Budgeting and Financial Planning

Chapter 15

Why budgets?Planning

Controlling

Coordination

Allocation of resources

Evaluation

Master budgetSeries of individual budgets and

schedules representing the plan for the organization

Begins with sales forecast

Ends with pro forma financial statements

Sales budgetRevenue and “unit” forecast

Based on various pieces of infoPast sales, trends, pricing policy,

competitors’ actions, etc.

Q1 Q2 Q3 Q4 TotalUnits 20,000 30,000 18,000 14,000 82,000 Selling price 20$ 20$ 20$ 20$ 20$ Revenue 400,000$ 600,000$ 360,000$ 280,000$ 1,640,000$

Operational budgetsFor various operational areas

Tailored to the type of organizationRevenue-producing resource needs

Production or acquisition

Selling and administrative

Cash receipts and disbursements

Capital budget

Production budgetBased on sales forecast, desired

inventory levelsSales + end. invty. – beg. Invty.

Q1 Q2 Q3 Q4 TotalSales 20,000 30,000 18,000 14,000 82,000 Ending inventoy 1,500 900 700 1,100 1,100 Needed 21,500 30,900 18,700 15,100 83,100 Beginning inventory 1,000 1,500 900 700 1,000 Production 20,500 29,400 17,800 14,400 82,100

Ending Inventory 5% of next month's salesAssumed

Materials budgetBased on production needs,

desired material inventory levelsQ1 Q2 Q3 Q4 Total

Production 20,500 29,400 17,800 14,400 82,100 Pieces per finished unit 3 3 3 3 3 Production needs 61,500 88,200 53,400 43,200 246,300 Ending inventory 4,410 2,670 2,160 3,383 3,383 Needed 65,910 90,870 55,560 46,583 249,683 Beginning inventory 3,075 4,410 2,670 2,160 3,075 Purchases 62,835 86,460 52,890 44,423 246,608

Cost per piece 4.00$ 4.00$ 4.00$ 4.00$ 4.00$ Cost of purchases 251,340$ 345,840$ 211,560$ 177,690$ 986,430$

Inventory is 5% of next month's production needsAssumed

Labor budgetBased on production needs

Q1 Q2 Q3 Q4 TotalProduction 20,500 29,400 17,800 14,400 82,100 Hours per unit 0.10 0.10 0.10 0.10 0.10 Hours required 2,050 2,940 1,780 1,440 8,210

Cost per hour 12.00$ 12.00$ 12.00$ 12.00$ 12.00$ Labor cost 24,600$ 35,280$ 21,360$ 17,280$ 98,520$

Assumes labor is a unit-level cost

Overhead budgetBased on production needs

Not all costs will be proportional to units producedBatch-levelProduct-levelFacility-level

Q1 Q2 Q3 Q4 TotalUnit-levelUnits 20,500 29,400 17,800 14,400 82,100 Indirect materials ($.50 per unit) 10,250$ 14,700$ 8,900$ 7,200$ 41,050$ Utilities ($.12 per unit) 2,460 3,528 2,136 1,728 9,852 Total unit-level costs 12,710 18,228 11,036 8,928 50,902

Batch-levelBatches 21 30 18 15 84 Set-up ($200 per batch) 4,200$ 6,000$ 3,600$ 3,000$ 16,800$ Material handling ($50 per batch) 1,050 1,500 900 750 4,200 Total batch-level costs 5,250 7,500 4,500 3,750 21,000

Product-levelEngineering change orders 7 4 2 1 14 Engineering ($1,200 per ECO) 8,400$ 4,800$ 2,400$ 1,200$ 16,800$ Total product-level costs 8,400$ 4,800$ 2,400$ 1,200$ 16,800$

Facility-level Administrative salaries 40,000$ 40,000$ 40,000$ 40,000$ 160,000$ Insurance 5,000 - 5,000 - 10,000 Depreciation 15,000 15,000 15,000 15,000 60,000 Total facility-level costs 60,000$ 55,000$ 60,000$ 55,000$ 230,000$

Total overhead 86,360$ 85,528$ 77,936$ 68,878$ 318,702$ Less depreciation 15,000 15,000 15,000 15,000 60,000 Cash overhead costs 71,360$ 70,528$ 62,936$ 53,878$ 258,702$

SG&A budgetMay be unit-, batch-, product-,

customer- or facility-level

Selling expenses based on units sold

Not units produced

Q1 Q2 Q3 Q4 TotalUnit-level Unit sales 20,000 30,000 18,000 14,000 82,000 Sales commissions ($.60 per unit) 12,000$ 18,000$ 10,800$ 8,400$ 49,200$ Total unit-level expenses 12,000$ 18,000$ 10,800$ 8,400$ 49,200$

Batch-levelBatches shipped 40 60 36 28 164 Freight-out ($45 per batch) 1,800$ 2,700$ 1,620$ 1,260$ 7,380$ Insurance ($5 per batch) 200 300 180 140 820 Total batch-level expenses 2,000$ 3,000$ 1,800$ 1,400$ 8,200$

Customer-levelNumber of new customers 17 21 14 9 61 Account set-up ($250 per new customer) 4,250$ 5,250$ 3,500$ 2,250$ 15,250$ Product support ($300 per new customer) 5,100 6,300 4,200 2,700 18,300 Total customer-level expenses 9,350$ 11,550$ 7,700$ 4,950$ 33,550$

Facility-level Sales salaries 20,000$ 20,000$ 20,000$ 20,000$ 80,000$ Administrative salaries 35,000 35,000 35,000 35,000 140,000$ Advertising 4,000 4,000 4,000 4,000 16,000$ Bad debt expense 8,000 12,000 7,200 5,600 32,800$ Depreciation 7,000 7,000 7,000 7,000 28,000$ Insurance 500 500 500 500 2,000$ Total facility-level expenses 74,500$ 78,500$ 73,700$ 72,100$ 298,800$

Total SG&A expenses 97,850$ 111,050$ 94,000$ 86,850$ 389,750$ Less depreciation 7,000 7,000 7,000 7,000 28,000 Less bad debt expense 8,000 12,000 7,200 5,600 32,800 Cash SG&A expenses 82,850$ 92,050$ 79,800$ 74,250$ 328,950$

Cash budgetAll cash inflows and outflows

Possible timing differences between revenues and expenses and the resulting cash flowsCredit sales

Schedule of cash receipts

Credit purchasesSchedule of cash disbursements

Q1 Q2 Q3 Q4 TotalMaterial purchases 251,340$ 345,840$ 211,560$ 177,690$ 986,430$

80% paid in month of purchase 201,072$ 276,672$ 169,248$ 142,152$ 789,144$

20% paid in month following purchase 27,852 50,268 69,168 42,312 189,600$ Total disbursed 228,924$ 326,940$ 238,416$ 184,464$ 978,744$

Assumed

Schedule of cash disbursements for materials

Q1 Q2 Q3 Q4 TotalSales revenue 400,000$ 600,000$ 360,000$ 280,000$ 1,640,000$

60% collected in quarter of sale 240,000$ 360,000$ 216,000$ 168,000$ 984,000$

38% collected in quarter after sale 78,420 152,000 228,000 136,800 595,220

2% uncollectible - - - - - Total collected 318,420$ 512,000$ 444,000$ 304,800$ 1,579,220$

Assumed

Schedule of cash collections

Q1 Q2 Q3 Q4 TotalMaterials 228,924$ 326,940$ 238,416$ 184,464$ 978,744$ Production labor 24,600 35,280 21,360 17,280 98,520 Indirect materials 10,250 14,700 8,900 7,200 41,050 Utilities 2,460 3,528 2,136 1,728 9,852 Set-up 4,200 6,000 3,600 3,000 16,800 Material handling 1,050 1,500 900 750 4,200 Engineering 8,400 4,800 2,400 1,200 16,800 Factory admin salaries 40,000 40,000 40,000 40,000 160,000 Factory insurance 5,000 - 5,000 - 10,000 Sales commissions 12,000 18,000 10,800 8,400 49,200 Freight-out 1,800 2,700 1,620 1,260 7,380 Insurance on shipments 200 300 180 140 820 Account set-up 4,250 5,250 3,500 2,250 15,250 Product support 5,100 6,300 4,200 2,700 18,300 Sales salaries 20,000 20,000 20,000 20,000 20,000 General admin salaries 35,000 35,000 35,000 35,000 35,000 Advertising 4,000 4,000 4,000 4,000 4,000 Insurance 500 500 500 500 500 Total cash disbursements for operations 407,734$ 524,798$ 402,512$ 329,872$ 1,486,416$

Schedule of cash disbursements for operations

Q1 Q2 Q3 Q4 TotalCash collections 318,420$ 512,000$ 444,000$ 304,800$ 1,579,220$ Cash disbursements 407,734 524,798 402,512 329,872 1,664,916 Change in cash from operations (89,314)$ (12,798)$ 41,488$ (25,072)$ (85,696)$ Proceeds from sale of equipment 7,500 7,500 Proceeds from bank loan 125,000 125,000 Proceeds from stock 200,000 200,000 Purchase of equipment (40,000) (52,000) (92,000) Payment of dividends (2,500) (2,500) (2,500) (2,500) (10,000) Repayment of bank loan (125,000) (125,000) Payment of interest on bank loan (1,875) (1,875) (1,875) (1,875) (7,500) Change in cash during the period 31,311$ (49,673)$ 37,113$ (6,447)$ 12,304$ Beginning cash balance 20,000 51,311 1,638 38,751 20,000 Ending cash balance 51,311$ 1,638$ 38,751$ 32,304$ 32,304$

Budgeted cost of goods manufactured

Determines the absorption cost per unit manufactured

Unit costTotal cost (82,100 units)

Direct material 3 pieces @ $4.00 per piece) 12.00$

Direct labor (0.10 hours @ $12.00 per hour) 1.20 Unit-level overhead 50,902$ 0.62 Batch-level overhead 21,000 0.26 Product-level overhead 16,800 0.20 Facility level overhead 230,000 2.80 Total cost per unit 17.08$

Pro forma financial statements

Income statement

Revenue from sales budget

Cost of goods sold from unit cost calculation

SG&A expenses from SG&A budget

Other expenses from cash budget

Interest expense

Income tax expense

Sales revenue 1,640,000$

Cost of goods sold (82,000 units @ $17.08) 1,400,560 Gross profit 239,440$ SG&A expenses 389,750 Income from operations (150,310)$ Interest expense 7,500 Income before taxes (157,810)$ Income tax expense - Net income (loss) (157,810)$

Pro forma income statement

Pro forma financial statements

Balance sheetSome items direct from budgets

Cash

Accounts receivable

Materials inventory

Finished goods inventory

Accounts payable

Some are “rolled forward” from previous year balances

Pro forma financial statements

Statement of retained earnings

Previous year balance

Add pro forma income

Subtract dividends (cash budget)

Cash flow statement

Direct from cash budget

Budget considerations

Different budgets for different usesPlanning

Master budgetStatic budget

ControllingFlexible budget

Includes different levels of activity as benchmarks

EvaluatingFlexible budget

Budget at actual level achieved

Budget considerations

Behavioral and ethical issues

Based on estimates

May be intentionally misstated to make actual results look better than planned

Misallocation of resources

Breakdown of coordination

Participative or imposed?

Who knows best?