1. Master Budgeting

2. Learning Objectives
Define budget, and understand why organizations budget and the approach they use to create budgets
Prepare a sales budget, including a schedule of expected cash receipts
Prepare a production budget
Prepare a direct material purchases budget, including a schedule of expected cash payments
Prepare a cash budget
Prepare a budgeted income statement and a budgeted balance sheet

3. Budget and Related Terms Defined
A budget is a formal plan that shows how financial and other resources are to be obtained and used during an upcoming period of time (normally a year).
The collection of various budgets brought together to form an overall (comprehensive) plan is called the master budget.
The act of preparing a budget is called budgeting.
The use of budgets to control an organization’s activities is known as budgetary control.

4. Uses of Budget A budget serves several purposes:
It forces managers to think about and plan for the future
It is a means of coordinating the activities of an organization, and of aligning goals of various units with those of the organization
It is a means of communicating an organization's plans and strategies to the various responsibility center managers
It is a benchmark for evaluating the performance of responsibility centers and their managers
It is a source of motivating managers to achieve their responsibility centers' goals, and thus the goals of the whole organization

5. Participatory Budget System
Flow of Budget Data

6. The Budget Committee A standing committee responsible for
overall policy matters relating to the budget
coordinating the preparation of the budget

7. The Master Budget
A master (overall) budget includes three principal parts:
Operating budgets (showing planned operations for the coming period, e.g., year)
A capital expenditures budget (showing planned changes in property, plant and equipment)
A cash budget (showing the anticipated cash receipts and payments in that year) and other financial budgets (income statement, balance sheet, etc.)

8. The Master Budget Sales forecast Plant capacity Sales Budget
Selling and
Administrative
Budget

9. The Master Budget Long-range sales forecast Sales Budget Capital Exp.
Ending
Inventory
Budget
Selling and
Administrative
Budget
Production
Budget
Direct
Material Pur-
chases Budget
Direct
Labor
Budget
Manufacturing
Overhead
Budget

10. Budgeted Financial Statements
The Master Budget
Sales
Budget
Capital Exp.
Budget
Ending
Inventory
Budget
Selling and
Administrative
Budget
Production
Budget
Direct
Material Pur-
chases Budget
Direct
Labor
Budget
Manufacturing
Overhead
Budget
Cash
Budget
Budgeted Financial Statements

11. Preparing the Master Budget
As indicated in the previous slides:
Sales budget is prepared first because the other operating budgets and also financial budgets depend on the information provided by it
The remaining operating budgets and also the capital expenditures budget are prepared next
A cash budget is then prepared
The other financial budgets are prepared last

12. Sales Budget
A sales budget shows an estimate of the quantity and dollar amount of sales, either in total or by segment, e.g., territory.
Normally includes a schedule of expected cash receipts
Planning sales is most difficult, because sales depend on general market conditions and the actions of the customers.
Basically, there are two ways to estimate (forecast) sales:
Make a forecast on the basis of a statistical analysis of market conditions, general business conditions, and organization specific information (e.g., plant capacity and planned selling expenses).
Make a judgmental forecast by collecting the opinions of managers or marketing people.

13. Budgeting Example Royal Company is preparing budgets for next year.
Budgeted sales by quarters are:
Q units
Q units
Q units
Q units
The selling price is $2 per unit.
At the end of current year, net accounts receivable is $20.
Usually 80% of each quarter’s sale is collected in the same quarter and another 15% in the following quarter.
Let’s prepare the sales budget and the related schedule of expected cash receipts.

14. Sales Budget Q1 Q2 Q3 Q4 Year Sales (in units) 100 200 150 250 700
Sales (in dollars) ,400
Schedule of expected cash receipts:
Collection on sale of:
Q4 this year
Q1 next year
Q2 next year
Q3 next year
Q4 next year
Total $180 $350 $ $ $1,275
80% × $200 = 160
15% × $200 = 30

15. Production Budget
A production budget shows the number of units to be produced.
Production must be adequate to meet budgeted sales and provide sufficient ending inventory.
Royal desires ending inventory to be 25% of next quarter’s budgeted sales in units.
At the end of current year, 25 units are on hand.
Let’s prepare the production budget.

16. Production Budget Assumed Q1 Q2 Q3 Q4 Year
Budgeted sales Q
Desired percent %
Desired inventory
Current year
ending inventory
Assumed
Q1 Q2 Q3 Q4 Year
Budgeted sales
+ Desired EI
Total needs
- BI
Bud. Production

17. Manufacturing Budget
The manufacturing budget shows the expected manufacturing costs.
It is based on production budget and price information on materials, labor and overhead.
In many manufacturing companies, the manufacturing budget is actually prepared in three sub-budgets: materials, labor and overhead.

18. Direct Material Purchases Budget
DM purchases budget shows the quantity and the cost of materials to be purchased.
Purchases must be adequate to meet production needs and provide sufficient ending inventory of materials.
At Royal, management desires materials on hand at the end of each quarter equal to 20% of the next quarter’s production needs.
Two pounds of materials are required for each unit; materials costs $.10 per pound.
At the end of current year, 50 pounds of materials are on hand.
Let’s prepare the direct material purchases budget.

19. Direct Material Purchases Budget
From production
budget
20% of next quarter’s prod.
Current year ending inventory
Assumed
Q Q Q Q Year
Production
Production needs ,430.0
+ Desired EI
Total needs ,510.0
- BI
Bud. Purchases (lb) ,460.0
Bud. purchases ($)

20. Selling and Administrative Expense Budgets
The estimates of most selling expenses (e.g., salaries and commissions) are based on the sales budget. Some selling expenses (e.g., depreciation, rent, and utilities) are not a function of sales.
Most of the administrative expenses do not depend on sales; some (e.g., bad debt expense) do.

21. Capital Expenditures Budget
The capital expenditures budget is simply a list of new property, plant, and equipment that will be purchased and those that will be disposed of.
The decision to purchase capital assets is based primarily on long-range sales forecast, but also on planned production and other activities for the next year.

22. Cash Budget
Cash budget shows the anticipated cash receipts and payments over the budget period.
Cash budget is an important budget since it is used to manage cash.
The cash budget is prepared by analyzing operating, capital expenditures and other plans, and estimating the cash receipts and payments associated with those plans.

23. Cash Budget Cash, beginning
Schedule of expected
cash collections
cash disbursements
Capital expenditures
budget
Manufacturing
budgets
Selling & Admin
Cash, beginning
+ Expected cash receipts (Customers, Sale of assets, Issuance of bonds/stocks)
Total cash available
- Expected cash payments (Suppliers, Labor, Overhead, Selling and Admin, Purchase of assets, Retirement of bonds/stocks, Dividend)
Excess (deficiency of) cash
Financing:
+ Borrowing
- Repayment
- Interest
Cash, ending

24. Budgeted Income Statement and Balance Sheet
Budgeted income statement and balance sheet are prepared from the information provided by all other budgets.
Usually a worksheet is used since a large number of transactions and account balances must be accumulated, summarized, and classified to prepare an income statement and a balance sheet.
For simple cases, an inspection of other budgets would suffice.

25. International Aspects of Budgeting
Multinational companies face special problems when preparing a budget:
Fluctuations in foreign currency exchange rates
High inflation rates in some foreign countries
Differences in local economic conditions
Local governmental policies