Budgeting and Financial Planning - CPA Diary · PDF file15.05.2013 · 15-59...

Copyright © 2008 The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

15Budgeting and

Financial Planning


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Learning Objective 1


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Strategic Planning

Critical success factors Critical success factors - Strengths of the company that enable it to outperform

competitors.

StrategicStrategicPlanPlan

CriticalSuccessFactors

Incorporated IntoIncorporated Into


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Strategic Long-Range Plan

The master budget is part of an overall The master budget is part of an overall organizational plan made up of three organizational plan made up of three

components . . .components . . . Organizational goals Organizational goals –– management’s broad management’s broad

objectives that employees work to achieve.objectives that employees work to achieve. The strategic longThe strategic long--range profit plan range profit plan –– steps to steps to

be taken to achieve organizational goals.be taken to achieve organizational goals. The master budget The master budget –– tactical shorttactical short--range profit range profit

plan.plan.


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Key Purposes of the Budgeting System

The five primary purposes are:The five primary purposes are:1.1. Planning. Planning. 2.2. Facilitating Communication and Coordination.Facilitating Communication and Coordination.3.3. Allocating Resources.Allocating Resources.4.4. Managing Financial and Operational Managing Financial and Operational

Performance.Performance.5.5. Evaluating Performance and Providing Evaluating Performance and Providing

Incentives.Incentives.


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Organizations Use Many Types of Budgets

Organizationgoals

Individual goalsand values

Long-rangestrategic plan

Anticipatedconditions

MasterMasterbudgetbudget

Actual periodresults

Individualbeliefs

Performanceevaluation

Strategicevaluation

OrganizationOrganization IndividualIndividual


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The Master Budget as a Planning Tool

After organization goals, strategies and long-range plans have been developed, work

begins on the master budget. The master budget is a detailed budget for the

coming fiscal year.

2008


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Sales Budget: The Starting Point

Sales Staff Sales Staff – close to customer needs. Market Research Market Research – can predict long-term

trends in attitudes and the effects of social and economic changes on the company’s sales, potential markets and products.

Sales ForecastingSales Forecasting – the process of predicting sales of services or goods.

Let’s look at some forecasting tools.Let’s look at some forecasting tools.


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Forecasting Tools Delphi technique Delphi technique – the elicitation of forecasts

from individual group members, for anonymous evaluation by the group as a whole, in a search for convergence.

Econometric modeling Econometric modeling – the use of various economic indicators and market factors to predict future sales, by means of regression analysis.


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Operational Budgets Manufacturing firms Manufacturing firms – A production budget is

developed from budgets for direct materials, direct labor and overhead. A budget for selling, general and administrative (SG&A) expenses is also prepared.

Merchandising firms Merchandising firms – Instead of a production budget, a budget of merchandise purchased is developed. The SG&A budget is also prepared.

ServiceService--industry firmsindustry firms – Based on the sales budget for its services, a set of budgets is developed for the resources to be used in providing the services.


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Operational Budgets

Every business prepares a . . . 1.1. Cash budgetCash budget2.2. Capital expenditures budget, and aCapital expenditures budget, and a3.3. Summary of operational budgetsSummary of operational budgets


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International Aspects of BudgetingFirms with international operations face a variety of Firms with international operations face a variety of additional challenges in preparing their budgets . . .additional challenges in preparing their budgets . . .

1.1. Translation of foreign currencies into local Translation of foreign currencies into local currency.currency.

2.2. Budget preparation is difficult when inflation (or Budget preparation is difficult when inflation (or deflation) is high or unpredictable.deflation) is high or unpredictable.

3.3. The economies of all countries fluctuate in The economies of all countries fluctuate in terms of consumer demand, availability of terms of consumer demand, availability of skilled labor, and laws affecting commerce.skilled labor, and laws affecting commerce.


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Activity-Based BudgetingActivity-based budgeting (ABB) is the process of

developing a master budget using information obtained from an activity-based costing (ABC) analysis

ResourcesResources

ActivitiesActivities

Forecast of products andForecast of products andservices to be produced,services to be produced,and customers served.and customers served.


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Illustrating the Master BudgetSchedule Title of Schedule

1 Sales Budget2 Production Budget3 Direct-Materials Budget4 Direct-Labor Budget5 Manufacturing Overhead Budget6 Selling, General, and Administrative Expense Budget (SG&A)7 Cash Receipts Budget8 Cash Disbursements Budget9 Cash Budget

10 Budgeted Schedule of Cost of Goods Manufactured and Sold11 Budgeted Income Statement12 Budgeted Balance Sheet


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The Sales Budget

Detailed schedule showing expected sales for the coming periods

expressed in units and dollars.


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Sales Budget of Collegiate Apparel

Collegiate Apparel Company is preparing budgets for Collegiate Apparel Company is preparing budgets for the year ending December 31, 20x1.the year ending December 31, 20x1.

Budgeted sales are:Budgeted sales are:First quarter First quarter –– 15,000 units15,000 unitsSecond quarter Second quarter –– 5,000 units5,000 unitsThird quarterThird quarter –– 10,000 units10,000 unitsFourth quarter Fourth quarter –– 20,000 units20,000 units

The selling price is $12 per unit.The selling price is $12 per unit.


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Sales Budget of Collegiate Apparel


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Production Budget

Sales Sales BudgetBudget

ProductionProductionBudgetBudget

Plan of resources needed to meet currentPlan of resources needed to meet currentsales demand and ensure inventory levelssales demand and ensure inventory levels

are sufficient for future sales.are sufficient for future sales.


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Forecasting Production

Rearrange the basic inventory formula as follows . . .

Units inbeginninginventory

Requiredproduction

in units

Salesin

Units

Units in ending

inventory++ –– ==

Now, solve for required production . . .

Unitsto be

Produced==

Salesin

Units++

Units in ending

inventory––

Expectedbeginninginventory


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The Production Budget

Collegiate Apparel wants units in ending finished goods inventory to be 10% of the next quarter’s expected sales in units.

At the beginning of the year, 1,500 completed units were on hand.

During the first quarter of 20x2, 15,000 units are expected to be sold.

Let’s prepare the production budget.Let’s prepare the production budget.


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The Production Budget

5,000 5,000 ×× 10% = 500 units10% = 500 units


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Direct-Materials Budget

Direct materials needed for the budget period Direct materials needed for the budget period can be determined as follows . . .can be determined as follows . . .

RequiredRequiredmaterialsmaterials

purchasespurchases==

MaterialsMaterialsused inused in

productionproduction++

EndingEndingmaterialsmaterialsinventoryinventory

––BeginningBeginningmaterialsmaterialsinventoryinventory


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At Collegiate Apparel 1.5 yards of fabric are required At Collegiate Apparel 1.5 yards of fabric are required per unit of product.per unit of product.

Management wants fabric on hand at the end of each Management wants fabric on hand at the end of each quarter to be 10% of next quarter’s raw materials quarter to be 10% of next quarter’s raw materials required. On January 1required. On January 1stst, 2,100 yards of fabric are on, 2,100 yards of fabric are on--hand. During the first quarter of 20x2, Collegiate hand. During the first quarter of 20x2, Collegiate expects 21,000 yards of fabric to be required.expects 21,000 yards of fabric to be required.

Each yard of fabric cost the company $2.Each yard of fabric cost the company $2.

Let’s prepare the direct materials budget.Let’s prepare the direct materials budget.


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8,250 8,250 ×× 10% = 825 units10% = 825 units


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Direct-Labor Budget

At Collegiate Apparel, each unit produced requires 0.20 hour (12 minutes) of direct labor.

Workers earn a wage rate of $10 per hour regardless of the hours worked. Collegiate Apparel can hire workers as needed to meet production.

Let’s prepare the direct labor budget.Let’s prepare the direct labor budget.


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Direct-Labor Budget


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Manufacturing-Overhead BudgetCollegiate Apparel uses activityCollegiate Apparel uses activity--based budgeting. based budgeting. At the unitAt the unit--level, each unit produced requires $0.25 of indirect level, each unit produced requires $0.25 of indirect

materials and $0.15 of electricity.materials and $0.15 of electricity. At the batchAt the batch--level, the company expects the following level, the company expects the following

production runs:production runs: 11stst quarter quarter –– 2828 22ndnd quarter quarter –– 1111 33rdrd quarter quarter –– 2222 44thth quarter quarter –– 3939

At the productAt the product--level, the company expects two new style level, the company expects two new style designs each quarter with each new Tdesigns each quarter with each new T--shirt design costing shirt design costing $500.$500.

Details of the facilitiesDetails of the facilities--level overhead costs are shown on the level overhead costs are shown on the manufacturingmanufacturing--overhead budget.overhead budget.


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Manufacturing-Overhead BudgetUnitUnit--, Batch, Batch--, and Product, and Product--level Portions of the Budgetlevel Portions of the Budget


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Manufacturing-Overhead BudgetProductProduct--, Facilities, Facilities--level and Total Overhead Budgetlevel and Total Overhead Budget

$5,600 + $8,400 + $1,000 + $36,500 = $51,500 $5,600 + $8,400 + $1,000 + $36,500 = $51,500


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SG&A Expense Budget At Collegiate Apparel, sales commissions

and freight-out are unit-level SG&A. Customer-level SG&A expenses include

licensing fees for use of names and logos. Facilities-level SG&A expense include

sales salaries, advertising and clerical wages.

Let’s prepare the SG&A expense budget.


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SG&A Expense Budget

$ $ $ $


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Cash Receipts Budget At Collegiate Apparel all sales are made on

account. The company collects 80% of its billings in the

quarter of the sale and 18% in the following quarter. The remaining two percent of each quarter’s sales are expected to be uncollectible.

Sales in the last quarter of 20x0 were $240,000.

Let’s prepare the Cash Receipts Budget.


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Cash Receipts Budget

$240,000 $240,000 ×× 18% = $43,20018% = $43,200

$180,000 $180,000 ×× 2% = $3,6002% = $3,600

$180,000 $180,000 ×× 18% = $32,40018% = $32,400


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Cash Payments for Direct-Materials At Collegiate Apparel all purchases of raw

materials are made on account. The company pays for 60% of its purchases in

the quarter of the purchase and the remaining 40% in the following quarter.

Purchases in the last quarter of 20x0 were $56,850.

Let’s prepare the Cash Disbursements Budget.


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Cash Payments for Direct-Materials

$18,150 $18,150 ×× 60% = $10,89060% = $10,890$39,450 $39,450 ×× 40% = $15,78040% = $15,780


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Other Cash Disbursements


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Cash Budget Collegiate Apparel started the year with a cash

balance of $10,000, and borrows $100,000 at the beginning of 20x1 to finance plant expansion.

The loan is repaid in the amount of $25,000 at the end of each quarter with interest on the unpaid balance at 10%.

Payments for the plant additions were: 1st quarter = $45,000 2nd quarter = $15,000 3rd quarter = $5,000 4th quarter = $35,000

Let’s prepare the Cash Budget.


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Cash Budget

$100,000 $100,000 ×× 10% 10% ×× ¼ = $2,500¼ = $2,500


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Calculation of Absorption Unit Cost


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Cost of Goods Manufactured and Sold Budget

At Collegiate Apparel the production cycle is short enough that it has no work-in-process inventory at any time.

From Schedule 3 in the text, we know there are 2,100 yards of fabric at $2.00 per yard in beginning raw material inventory.

And from Schedule 2 we know there are 1,500 units in ending finished goods inventory. We just computed the absorption cost per unit at $9.00.

Let’s prepare the Cost of Goods Manufactured and Sold Budget.


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Cost of Goods Manufactured and Sold Budget

1,5001,500×× $9$9

$13,500$13,500

2,1002,100×× $2$2

$4,200$4,200


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Budgeted Income Statement


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Budgeted Balance Sheet The balance in the building account on December 31,

20x0 was $400,000, and the balance in the equipment account was $320,000. Total accumulated depreciation was $240,000. Depreciation expense is recorded at the rate of $60,000 per year.

At December 31, 20x1, the company had a long-term, noninterest-bearing note payable of $200,000. The note is due on December 31, 20x3.

The balance in the owners’ equity account at December 31, 20x0, was $330,160.

Supplies on hand at December 31, 20x1 were $2,000.

Let’s prepare the Budgeted Balance Sheet.


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$330,16056,750

$386,910

$240,000$240,000×× 18%18%$43,200$43,200

$56,850$56,850×× 40%40%$22,740$22,740


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How It All Fits Together

Sales forecastProductionbudget

SG&Abudget


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SG&Abudget

Required directmaterials, labor

and mfg. overheadbudgets

Budgetedincome

statement


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SG&Abudget



Budgeted costof goods mfg.

and sold

Budgetedincome

statement


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SG&Abudget



Budgeted costof goods mfg.

and sold

Budgetedincome

statement

Cash budget

Budgeted balancesheet


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Responsibility for Budget Administration

Budget CommitteeBudget Committee – Consists of key senior executives who may advise the budget director

during the preparation of the budget. The authority to give final approval to the budget

usually rests with the board of directors.


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Budgetary Slack: Padding the BudgetPadding the budgetPadding the budget means intentionally means intentionally underestimating revenues or overestimating underestimating revenues or overestimating costs.costs.

The difference between the revenue or cost The difference between the revenue or cost projection that a person provides and a projection that a person provides and a realistic estimate of the revenue or cost is realistic estimate of the revenue or cost is called called budgetary slackbudgetary slack..

A solution: reward managers for making A solution: reward managers for making accurate estimates.accurate estimates.


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Participative Budgeting

Participative Budgeting Participative Budgeting – the use of input from lower- and middle-management employees. The process is time consuming but enhances

employee motivation and acceptance of goals.


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Ethical Problems in BudgetingMuch of the information for the budget is provided by persons whose performance is then compared with the budget they help

develop.I think sales

will increase by10% next year.

Let’s prepare thesales forecast with a4% increase, so we

will really look good!


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Zero-Based Budgeting for Discretionary CostsA system of establishing financial plans beginning with an assumption of no activity and justifying each program or activity level.

After some initial success, zero-based budgeting was found to be impractical.

Massive amounts of time Massive amounts of time were required to implement and update the budget.


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Contemporary Trends in Budgeting and Financial Planning

The emerging concept of financial planning is gradually replacing a budgeting process in which remote sales projections drive decisions and push costs onto inventory.

The process is more customer-driven, not by large-scale sales statistics but by specific orders. The budgeting process is adapting to this sales model.

In cost management, costs “don’t just happen” but are actively managed with techniques such as activity-based management. Activities are reviewed for the value they add to products and services.


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Beyond Budgeting

A break from the budgeting process already shown, based on the growing need to satisfy customers and relying on a company’s intellectual assets.

This approach emphasizes: rolling forecasts and optimization of resources no evaluation on meeting specific targets decentralized decision making and teams a climate based on sustained competitive success transparent and open information systems


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Inventory Management –Economic Order Quantity

“How much inventory to keep on hand?” Inventory decisions involve a delicate balance

between these classes of cost: ordering costs holding costs shortage costs

EOQ is a mathematical tool to determine the order quantity that minimizes the ordering and holding costs:

√


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Inventory Management under JIT

Under JIT, there would be no inventories at all! Inventory cost would be wasteful.

In fact, as inventory holding costs are reduced, so is EOQ.

So, order as needed. There is no ideal order quantity.


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End of Chapter 15

Budgeting and Financial Planning - CPA Diary · PDF file15.05.2013 · 15-59...

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