5.01 Budget Planning & Control

Budget Planning Financial planning is one tool managers use to improve profitability. Planning the financial operations of the business is called budgeting. A written financial plan expressed in dollars is called a budget.

Budget Planning (continued) A budget is a view into the future – a financial estimate of future business activities. Identifying company goals is the first step in budget preparation. Company goals might be:  to increase sales  reduce cost of merchandise sold  increase net income

Budget Planning (continued) Two budgets commonly prepared in businesses are:  Budgeted income statement – projection of a business’s sales, costs, expenses and net income for a fiscal period. Often called an operating budget.  Cash budget – projection of a business’s cash receipts and payments for a fiscal period. Used to manage estimated cash shortages and overages.

Budget Functions A budget serves three important functions:  Planning – managers make projections, plan actions to meet goals  Operational control – management compares actual amounts to budgeted amounts to determine how well a business is performing  Department coordination – all management personnel must help plan and use budget as a guide to manage sales, costs, and expenses

Budget Period The length of time covered by a budget is usually one year. Annual budget is used to compare current financial performance with budget plans. Annual budget is normally prepared for a company’s fiscal year.

Sources of Budget Information Budgets are not exact since they show only projected sales, costs, and expenses. Companies use many sources to prepare budgets.  Company records – accounting and sales records from prior periods are used to determine trends  General economic information – changes in the national economy affect budget decisions  Company staff and managers – department managers project budget items for their areas of responsibility of the business  Good judgment – final budget decisions must be based on good judgment

Comparative Income Statement  Provides an analysis of previous years’ sales, cost, and expense amounts  Income statement containing sales, cost, and expense information for two or more years  Highlights items that may be increasing or decreasing at a higher rate than other items on the statement

Interpreting the Comparative Income Statement  First column shows actual sales, costs, and expenses for the current year  Second column shows actual amounts for the prior year  Third column shows the amount of increase or decrease from the prior year  Fourth column shows the percentage by which the current year amount increased or decreased from the prior year amount

Interpreting the Comparative Income Statement (continued) The percentage change indicates whether the change is:  Favorable  Unfavorable  Normal

Favorable Percentage increase in expenses or costs is less than percentage increase in sales Percentage decrease in expenses or costs is more than percentage decrease in sales

Unfavorable Percentage increase in expenses or costs is greater than percentage increase in sales Percentage decrease in expenses or costs is less than percentage decrease in sales

Normal Percentage increase in expenses or costs is equal to percentage increase in sales Percentage decrease in expenses or costs is equal to percentage decrease in sales

Budgeted Income Statement  Businesses set goals, develop operational plans, and project sales, expenses, and costs  Operational plans provide general guidelines for achieving the company’s goals.  Operational plan is converted into a more precise plan expressed in dollars by preparing a budgeted income statement.

Budgeted Income Statement (continued)  Separate schedules are prepared to assist management in evaluating operations and goals.  Sales budget schedule  Purchases budget schedule  Selling expenses budget schedule  Administrative expenses budget schedule  Other revenue and expenses budget schedule  Budgeted Income Statement shows a company’s projected sales, costs, expenses, and net income.

Sales Budget Schedule Prepared first because other budget schedules are affected by the projected net sales Projected net sales are used to estimate the amount of merchandise to purchase and the amount that may be spent for salaries, advertising, and other selling and administrative expenses.

Purchases Budget Schedule Shows the projected amount of purchases that will be required during a budget period Factors considered when planning a purchases budget:  Projected unit sales  Quantity of merchandise on hand at the beginning of the budget period  Quantity of merchandise needed to fill projected sales orders without having excessive inventory  Price trends of merchandise to be purchased

Selling Expenses Budget Schedule Shows projected expenditures directly related to selling operations Some selling expenses are relatively stable and require little budget planning. Example: Depreciation Expense Other selling expenses increase and decrease in relation to increases and decreases of sales. Most selling expenses are linked closely to net sales.

Administrative Expenses Budget Schedule Shows the projected expenses for all operating expenses not directly related to selling operations Most administrative expenses are known and remain the same each period. Sources used to prepare this budget schedule are:  Past records  Company plans  Sales and selling expenses budget schedules  Discussions with other managers

Other Revenue and Expenses Budget Schedule Show projections for revenue and expenses from activities other than normal operations. Typical items in this budget schedule are:  Interest income  Interest expense  Gains or losses on sale of plant assets

Budgeted Income Statement Shows a company’s projected sales, costs, expenses, and net income Prepared from the details of the five budget schedules Allows for budgeting of federal income tax

Cash Budgets  Good cash management requires planning and controlling cash so that it will be available to meet obligations when they come due.  Cash budgets help analyze cash inflows and outflows.

Cash Budgets (continued)  Cash receipts budget schedule reports projected cash receipts for a budget period.  Projections are made from the following: Cash sales Collections on account from customers Cash to be received from other sources

Cash Budgets (continued) Cash payments budget schedule reports projected cash payments for a budget period. Projections are made from the following: Cash payments for accounts payable or notes payable to vendors Cash payments for each expense item (requires an analysis of the selling expenses, administrative expenses, and other revenue and expenses budget schedules) Cash payment for buying equipment and other assets Cash payments for dividends Cash payments for investments

Cash Budgets & Performance Reports  Analysis of actual cash balance is used to determine how actual cash compares to projected cash  If actual cash is less than projected cash, management must determine the reason and take action to correct. Decrease could be caused by customers not paying Decrease could be caused by expenses exceeding budget projections If decrease continues, business may have to borrow money until receipts and expenses are brought into balance.

Performance Reports  Compares actual amounts with the budgeted income statement  Shows variations between actual and projected items  Management reviews performance reports to identify areas that need to be reviewed.

Performance Reports (continued)  First column shows amounts projected.  Second column shows actual sales, costs, and expenses.  Third column shows the difference between actual and projected.  Fourth column shows the percentage of the amount increased or decreased from the projected amount

Performance Reports (continued)  Management should determine what causes unfavorable results and how to correct those situations.  Management should also determine what causes favorable results and encourage continuation of those actions.