GROUP NO.

Operational Budgeting

Presentors:
John Mark T. Engoc
Zumiku P. Novela
Continuing . . . Learning
Objectives
3. Why does a budget manual facilitate the budgeting process?

4. What complicates the budgeting process in a multinational

environment?

5. What is the starting point of a master budget and why is this

item chosen?

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Learning
Objectives

1. What is the importance of the budgeting process?

2. How do the advantages and disadvantages of imposed

budgets and participatory budgets compare?

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Continuing . . . Learning
Objectives
6. How are the various master budget schedules
prepared and how do they relate to one another?

7. Why is the cash budget so important in the master

budgeting process?

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Continuing . . . Learning
Objectives

8. How does the statement of cash flows relate to

the income statement and the cash budget?

9. Why does actual revenue from a product differ

from budgeted revenue? (Appendix)

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Continuing . . . Learning
Objectives

10. How does traditional budgeting differ from zero-

based budgeting? (Appendix)

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 Different Roles of Budgeting Process
and Budgets

• Planning
• Motivation
• Evaluation
• Coordination
• Communication
• Education
• Ritual
 Participation
in the Budgeting Process

Imposed budgets

Top
Management

Middle Management

Operational Management Participatory

budgets
 Best Times to Use Imposed Budgets

• In start-up organizations
• In extremely small businesses
• In times of economic crisis
• When operating managers lack budgetary skills or
perspective
• When organizational units require precise
coordination of efforts
 Advantages of Imposed Budgets

• Increase probability that organization’s strategic plans

will be incorporated in planned activities
• Enhance coordination among divisional plans and
objectives
• Use top management’s knowledge of overall resource
availability
• Reduce the possibility of input from inexperienced or
uninformed lower-level employees
• Reduce the time frame for the budgeting process
 Disadvantages of Imposed Budgets
• May result in dissatisfaction, defensiveness, and low morale
among individuals who must work under the budget
• Reduce the feeling of teamwork
• May limit the acceptance of the stated goals and objectives
• Limit the communication process among employees and
management
• May create a view of the budget as a punitive device
• May result in unachievable budgets for international divisions
if local operating and political environments are not
adequately considered
• May stifle the initiative of lower-level managers
 Best Times to Use
Participatory Budgets

• In well-established organizations
• In extremely large businesses
• In times of economic affluence
• When operating managers have strong budgetary
skills and perspectives
• When organizational units are quite autonomous
 Advantages of Participatory Budgets

• Provide information from persons most familiar with the

needs and constraints of organizational units
• Integrate knowledge that is diffused among various levels
of management
• Lead to better morale and higher motivation
• Provide a means to develop fiscal responsibility and
budgetary skills of employees
• Develop a high degree of acceptance of and commitment to
organizational goals and objectives by operating
management
 Continuing . . . Advantages of Participatory
Budgets

• Are generally more realistic

• Allow organizational units to coordinate with one another
• Allow subordinate managers to develop operational plans that
conform to organizational goals and objectives
• Include specific resource requirements
• Blend overview of top management with operating details
• Provide a social contract that expresses expectations of top
management and subordinates
 Disadvantages of
Participatory Budgets
• Require significantly more time
• Create a level of dissatisfaction with the process
approximately equal to that occurring under imposed budgets
in cases in which the effects of managerial participation are
negated by top-management changes
• Create an unachievable budget in cases in which managers
may be ambivalent or unqualified to participate
• May cause managers to introduce slack into the budget
• May support “empire building” by subordinates
• May start the process earlier in the year when there is more
uncertainty about the future year
 Budget Manual

• Statements of the budgeting

purpose and its desired results
• A listing of specific budgetary
activities to be performed
• A calendar of scheduled budgetary
activities
• Sample budget forms
• Original, revised, and approved
budgets
 Calendar Budget Period

Year

Quarter 1 Quarter 2 Quarter 3 Quarter 4

January April July October

February May August November

March June September December

 The Master Budget

A comprehensive set of an organization’s

budgetary schedules and
pro forma (projected) financial statements
 Composition of the Master Budget

Operating Budgets Financial Budgets

(units & dollars) (dollars)

Sales Budget Cash Budget

Production Budget Capital Budget
Purchases Budget Schedule of Cost of Goods
Direct Labor Budget Manufactured
Overhead Budget Income Statement
Selling & Administrative Statement of Retained
Budget Earnings
Balance Sheet
Statement of Cash Flows
 Budget Example
Sales budgets by month:
January 200
February 300
March 400

Variable cost of goods sold will be 60 percent of sales.

Other variable costs will be 15 percent of sales, paid
one month later.
Total fixed costs for the year will be 240, of which 10
per month is depreciation expense.
 Balance Sheet Example

Assets: Liabilities:
Cash 30 Accts. payable 180
Accts. receivable 288 Accrued payables 25
Inventory 300 Total liabilities 205
Plant & equip., net 300 Common stock 500
Retained earnings 213
Total 918 Total 918
 Budgeted Income Statement for the
Quarter Ending
Jan. Feb. Mar. Total
Sales 200 300 400 900
Variable cost of goods sold 120 180 240 540
Gross margin 80 120 160 360
Other variable costs 25 30 45 100
Contribution margin 55 90 115 260
Fixed costs 20 20 20 60
Income 35 70 95 200
 Purchases Budget for the Three
Months Ending
Jan. Feb. Mar. Total

Cost of sales 120 180 240 540

Ending inventory* 420 540 660 660

Total requirements 540 720 900 1200

Beginning inventory 300 420 540 300

Purchases required 240 300 360 900

*Ending inventory is equal to the next two month's

COGS. April's and May's sales were estimated as 500
and 600, respectively.
Cash Collections from Customers
Collections are estimated to be 20 percent in
the month of sale, 48 percent the month
following, and 32 percent in the second
month following. There are no
uncollectible accounts.
 Cash Receipts
Jan. Feb. Mar. Total

Sales for the month 200 300 400 900

Collections from sales:

20% of current month's 40 60 80 180

48% of prior month's* 120 96 144 360

32% of second month's* 88 80 64 232

Total cash collections 248 236 288 772

*November and December sales were 275 and 250, respectively

 Cash Disbursements for Purchases

Jan. Feb. Mar. Total

Budgeted purchases 240 300 360 900

Payments 180 240 300 720

Purchases are paid for the month following the purchase.

 Cash Disbursements–All Costs

Jan. Feb. Mar. Total

For purchases 180.00 240.00 300.00 720.00

Other variable costs 25.00 30.00 45.00 100.00

Fixed costs 10.00 10.00 10.00 30.00

Total 215.00 280.00 355.00 850.00

 Tentative Cash Budget

Jan. Feb. Mar. Total

Beginning balance 30 63 19 30

Collections 248 236 288 772

Total available 278 299 307 802

Disbursements 215 280 355 850

Ending balance 63 19 -48 -48

 Minimum Cash Balance Policies
Financial managers devote considerable
attention to determining the needed
minimum level of cash. As with most
decisions, a trade off between two conflicting
factors is involved. Too small a minimum
balance would lead to a higher probability of
running out of cash, while too large a
minimum balance would lead to little or no
return.
 Continuing . . .
Minimum Cash Balance Policies

In this example, the desired minimum

cash is 25. Cash can be borrowed in 5
increments at an interest rate of 12
percent per year.
 Revised Cash Budget
Jan. Feb. Mar. Total

Beginning balance 30 63 29 30

Collections 248 236 288 772

Total available 278 299 317 802

Disbursements 215 280 355 850

Tentative balance 63 19 -38 -48

Borrowing 10 65 75

Ending balance 63 29 27 27
 Budgeted Income Statement for the
Quarter Ending
Total
Sales 900
Variable cost of goods sold 540.00
Gross profit 360
Other variable costs 100.00
Contribution margin 260
Fixed costs 60.00
Operating income 200
Interest expense 0.85
Income 199.15
 Balance Sheet

Assets: Liabilities:
Cash 27 Accts. payable 360
Accts. receivable 416.00 Accrued expenses 60.00
Inventory 660.00 Short-term loan 75.00
Plant & equip., net 270.00 Accrued interest 0.85
Total liabilities 495.85
Common stock 500.00
Retained earnings 377.15
Total 1373 Total 1373
 Total Revenue Variance

Actual sales Budgeted

Sales
(ASP x AV)
(BSP x BV)

Total Revenue Variance*

*Favorable or unfavorable
 Sales Price Variance

ASP x AV BSP x AV BSP x BV

Sales
Price Variance
AV (ASP - BSP) *

*Favorable or unfavorable
 Sales Volume Variance

ASP x AV BSP x AV BSP x BV

Sales Volume
Variance

BSP (AV - BV) *

*Favorable or unfavorable
 Example

The Maine Lobsters budget 1999 ticket sales at

P70,000 per home game, which represent the sale of
an estimated 10,000 tickets at a selling price of P7.
At July’s first home game, actual gate ticket revenue
was P66,000, creating a total unfavorable revenue
variance of P4,000. The actual sales consisted of
12,000 tickets at P5.50.
 Revenue Variance Calculations
Total Revenue Variance equals:
70,000 - (P5.50 x 12,000) = P4,000 U

Sales Price Variance equals:

12,000 x (P5.50 - P7.00) = P18,000 U

Sales Volume Variance equals:

P7.00 x (12,000 - 10,000) = P14,000 F
 Traditional Budgeting

• Starts with last year’s funding appropriation

• Focuses on money
• Does not systematically consider alternatives to
current operations
• Produces a single level of appropriation for an
activity
 Zero-Based Budgeting

• Starts with a minimal (or zero) figure for

funding
• Focuses on goals and objectives
• Directly examines alternative approaches to
achieving similar results
• Produces alternative levels of funding based on
availability of funds and desired results