Financial planning and

Cash Budgeting
Objectives of Financial Forecasting
• Adequate financial planning is a key element
in the success of any business venture.
• Short-term and long-term planning:
– Common objective: development of financial
planning and control system to guide financial
future of firm
– Techniques employed differ in degree of detail
developed in analysis
Objectives of Financial Forecasting
• Short-term planning focus on cash budgeting
and cash flow planning
• Long-term planning focus on planning for
future growth in sales and assets and for
financing of this growth
 Short-term Forecasts and Cash
Budgeting
• Short-term forecast and cash budget: plan for
near future expressed in monetary terms
– Objective: provide a planning and control system to
guide next few months or quarters of operations
• Budget is not simply a device for controlling expenditures
– As general economic conditions and business
opportunities changes, budget must change.
– As actual operations deviate from plan, financial
manager can use cash budget to assess reason for
variation and take corrective action where appropriate
 Short-term planning and Cash
Budgeting
• General procedure results in dynamic short-term
financial planning and cash budgeting system:
1. Develop sales forecast for upcoming year
2. Develop estimates of next year’s expected profitability
3. Develop forecasted (pro-forma) income statement for
upcoming year
4. Estimate cash payment and collection lags
5. Develop detailed cash collection and payments forecast
6. Construct cash budget
7. Develop forecasted (pro-forma) balance sheet for end of
next year
 Long-term Financial Planning
• Long-term financial planning: concerns future sales
growth and devising plans to finance this growth
• Percentage of sales technique
– As future sales grow, assets will also have to increase to
support sales increases
– Increased assets will be financed by reinvested earnings
and increases in so-called spontaneous liabilities (i.e.
accounts payable)
– Any shortages of financing sources will have to be
provided for from external financing sources (i.e. long-
term debt, additional equity)
Financial Planning
 Prepare a sales budget,
including a schedule of
expected cash collections.
 Budgeting Example
 Royal Company is preparing budgets for the quarter
ending June 30.
 Budgeted sales for the next five months are:
 April 20,000 units
 May 50,000 units
 June 30,000 units
 July 25,000 units
 August 15,000 units.
 The selling price is $10 per unit.
 The Sales Budget
The individual months of April, May, and June are
summed to obtain the total projected sales in units
and dollars for the quarter ended June 30 th
 Expected Cash Collections
•• All
All sales
sales are
are on
on account.
account.
•• Royal’s
Royal’s collection
collection pattern
pattern is:
is:
 70%
70% collected
collected in
in the
the month
month of of sale,
sale,
 25%
25% collected
collected in
in the
the month
month following
following sale,
sale,
 5%5% uncollectible.
uncollectible.
•• The
The March
March 3131 accounts
accounts receivable
receivable balance
balance of
of
$30,000
$30,000 will
will be
be collected
collected in
in full.
full.
Expected Cash Collections
Expected Cash Collections

From the Sales Budget for April.

Expected Cash Collections

From the Sales Budget for May.

Expected Cash Collections
 Prepare a
production budget.
 The Production Budget

Sales Production
Budget Budget
ed
andl et
p
Expected
om
C
Cash
Collections

Production must be adequate to meet budgeted

sales and provide for sufficient ending inventory.
 The Production Budget
• The management at Royal Company wants
ending inventory to be equal to 20% of the
following month’s budgeted sales in units.

• On March 31, 4,000 units were on hand.

 Let’s prepare the production budget.

The Production Budget
 The Production Budget

Budgeted May sales 50,000

Desired ending inventory % 20%
March 31
Desired ending inventory 10,000
ending inventory
The Production Budget
The Production Budget

Assumed ending inventory.

Prepare a direct materials
budget, including a
schedule of expected cash
disbursements for
purchases of materials.
 The Direct Materials Budget
•• At
At Royal
Royal Company,
Company, five
five pounds
pounds of of material
material are
are
required
required per
per unit
unit of
of product.
product.
•• Management
Management wantswants materials
materials on on hand
hand at
at the
the
end
end of
of each
each month
month equal
equal to to 10%
10% of
of the
the
following
following month’s
month’s production.
production.
•• On
On March
March 31,
31, 13,000
13,000 pounds
pounds of of material
material are
are
on
on hand.
hand. Material
Material cost
cost isis $0.40
$0.40 per
per pound.
pound.
Let’s
Let’s prepare
prepare the
the direct
direct materials
materials budget.
budget.
 The Direct Materials Budget

From production budget

The Direct Materials Budget
 The Direct Materials Budget

March 31 inventory

10% of following month’s Calculate the materials to

production needs. be purchased in May.
The Direct Materials Budget
The Direct Materials Budget

Assumed ending inventory

 Expected Cash Disbursement for Materials

•• Royal
Royal pays
pays $0.40
$0.40 per
per pound
pound for
for its
its materials.
materials.
•• One-half
One-half of of aa month’s
month’s purchases
purchases isis paid
paid for
for in
in the
the
month
month of of purchase;
purchase; thethe other
other half
half isis paid
paid in
in the
the
following
following month.
month.
•• The
The March
March 31 31 accounts
accounts payable
payable balance
balance isis
$12,000.
$12,000.

Let’s
Let’s calculate
calculate expected
expected cash
cash disbursements.
disbursements.
Expected Cash Disbursement for Materials
 Expected Cash Disbursement for Materials

Compute the expected cash

disbursements for materials
for the quarter.

140,000 lbs. × $.40/lb. = $56,000

Expected Cash Disbursement for Materials
Prepare a direct
labor budget.
 The Direct Labor Budget

• At Royal, each unit of product requires 0.05 hours (3 minutes) of

direct labor.
• The Company has a “no layoff” policy so all employees will be paid
for 40 hours of work each week.
• In exchange for the “no layoff” policy, workers agree to a wage
rate of $10 per hour regardless of the hours worked (no overtime
pay).
• For the next three months, the direct labor workforce will be paid
for a minimum of 1,500 hours per month.
• Let’s prepare the direct labor budget.
The Direct Labor Budget

From production budget.

The Direct Labor Budget
The Direct Labor Budget

Greater
Greater of
of labor
labor hours
hours required
required
or
or labor
labor hours
hours guaranteed.
guaranteed.
The Direct Labor Budget
 Prepare a
manufacturing
overhead budget.
 Manufacturing Overhead Budget

• At Royal, manufacturing overhead is applied to units of

product on the basis of direct labor hours.
• The variable manufacturing overhead rate is $20 per
direct labor hour.
• Fixed manufacturing overhead is $50,000 per month and
includes $20,000 of noncash costs (primarily depreciation
of plant assets).

 Let’s prepare the manufacturing overhead budget.

Manufacturing Overhead Budget

Direct Labor Budget.

Manufacturing Overhead Budget

Total mfg. OH for quarter $251,000

= $49.70 per hour *
Total labor hours required 5,050

* rounded
 Manufacturing Overhead Budget

Depreciation
Depreciation is
is aa noncash
noncash charge.
charge.
 Ending Finished Goods Inventory Budget

Production costs per unit Quantity Cost Total

Direct materials 5.00 lbs. $ 0.40 $ 2.00
Direct labor
Manufacturing overhead

Budgeted finished goods inventory

Ending inventory in units
Unit product cost
Ending finished goods inventory

Direct materials
budget and information.
 Ending Finished Goods Inventory Budget

Production costs per unit Quantity Cost Total

Direct materials 5.00 lbs. $ 0.40 $ 2.00
Direct labor 0.05 hrs. $10.00 0.50
Manufacturing overhead

Budgeted finished goods inventory

Ending inventory in units
Unit product cost
Ending finished goods inventory

Direct labor budget.

 Ending Finished Goods Inventory Budget

Production costs per unit Quantity Cost Total

Direct materials 5.00 lbs. $ 0.40 $ 2.00
Direct labor 0.05 hrs. $ 10.00 0.50
Manufacturing overhead 0.05 hrs. $ 49.70 2.49
$ 4.99
Budgeted finished goods inventory
Ending inventory in units
Unit product cost $ 4.99
Ending finished goods inventory ?

Total mfg. OH for quarter $251,000

= $49.70 per hour *
Total labor hours required 5,050
 Ending Finished Goods Inventory Budget

Production costs per unit Quantity Cost Total

Direct materials 5.00 lbs. $ 0.40 $ 2.00
Direct labor 0.05 hrs. $10.00 0.50
Manufacturing overhead 0.05 hrs. $49.70 2.49
$ 4.99
Budgeted finished goods inventory
Ending inventory in units 5,000
Unit product cost $ 4.99
Ending finished goods inventory $24,950

Production Budget.
Prepare a selling and administrative
expense budget.
 Selling and Administrative Expense Budget

•• At
At Royal,
Royal, the
the selling
selling and
and administrative
administrative expenses
expenses budget
budget isis divided
divided
into
into variable
variable and
and fixed
fixed components.
components.
•• The
The variable
variable selling
selling and
and administrative
administrative expenses
expenses are
are $0.50
$0.50 per
per unit
unit
sold.
sold.
•• Fixed
Fixed selling
selling and
and administrative
administrative expenses
expenses are
are $70,000
$70,000 per
per month.
month.
•• The
The fixed
fixed selling
selling and
and administrative
administrative expenses
expenses include
include $10,000
$10,000 in
in
costs
costs –– primarily
primarily depreciation
depreciation –– that
that are
are not
not cash
cash outflows
outflows of
of the
the
current
current month.
month.

Let’s
Let’s prepare
prepare the
the company’s
company’s selling
selling and
and administrative
administrative
expense
expense budget.
budget.
Selling and Administrative Expense Budget

Calculate the selling and administrative

cash expenses for the quarter.
Selling and Administrative Expense Budget
Prepare a cash budget.
 Format of the Cash Budget
The cash budget is divided into four sections:
1. Cash receipts listing all cash inflows excluding
borrowing;
2. Cash disbursements listing all payments
excluding repayments of principal and interest;
3. Cash excess or deficiency; and
4. The financing section listing all borrowings,
repayments and interest.
 The Cash Budget
Royal:
 Maintains
 Maintains aa 16%
16% open
open line
line of
of credit
credit for
for $75,000
$75,000
 Maintains
 Maintains aa minimum
minimum cash
cash balance
balance of
of $30,000
$30,000
 Borrows
 Borrows on
on the
the first
first day
day of
of the
the month
month and
and repays
repays
loans
loans on
on the
the last
last day
day of
of the
the month
month
 Pays
 Pays aa cash
cash dividend
dividend ofof $49,000
$49,000 in
in April
April
 Purchases
 Purchases $143,700
$143,700 of of equipment
equipment in in May
May and
and
$48,300
$48,300 inin June
June (both
(both purchases
purchases paid
paid in
in cash)
cash)
 Has
 Has an
an April
April 11 cash
cash balance
balance ofof $40,000
$40,000
The Cash Budget

Schedule
Schedule of
of Expected
Expected
Cash
Cash Collections.
Collections.
The Cash Budget

Schedule
Schedule of
of Expected
Expected
Cash
Cash Disbursements.
Disbursements.

Direct Labor
Budget.
Manufacturing
Overhead Budget.

Selling and Administrative

Expense Budget.
The Cash Budget

Because Royal maintains

a cash balance of $30,000,
the company must borrow
$50,000 on its line-of-credit.
The Cash Budget

Ending cash balance for April

is the beginning May balance.
The Cash Budget
 The Cash Budget

$50,000 × 16% × 3/12 = $2,000

Borrowings on April 1 and
repayment on June 30.
The Budgeted Income Statement

Cash Budgeted
Budget Income
Statement
t ed
e
pl
om
C

After we complete the cash budget,

we can prepare the budgeted income
statement for Royal.
Prepare a budgeted
income statement.
 The Budgeted Income Statement
Sales
Sales Budget.
Budget.
Royal Company
Budgeted Income Statement
For the Three Months Ended June 30
Ending
Ending Finished
Finished
Sales (100,000 units @ $10) $ 1,000,000 Goods
Cost of goods sold (100,000 @ $4.99) 499,000
Goods Inventory.
Inventory.
Gross margin 501,000
Selling and administrative expenses 260,000 Selling
Selling and
and
Operating income 241,000 Administrative
Administrative
Interest expense 2,000
Expense
Expense Budget.
Budget.
Net income $ 239,000

Cash
Cash Budget.
Budget.
Prepare a budgeted
balance sheet.
 The Budgeted Balance Sheet
Royal
Royal reported
reported thethe following
following account
account balances
balances
prior
prior toto preparing
preparing its its budgeted
budgeted financial
financial
statements:
statements:
•• Land
Land -- $50,000
$50,000
•• Common
Common stock
stock -- $200,000
$200,000
•• Retained
Retained earnings
earnings -- $146,150
$146,150
•• Equipment
Equipment -- $175,000
$175,000
 Royal Company
Budgeted Balance Sheet 25%
25% of
of June
June
June 30 sales
sales of
of
Current assets $300,000.
$300,000.
Cash $ 43,000
Accounts receivable 75,000 11,500
11,500 lbs.
lbs.
Raw materials inventory 4,600 at
at $0.40/lb.
$0.40/lb.
Finished goods inventory 24,950
Total current assets 147,550 5,000
5,000 units
units
Property and equipment at
at $4.99
$4.99 each.
each.
Land 50,000
Equipment 367,000
Total property and equipment 417,000
Total assets $ 564,550
50%
50% ofof June
June
Accounts payable $ 28,400
purchases
purchases
Common stock 200,000
of
of $56,800.
$56,800.
Retained earnings 336,150
Total liabilities and equities $ 564,550
 Royal Company
Budgeted Balance Sheet
June 30
Current assets
Cash $ 43,000
Accounts receivable Beginning balance
75,000 $146,150
Add: net income 239,000
Raw materials inventory 4,600
Deduct: dividends (49,000)
Finished goods inventory 24,950
Ending balance $336,150
Total current assets 147,550
Property and equipment
Land 50,000
Equipment 367,000
Total property and equipment 417,000
Total assets $ 564,550

Accounts payable $ 28,400

Common stock 200,000
Retained earnings 336,150
Total liabilities and equities $ 564,550