Budgeting

Advantages of Budgeting Define goals and objectives Communicate plans Think about and plan for the future Advantages Coordinate activities Allocate resources Uncover potential bottlenecks

Budget Planning and Control Planning -- involves developing objectives and preparing various budgets to achieve these objectives. Control -- involves the steps taken by management that attempt to ensure the objectives are attained.

Choosing the Budget Period Operating Budget 2011 2012 2013 2014 The annual operating budget may be divided into quarterly or monthly budgets.

The Basic Framework of Budgeting Detail Budget Master Summary of a company’s plans. Sales Purchases SG&A

The Master Budget-Manufacturer Sales Budget Selling and Administrative Budget

The Master Budget-Manufacturer Sales Budget Ending Inventory Budget Selling and Administrative Budget Production Budget Direct Materials Budget Direct Labor Budget Manufacturing Overhead Budget

The Master Budget-Manufacturer Sales Budget Ending Inventory Budget Selling and Administrative Budget Production Budget Direct Materials Budget Direct Labor Budget Manufacturing Overhead Budget Cash Budget Budgeted Financial Statements

The Master Budget-Merchandiser Sales Budget Selling and Administrative Budget

The Master Budget-Merchandiser Sales Budget Ending Inventory Budget Selling and Administrative Budget Purchases Budget Direct Materials Budget Manufacturing Overhead Budget Direct Labor Budget

The Master Budget-Merchandiser Sales Budget Ending Inventory Budget Selling and Administrative Budget Purchases Budget Manufacturing Overhead Budget Direct Materials Budget Direct Labor Budget Cash Budget Budgeted Financial Statements

The Budgeted Income Statement Cash Budget Budgeted Income Statement Completed After we complete the cash budget, we can prepare the budgeted income statement.

And the Budgeted Balance Sheet and Cash Flow Statement

Pro forma Financial Statements Cash Receipts and Payments Schedules Operating Budgets Pro forma Financial Statements Start Cash receipts Income statement Sales budget Cash payments for inventory Inventory purchases budget Balance sheet Cash payments for S & A S & A expense budget Statement of cash flows Cash budget 14

The Sales Budget Detailed schedule showing expected sales for the coming periods expressed in units and dollars.

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 Sales Budget

Expected Cash Collections All sales are on account. Royal’s collection pattern is: 70% collected in the month of sale, 25% collected in the month following sale, 5% is uncollectible. The March 31 accounts receivable balance of $30,000 will be collected in 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

Budget and Expected Cash Collections The Production Budget Sales Budget and Expected Cash Collections Production Budget Completed Production must be adequate to meet budgeted sales and provide for sufficient ending inventory. 24

The Direct Materials Budget The Direct Labor Budget The Overhead Budget 25

Inventory Purchases Budget The total amount of inventory needed for each month is equal to the amount of the cost of budgeted sales plus the desired ending inventory. Now we can move on to the inventory purchases budget. The general format used to determine the amount of the purchases is to take the cost of budgeted sales, plus the desired ending inventory, minus the beginning inventory. This computation gives us the amount we need to purchase. 7-26

Inventory Purchases Budget HH’s policy is that ending inventory should be equal to 25% of next month’s projected cost of goods sold. At HH, cost of goods sold normally equal 70% of sales. Suppliers require HH to pay 60% of inventory purchases in the month goods are purchased and the remaining 40% in the month after the purchase. Let’s prepare the inventory purchases budget and the schedule of cash payments for inventory purchases. January’s cost of goods sold is budgeted at $140,000. To prevent a stock-out of inventory, management has decided that ending inventory should always be equal to 25% of next month’s projected cost of goods sold. Cost of goods sold normally equals 70% of sales. Based on past experience, management knows that suppliers require that 60% of the inventory purchases be paid for in the month of purchase and 40% be paid for in the month following the month of purchase. Given this additional information, let’s prepare two budgets. The first will be the inventory purchase budget and the second will be the cash payments schedule for inventory purchases. January’s cost of goods sold is budgeted at $140,000. 7-27

Sales Budget Exhibit 7.2 Sales Budget Sales revenue on the income statement will be the sum of the monthly sales ($582,400). Part I The only cash collected in October is from the cash sales. Part II The October sales on account will be collected in November, and the November sales on account will be collected in December. Part III The sales revenue on the pro forma income statement will be $582,400, the sum of the budgeted sales. Total cash collections for the quarter will be $409,600. 7-28

$145,600 × 60% = $87,360 $145,600 × 40% = $58,240 29 29

Selling and Administrative Expense Budget The details of the Selling and Administrative (S&A) Budget are shown on the next screen. It is important to note that sales commission (based on 2% of sales) is paid in the month following the sale, while supplies expense (based on 1% of sales) is paid in the month of the sale. The utility expense is paid in the month following the usage of the electricity, gas, and water. 30 30

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The Cash Budget The cash budget is divided into four sections: 9-32 The Cash Budget The cash budget is divided into four sections: Cash receipts listing all cash inflows excluding borrowing Cash disbursements listing all payments excluding repayments of principal and interest Cash excess or deficiency The financing section listing all borrowings, repayments and interest The preparation of the cash budget can be quite complex. We have to pay close attention to details from our other budgets if we are to be successful in preparing the cash budget. On your screen, we listed the four major sections of the cash budget. As we prepare the budget, you will clearly see these four sections. 32

Cash Budget HH plans to purchase, for cash, store fixtures with a cost of $130,000 in October. HH borrows or repays principal and interest on the last day of each month. Any money borrowed from the bank bears interest at an annual rate of 12% (1% per month). The management at HH wants to maintain a cash balance of at least $10,000 at the end of every month. Borrowings must be in $1000 increments. 33

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Pro Forma Income Statement 35

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End of Chapter 7 End of Chapter 15.