1. The Use of Budgets in Planning and Decision Making
Chapter 9
The Use of Budgets in Planning and Decision Making

2. Topics to be Discussed Introduction The Budget Development Process
Budgets for Planning, Operating and Control
Advantages of Budgeting

3. Introduction
Budgets are plans dealing with the acquisition and use of resources over a specified time period.

4. Introduction Budgets can be in terms of: Monetary or financial Time
Acquisition and use of thousands of materials
Manufacturing of hundreds of products
Attendance at a baseball game

5. Introduction Pause and Reflect Have you ever prepared a budget?
Was it a monetary or non-monetary budget?
How did you use it?

6. The Budget Development Process
Traditionally, budgeting is a bottom-up process dependent on departmental managers to provide detailed plans for the upcoming month, quarter or year.

7. The Budget Development Process
Zero-Based Budgets require managers to build budgets from the ground up each year rather than just add a percentage increase to last year’s numbers.
Why shouldn’t I just use 10% more than last year for everything?

8. The Budget Development Process
Key Concept
Budgets must start with a top-down strategic plan that guides and integrates the whole company and its individual budgets.

9. The Budget Development Process
Key Concept
Budgeting is a management task, not a bookkeeping task.

10. The Budget Development Process
Budgeting is an integral part of the planning, operating, and control activities of managers.
Planning: developing objectives and goals
Operating Day-to-Day management decisions
BUDGETING
Control: Insuring that objectives and goals are met, comparing actual to budget

11. The Budget Development Process
Key Concept
Budgets are used throughout the planning, operating, and controlling activities of managers.

12. The Budget Development Process
The operating cycle focuses on cash, thus budgeting for cash needs is crucial.
Disbursement of cash for manufacturing costs or purchases of inventory
Cash on hand
Sale of Product
Collection of cash from customers

13. Advantages of Budgeting
The budgeting process forces communication throughout the organization.
The budgeting process forces managements to focus of the future and not be distracted by daily crisis in the organization.

14. Advantages of Budgeting
The budgeting process can help management identify and deal with potential bottlenecks or constraints before they become major problems.
The budgeting process can increase the coordination of organizational activities and help facilitate goal congruence.
The budgeting process can define specific goals and objectives that can become benchmarks, or standards of performance for evaluating future performance.

15. More Topics to Discuss Budgeting for Sales
Operating Budgets-An Example
Budgeting for a Traditional Manufacturing Company with Inventory
Manufacturing Overhead Budget
Cash Budgets

16. Budgeting for Sales
In large companies, preparation of the sales forecast is usually accomplished by the marketing department and requires significant effort in the area of market research to arrive at an accurate forecast of expected sales.
In smaller companies, the sales forecast may be made by an individual or small group of managers.

17. Budgeting for Sales: Some Ways to Forecast Sales
Anticipated marketing or advertising plans
The impact of new products or changes in product mix on the entire product line
Other factors such as political and legal events and weather changes.

18. Budgeting for Sales Pause and Reflect
What unique factors might a CPA firm specializing in tax planning and the preparation of tax return consider in forecasting sales?

19. Budgeting for Sales Key Concept
Budgets are future oriented and make extensive use of estimates and forecasts.

20. Operating Budgets: An Example
Produces bottled orange juice from fruit concentrate
Only ingredients are water and juice concentrate
Juice is blended, pasteurized and bottled
Process is heavily automated
Each machine is run by one employee and can process 10 bottles of juice per minute or 600 bottles per hour

21. Inventory Policy
10% of next month’s expected sales in ending inventory of finished goods
20% of next month’s expected production of bottles in ending inventory of materials.

22. Operating Budgets: An Example
Pause and Reflect
What kind of costing system is Tina’s likely to use?

23. Operating Budgets: An Example
Sales Forecast
January
February
March
April
May
250,000 Bottles
325,000 Bottles
450,000 Bottles
500,000 Bottles
400,000 Bottles

24. Operating Budgets: An Example
Sales Budget
January
250,000
$1.05
$262,500
February
325,000
$1.05
$341,250
March
450,000
$1.05
$472,500
1st Quarter
1,025,000
$1.05
$1,076,250
Projected Sales (bottles)
Price per bottle
Total Projected Sales

25. Operating Budgets: An Example
Basic Production Budget
Sales forecast (in units)
Projected ending inventory
Total projected production needs
Beginning Inventory
Projected production volume + -

26. Operating Budgets: An Example
Production Budget
Jan
250,000
32,500
282,500
25,000
257,500
Feb
325,000
45,000
370,000
32,500
337,500
March
450,000
50,000
500,000
45,000
455,000
Total Qtr.
1,025,000
50,000
1,075,000
25,000
1,050,000
Sales Forecast (bottles)
Projected ending Inventory (+)
Total projected production needs
Beginning inventory (-)
Projected production bottles

27. Operating Budgets: An Example
Materials Purchases Budget - Bottles
Jan
257,500
67,500
325,000
51,500
273,500
$27,350
Feb
337,500
91,000
428,500
67,500
361,000
$36,100
March
455,000
98,000
553,000
91,000
462,000
$46,200
Total Qtr.
1,050,000
98,000
1,148,000
51,500
1,096,500
$109,650
Projected production (bottles)
Projected ending Inventory (+)
Total projected needs
Projected beginning Inventory (-)
Bottles to be purchased
Projected purchases x $.10/bottle

28. Operating Budgets: An Example
Direct Labor Budget
Jan
257,500
1 hour
429.17
$15/hr
$6,438
Feb
337,500
1 hour
562.5
$15/hr
$8,438
March
455,000
1 hour
758.33
$15/hr
$11,375
1st Qtr.
1,050,000
1 hour
1,750 hrs
$15/hr
$26,250
Projected production (bottles)
Direct labor time per 600 bottles
Direct labor hours for production*
Direct labor rate per hour
Projected DL cost
*Projected production/600

29. Operating Budgets: An Example
Pause and Reflect
Why are we not concerned with inventories in the direct labor purchases budget?

30. Operating Budgets: An Example
Manufacturing Overhead Budget
Jan
429.17
$54.75
$23,497
123,333
$146,830
Feb
562.5
$54.75
$30,797
123,333
$154,130
March
758.33
$54.75
$30,797
123,333
$164,852
1st Qtr.
1,750
$54.75
$95,813
123,333
$465,813
Budgeted Machine Hrs
Variable Overhead Rate
Projected Variable OH
Budgeted Fixed OH
Total Projected Manufacturing OH

31. Operating Budgets: An Example
Total Manufacturing Cost Budget
Jan
$41,027
27,350
6,438
146,830
$221,645
Feb
$54,150
36,100
8,438
154,130
$252,818
March
$69,300
43,200
11,375
164,852
$291,727
1st Qtr.
$164,477
109,650
26,250
465,813
$766,189
Projected material cost-concentrate
PMC – bottles
Projected DL costs
Projected MO costs
Total projected manufacturing costs

32. Cash Budgets
Many managers consider managing the cash flow to be the single most important consideration in running a successful business.

33. Cash Budgets
All of the sales of Tina’s are on account. Collections are estimated as follows:
50% in the month of the sale
35% in the month following the sale
15% in the second month following the sale

34. Cash Budgets Cash Receipts Nov Dec Jan Feb Mar
Sales $200, $250, $262, $341, $472,500
Cash Receipts
Nov sales % % %
Dec sales % % %
Jan sales % % %
Feb sales % %
March sales %
Cash Receipts for 1st Qtr.

35. Cash Budgets Cash Receipts Jan Feb March 1st Qtr.
15% Nov $30,000 $30,000
35% Dec $87, ,500
15% Dec $37, ,500
50% Jan $131, ,250
35% Jan $91, ,875
15% Jan $39, ,375
50% Feb $170, ,625
35% Feb $119, ,438
50% March $236, ,250
Total $248,750 $300,000 $395,063 $943,183

36. Cash Budgets Cash Disbursement Budget- Operating Activities
Cash Disbursements include:
Material Purchases for Concentrate
Material Purchases for Bottles
Direct Labor
Manufacturing Overhead
Selling and Administrative Costs

37. Cash Budgets Pause and Reflect
Can you trace each of the amounts in the cash disbursements budget back to the original budget in which it appears?

38. Cash Budgets Summary Cash Budget Beginning cash balance
Cash flows from operating activities
Cash receipts
Cash disbursements
Cash flows from investing activities
Equipment purchases

39. Cash Budgets Summary Cash Budget, continued
Cash flows form financing activities
Payment of dividends
Interest on long-term debt
Borrowing from line of credit
Repayments of line of credit
Final cash balance

40. More Budget Topics Budgeted Financial Statements
Budgets for a Manufacturing Company in a JIT Environment
Budgets for Merchandising Companies and Service Companies
Life Cycle Costs, the Value Chain and Budgeting

41. More Budget Topics
Using the budgets, management prepares pro-forma (budgeted) financial statements. They are used for internal planning purposes and to provide information to external users, such as a bank when requesting a loan.
What do I do with all of these budgets?

42. Budgeted Financial Statements
Pro-forma Statements include:
Cost of Goods Manufactured
Income Statement
Balance Sheet

43. Budgeted Financial Statements
If the budget is prepared as a template using spreadsheet software, changes in assumptions can be reflected in the entire budget in a few seconds.

44. Other Budgeting Topics
Life Cycle Costs, the Value Chain, and Budgeting
Budgeting in an International Environment
Nonmonetary Budgets
Static Versus Flexible Budgets
ABC and Flexible Budgets

45. Life Cycle Costs, the Value Chain and Budgeting
In making decisions to introduce new products, the forecasted sales over the life of the product must exceed its life cycle costs. Given that a significant % of total costs are incurred before a new product is actually produced and sold, early and accurate budgeting is critically important in making good decisions regarding the introduction of new products.

46. Budgeting in an International Environment
Considerations:
Translating foreign currency
Predicting inflation rates and prices in unstable economies
Predicting sales in countries with different consumer preferences
Dealing with different labor laws, social customs, and norms affecting wage rates and the productivity of workers

47. Nonmonetary Budgets
Time Budgets: to plan the number of hours expected to be incurred in each engagement (CPA firm and law offices)
Customer Satisfaction Measures: includes the number of retuned or defective items, the number of customer complaints, time waiting to be served

48. Static vs Flexible Budgets
Static budgets are set at the beginning of the period and remain constant throughout the budget period.
What if my sales are not what I projected?
Flexible budgets take differences in cost and revenue due to volume differences out of the analysis by budgeting for labor (and other costs) based on the actual number of units produced.
I know. I’ll use flexible budgets.

49. Static vs Flexible Budgets
Key Concept
Flexible budgets are based on the actual number of units produced rather than the budgeted units of production.

50. Static vs Flexible Budgets
Static Budget Actual
Projected production (bottles) , ,000
Projected direct labor costs $6, $6,300
Difference $138 favorable
Flexible Budget Actual
Projected production (bottles) , ,000
Projected direct labor costs $6, $6,300
Difference $50 unfavorable

51. ABC and Flexible Budgets
Tina’s would budget costs for moving materials based on the budgeted cost per move and the actual number of moves made during the month.
Tina’s would compute the per-unit budget amounts for other batch-level and product-level costs and include those in the flexible budget along with the regular variable costs and fixed costs.

52. End of Chapter 9
The budgeting process is worth the effort.