1 CHAPTER 11 The Use of Budgets in Planning and Decision Making © 2009 Cengage Learning
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1
CHAPTER 11
The Use of Budgets in Planning and Decision Making
© 2009 Cengage Learning
2
Introduction
•Budgets are plans dealing with the acquisition and use of resources over a specified time period.
•Who budgets?•Everyone from college students to large multinational companies
3
Introduction
•Budgets aren’t just financial, they can be in terms of:
•Time•Acquisition and use of thousands of different materials•Manufacturing of hundreds of products
4Budgets for Planning,
Operating, and Control
Budgets are used throughout the
planning, operating, and control activities of managers.
Key Concept
5
Budgets for Planning,
Operating, and Control
Budgeting is an integral part of the planning, operating, and
control activities of managers.Planning:
Developing objectives and goals
Control: Insuring that
objectives and goals are met,
comparing actual to budget
BUDGETINGOperating: Day-to-day management
decisions
6Budgets for Planning,
Operating, and ControlThe operating cycle focuses
on cash; thus, budgeting for cash needs is crucial.
Cash on hand
Collection of cash from
customers
Disbursement of cash for
manufacturing costs or purchases of
inventorySale of Product
7The Budget Development
Process
Budgeting is a management task, not a bookkeeping task.
Key Concept
8
The Budget Development Process
Zero-Based Budgets require
managers to build budgets
from the ground up each year
rather than just add a
percentage increase to last year’s numbers.
Why shouldn’t I just use 10% more than last
year for everything?
9
The Budget Development Process
•Traditionally, budgeting is a bottom-up process dependent on departmental managers to provide detailed plans for the upcoming month, quarter, or year.
•Participatory budgeting starts with departmental managers and flows up to top management
10The Budget Development
Process
Budgets must start with a top-down strategic plan that guides
and integrates the whole company and its individual
budgets.
Key Concept
11
Advantages of Budgeting
1. The budgeting process forces communication throughout the organization.
2. The budgeting process forces management to focus on the future and not be distracted by
daily crises in the organization.
12Advantages of Budgeting(continued)
3. The budgeting process can help management identify and deal with potential bottlenecks or constraints before they become major problems.
4. The budgeting process can increase the coordination of organizational activities and help facilitate goal congruence.
5. The budgeting process can define specific goals and objectives that can become benchmarks, or standards of performance for evaluating future performance.
13The Master Budget
•The master budget consists of an interrelated set of budgets prepared by a business.
•The starting point is forecasting sales and preparing the sales budget.
14Budgeting for Sales
•In large companies, preparation of the sales forecast is usually accomplished by the marketing department
•Requires significant effort in the area of market research
•In smaller companies, the sales forecast may be made by an individual or small group of managers
15
Budgeting for Sales
Things to consider
• Anticipated marketing or advertising plans
• The impact of new products or changes in product mix on the entire product line
• Other factors, such as political and legal events and weather changes
16Budgeting for Sales
Budgets are future oriented and make extensive use of estimates and
forecasts.
Key Concept
17Operating Budgets: An
Example
•Tina’s Fine Juices•Produces bottled orange juice from fruit concentrate•Only ingredients are water and juice concentrate•Juice is blended, pasteurized, and bottled•Process is heavily automated•Each machine is run by one employee and can process 10 bottles of juice per minute or 600 bottles per hour
18Operating Budgets
Sales Forecast
January
February
March
250,000 Bottles
325,000 Bottles
450,000 Bottles
19Operating Budgets
Sales Budget
MONTH
Projected sales (bottles)
Price per bottle
Total projected sales
January
250,000
$1.05
$262,500
February
325,000
$1.05
$341,250
March
450,000
$1.05
$472,500
1st Quarter
1,025,000
$1.05
$1,076,250
20Operating Budgets
Basic Production Budget
Sales forecast (in units)
+ Desired ending inventory
= Projected production needs
- Projected beginning inventory
= Projected production volume
21Operating Budgets
Sales forecast (bottles)
Projected ending inventory (+)
Total projected production needs
Beginning inventory (-)
Projected production bottles
Jan
250,000
32,500
282,500
25,000
257,500
Feb
325,000
45,000
370,000
32,500
337,500
March
450,000
50,000
500,000
45,000
455,000
Total Qtr.
1,025,000
50,000
1,075,000
25,000
1,050,000
Production Budget
22Operating Budgets
Projected production (bottles)
Projected ending inventory (+)
Total projected needs
Projected beginning inventory (-)
Bottles to be purchased
Projected purchases x $.10/bottle
Jan
257,500
67,500
325,000
51,500
273,500
$27,350
Feb
337,500
91,000
428,500
67,500
361,000
$36,100
March
455,000
98,000
553,000
91,000
462,000
$46,200
Total Qtr.
1,050,000
98,000
1,148,000
51,500
1,096,500
$109,650
Materials Purchases Budget - Bottles
23Operating Budgets
Projected production (bottles)
Direct labor time per 600 bottles
Direct labor hours for production*
Direct labor rate per hour
Projected DL cost
*Projected production/600
Jan
257,000
1 hour
429.17
$15/hr
$6,438
Feb
337,500
1 hour
562.5
$15/hr
$8,437
March
455,000
1 hour
758.33
$15/hr
$11,375
1st Qtr.
1,050,000
1 hour
1,750 hrs
$15/hr
$26,250
Direct Labor Budget
24Operating Budgets
Budgeted machine hrs.
Variable overhead rate
Projected variable OH
Budgeted fixed OH
Total projected
manufacturing overhead
Jan
429.17
$54.75
$23,497
123,333
$146,830
Feb
562.5
$54.75
$30,797
123,333
$154,130
March
758.33
$54.75
$41,519
123,333
$164,852
1st Qtr.
1,750
$54.75
$95,813
369,999
$465,812
Manufacturing Overhead Budget
25Operating Budgets
Projected material cost--concentrate
PMC – bottles
Projected DL costs
Projected MO costs
Total projected
manufacturing costs
Jan
$41,026
27,350
6,348
146,830
$221,644
Feb
$54,154
36,100
8,437
154,130
$252,821
March
$69,302
43,200
11,375
164,852
$291,729
1st Qtr.
$164,482
109,650
26,250
465,812
$766,194
Total Manufacturing Cost Budget
26
Cash Budgets
Many managers consider managing cash flow to be the single most important consideration in running a
successful business.
27
Cash Budgets
•Tina’s Fine Juices
•All sales are on account. Collections are estimated as follows:
•50% in the month of the sale
•35% in the month following the sale
•15% in the second month following the sale
28Cash Budgets
Nov Dec Jan Feb Mar
Sales $200,000 $250,000 $262,500 $341,250 $472,500
Nov sales 50% 35% 15%Dec sales 50% 35% 15%Jan sales 50% 35%
15%Feb sales 50%
35%March sales 50%
Cash Receipts for 1st Qtr.
Cash Receipts
29Cash Budgets
Cash ReceiptsJan Feb March 1st Qtr.
15% Nov $30,000 $30,00035% Dec $87,500 87,500 15% Dec $37,500 37,500
50% Jan $131,250 131,25035% Jan $91,875 91,875 15% Jan $39,375 39,375 50% Feb $170,625 170,625 35% Feb $119,438 119,43850% March $236,250 236,250Total $248,750$300,000 $395,063
$943,183
30Cash Budgets
Cash Disbursements Budget- Operating ActivitiesCash disbursements include:
•Material Purchases for Concentrate•Material Purchases for Bottles•Direct Labor•Manufacturing Overhead•Selling and Administrative Costs
31Cash Budgets
Summary Cash Budget
Beginning cash balance
Cash flows from operating activities
Cash receipts
Cash disbursements
Income taxes
Cash flows from investing activities
Equipment purchases
Cash flows from financing activities
Payment of dividends
Interest on long-term debt
Borrowing from line of credit
Repayments of line of credit
Interest on line of credit
Final cash balance
32
Budgeted Financial Statements
Using the budgets, management prepares pro forma (budgeted) financial statements. They are used for internal planning purposes and to provide information to external users, such as a bank, when requesting a loan.
What do I do with all of these
budgets?
33Budgeted Financial Statements
Pro forma statements include:
•Schedule of Cost of Goods Manufactured
•Income Statement
•Balance Sheet
34Budgeting in an International Environment
•Considerations:•Translating foreign currency
•Predicting inflation rates and prices in unstable economies
•Predicting sales in countries with different consumer preferences
•Dealing with different labor laws, social customs, and norms affecting wage rates and the productivity of workers
35 Nonfinancial Budgets
Time Budgets: to plan the number of hours expected to be incurred in each engagement (CPA firm and law offices)
Customer-Satisfaction-Measures: includes the number of returned or defective items, the number of customer complaints, time waiting to be served
36Static vs. Flexible Budgets
Static budgets are set at the beginning of the period and remain constant throughout the budget period.
Flexible budgets take differences in cost and revenue due to volume differences out of the analysis by budgeting for labor (and other costs) based on the actual number of units produced.
What if my sales are not
what I projected?
37Static vs. Flexible Budgets
Flexible budgets are based on the actual
number of units produced rather than the
budgeted units of production.
Key Concept
38Static vs. Flexible Budgets
Static Budget ActualProjected production (bottles) 257,500
250,000Projected direct labor costs $6,438 $6,300
Difference $138
Flexible Budget Actual
Projected production (bottles) 250,000 250,000
Projected direct labor costs $6,250 $6,300
Difference
$50
39ABC and Flexible Budgets
Tina’s Fine Juices would:•Budget costs for moving materials based on the budgeted cost per move and the actual number of moves made during the month.
•Compute the per-unit budget amounts for other batch-level and product-level costs and include those in the flexible budget along with the regular variable costs and fixed costs.
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