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Chapter Seven
Planning for Profit andCost Control
Three Levels of Planning
1.1. Strategic planningStrategic planning involves making long-term involves making long-term decisions such as defining the scope of the decisions such as defining the scope of the business, determining which products to business, determining which products to develop or discounting, and identifying the develop or discounting, and identifying the most profitable markets.most profitable markets.
2.2. Capital budgetingCapital budgeting focuses on intermediate focuses on intermediate range planning and involves decisions as range planning and involves decisions as whether to buy or lease equipment, whether to whether to buy or lease equipment, whether to stimulate sales, or whether to increase stimulate sales, or whether to increase company assets.company assets.
3.3. Master budgetMaster budget describes short-term objectives describes short-term objectives in specific sales targets, production goals, and in specific sales targets, production goals, and financing plans.financing plans.
1.1. Strategic planningStrategic planning involves making long-term involves making long-term decisions such as defining the scope of the decisions such as defining the scope of the business, determining which products to business, determining which products to develop or discounting, and identifying the develop or discounting, and identifying the most profitable markets.most profitable markets.
2.2. Capital budgetingCapital budgeting focuses on intermediate focuses on intermediate range planning and involves decisions as range planning and involves decisions as whether to buy or lease equipment, whether to whether to buy or lease equipment, whether to stimulate sales, or whether to increase stimulate sales, or whether to increase company assets.company assets.
3.3. Master budgetMaster budget describes short-term objectives describes short-term objectives in specific sales targets, production goals, and in specific sales targets, production goals, and financing plans.financing plans.
Advantages of Budgeting
BudgetingBudgetingBudgetingBudgeting
PromotesPromotesPlanningPlanningPromotesPromotesPlanningPlanning
PromotesPromotesCoordinationCoordination
PromotesPromotesCoordinationCoordination
EnhancesEnhancesPerformance Performance MeasuremenMeasuremen
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EnhancesEnhancesPerformance Performance MeasuremenMeasuremen
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EnhancesEnhancesCorrective Corrective
ActionsActions
EnhancesEnhancesCorrective Corrective
ActionsActions
Budgeting and Human Behavior
Upper management must be sensitive to the impact of the budgeting process on employees.
Budgets are Budgets are constraining. constraining.
They limit They limit individual individual
freedom in favor freedom in favor of an established of an established
plan.plan.
Budgets are Budgets are constraining. constraining.
They limit They limit individual individual
freedom in favor freedom in favor of an established of an established
plan.plan.
Many people find Many people find evaluation based evaluation based
on budget on budget expectations expectations
stressful. Think of stressful. Think of students and students and
exams.exams.
Many people find Many people find evaluation based evaluation based
on budget on budget expectations expectations
stressful. Think of stressful. Think of students and students and
exams.exams.Upper management must demonstrate Upper management must demonstrate
that budgets are sincere efforts to that budgets are sincere efforts to express realistic goals employees are express realistic goals employees are
expected to meet.expected to meet.
Upper management must demonstrate Upper management must demonstrate that budgets are sincere efforts to that budgets are sincere efforts to
express realistic goals employees are express realistic goals employees are expected to meet.expected to meet.
Cashpaymentsfor S & A
Cashpayments
for inventory
Inventorypurchases
budget
IncomeStatement
S & Aexpensebudget
BalanceSheet
Cashreceipts
Salesbudget
Cashbudget
Statement ofCash Flows
Cash Receiptsand Payments
Schedules
OperatingBudgets
Pro formaFinancial
StatementsStartStart
Sales Budget
Detailed schedule prepared by the marketing department showing expected
sales for the coming periods and expected collections on those sales. It is critical to
the success of the entire budgeting process.
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.
Selling and Administrative Expense Budget
The details of the Selling and Administrative (S&A) Budget are shown on the next two screens. It is important to note that sales
commissions (based on 2% of sales) are paid in the month following the sale, while supplies
expense, based on 1% of sales) are paid in the month of the sale. The utility expense is paid in the month following the usage of the
electricity, gas, and water.
The details of the Selling and Administrative (S&A) Budget are shown on the next two screens. It is important to note that sales
commissions (based on 2% of sales) are paid in the month following the sale, while supplies
expense, based on 1% of sales) are paid in the month of the sale. The utility expense is paid in the month following the usage of the
electricity, gas, and water.
Check Yourself
Astor Company expects to incur the following Astor Company expects to incur the following operating expenses during September: Salary operating expenses during September: Salary Expense, $25,000; Utility Expense, $1,200; Expense, $25,000; Utility Expense, $1,200; Depreciation Expense, $5,400; and Selling Expense, Depreciation Expense, $5,400; and Selling Expense, $14,000. It pays operating expenses in cash in the $14,000. It pays operating expenses in cash in the month in which it incurs them. Based on this month in which it incurs them. Based on this information, the total amount of cash outflow information, the total amount of cash outflow reported in the Operating Activities section of the pro reported in the Operating Activities section of the pro format Statement of Cash Flows would be:format Statement of Cash Flows would be:
a.a. $45,600.$45,600.
b.b. $31,600.$31,600.
c.c. $40,200.$40,200.
d.d. $44,400$44,400
Depreciation Expense is a non-cashDepreciation Expense is a non-cashcharge to income and will not appearcharge to income and will not appear
on the Statement of Cash Flows.on the Statement of Cash Flows.
Depreciation Expense is a non-cashDepreciation Expense is a non-cashcharge to income and will not appearcharge to income and will not appear
on the Statement of Cash Flows.on the Statement of Cash Flows.
Pro Forma Income Statement
The pro forma income statement gives management an estimate of the expected
profitability of HH. If the project appears to be unprofitable, management can make the
decision to abandon it. Although managers remain responsible for data analysis and
decision making, computer technology offers powerful tools to asset in those tasks.
Pro Forma Statement of Cash Flows
Almost all the information for the Pro Forma Statement of Cash Flows can be
found on the Cash Budget.
End of Chapter Seven