Chapter 9

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

2. Topics to be Discussed Introduction The Budget Development Process Budgets for Planning, Operating and Control Advantages of Budgeting

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

4. 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

5. Introduction Pause and Reflect Have you ever prepared a budget? Was it a monetary or non-monetary budget? How did you use it?

6. 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.

7. 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?

8. The Budget Development Process Key Concept Budgets must start with a top-down strategic plan that guides and integrates the whole company and its individual budgets.

9. The Budget Development Process Key Concept Budgeting is a management task, not a bookkeeping task.

10. The Budget Development Process Budgeting is an integral part of the planning, operating, and control activities of managers. Planning: developing objectives and goals Operating Day-to-Day management decisions BUDGETING Control: Insuring that objectives and goals are met, comparing actual to budget

11. The Budget Development Process Key Concept Budgets are used throughout the planning, operating, and controlling activities of managers.

12. The Budget Development Process The operating cycle focuses on cash, thus budgeting for cash needs is crucial. Disbursement of cash for manufacturing costs or purchases of inventory Cash on hand Sale of Product Collection of cash from customers

13. Advantages of Budgeting 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.

14. Advantages of Budgeting 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.

15. More Topics to Discuss Budgeting for Sales Operating Budgets-An Example Budgeting for a Traditional Manufacturing Company with Inventory Manufacturing Overhead Budget Cash Budgets

16. 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.

17. 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.

18. 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?

19. Budgeting for Sales Key Concept Budgets are future oriented and make extensive use of estimates and forecasts.

20. 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

21. 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.

22. Operating Budgets: An Example Pause and Reflect What kind of costing system is Tina’s likely to use?

23. Operating Budgets: An Example Sales Forecast January February March April May 250,000 Bottles 325,000 Bottles 450,000 Bottles 500,000 Bottles 400,000 Bottles

24. Operating Budgets: An Example Sales Budget 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 Projected Sales (bottles) Price per bottle Total Projected Sales

25. Operating Budgets: An Example Basic Production Budget Sales forecast (in units) Projected ending inventory Total projected production needs Beginning Inventory Projected production volume + -

26. Operating Budgets: An Example Production Budget 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 Sales Forecast (bottles) Projected ending Inventory (+) Total projected production needs Beginning inventory (-) Projected production bottles

27. Operating Budgets: An Example Materials Purchases Budget - Bottles 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 Projected production (bottles) Projected ending Inventory (+) Total projected needs Projected beginning Inventory (-) Bottles to be purchased Projected purchases x $.10/bottle

28. Operating Budgets: An Example Direct Labor Budget 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 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

29. Operating Budgets: An Example Pause and Reflect Why are we not concerned with inventories in the direct labor purchases budget?

30. Operating Budgets: An Example Manufacturing Overhead Budget 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 Budgeted Machine Hrs Variable Overhead Rate Projected Variable OH Budgeted Fixed OH Total Projected Manufacturing OH

31. Operating Budgets: An Example Total Manufacturing Cost Budget 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 Projected material cost-concentrate PMC – bottles Projected DL costs Projected MO costs Total projected manufacturing costs

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

33. 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

34. Cash Budgets Nov Dec Jan Feb Mar Sales $200,000 $250,000 $262,500 $341,250 $472,500 Cash Receipts Nov sales50% 35% 15% Dec sales 50% 35% 15% Jan sales 50% 35% 15% Feb sales 50% 35% March sales 50% Cash Receipts for 1st Qtr.

35. Cash Budgets Cash Receipts Jan Feb March 1st Qtr. 15% Nov $30,000 $30,000 35% Dec $87,500 87,500 15% Dec $37,500 37,500 50% Jan $131,250 131,250 35% Jan $91,875 91,875 15% Jan $39,375 39,375 50% Feb $170,625 170,625 35% Feb $119,438 119,438 50% March $236,250 236,250 Total $248,750 $300,000 $395,063 $943,183

36. 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

37. 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?

38. Cash Budgets Summary Cash Budget Beginning cash balance Cash flows from operating activities Cash receipts Cash disbursements Cash flows from investing activities Equipment purchases

39. 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

40. 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

41. 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?

42. Budgeted Financial Statements Pro-forma Statements include: Cost of Goods Manufactured Income Statement Balance Sheet

43. Budgeted Financial Statements 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.

44. 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

45. 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.

46. 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

47. 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

48. 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? 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. I know. I’ll use flexible budgets.

49. Static vs Flexible Budgets Key Concept Flexible budgets are based on the actual number of units produced rather than the budgeted units of production.

50. Static Budget Actual Projected production (bottles) 257,000 250,000 Projected direct labor costs $6,438 $6,300 Difference $138 favorable Static vs Flexible Budgets Flexible Budget Actual Projected production (bottles) 250,000 250,000 Projected direct labor costs $6,250 $6,300 Difference $50 unfavorable