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Profit Planning

Profit Planning. Chapter 10. Learning Objective 1. Understand why organizations budget and the processes they use to create budgets. The Basic Framework of Budgeting.

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Profit Planning

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  1. Profit Planning Chapter 10

  2. Learning Objective 1 Understand why organizations budget and the processes they use to create budgets.

  3. The Basic Framework of Budgeting A budget is a detailed quantitative plan for acquiring and using financial and other resources over a specified forthcoming time period. • The act of preparing a budget is called budgeting. • The use of budgets to control an organization’s activities is known as budgetary control.

  4. Planning and Control Planning – involves developing objectives and preparing various budgets to achieve those objectives. Control–involves the steps taken by management to increase the likelihood that the objectives set down while planning are attained and that all parts of the organization are working together toward that goal.

  5. Define goals and objectives Communicate plans Think about and plan for the future Coordinate activities Means of allocating resources Uncover potential bottlenecks Advantages of Budgeting Advantages

  6. Managers should be held responsible for those items - and only those items - that they can actually control to a significant extent. Responsibility Accounting

  7. Choosing the Budget Period Operating Budget 2011 2012 2013 2014 Operating budgets ordinarily cover a one-year period corresponding to a company’s fiscal year. Many companies divide their annual budget into four quarters. A continuous budget is a12-month budget that rollsforward one month (or quarter)as the current month (or quarter)is completed.

  8. Learning Objective 2 Understand Basic Budgeting Terms and the Behavioral Aspects of Budgeting.

  9. Bottom-up and Top-down Budgeting

  10. Advantages of the Bottom-up Budgeting (Self-Imposed Budgets) • Individuals at all levels of the organization are viewed as members of the team whose judgments are valued by top management. • Budget estimates prepared by front-line managers are often more accurate than estimates prepared by top managers. • Motivation is generally higher when individuals participate in setting their own goals than when the goals are imposed from above. • A manager who is not able to meet a budget imposed from above can claim that it was unrealistic. Self-imposed budgets eliminate this excuse.

  11. How to overcome problems of self-imposed budgets Self-imposed budgets should be reviewed by higher levels of management to prevent “budgetary slack (or budget padding).” Most companies issue broad guidelines in terms of overall profits or sales. Lower level managers are directed to prepare budgets that meet those targets.

  12. Advantages of the Top-down Budgeting • Avoid the potential budgetary slack (budget padding). • Provide a clearer performance goals and expectations from the top management. • May provide better budget due to top management’s access to privileged/confidential market and organization information . • Provide an efficient budgetary process.

  13. Budget Lapsing • A popular method among government agencies, universities and organizations relying on allocated funds. • Any unused funding at the end of the financial period cannot be carried forward to the following year. • As a result, the following year’s budget may be cut because of the under-expenditure in the previous year.

  14. Budget Lapsing: Advantages • Budget lapsing helps ensure that the appropriate level of resources is utilized in each period. Without budget lapsing, risk-averse managers may unnecessarily accumulate funds and this may adversely affect the performance of the organization. • It helps provide an opportunity for a clean cut-off of expenditures and to reallocate any unused resources for other more appropriate requirements.

  15. Budget Lapsing: Potential Problem & Solution • Budget lapsing can cause undesired behavior effects. For example, managers may wastefully spend their entire budget before the end of the period in order to avoid budget cuts. • A system of reviewing the expenditures near end of the period may uncover unnecessary expenditures and discourage managers to wastefully spend because of budget lapsing.

  16. Incremental versus Zero-based Budgets • Incremental method of budgeting is most commonly used by companies. Companies start off one year’s budget by referring back to the previous year’s figures. Adjustments are then made to the budget to account for the expected changes such as prices for the next year. • While incremental method of budgeting is practical and fast, any inefficiency in the previous year’s figures may be carried forward. For example, if all along the organization is over staffed, then the budget will continually to be allowing for the over staffing situation under this method.

  17. Incremental versus Zero-based Budgets • Zero-Based Budgets are prepared based on the assumption that the company has just started. Therefore, resources required have to be justified from scratch. • For example, when budgeting for staff cost for a restaurant, managers using the zero-based budgeting approach will ignore the existing staff level and expenses, rather, they will examine factors such as opening hours, number of tables, expected patron numbers to work out the number of staff required at each position and level, hence the associate costs, to produce a budget.

  18. Incremental versus Zero-based Budgets • Companies using the zero-based method do not simply ignore previous years’ figures. Figures generated by the zero-based method are usually compared with previous years’ figures. Any large differences are investigated. • As zero-based budgeting is time consuming and costly, companies tend to use this method for the relatively large items and the incremental method for the rest.

  19. Top Management Attitude:Human Factors in Budgeting The success of a budget program depends on three important factors: • Top management must be enthusiastic and committed to the budget process. • Top management must not use the budget topressure employees or blame them when something goes wrong. • Budget targets should be challenging but achievable in order to have good motivational effects.

  20. The Budget Committee A standing committee responsible for • overall policy matters relating to the budget • coordinating the preparation of the budget • resolving disputes related to the budget • approving the final budget

  21. Learning Objective 3 Understand the Key Components of Master Budget in Manufacturing, Merchandising and Service Industries

  22. Understand the key components of master budget in Manufacturing, Merchandising, and Service Industries • The first step of budgeting for every business is to budget for the revenue, whether it is a sales budget for providing goods or services or a funding budget. Although operational budgets are adapted according to the industries, they are very similar and typically comprise of budgets for • Income statement • Cash • Balance sheet. • The major differences of different industries include: • Manufacturing: production budget is involved • Merchandising: no production budget, only purchase budget of merchandise is required. • Service Industries: budget for revenue and cost of providing services • Not-for-profit: expected funding available and plan usage of funding.

  23. Learning Objective 4 Prepare a Master Budget for a Manufacturing Company.

  24. The Master Budget: An Overview Sales budget Selling and administrative budget Production budget Ending inventory budget Direct materials budget Direct laborbudget Manufacturing overhead budget Cash Budget Budgetedincomestatement Budgetedbalance sheet

  25. Learning Objective 4 (a) Prepare a sales budget, including a schedule of expected cash collections.

  26. Budgeting Example • Royal Company is preparing budgets for the quarter ending June 30. • Budgeted sales for the next five months are: • April 20,000 units • May 50,000 units • June 30,000 units • July 25,000 units • August 15,000 units. • The selling price is $10 per unit.

  27. The Sales Budget The individual months of April, May, and June are summed to obtain the total budgeted sales in units and dollars for the quarter ended June 30th

  28. Expected Cash Collections • All sales are on account. • Royal’s collection pattern is: • 70% collected in the month of sale, • 25% collected in the month following sale, • 5% uncollectible. • The March 31 accounts receivable balance of $30,000 will be collected in full.

  29. Expected Cash Collections

  30. From the Sales Budget for April. Expected Cash Collections

  31. From the Sales Budget for May. Expected Cash Collections

  32. Quick Check  What will be the total cash collections for the quarter? a. $700,000 b. $220,000 c. $190,000 d. $905,000

  33. Quick Check  What will be the total cash collections for the quarter? a. $700,000 b. $220,000 c. $190,000 d. $905,000

  34. Expected Cash Collections

  35. Learning Objective 4 (b) Prepare a production budget.

  36. The Production Budget Sales BudgetandExpectedCashCollections Production Budget Completed The production budget must be adequate to meet budgeted sales and to provide for the desired ending inventory.

  37. The Production Budget • The management at Royal Company wants ending inventory to be equal to 20% of the following month’s budgeted sales in units. • On March 31, 4,000 units were on hand. • Let’s prepare the production budget.

  38. The Production Budget

  39. March 31 ending inventory The Production Budget

  40. Quick Check  What is the required production for May? a. 56,000 units b. 46,000 units c. 62,000 units d. 52,000 units

  41. Quick Check  What is the required production for May? a. 56,000 units b. 46,000 units c. 62,000 units d. 52,000 units

  42. The Production Budget

  43. Assumed ending inventory. The Production Budget

  44. Learning Objective 4 (c) Prepare a direct materials budget, including a schedule of expected cash disbursements for purchases of materials.

  45. The Direct Materials Budget • At Royal Company, five poundsof material are required per unit of product. • Management wants materials on hand at the end of each month equal to 10% of the following month’s production. • On March 31, 13,000 pounds of material are on hand. Material cost is $0.40per pound. Let’s prepare the direct materials budget.

  46. From production budget The Direct Materials Budget

  47. The Direct Materials Budget

  48. March 31 inventory 10% of following month’s production needs. The Direct Materials Budget Calculate the materials tobe purchased in May.

  49. How much materials should be purchased in May? a. 221,500 pounds b. 240,000 pounds c. 230,000 pounds d. 211,500 pounds Quick Check 

  50. Quick Check  How much materials should be purchased in May? a. 221,500 pounds b. 240,000 pounds c. 230,000 pounds d. 211,500 pounds

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