Hilton • Maher • Selto

15Budgeting & Financial

Planning

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.

15-3

Every enterprise has a set of goalsEvery enterprise has a set of goals

ProfitabilityProfitability

GrowthGrowth

PublicService

PublicService

StrategicPlanning

StrategicPlanning

Achieving and Maintaining

a Competitive Advantage

Achieving and Maintaining

a Competitive Advantage

CRITICAL SUCCESS FACTORS

The key strengths that are most responsible

for making the organization successful

CRITICAL SUCCESS FACTORS

The key strengths that are most responsible

for making the organization successful

Strategic Planning

15-4

•Express the specific steps required to achieve the organization’s goals.

•Discuss the major capital investments required to:

•Express the specific steps required to achieve the organization’s goals.

•Discuss the major capital investments required to:

MaintainPresent

Facilities

MaintainPresent

Facilities

IncreaseCapacityIncreaseCapacity

DiversifyProducts orProcesses

DiversifyProducts orProcesses

DevelopParticularMarkets

DevelopParticularMarkets

Strategic Long-Range Plans

15-5

A detailed plan, expressed in quantitative term, that specifies how an organization will acquire and use

resources during a particular period of time.

A detailed plan, expressed in quantitative term, that specifies how an organization will acquire and use

resources during a particular period of time.

What is a budget?What is a budget?

What is a budgeting system?What is a budgeting system?

The procedures used to develop a budgetThe procedures used to develop a budget

What Are The Key Purposes Of Budgeting Systems?

15-6

Managing Financial & Operating Performance

Managing Financial & Operating Performance

Facilitating Communication

and Coordination

Facilitating Communication

and Coordination

Evaluating Performance &

Providing Incentives

Evaluating Performance &

Providing IncentivesPlanningPlanning

AllocatingResources

AllocatingResources

What Are The Key Purposes Of Budgeting Systems?

15-7

MASTER BUDGET A comprehensive set of budgets covering all phases of the

organization’s operations for a period of time

MASTER BUDGET A comprehensive set of budgets covering all phases of the

organization’s operations for a period of time

PRO FORMA FINANCIAL STATEMENTS Show how the organization’s financial statements will appear at a

specified time if operations proceed according to plan

PRO FORMA FINANCIAL STATEMENTS Show how the organization’s financial statements will appear at a

specified time if operations proceed according to plan

CAPITAL BUDGETA plan for the acquisition of capital asset

CAPITAL BUDGETA plan for the acquisition of capital asset

FINANCIAL BUDGET Shows how the organization will acquire its financial resources

FINANCIAL BUDGET Shows how the organization will acquire its financial resources

ROLLING BUDGET Continually updated by periodically adding a new incremental time period, such as a quarter, and dropping the period just completed

ROLLING BUDGET Continually updated by periodically adding a new incremental time period, such as a quarter, and dropping the period just completed

Organizations Use Many Types Of Budgets

15-8

Sales Budget

Production Budget

Direct Material Budget

Budgeted schedulecost of goods

manufactured and sold

Capital Budget Budgeted balanceStatement

Direct Labor Budget

Mft. Overhead Budget

Cash budget

Budgeted incomeStatement

Budgeted Statement of Cash Flows

Sales Budget

Selling, Generaland Administrative

Budget

R&D Budget

Marketing Budget

Customer Service Budget

Operational Budget

Exh.15-1

Master Budget Components

15-9

Among the major factors considered when forecasting sales are:

Sales forecasting is the process of predicting sales of goods and services.

Sales Forecasting

1. Past sales levels and trends

2. General economic trends

3. Economic trends in the company’s industry

4. Other factors expected to affect sales in the industry

5. Political and legal events

6. The intended pricing policy of the company

7. Planned advertising and product promotion

8. Expected action of competitors

9. New products contemplated by the company or other firms

10. Market research studies

15-10

The sales level of the prior year

The sales level of the prior year

Sales staffSales staff

Market researchers

Market researchers

Delphi techniqueDelphi technique

Econometric models

Econometric models

StartingPoint

Sales Forecasting

15-11

OPERATIONAL BUDGETSSpecify how the company’s

operations will be carried out to meet the demand.

OPERATIONAL BUDGETSSpecify how the company’s

operations will be carried out to meet the demand.

Prepared from the

sales budget

MANUFACTURINGProduction Budget

shows the number of product units to be

manufactured

MANUFACTURINGProduction Budget

shows the number of product units to be

manufactured

MERCHANDISINGMerchandise

Purchases Budget used instead of a

production budget

MERCHANDISINGMerchandise

Purchases Budget used instead of a

production budget

SERVICE INDUSTRYSet of budgets that shows how

the firm will meet the demand for its

services

SERVICE INDUSTRYSet of budgets that shows how

the firm will meet the demand for its

services

Operational Budgets: Meeting Demand For Goods & Services

15-12

OPERATIONAL BUDGETSSpecify how the company’s operations will be carried

out to meet the demand for its goods or services

OPERATIONAL BUDGETSSpecify how the company’s operations will be carried

out to meet the demand for its goods or services

CashBudget

CashBudget

Shows expected cash receipts from selling goods and

services, anddisbursements to pay

bills

Shows expected cash receipts from selling goods and

services, anddisbursements to pay

bills

CapitalBudget

CapitalBudget

Details plans formajor acquisitionsand disposals of

assets

Details plans formajor acquisitionsand disposals of

assets

Operationalbudgets

encompass a plan for using

the basic factors of production

(material, labor, and overhead)

to produce a product or

provide a service

Operationalbudgets

encompass a plan for using

the basic factors of production

(material, labor, and overhead)

to produce a product or

provide a service

Operational Budgets: Meeting Demand For Goods & Services

15-13

The sales budget displays the projected sales in units and the projected sales return

The sales budget displays the projected sales in units and the projected sales return

1st 2nd 3rd 4th YearSales in Units 15,000 5,000 10,000 20,000 50,000Unit sales price X $12 X $12 X $12 X $12 X $12Total sales revenue $180,000 $60,000 $120,000 $240,000 $600,000

Seasonal Pattern in SalesSeasonal Pattern in Sales

Sales Budget

15-14

10% of next quarter’sexpected sales

10% of next quarter’sexpected sales

10% of first quarter of nextyear’s expected sales of 15,000

10% of first quarter of nextyear’s expected sales of 15,000

Production Budget

Total units required - Expected beginning finished goods inventory = Units to be produced

Total units required - Expected beginning finished goods inventory = Units to be produced

Sales in units + Desired ending finished goods inventory = Total units requiredSales in units + Desired ending finished goods inventory = Total units required

15-15

Raw materials required for production +

Desired ending inventory = Total

raw material required

Raw materials required for production +

Desired ending inventory = Total

raw material required

Shows the number of units and the cost of material to be purchased and used

Shows the number of units and the cost of material to be purchased and used Total raw material

required - Expected beginning

inventory of raw material = Raw material to be

purchased

Total raw material required - Expected beginning

inventory of raw material = Raw material to be

purchased

Direct Material Budget

15-16

Shows the number of hours and the cost of direct labor to be used during the budget period

Shows the number of hours and the cost of direct labor to be used during the budget period

For either strategic business reasons or ethical concerns, many companies try to maintain a relatively stable labor force. If

production employees are retained when production declines, the labor force will not be a unit-level cost.

For either strategic business reasons or ethical concerns, many companies try to maintain a relatively stable labor force. If

production employees are retained when production declines, the labor force will not be a unit-level cost.

Direct-Labor Budget

15-17

Shows the cost of overhead expected to be incurred in the production process during the budget period

Shows the cost of overhead expected to be incurred in the production process during the budget period

Indirect material Electricity for machinery

Indirect material Electricity for machinery

Setup Purchasing & material handling

Inspection

Setup Purchasing & material handling

Inspection

Supervisory salariesInsurance and property

taxes MaintenanceUtilities Depreciation

Supervisory salariesInsurance and property

taxes MaintenanceUtilities Depreciation

DesignDesign

Manufacturing Overhead Budget

15-18

1st 2nd 3rd 4th YearUnit-level expenses $14,000 $5,500 $11,000 $19,500 $50,000Customer-level expenses $1,500 $1,500 $1,500 $1,500 $6,000Facility and general operations-level expenses $4,750 $4,750 $4,750 $4,750 $19,000Total expenses $20,250 $11,750 $17,250 $25,750 $75,000

1st 2nd 3rd 4th YearUnit-level expenses $14,000 $5,500 $11,000 $19,500 $50,000Customer-level expenses $1,500 $1,500 $1,500 $1,500 $6,000Facility and general operations-level expenses $4,750 $4,750 $4,750 $4,750 $19,000Total expenses $20,250 $11,750 $17,250 $25,750 $75,000

Shows the planned amounts of expenditures for selling, general, and administrative expenses during a budget period

Shows the planned amounts of expenditures for selling, general, and administrative expenses during a budget period

Sales commissionsFreight-out

Sales commissionsFreight-out

Licensing fees for use ofuniversities’ names and logos

Licensing fees for use ofuniversities’ names and logos

Sales salaries, Advertising,& Clerical wages

Sales salaries, Advertising,& Clerical wages

Selling, General, & Administration (SG&A) Expense Budget

15-19

Details the expected cash collections during a budget periodDetails the expected cash collections during a budget period

80% of revenue80% of revenue

18% x $240,000 (prior quarter’s revenue)

18% x $240,000 (prior quarter’s revenue)

Cash Receipts Budget

15-20

2nd quarter

X 80%X 80%

$48,000$48,000

$32,400$32,400

$80,400$80,400

X 18%X 18%

$180,000$180,000 $60,000$60,000

1st quarter

Total cash receipts($48,000 + $32,400)

Total cash receipts($48,000 + $32,400)

Collections in quarterfollowing sale (18% of

sales)

Collections in quarterfollowing sale (18% of

sales)

Collections in quarter of sale (80% of sales)

Collections in quarter of sale (80% of sales)

Total revenueTotal revenue

Uncollectible accounts2% X $60,000 = $1,200

Uncollectible accounts2% X $60,000 = $1,200

Budgeting Cash Receipts

15-21

Details the expected cash payments during a budget periodDetails the expected cash payments during a budget period

1st 2nd 3rd 4th YearCost of raw material purchases $39,450 $18,150 $35,550 $56,850 $150,000

Cash payments for purchases made during the quarter $23,670 $10,890 $21,330 $34,110 $90,000Cash payments for prior quarter's purchases 22,740 15,780 7,260 14,220 60,000

Total cash payments for direct material purchases $46,410 $26,670 $28,590 $48,330 $150,000

Other cash disbursements $84,750 $50,750 $72,750 $106,750 $315,000

Total cash disbursements $131,160 $77,420 $101,340 $155,080 $465,000

1st 2nd 3rd 4th YearCost of raw material purchases $39,450 $18,150 $35,550 $56,850 $150,000

Cash payments for purchases made during the quarter $23,670 $10,890 $21,330 $34,110 $90,000Cash payments for prior quarter's purchases 22,740 15,780 7,260 14,220 60,000

Total cash payments for direct material purchases $46,410 $26,670 $28,590 $48,330 $150,000

Other cash disbursements $84,750 $50,750 $72,750 $106,750 $315,000

Total cash disbursements $131,160 $77,420 $101,340 $155,080 $465,000

60% of current

quarter’spurchases

60% of current

quarter’spurchases

40% of prior

quarter’spurchases

40% of prior

quarter’spurchases

Cash Disbursements Budget

15-22

2nd quarter

X 60%X 60%

$10,890$10,890

$15,780$15,780

$26,670$26,670

X 40%X 40%

$39,450$39,450 $18,150$18,150

1st quarter

Total($10,890 + $15,780)

Total($10,890 + $15,780)

Payments made during the quarter following

(40% of purchases)

Payments made during the quarter following

(40% of purchases)

Payments made during the same

quarter as purchases (60% of sales)

Payments made during the same

quarter as purchases (60% of sales)

Total purchaseon account

Total purchaseon account

Budgeting Cash Disbursements

15-23

1st 2nd 3rd 4th YearCash receipts $187,200 $80,400 $106,800 $213,600 $588,000Less cash disbursements (131,160) (77,420) (101,340) (155,080) (465,000)

Change in cash balance during quarter due to operations $56,040 $2,980 $5,460 $58,520 $123,000

Proceeds from bank loan 100,000 100,000

Payments for construction of plant addition (45,000) (15,000) (5,000) (35,000) (100,000)

Repayment of principal on bank loan (25,000) (25,000) (25,000) (25,000) (100,000)Interest on bank loan (2,500) (1,875) (1,250) (625) (6,250)

Change in cash balance during the period $83,540 ($38,895) ($25,790) ($2,105) $16,750Cash balance, beginning of period 10,000 93,540 54,645 28,855 10,000Cash balance, end of period $93,540 $54,645 $28,855 $26,750 $26,750

1st 2nd 3rd 4th YearCash receipts $187,200 $80,400 $106,800 $213,600 $588,000Less cash disbursements (131,160) (77,420) (101,340) (155,080) (465,000)

Change in cash balance during quarter due to operations $56,040 $2,980 $5,460 $58,520 $123,000

Proceeds from bank loan 100,000 100,000

Payments for construction of plant addition (45,000) (15,000) (5,000) (35,000) (100,000)

Repayment of principal on bank loan (25,000) (25,000) (25,000) (25,000) (100,000)Interest on bank loan (2,500) (1,875) (1,250) (625) (6,250)

Change in cash balance during the period $83,540 ($38,895) ($25,790) ($2,105) $16,750Cash balance, beginning of period 10,000 93,540 54,645 28,855 10,000Cash balance, end of period $93,540 $54,645 $28,855 $26,750 $26,750

A short- term loan was taken

out on Jan. 2, 20x1

A short- term loan was taken

out on Jan. 2, 20x1

The loan was used for construction

The loan was used for construction

Details the expected cash receipts and disbursementsDetails the expected cash receipts and disbursements

Unpaidprincipalx 10%

Unpaidprincipalx 10%

Cash Budget: Combining Receipts And Disbursements

15-24

Details the direct material, direct labor, and manufacturing overheadcosts to be incurred and the cost of the goods to be sold

Details the direct material, direct labor, and manufacturing overheadcosts to be incurred and the cost of the goods to be sold

Direct material Raw material inventory, January 1 $4,200 Add: Purchases of raw material 150,000

Raw material available for use $154,200 Deduct: Raw-material, December 31 4,200

Direct material used $150,000Direct labor 100,000Manufacturing overhead 200,000

Subtotal $450,000Add: Work-in-process inventory, Jan. 1 0

Subtotal 450,000Deduct: Work-in-process inventory, Dec. 31 0Cost of goods manufactured 450,000Add: Finished goods inventory, Jan. 1 13,500

Cost of goods available for sale $463,500Deduct: Finished goods inventory, Dec. 31 13,500

Cost of goods sold $450,000

Direct material Raw material inventory, January 1 $4,200 Add: Purchases of raw material 150,000

Raw material available for use $154,200 Deduct: Raw-material, December 31 4,200

Direct material used $150,000Direct labor 100,000Manufacturing overhead 200,000

Subtotal $450,000Add: Work-in-process inventory, Jan. 1 0

Subtotal 450,000Deduct: Work-in-process inventory, Dec. 31 0Cost of goods manufactured 450,000Add: Finished goods inventory, Jan. 1 13,500

Cost of goods available for sale $463,500Deduct: Finished goods inventory, Dec. 31 13,500

Cost of goods sold $450,000

1,500 unitsx $9

absorptionmanufacturing

cost(direct material

= $3, direct labor = $2, andoverhead = $4)

1,500 unitsx $9

absorptionmanufacturing

cost(direct material

= $3, direct labor = $2, andoverhead = $4)

Budgeted Schedule Of Cost Of Goods Manufactured & Sold

15-25

Shows the expected revenue and expenses for the budget periodShows the expected revenue and expenses for the budget period

Sales revenue $600,000Less: Cost of goods sold 450,000

Gross margin $150,000

Other expenses:

Selling, general and administrative expenses $75,000Uncollectible accounts expense 12,000Interest expense 6,250

Total other expenses 93,250

Net income $56,750

Sales revenue $600,000Less: Cost of goods sold 450,000

Gross margin $150,000

Other expenses:

Selling, general and administrative expenses $75,000Uncollectible accounts expense 12,000Interest expense 6,250

Total other expenses 93,250

Net income $56,750

$600,000x 2%

$600,000x 2%

Budgeted Income Statement

15-26

Shows the expected end of period balances

for the company’s

assets, liabilities, and owner’s equity

Shows the expected end of period balances

for the company’s

assets, liabilities, and owner’s equity

Budgeted Balance Sheet

15-27

Shows the expected end of period balances for the company’s assets, liabilities, and owner’s equity

Shows the expected end of period balances for the company’s assets, liabilities, and owner’s equity

Current liabilitiesAccounts payable $22,740

Total current liabilities $22,740Long-term liabilitiesNote payable 200,000

Total liabilities 222,740Owner's equity 386,910Total liabilities and owner's equity $609,650

Current liabilitiesAccounts payable $22,740

Total current liabilities $22,740Long-term liabilitiesNote payable 200,000

Total liabilities 222,740Owner's equity 386,910Total liabilities and owner's equity $609,650

Budgeted Balance Sheet

15-28

Managers make assumptions and predictions in preparing budgets because organizations operate in a world of uncertainty

Managers make assumptions and predictions in preparing budgets because organizations operate in a world of uncertainty

FINANCIAL PLANNING MODELa set of mathematical relationships that expresses

the interactions among the various operational, financial, and environmental events that determine

the overall results of an organization’s activities

FINANCIAL PLANNING MODELa set of mathematical relationships that expresses

the interactions among the various operational, financial, and environmental events that determine

the overall results of an organization’s activities

Uncollectible accounts expense = 2% (Sales revenue)Uncollectible accounts expense = 2% (Sales revenue)

Uncollectible accounts expense = p (Sales revenue)Uncollectible accounts expense = p (Sales revenue)

The budget staff can run the financial

planning model as many times as

desired with p = a different value each

time

The budget staff can run the financial

planning model as many times as

desired with p = a different value each

time

Financial Planning Models

15-29

Designate a BUDGET

DIRECTOR (usually the

controller) who specifies the

process by which budget data will

be gathered, collects the

information, and prepares the

master budget

Designate a BUDGET

DIRECTOR (usually the

controller) who specifies the

process by which budget data will

be gathered, collects the

information, and prepares the

master budget

The BUDGET DIRECTOR develops

& disseminates a BUDGET MANUAL indicating who is responsible for

providing various types of budget

information, when the information is required, and what

form the information is to take

The BUDGET DIRECTOR develops

& disseminates a BUDGET MANUAL indicating who is responsible for

providing various types of budget

information, when the information is required, and what

form the information is to take

A BUDGET COMMITTEE,

consisting of key senior executives,often is appointed

to advise the budget director

during the preparation of the

budget

A BUDGET COMMITTEE,

consisting of key senior executives,often is appointed

to advise the budget director

during the preparation of the

budget

Responsibility For Budget Administration

15-30

A budget affects virtually everyone in an organization: those who prepare it, those who use it to facilitate decision-making, and those

who are evaluated using the budget

A budget affects virtually everyone in an organization: those who prepare it, those who use it to facilitate decision-making, and those

who are evaluated using the budget

BudgetarySlack

BudgetarySlack

Participative

Budgeting

Participative

Budgeting

PADDING THE BUDGETIntentionally

underestimatingrevenue or overestimatingcosts in order to enhancethe person’s performance

evaluation

PADDING THE BUDGETIntentionally

underestimatingrevenue or overestimatingcosts in order to enhancethe person’s performance

evaluation

People perform better and make greater attempts to

achieve a goal if they have been consulted in setting

the goals

People perform better and make greater attempts to

achieve a goal if they have been consulted in setting

the goals

Behavioral Implications Of Budget

15-31

END OF CHAPTER

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