Chapter 9 The Use of Budgets in Planning and Decision Making.

Chapter 9

The Use of Budgets in Planning and Decision Making

Topics to be Discussed

Introduction

The Budget Development Process

Budgets for Planning, Operating and Control

Advantages of Budgeting

Introduction

Budgets are plans dealing with the acquisition and use of resources over a specified time period.

Introduction

Budgets can be in terms of:

Monetary or financial

Time

Acquisition and use of thousands of materials

Manufacturing of hundreds of products

Attendance at a baseball game

Introduction

Pause and Reflect

Have you ever prepared a budget?

Was it a monetary or non-monetary budget?

How did you use it?


Traditionally, budgeting is a bottom-up process dependent on departmental managers to provide detailed plans for the upcoming month, quarter or year.


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?


Key Concept

Budgets must start with a top-down strategic plan that guides and integrates the whole company and its individual budgets.


Key Concept

Budgeting is a management task, not a bookkeeping task.


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


Key Concept

Budgets are used throughout the planning, operating, and controlling activities of managers.


The 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 inventory

Sale of Product


The budgeting process forces communication throughout the organization.

The budgeting process forces managements to focus of the future and not be distracted by daily crisis in the organization.


The budgeting process can help management identify and deal with potential bottlenecks or constraints before they become major problems.

The budgeting process can increase the coordination of organizational activities and help facilitate goal congruence.

The budgeting process can define specific goals and objectives that can become benchmarks, or standards of performance for evaluating future performance.

More Topics to Discuss

Budgeting for Sales

Operating Budgets-An Example

Budgeting for a Traditional Manufacturing Company with Inventory

Manufacturing Overhead Budget

Cash Budgets

Budgeting for Sales

In large companies, preparation of the sales forecast is usually accomplished by the marketing department and requires significant effort in the area of market research to arrive at an accurate forecast of expected sales.

In smaller companies, the sales forecast may be made by an individual or small group of managers.

Budgeting for Sales: Some Ways to Forecast Sales

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.

Budgeting for Sales

Pause and Reflect

What unique factors might a CPA firm specializing in tax planning and the preparation of tax return consider in forecasting sales?

Budgeting for Sales

Key Concept

Budgets are future oriented and make extensive use of estimates and forecasts.

Operating Budgets: An Example

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

Inventory Policy

10% of next month’s expected sales in ending inventory of finished goods

20% of next month’s expected production of bottles in ending inventory of materials.


Pause and Reflect

What kind of costing system is Tina’s likely to use?


Sales Forecast

January

February

March

April

May

250,000 Bottles

325,000 Bottles

450,000 Bottles

500,000 Bottles

400,000 Bottles


Sales Budget

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


Basic Production Budget

Sales forecast (in units)

Projected ending inventory

Total projected production needs

Beginning Inventory

Projected production volume

+

-


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


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


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

257,500

1 hour

429.17

$15/hr

$6,438

Feb

337,500

1 hour

562.5

$15/hr

$8,438

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


Pause and Reflect

Why are we not concerned with inventories in the direct labor purchases budget?


Budgeted Machine Hrs

Variable Overhead Rate

Projected Variable OH

Budgeted Fixed OH

Total Projected Manufacturing OH

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

$30,797

123,333

$164,852

1st Qtr.

1,750

$54.75

$95,813

123,333

$465,813

Manufacturing Overhead Budget


Projected material cost-concentrate

PMC – bottles

Projected DL costs

Projected MO costs

Total projected manufacturing costs

Jan

$41,027

27,350

6,438

146,830

$221,645

Feb

$54,150

36,100

8,438

154,130

$252,818

March

$69,300

43,200

11,375

164,852

$291,727

1st Qtr.

$164,477

109,650

26,250

465,813

$766,189

Total Manufacturing Cost Budget

Cash Budgets

Many managers consider managing the cash flow to be the single most important consideration in running a successful business.

Cash Budgets

All of the sales of Tina’s 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

Cash Budgets

Nov Dec Jan Feb Mar Nov Dec Jan Feb Mar Sales $200,000 $250,000 $262,500 $341,250 $472,500Sales $200,000 $250,000 $262,500 $341,250 $472,500

Cash ReceiptsCash ReceiptsNov salesNov sales 50% 35% 15%50% 35% 15%

Dec sales 50% 35% 15%Dec sales 50% 35% 15%

Jan sales 50% 35% 15%Jan sales 50% 35% 15%

Feb sales 50% 35%Feb sales 50% 35%

March salesMarch sales 50%50%

Cash Receipts for 1st Qtr.

Cash Budgets

Cash ReceiptsCash ReceiptsJanJan FebFeb MarchMarch 1st Qtr.1st Qtr.

15% Nov15% Nov $30,000$30,000 $30,000$30,00035% Dec35% Dec $87,500$87,500 87,500 87,500

15% Dec15% Dec $37,500$37,500 37,500 37,500

50% Jan50% Jan $131,250 $131,250 131,250131,25035% Jan35% Jan $91,875$91,875 91,875 91,875 15% Jan15% Jan $39,375$39,375 39,375 39,375 50% Feb50% Feb $170,625$170,625 170,625 170,625 35% Feb 35% Feb $119,438$119,438 119,438119,43850% March50% March $236,250$236,250 236,250236,250TotalTotal $248,750$248,750 $300,000$300,000 $395,063$395,063 $943,183 $943,183

Cash Budgets

Cash Disbursement Budget- Operating Activities

Cash Disbursements include:

Material Purchases for Concentrate

Material Purchases for Bottles

Direct Labor

Manufacturing Overhead

Selling and Administrative Costs

Cash Budgets

Pause and Reflect

Can you trace each of the amounts in the cash disbursements budget back to the original budget in which it appears?

Cash Budgets

Summary Cash Budget

Beginning cash balance

Cash flows from operating activities

Cash receipts

Cash disbursements

Cash flows from investing activities

Equipment purchases

Cash Budgets

Summary Cash Budget, continued

Cash flows form financing activities

Payment of dividends

Interest on long-term debt

Borrowing from line of credit

Repayments of line of credit

Final cash balance

More Budget Topics

Budgeted Financial Statements

Budgets for a Manufacturing Company in a JIT Environment

Budgets for Merchandising Companies and Service Companies

Life Cycle Costs, the Value Chain and Budgeting

More Budget Topics

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?


Pro-forma Statements include:

Cost of Goods Manufactured

Income Statement

Balance Sheet


If the budget is prepared as a template using spreadsheet software, changes in assumptions can be reflected in the entire budget in a few seconds.

Other Budgeting Topics

Life Cycle Costs, the Value Chain, and Budgeting

Budgeting in an International Environment

Nonmonetary Budgets

Static Versus Flexible Budgets

ABC and Flexible Budgets

Life Cycle Costs, the Value Chain and Budgeting

In making decisions to introduce new products, the forecasted sales over the life of the product must exceed its life cycle costs. Given that a significant % of total costs are incurred before a new product is actually produced and sold, early and accurate budgeting is critically important in making good decisions regarding the introduction of new products.

Budgeting 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

Nonmonetary 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 retuned or defective items, the number of customer complaints, time waiting to be served

Static vs Flexible Budgets

Static budgets are set at the beginning of the period and remain constant throughout the budget period.

What if my sales are not what I projected?

I know. I’ll use flexible budgets.

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.


Key Concept

Flexible budgets are based on the actual number of units produced rather than the budgeted units of production.


Static Budget Actual

Projected production (bottles) 257,000 250,000

Projected direct labor costs $6,438 $6,300

Difference $138 favorable

Flexible Budget Actual

Projected production (bottles) 250,000 250,000

Projected direct labor costs $6,250 $6,300

Difference $50 unfavorable

ABC and Flexible Budgets

Tina’s would budget costs for moving materials based on the budgeted cost per move and the actual number of moves made during the month.

Tina’s would 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.

End of Chapter 9

The budgeting process is worth the effort.

Chapter 9 The Use of Budgets in Planning and Decision Making.

Documents

sales operating budgets

hour slide

example budgeting

use of budgets

introduction budgets

sales key concept budgets

individual budgets

sales pause