1. Management Accounting:
A Road of Discovery
A Road of Discovery

2. Management Accounting:
A Road of Discovery
James T. Mackey
Michael F. Thomas
Presentations by:
Roderick S. Barclay
Texas A&M University - Commerce
James T. Mackey
California State University - Sacramento
© 2000 South-Western College Publishing

3. Chapter 4 How much cash can we take?
Developing cash budgets from proformas

4. Key Learning Objectives
Explain why proforma income statements and CVP analysis have to be translated into a cash budget.
Discuss the usefulness of budgets when cash inflows are known.
Prepare a schedule for cash collections from sales.
Develop operating budgets (schedules for purchases, labor, overhead, and operating expenses).
Create a monthly cash budget.
Describe how cash budgeting can affect motivation and control.
7. [Appendix A] Comment on spreadsheet usefulness in budgeting.

5. Profit and Cashflows are not the Same Thing
Profit = Revenues less Expenses.
Cashflow = Deposits into and withdrawals from our bank account.
Revenue is an increase in our assets attributed to our sales activities.
Expenses are reductions in assets to earn revenue — and include noncash and cash expenses.
Matching means we match revenue and expenses in the same period to determine our profit — the amount by which revenue exceeds expenses.
The timing of cashflows does not necessarily match the recognition of revenue.

6. Why Plan? Cash and Operational Budgets
Limited resources — we need to allocate our resources to create the greatest value.
Uncertainty — we need to assure we have enough cash to pay our bills when due. (This is why we prepare cash budgets.)
Communication — we need to understand what we can accomplish and communicate to our employees what we expect.
Evaluation — we need to set performance expectations and measure productivity.
Share/Pair From your own experience in your own life, name two situations whee you would find budgeting valuable.
Share/Pair It is possible for a company to make a profit and become insolvent. How could this happen?

7. The Cash Management Process
Estimate cash inflows.
Plan expenditures (cash outflows).
Limit spending to budget (Cash control).
Compare budgeted to actual cashflows (evaluation).
We think it is appropriate to point out to your students that cash management is simply good management and for many organizations the operational management process itself.

8. Planning Motivates Control Through Evaluation
Balanced scorecard to evaluate the success of the strategic plan.2
Variance reporting for operations and cash management.3
Control
Motivate daily decisions, communication, and coordination through knowing actual performance will be compared to plan and used as a basis for rewards.
Planning
Strategic plan to define what we want to accomplish and how we are going to do it.1
Cash budget to identify the timing of cash receipts and payments necessary for the strategic plan to work.
See chapter 3
See Chapter 14
See Chapter 6
Control means getting people to do what you want them to do. The plan allows managers to understand what is possible and communicate to others. The budget is a basis for control.

9. Brian’s College Dilemma — Send Cash, Hurry!
Brian’s cash budget with limited uncertainty.
See Exhibit 4-3, p. 101.
Brian has a timing problem with his cash flow.
The first step in the budgeting process involves negotiating a contract between the employee and the employer. (In this case, Brian fulfills both positions because he must be his own cash manager.) To express the concept a little more clearly, negotiation, information transfer, and contracting between different levels of management. By using the first example with limited uncertainty the management implications of budgeting can be introduced with greater clarity.
This is Brian’s first pass. He is communicating his estimate costs.
Share/Pair If you were Brian under what conditions would you consider buiding slack into your budget?
Share/Pair If you were Brian’s Dad, what could you do to stop Brian from building slack into his budget?

10. Brian’s Next Try at a Budget
Cash-ins
Pell grant
State university grant
Scholarships
Student loans
Total financial aid
From Mom and Dad’s payroll
Cash-outs
Tuition
Books
School fees
Miscellaneous
Living expenses
Ending Cash Balance
September
$1,300
800
500
1,700
$4,300
740
(1,200)
(500)
(100)
(71)
(1,150)
$2,020
Note: See Exhibit 4-4, p. 104, for the remainder of Brian’s Second Draft of his budget.
After negotiating the contract (budget) managers are not committed to living within their budget. The conditions discussed in creating the budget are considered the normal operating conditions. If conditions change, then the budget may need to be revised. Thus the budget acts as insurance to protect the manager against arbitrary evaluations. The acceptable conditions for performance are defined, if operating conditions are different, then the budget is subject to revision. If the operating conditions occur as planned and the budget is not met, then management has made some bad decisions and can be held accountable.
These circumstances apply to general business operations. However, if we are talking about a governmental organization, or a not-for-profit organization, the budget may have more teeth in it. There may not be an opportunity for a revision, regardless of the circumstances.
Share/Pair Suppose you run out of cash before your next budgeted payment. How could you use your original budget to justify and increase? Give an example.
Share/Pair How can the budgeting process train managers?

11. Budgeting in an Uncertain Business World — Solvency Management
Once we have taken care of the internal management issues, we must forecast the flow of cash needed to operate as planned. This will likely take several iterations.
We must balance the outward flow of cash with the inward flow of cash.
We must take into account the timing of the cash inflows and outflows.
We have found that a good illustration is to compare each sales and purchases event to waves on a beach. The initial transaction has a ripple effect. The current effect is the result of many waves, all contributing different amounts to the current cash needs. To manage this, we break out the impact of each wave separately — each month’s sales, each month’s purchases, each month’s payroll, etc.

12. The Cash-to-Cash Operating Cycle for Multree’s Standard Homes
Cash-ins
Cash-outs
Pay for ½ of direct materials.
Pay for 1/3 of the direct labor and variable overhead.
Pay monthly fixed overhead.
Month 2
Buy all of the direct materials; pay 1/2 this month.
Pay sales commissions.
Make sale and collect a 40% down payment.
Month 1

13. The Cash-to-Cash Operating Cycle for Multree’s Standard Homes (Continued)
Cash-ins
Cash-outs
Pay monthly fixed overhead.
Pay shipping cost.
Deliver house and collect 50% of sales price.
Month 4
Collect the last 10% of the sales price.
Month 5
Pay for 1/3 of the direct labor and variable overhead.
Month 3
You should review Exhibit 4-7 with the students so that they will fully understand this concept. It was not practical to replicate the exhibit on a slide.
Note that each transaction creates a ripple effect of cashflow over many periods. An illustration is supplied as Exhibit 4-7, p. 109.

14. Factors Influencing the Need for Budgeting & Planning
Factors increasing the value of cash budgeting
Scarce or expensive resources; money, materials, labor, etc.
Long manufacturing or delivery times.
High operating uncertainty; unreliable suppliers, unskilled or unmotivated workers, poorly maintained machinery, etc.
Complexity and variety; many different types of products or services, customers, or activities.
Factors decreasing the value of cash budgeting
Abundance of resources; lots of money in the bank, many available workers, highly qualified workers, plenty of materials, etc.
Short cash-to-cash operating cycle; e.g. a grocery store.
Highly reliable operating environment.
Little variety of products, customers, or activities.
Under certain conditions, budgeting is essential for solvency while under other sufficient slack is available to insure solvency. For students, it is the difference between having a very large bank account at the beginning of the semester versus a modest one.

15. Budgeting Cashflows From Sales
Timing Differences — cashflows lag sales.
Trends and cycles — Sales vary from month to month.
To help understand this process, we use the following several slides to illustrate and discuss the operations of Carrie’s Snowblowers.
Unit Sales
200
500
1,500 10
Sales
$ 40,000
100,000
300,000
40,000
2,000
Month
October
November
December
January
February
March

16. Carrie’s Snowblowers (Continued)
30% of all sales are for cash, 60% of receivables are collected in the month following the sale, 35% are collected two months after the purchase, and the rest become bad debts. There are no accounts receivable outstanding at the beginning of October.
Calculate the budgeted cashflows from sales for December, January and February.
+35% x (70% x $100,000) = $24,500
+ 60% x (70% x $300,000) = $126,000
= 30% x $100,000 = $30,000
Cash collections for January = $180,500
Cash collections for February = $127,500
+ 35% x (70% x $40,000 = $9,800
+ 60% x (70% x $100,000) = $42,000
= 30% x $300,000 = $90,000
Cash collections for December = $141,800
+ 35% of two month’s previous credit sales
+ 60% of previous month’s credit sales
= 30% of the current sales
Cash collections for the month.
Share/Pair Working with your partner, calculate the cashflows received in February from sales in February, December, and October.

17. Carrie’s Snowblowers (Continued)
Budgeting for Cash Disbursements on Purchases.
Because of the uncertainty of sales forecasts, the company has a policy of having 120% of the following month’s forecast sales available at the beginning of each month. Prepare the purchasing schedule for Carrie company from October, November, and December. The beginning inventory in October is 200 units.
When inventories are carried that may change from time to time, a Balance equation is a useful planning tool. The Balance equation simply states that for planning purposes:
‘The unit available’ must equal ‘the units required’.
WE think it is useful to ask your students what some of the considerations the, as management, would consider when setting the inventory level required at the beginning of each planning period, in this case each month. The objective with this question is to begin to get them to think about conditions that we will address in the next chapter. Planning and excess inventories, a type of slack, are more important as operating uncertainty increases.

18. Carrie’s Snowblowers (Continued)
Units Available
= Period Sales
+ Ending Inventory
- (120% x current month’s sales
+ (120% x next month’s sales
= Sales for the current month
Thus: Purchase during the current month
- 200 units
+ 1.2 x 500 units
= 200 units
Purchases for October = 600 units
Purchases for December = 300 units
Purchases for January = 140 units
- 600 units
+ 1,800 units
= 500 units
Purchases for November = 1,700 units
+ Ending Inventories
= Period Sales
+ Beginning inventories
Purchases for the period
Share/Pair Verify the calculation of the December and January purchases.

19. Carrie’s Snowblowers (Continued)
Purchases Schedule
Month Unit Purchases
October
November 1,700
December
January
February No budgeted purchases
March No budgeted purchases

20. Carrie’s Snowblowers (Continued)
Cost of goods is $100 per unit Inventories are bought on credit. 45% are paid in the month of purchase and 55% are paid in the month following purchase. Accounts receivable at the beginning of October were $15,000.
Payments on payables = 45% x current month’s purchases + 55% x last month’s
February payments
= $7,700
January payments
= $22,800
+ .55 x 1,700 units x $100
= .45 x 300 units x $100
December payments
= $107,000
+ .55 x 600 units x $100
= .45 x 1,700 units x $100
November payments
= $109,500
+ $15,000 (given)
= .45 x 600 units x $100
October payments
= $42,000
Share/Pair Verify the calculation of the payments for January and February.

21. Carrie’s Snowblowers (Continued)
Expenses on the income statement for Selling, General and Administrative costs include noncash expenses for depreciation of $15,000. Monthly selling costs include a variable shipping cost of $5 per unit. The fixed expenses for SG&A are $40,000 a month.
Payments for SG&A = $5 x sales units + total fixed expenses – noncash expenses
= $5 x sales units + ($40,000 – $15,000)
= $27,500
= $5 x $25,000
Payments in January
= $25,050
= ?
Payments in March
= $26,000
Payments in February
= $32,500
= $5 x 1,500 units + $25,000
Payments in December
= $5 x 500 units + $25,000
Payments in November
= $5 x 200 units + $25,000
Payments in October
Share/Pair Verify the calculation of payments for February and March.

22. Carrie’s Snowblowers (Continued)
Capital and Irregular Payments.
In November, Carrie company buys new machinery for $20,000 in cash and $5,000 a month for the succeeding four months.
= $ 5,000
Payments in January
Payments in March
Payments in February
Payments in December
= $20,000
Payments in November
Payments in October
Due to operating uncertainties and forecasting errors in the past, Carrie Company has a policy of having at least $20,000 in cash at the beginning of each month even if this means borrowing the money.
Beginning cash + Cash receipts = Cash payments + Ending cash
Cash available = Cash required

23. Carrie’s Snowblowers (Continued)
Cash Budget for Carrie Company — 4th Quarter
(128,900)
17,300
(90,200)
(16,000)
Excess (Deficit)
$369,500
$144,500
$157,000
$68,000
Total cash requirements
$258,500
$107,000
$109,500
$42,000
Purchases
86,000
32,500
27,500
26,000
SG&A
25,000
5,000
20,000
Capital equipment
$ 20,000
$20,000
Ending Balance
$148,900
$ 2,700
$110,200
$36,000
Borrowings (Repayments)
Less cash disbursements:
$240,600
$161,800
$66,800
$52,000
Total cash available
$200,600
$141,800
$46,800
$12,000
Sales and Receivables
Cash collections:
$ 40,000
$ 20,000
$40,000
Beginning Cash Balance
4th Quarter
December
November
October

24. Carrie’s Snowblowers (Continued)
Fourth Quarter Income Statement, Carrie Company
$ 85,689
Net income
3,311
1% per month on outstanding balance
Interest payable
131,000
Cash and noncash
SG&A
Less:
220,000
Gross margin
2,200 units x $100
Cost of Sales
$440,000
2,200 units x $200
Sales
Why does the company have to borrow money when it is so profitable?

25. What Makes the Budgeting Process Successful?
Top management commitment.
Budgeting is part of overall good management.
It operationalizes the strategic plan.
It guides day-to-day operational control
It is the basis for performance evaluation.
Communication to employees about how the strategic plan is going to work.
Forces everyone to plan.
Formalizes the planning process.
Provides for financial resource allocations.
(Continued)

26. What Makes the Budgeting Process Successful? (Continued)
Gain Employee commitment.
Employees participate in determining the budget.
Employees are rewarded for good cash management
Coordination of value chain processes.
Determine how change in the sales forecast affects purchasing and production processes.
Effect on administrative support processes from changes in production schedules.
Use the budget.
Continuously update the budget for changing circumstances
Budget only for programs that add value.

27. Comparing Participative and Authoritative Budgeting
Goals
Participative
Authoritative
Downward flow only passes top management information to workers.
Because budget is imposed extra explanation and instruction may be needed for coordination.
Accomplished by two-way information flows (back and forth between workers and managers).
Plans understood because workers involved from the beginning of the process.
Communicate budget information throughout organization and coordinate operations.
Less people involved speeds up the process.
Time and effort increase with more people involved.
Minimize time and effort
If best source is top management.
If best source is employees.
Get needed information.

28. Comparing Participative and Authoritative Budgeting
Goals
Participative
Authoritative
Must come from already existing loyalty to organization. Limited understanding of how budget is linked to strategic plan.
Through participation and negotiation.
Communication fosters better understanding of strategic plan.
Budget commitment
Don’t allow private lobbying.
Continuous and zero-based budgets.
Participation and peer pressure through information sharing.
Continuous and zero-based budgets
Driving out slack.
The budget is not an important motivator if the corporate culture is characterized by workers’ pre-existing dedication to the organization.
Participation leads to higher motivation if individual performance is important within the corporate culture.
Motivation to do better than the budgets.