
3. Ending inventory budget. This is a budget that specifies the number of units that the
company desires to have in their balance sheet at the end of the period.
4. Direct materials budget. This shows the quantity of materials required to meet the production
units and the number of units that must be purchased. It determines first how many
units of material are needed per unit of production.
5. Direct labor budget. This refers to the budget that provides the total cost of labor to
meet the production requirements.
6. Factory overhead budget. This is a schedule of all manufacturing costs other than direct
materials and direct labor.
7. Selling and administrative budget. This details the sales and administrative expenses
in selling the products of the company.
8. Pro-forma income statement. This is one of the major schedules in financial planning
showing the projected income of the company.

• Financial Budget

The financial budget shows the budgeted financial resources of the firm. Prepared right after the
operating budget, it consists of the following:

1. Cash budget. It is prepared to determine the financial needs of the company. It shows
the detailed lists of all cash receipts and expenses for a particular period.
2. Pro-forma Statement of Financial Position. This budget presents the forecasted components
of the balance sheet a future date. The actual balance sheet of the previous period is the
starting point of the pro-forma balance sheet.

Basic Steps in Preparing the Budget

• Budget preparation is done in a sequential manner. Leaving out one of the processes could result
in a material error in preparing a budget. The budget normally identifies the following items:

1. Firm's sales
2. Production volume
3. Materials' cost
4. Materials purchased
5. Direct labor cost
6. Factory overhead
7. Inventory level
8. Cost of goods sold
8 FINANCIAL PLANNING AND BUDGETING • NU LAGUNA

9. Selling and administrative expenses

10. Cash budget
11. Pro-forma income statement
12. Pro-forma balance sheet

Sales Forecast

• This is the process of estimating the volume of sales.

• It serves as the mother of all the budgets that every subsequent operating and financial budget will
rely on.
• It is prudent to make the sales forecast to be as reasonable and accurate as possible to be useful.

Sales Budget

• This refers to the planned volume that the company is expected to sell based on forecasted sales.
• It also begins the operating budget and financial budget.
• Sales estimates may be made based on the analysis of the general business condition, market
conditions, political conditions, product growth curves, etc.
• After determining the estimated sales volume, the sales budget is computed as follows:

Expected sales in units xxx

Multiply by the unit selling price Pxxx
Total sales Pxxx

Example:

Assume that the firm is expecting to have the following quarterly sales:

First quarter 1,200 units

Second quarter 1,050 units
Third quarter 1,350 units
Fourth quarter 1,450 units

Assumed that the company still have receivables on the beginning of the year amounting to P14,250.
Assumed further that 65% of the expected sales were collected in the first quarter of the sale, 30% were
collected in the quarter after the sale, and 5% were uncollectible, the selling price per unit is P120.

Lucky Merchandising
Sales Budget
For the Year Ended Dec. 31, 2023

Quarter
1 2 3 4 Total
Expected sales in units 1,200 1,050 1,350 1,450 5,050
Unit sales price (P) x 120 x 120 x 120 x 120 x 120
Total sales P144,000 P126,000 P162,000 P174,000 P606,000
FINANCIAL PLANNING AND BUDGETING • NU LAGUNA 9

Schedule of Expected Cash Collections

1 2 3 4 Total
Accounts Receivable, 01/01/23 P14,250 P14,250
Sales
First quarter P93,600 P43,200 136,800
Second quarter 81,900 P37,800 119,700
Third quarter 105,300 P48,600 153,900
Fourth quarter 113,100 113,100
Total cash collections P107,850 P125,100 P143,100 P161,700 P537,750

The cash collections are computed as follows:

For the first quarter sales,

P144,000 x 0.65 = P93,600 presented in the first quarter

P144,000 x 0.30 = P43,200 presented in the second quarter

P144,000 x 0.05 = P7,200 uncollectible account

The same procedure shall be applied for the second to fourth quarters. However, the second collection
for the fourth quarter sale will not be reflected in the schedule of cash collections since it will be
collected in the first quarter of the succeeding year.

Production Budget

• The next step after creating the sales budget is planning the production budget.
• This budget gives an assurance that the units required to produce the sales requirement for each
period will be met.
• The production budget serves as the basis of forming the budget for the direct materials, direct
labor, factory overhead, and other expenses which are directly associated with the production.

The expected volume of production is determined as follows:

Planned sales Pxxx

Add: Desired ending inventory xxx
Total needs Pxxx
Less: Beginning inventory xxx
Units to be produced Pxxx

It should be noted that the production requirements for each period are influenced by the levels of the
ending inventory and, therefore, should be carefully planned.

Example:

Assume that the ending inventory is 15% of the next quarter's sales and that the ending inventory
for the fourth quarter is 200 units.
10 FINANCIAL PLANNING AND BUDGETING • NU LAGUNA

The Lucky Merchandising

Production Budget
For the Year Ended Dec. 31, 2023

1 2 3 4 Total
Budgeted sales volume 1,200 1,050 1,350 1,450 5,050
Add: Desired ending inventory 158 203 218 200 200
Units available for sale 1,358 1,253 1,568 1,650 5,250
Less: Beginning inventory 180 158 203 218 180
Required production in units 1,178 1,095 1,365 1,433 5,070

The beginning inventory for the first quarter is obtained by multiplying 1,200 by 15%. The beginning
inventory of 180 for the first quarter is also the ending inventory of the fourth quarter of the previous
year.

Direct Materials Budget

• When the production requirements have been computed, a direct materials budget can then be
prepared to show the number of materials required and the quantity that must be purchased to
meet the production requirements.

The formula in computing the purchase is as follows:

Required production volume xxx

Multiply materials allowed per unit of production xxx
Materials needed in production xxx
Add: Desired ending inventory of materials xxx
Total needs xxx
Less: Beginning inventory of materials xxx
Direct materials budget xxx

The direct materials budget is usually accompanied by a schedule of expected cash disbursements for
the purchased materials.

Example:

Assume that the ending inventory is 15% of the next quarter's production needs; the ending materials
inventory for the fourth quarter is 600 units; and 75% of each quarter's purchases in that quarter, with the
remainder be paid in the following quarter. Accounts Payable beginning is P3,330. Also, 3 pounds of needed
unit of product at a cost per of P3 per pound.
FINANCIAL PLANNING AND BUDGETING • NU LAGUNA 11

Lucky Merchandising
Direct Materials Budget
For the Year Ended Dec. 31, 2023

Quarter
1 2 3 4 Total
Required production volume 1,178 1,095 1,365 1,433 5,070
Multiply materials allowed per unit of x 3 x 3 x 3 x 3 x 3
production
Materials needed in production 3,533 3,285 4,095 4,298 15,210
Add: Desired ending inventory of 493 614 645 600 600
materials
Total needs 4,025 3,899 4,740 4,898 15,810
Less: Beginning inventory of materials 530 493 614 645 530
Direct materials to be purchased 3,495 3,407 4,125 4,253 15,280
Unit price of the materials x 3 x 3 x 3 x 3 x 3
Total purchase cost P10,486 P10,220 P12,376 P12,759 P45,840

Schedule of Expected Cash Payments

Quarter
1 2 3 4 Total
Accounts Payable, 12/31/22 P3,300 P3,300
Purchases
First quarter 7,865 P2,622 10,486
Second quarter 7,665 P2,555 10,220
Third quarter 9,282 P3,094 12,376
Fourth quarter 9,569 9,569
Total cash payments P11,165 P10,286 P11,837 P12,663 P45,951

The cash payments are computed as follows:

For the first quarter purchases,

P10,486 x 0.75= P7,865 presented in the first quarter

P10,486 x 0.25 = P2,622 presented in the second quarter

The same procedures are to be applied for the second to fourth quarter purchases.

Direct Labor Budget

Like the direct materials budget, the production budget is also a preliminary point for the preparation
of the direct labor cost budget. The firm needs to know the required labor time to meet the production
requirements so that if any problem arises with regard to the labor force, the firm can immediately make
adjustment. Listed below is an the formula for the direct labor cost.
12 FINANCIAL PLANNING AND BUDGETING • NU LAGUNA

Units to be produced xxx

Multiply by the direct labor hours per unit xxx
Number of hours required xxx
Multiply by the direct labor cost per hour xxx
Total direct labor cost xxx

Example:

Ther per unit of production requires 6 hours of labor. The laborers are paid with an hourly rate of
P8.

Lucky Merchandising
Direct Labor Budget
For the Year Ended Dec. 31, 2023

Quarter
1 2 3 4 Total
Units to be produced 1,178 1,095 1,365 1,433 5,070
Direct labor hours per unit x 6 x 6 x 6 x 6 x 6
Total hours 7,065 6,570 8,190 8,595 30,420
Direct labor cost per hour x 8 x 8 x 8 x 8 x 8
Total direct labor cost P56,520 P52,560 P65,520 P68,760 P243,360

Factory Overhead Budget

The next step in preparing budgets is making the factory overhead budget. The factory overhead
budget provides schedules for indirect materials, indirect labor, and all other manufacturing costs that
cannot be conveniently charged to specific units, jobs, or products. Indirect materials refer to those needed
for the completion of the product but whose consumption with regard to the product is either so small or
so complex that it would be futile to treat it as a direct material item. Glue, paint, varnish, thread, nails, tacks,
rivets, and other items usually belong to this category. Indirect labor is an expense which does not affect
the construction or the composition of the finished product. Examples are labor of foremen, shop clerks,
general helpers, and cleaners.

In doing the factory overhead budget, the variable cost and fixed cost must be separated. Normally,
firms establish a predetermined overhead rate on the variable portion of the factory overhead.

The variable cost varies in direct proportion to the unit produced. The total variable cost increases as
the production increases. Examples are supplies, fuel, power, small tools, spoilage, salvage, and reclamation
expenses; receiving, hauling within plant, royalty, travel, and communication costs; overtime premium, and
payroll taxes.

Fixed cost, on the other hand, is a cost that does not vary in direct proportion to the unit produced.
The total fixed cost does not change but the unit cost becomes smaller as production increases. Examples
are salaries of production executives, depreciation, taxes on real estate, taxes on plant equipment, patent
amortization, wages of watchmen and janitors, maintenance and repairs of building and grounds, insurance,
and rent.
FINANCIAL PLANNING AND BUDGETING • NU LAGUNA 13

Example:

It was determined that the quarterly variable factory overhead rate is at P3.50 of the quarterly
direct labor hours. The fixed factory overhead is budgeted at P15,000 per quarter. The depreciation
expense per quarter is P12,500. Factory overhead costs are paid in the quarter when they are incurred.
Prepare the overhead budget.

Lucky Merchandising
Factory Overhead Budget
For the Year Ended Dec. 31, 2023

Quarters
1 2 3 4 Total
Direct labor hours per quarter 7,065 6,570 8,190 8,595 30,420
Variable overhead rate 3.50 3.50 3.50 3.50 3.50
Budgeted variable overhead P24,728 P22,995 P28,665 P30,083 P106,470
Budgeted fixed overhead 15,000 15,000 15,000 15,000 60,000
Budgeted factory overhead P39,728 P37,995 P43,665 P45,083 P166,470
Less: Non-cash expense
Depreciation 12,500 12,500 12,500 12,500 50,000
Cash payments for the overhead P27,228 P25,495 P31,165 P32,583 P116,470

Ending Inventory Budget

To determine the unit cost of the unsold units, the formula is as follows:

Direct materials
Unit cost of direct materials Pxxx
Multiply by raw materials per unit of production xxx
Total unit cost of direct materials Pxxx

Direct labor
Labor rate per hour Pxxx
Multiply by direct labor hours per unit of production. xxx
Total unit cost of direct labor Pxxx

Variable factory overhead

Predetermined variable overhead rate Pxxx
Multiply by direct labor hours per unit of production xxx
Total unit cost of variable factory overhead xxx
Total variable manufacturing cost Pxxx

Once all the needed data had been computed for the unit production cost, the ending inventory budget
then be prepared. This budget is necessary in computing for the cost of goods sold in the pro-forma income
statement and the ending balance of the merchandise inventory for the unsold units to be presented can in
the pro-forma balance sheet.
14 FINANCIAL PLANNING AND BUDGETING • NU LAGUNA

Example:

Direct materials
Unit cost of direct materials P3.00
Multiply by raw materials per unit of production x 3
Total unit cost of direct materials P9.00

Direct labor
Labor rate per hour P8.00
Multiply by direct labor hours per unit of production x 6
Total unit cost of direct labor P48.00

Variable factory overhead

Predetermined variable overhead rate P3.50
Multiply by direct labor hours per unit of production x 6
Total unit cost of variable factory overhead 21.00
Total variable manufacturing cost P78.00

Lucky Merchandising
Ending Inventory Budget
For the Year Ended Dec. 31, 2023

Ending Inventory

Units Unit Cost Total

Direct materials 600 P3 P1,800
Finished goods 200 units P78 P15,600

Selling and Administrative Expense Budget

The selling and administrative expense budget lists the overall budgeted operating expenses in areas
other than those included in manufacturing. Like the factory overhead, the selling and administrative
expense is segregated into variable and fixed expenses. The variable selling and administrative expense is
in direct proportion to sales while the fixed selling and administrative expense remains unchanged unless
the firm goes beyond its normal capacity. To arrive at the estimated cash payment for selling and
administrative expense, all non-cash expenses should be excluded.

Example:

The variable selling and administrative expense of Lucky Merchandising amounts to P6 per unit of
sales, including sales commission, freight, and office supplies. The fixed selling and administrative
expense amounts to P12,000 per quarter. The expenses are paid in the same quarter they are incurred.
FINANCIAL PLANNING AND BUDGETING • NU LAGUNA 15

Lucky Merchandising
Selling and Administrative Expenses Budget
For the Year Ended Dec. 31, 2023

Quarter
1 2 3 4 Total
Budgeted sales volume 1,200 1,050 1,350 1,450 5,050
Variable selling and administrative P 6.00 P 6.00 P 6.00 P 6.00 P 6.00
expense rate per unit

Budgeted variable selling and 7,200 P6,300 P8,100 P8,700 P30,300

administrative expense
Fixed selling and administrative 12,000 12,000 12,000 12,000 48,000
expense
Budgeted selling and administrative P19,200 P18,300 P20,100 P20,700 P78,300
expense

Cash Budget

One of the final stages in the preparation of a budget is making the cash budget. Organizing the budget
is a continuous process. It can be checked for consistency and accuracy by comparing budgeted amounts
with amounts that can be expected from using typical ratios or financial statement relationships.

With careful cash planning, the firm should able to maintain a sufficient cash balance for its needs and
not put itself in the position of holding excessive balances of non-productive cash.
The cash budget is composed of four major sections:

1. The cash receipts section lists all the cash inflows, except for financing, during the covered period
of the budget. Cash receipts start with the beginning balance where the cash collections from sales
are added.

2. The cash payments section consists of all cash outflows in the budget period. Included in the cash
payments are direct material purchases, direct labor, factory overhead, and other cash payments.

3. The cash surplus or deficit section simply shows the difference between the cash receipts section
and the cash payments section. This section indicates if the firm needs to borrow funds to support
the operations of the company or use the excess money for paying their obligations or investing in
other profitable activities.

4. The financing section shows the borrowings and payments made by the company.

Example:

To prepare the cash budget of Lucky Merchandising, further assume the following information:

1. The cash balance at the beginning of the first quarter is P10,000.

2. The management desires to maintain a P10,000 minimum cash balance at the end of each
quarter.
16 FINANCIAL PLANNING AND BUDGETING • NU LAGUNA

3. Lucky Merchandising has a credit line with RCBC that enables it to borrow at an interest rate
of 12% per year. All borrowings and repayments must be in multiples of P1,000 and take
place at the beginning and at the end of each quarter, respectively.
4. Additional equipment amounting to P25,000 is to be acquired in the third quarter
5. The board of directors approved a cash dividend of P1,500 per quarter.
6. The income tax payable amounting to P6,000 was paid in March of 2023.

Lucky Merchandising
Cash Budget
For the Year Ended Dec. 31, 2023

Quarter
1 2 3 4 Total
Cash balance, beginning P10,000 P10,238 P12,357 P10,335 P10,000
Add: Cash receipts
Accounts receivable collections 107,850 125,100 143,100 161,700 537,750
Total cash available P117,850 P135,338 P155,457 P172,035 P547,750
Less: Cash payments
Direct materials P11,165 P10,286 P11,837 P12,663 P45,951
Direct labor 56,520 52,560 65,520 68,760 243,360
Factory overhead 27,228 25,495 31,165 32,583 116,470
Selling and administrative expense 19,200 18,300 20,100 20,700 78,300
Purchase of equipment 25,000 25,000
Cash dividend 1,500 1,500 1,500 1,500 6,000
Income tax payment 6,000 6,000
P121,612 P108,141 P155,122 P136,206 P521,081
P(3,762) P27197 P335 P35,829 P26,669
Cash surplus (deficit)
Financing
Borrowing 14,000 10,000 24,000
Repayment (14,000) (10,000) (24,000)
Interest (840) (600) (1,440)
Total financing P14,000 P(14,840) P10,000 P(10,600) P(1,440)
Cash balance, ending P10,238 P12,357 P10,335 P25,229 P25,229

Budgeted Income Statement

From the various budgets prepared, the pro-forma income statement can then summarize the various
components of planned revenue and expenses for the budgeting period. In a sense, the pro-forma income
statement serves as a control device in measuring the firm's performance by means of comparing the actual
outcome with its budgeted figures.

The concerned department with a significant difference between the budgeted and the actual figures
should investigate the reason for such. Likewise, the pro-forma income statement becomes the basis for
monitoring the performance of the different units of the organization, whether they met their assigned
budgets or not.

The projected income statement for Lucky Merchandising follows. Assume a tax rate of 32%
FINANCIAL PLANNING AND BUDGETING • NU LAGUNA 17

Lucky Merchandising
Pro-Forma Income Statement
For the Year Ended December 31, 2023
Sales (5,050 units x P120) P606,000
Less: Variable expenses
Variable cost of sales (5,050 units x P78) P393,900
Variable selling and administrative expenses 30,300 424,200
Contribution margin P181,800
Less: Fixed expenses
Fixed factory overhead P60,000
Fixed selling and administrative expenses 48,000 108,000
Net income before interest and income tax P73,800
Less: Interest expense 1,440
Net income before income tax P72,360
Less: Income tax (32%) 23,155
Net income P49,205

It is noticeable that the prepared pro-forma income statement consists only of variable expenses and
fixed expenses. The firm has the option to choose which type of income statement the traditional income
statement or the contribution margin approach -- to prepare. It is important that the income statement is
useful and applicable to whatever purpose it may serve the company.

Budgeted Balance Sheet

The budgeted balance sheet is developed using the previous year's actual balance sheet. All the
accounts entered in the balance sheet are real and are used to carry over the remaining balances to the
succeeding year. The same balances from the previous year's balance sheet are added or subtracted from
the budgeted accounts appearing from the different budgets to arrive at the budgeted balance sheet.

Having a budgeted balance sheet helps the company y check the accuracy of the other budgets made
At the final stage of the budget preparation, it helps compute financial ratios to highlight any unfavorable
financial conditions that might occur. With these forward-looking capabilities, the firm can easily change
any unfavorable conditions or situations in the future.

Example:

Assume that the previous year's balance sheet of Lucky Merchandising has the following balances:

Lucky Merchandising
Balance Sheet
For the Year Ended December 31, 2009

Assets Liabilities and

Stockholders' Equity
Current assets Current liabilities
Cash P10,000 Accounts payable P3,300
Accounts receivable 14,250 Income tax payable 6,000
Raw materials 1,590 P9,300
inventory
18 FINANCIAL PLANNING AND BUDGETING • NU LAGUNA

Finished goods 14,040

inventory
P39,880
Non-current assets Stockholders' equity

Land P80,000 Common stock, no par P114,999

Building and 150,000 Retained earnings 55,581
equipment
Accumulated (90,000)
depreciation
P140,000 P170,580

Total Assets P179,880 Total liabilities and P179,880

stockholders' equity

The illustrated balances from the previous year's balance sheet serve as the starting point of the pro-
forma balance sheet. The changes on the accounts together with the source budget or schedules are as
follows:

1. Cash
The balance amounting to P25,229 appears in the cash budget.

Cash, beginning balance P10,000

Add: Expected cash receipts 537,750
Total cash available 547,750
Less: Expected cash payments 521,081
Cash surplus P26,669
Less: Interest expense on financing 1,440
Budgeted cash, ending balance P25,229

2. Accounts receivable
Accounts receivable, Dec. 31, 2009 P14,250
Add: Planned sales (from sales budget) 606,000
Total P620,250
Less: Expected cash collections (Schedule of
expected cash collections) 537,750
Budgeted accounts receivable, Dec. 31, 2023 P82,500

3. Raw materials inventory (See ending inventory budget) P1,800

4. Finished goods inventory (See ending inventory budget) P15,600

5. Land - No acquisition made in 2023 P80,000

6. Building and equipment

Building and equipment, Dec. 31, 2009 P150,000
Add: Equipment to be acquired in the 3rd quarter 25,000
Budgeted building and equipment, Dec. 31, 2023 P175,000

7. Accounts payable
FINANCIAL PLANNING AND BUDGETING • NU LAGUNA 19

Accounts payable, Dec. 31, 2009 P3,300

Add: Planned purchases (Direct materials budget) 45,840
Total accounts payable P49,140
Less: Planned cash payments (Schedule of
expected cash payments) 45,951
Budgeted accounts payable, December 31, 2023 P3,189

8. Income tax payable (See pro-forma income statement) P23,155

9. Common stock (See Dec. 31, 2009 balance sheet) P114,999

10. Retained earnings

Retained earnings, Dec. 31, 2009 P55,581
Add: Net income (Pro-forma income statement) 49,205
Total P104,786
Less: Planned dividend payments (Cash budget) 6,000
Budgeted retained earnings, Dec. 31, 2023 P98,786

Then pro-forma balance sheet will be:

Lucky Merchandising
Pro-forma Balance Sheet
For the Year Ended December 31, 2023

Assets Liabilities and

Stockholders' Equity
Current assets Current liabilities
Cash P25,229 Accounts payable P3,189
Accounts receivable 82,500 Income tax payable 23,155

Raw materials 1,800 Total current liabilities P26,344

inventory
Finished goods 15,600
inventory
P125,129
Non-current assets Stockholders' equity

Land P80,000 Common stock P114,999

Building and 175,000 Retained earnings 98,786
equipment
Accumulated (140,000) Total stockholder’s equity P213,785
depreciation
P115,000 P170,580

Total Assets P240,129 Total liabilities and P240,129

stockholders' equity
20 FINANCIAL PLANNING AND BUDGETING • NU LAGUNA

Other Budgets

Aside from the aforementioned budgets, there are other possible budgets that the firm can do. They
are the pro-forma cash flow statement and the budgeted financial ratios.

Pro-forma Cash Flow Statement

Once the pro-forma balance sheet is prepared and the actual balance sheet is available, the pro-forma
cash flow statement can be done. Like the regular cash flow statement, the pro-forma cash flow statement
is classified into three activities: operating, investing, and financing.

The pro-forma cash flow statement is prepared so that firms can have a preview of the likely movements
of cash in the next accounting period. Although the cash budget can also provide the information needed,
companies sometimes need assistance in making sound judgments about the firm's ability to handle more
fixed commitments. The top management would also like to see the general perspective of cash flows by
classifying them into three activities that are not provided by the cash budget which generally show only
the cash receipts and cash disbursements.

Example:

Using the balance sheet of December 31, 2009 and the pro-forma balance sheet and income statement
for December 31, 2023 of Lucky Merchandising, the pro-forma cash flow statement could be written as
follows:

Lucky Merchandising
Pro-forma Cash Flow Statement
For the Year Ended December 31, 2023

Cash flows from operating activities

Net income P49,205
Add: Depreciation expense Increase in accounts receivable 50,000
Increase in raw materials inventory (68,250)
Increase in finished goods inventory (210)
Decrease in accounts payable (1,560)
Increase in income tax payable (110)
Cash flows from operating activities 17,155 P46,230

Cash flow from investing activity

Purchase of an equipment (25,000)

Cash flow from financing activities

Cash dividend payment (6,000)

Net increase in cash P15,230

Cash at the beginning of the year 10,000
Budgeted cash at the end of the year P25,230

Much of the cash flows of the Lucky Merchandising come from its operating activities totaling P46,230.
Despite a planned acquisition of an equipment worth P25,000 and cash dividend payment of P6,000, Lucky
Merchandising is able to increase its cash by P15,230.
FINANCIAL PLANNING AND BUDGETING • NU LAGUNA 21

Budgeted Financial Ratios

With a pro-forma income statement and a balance sheet, the company may develop several financial
ratios for a more detailed analysis. Having an initial preview of the financial ratios, the company can also
compare their past performance with the possible outcome in the incoming accounting period. From there,
the firm may decide to scrap or change the budget for improved or better results.

Example:
12/31/09 Budget for 2023
Current ratio Current assets 4.29x 4.75x
Current liabilities
Debt-to-equity ratio Total liabilities 5.45% 12.32%
Stockholders' equity
Rate of return on sales Net income 8.12%
Net sales
Rate of return on total Net income 20.49%
assets Total assets
Total asset turnover Net sales 2.52x
Total assets

From the illustrated financial ratios, the firm will be able to decide if it will change its budget or not.
One has to bear in mind that in developing the financial ratios, a comparison should always be made for
better outcomes.

POST-TEST

Answer the following questions:

1. Day Tierro Company reported the following information for 2019:

September October November December January 2020

Budgeted Sales P280,000 P300,000 P320,000 P360,000 P200,000
Budgeted Purchases P90,000 P120,000 P128,000 P144,000 P88,000

• All sales are on credit

• Sixty percent of the customer amounts on account are collected in the month of sale and forty
percent on the following month

How much is the November 30, 2019 budgeted Accounts Receivable?

2. Additional data on Day Tierro Company are as follows:

• Cost of goods sold is 40% of sales
• Day Tierro purchases and pays for 70% of the merchandise in the month of acquisition
and 30% in the following month.
• Accounts payable are used only for inventory acquisitions.
22 FINANCIAL PLANNING AND BUDGETING • NU LAGUNA

How much is the budgeted balance for accounts payable on November 30, 2019

3. Further data on the company are the following:

• Operating expenses are: salaries, P60,000; depreciation, P10,000; rent P20,000 and utilities
P11,000
• Supplies are 1% of the current month’s sale and are used during the month acquired.
• Operating expenses are paid for in the month they are incurred.
• Accounts payable are used only for inventory acquisitions.

How much is the budgeted amount of cash to be paid for operating expenses in November 2019.

INSTRUCTOR

I am Lawrence Zyril D. Lizardo. I am a CPA since 2011. I finished my

Master in Accountancy in December 2018.

Currently, a managing partner of Lizardo, Natanauan CPAs and Co.

REFERENCE

1. Timbang, F (2015) Financial Management Part I, C & E Publishing Inc, Quezon City
2. Cabrera, E (Et. Al) (2019) Financial Management Principles and Concepts, GIC Enterprises and
Co.