DEVELOPING A BUSINESS PLAN FOR A MANUFACTURING COMPANY: BUDGETING CHAPTER 12 DEVELOPING A BUSINESS PLAN FOR A MANUFACTURING COMPANY: BUDGETING

Chapter Overview What are the similarities and differences between a large company’s master budget and that of an entrepreneurial company? What are the similarities and differences between a large company’s master budget and that of a retail company? How is a manufacturing company’s operating cycle difference from that of a retail company?

Chapter Overview Is there a strategy a manufacturing company can use to complete its budget? If a company’s actual sales are different than its budgeted sales (or actual production is different from budgeted production) for the same time period, how can managers meaningfully evaluate how well the company met its cost goals? How do budgets affect the business decisions that employees make?

Manufacturing Company Master Budget Sales budget Production budget Direct materials budget Direct labor budget Factory overhead budget Selling expenses budget G&A expenses budget Capital expenditures budget Cash budget Projected income statement Projected balance sheet A manufacturing company’s master budget might include these related components

Master Budget Relationships Exhibit 12-1

Unlimited Decadence’s Operating Cycle Exhibit 12-2

Sales Budget Like the retail budget, the budgeting process for a manufacturing company begins with the sales budget. The reason for this is that product sales affect all of the other operating activities of a company. The sales budget shows the amount of inventory (in units) that the company expects to sell in each month of the budget period and the related revenues earned.

Unlimited Decadence Sales Budget Exhibit 12-3

Production Budget Once the units sales are budgeted, the next step is the production budget. The production budget is a schedule showing how many units the company should produce during each budget period to satisfy expected sales (from the sales budget) for that period. In addition, the budget shows the desired ending finished goods inventory.

Production Budget The production budget begins with budgeted unit sales from the sales budget, adding in desired ending inventory. This approach helps to minimize risks of underestimating actual sales or overestimating the inventory that should be on hand. Out of stock; high cost of ordering materials Too low Estimated ending inventory Ties up cash resources; high storage costs Too high Inventory on hand

Unlimited Decadence Production Budget Exhibit 12-4

Direct Materials Purchases Budget The direct materials purchases budget is a schedule showing the number of direct material units the company should produce during each budget period to meet production for that period. In addition, the budget shows the desired ending direct materials inventory. It also shows the costs related to those purchases and when the company expects to pay for them.

Unlimited Decadence Direct Materials Purchases Budget Exhibit 12-5

Direct Labor Budget The direct labor budget is a schedule showing the hours and the cost of the direct labor required to meet the budgeted production for that period. It also shows the the cash payments the company expects to make for direct labor during each budget period.

Unlimited Decadence Direct Labor Budget

Factory Overhead Budget The factory overhead budget is a schedule showing the estimates of all factory overhead costs and their related cash payments for each budget period. Managers based these factory overhead cost estimates on the production budget and on studies of the behavior of the various overhead costs (fixed, variable) discussed in Chapter 11. Like other budgets, it also includes expected cash payments during each budget period.

Unlimited Decadence Factory Overhead Budget

Selling Expenses Budget The selling expenses budget of a manufacturing company is developed in the same way as that of a retail company, with a few exceptions. Sales-determined expenses include such items as shipping expenses, which are directly related to the volume of budgeted sales. Sales-determining expenses include items that affect the volume of budgeted sales, such as advertising expenses. Like other budgets, it also includes expected cash payments during each budget period.

Unlimited Decadence Selling Expenses Budget

G&A Expenses Budget The G&A (general and administrative) expenses budget of a manufacturing company is developed in the same way as that of a retail company. This budget would include expenses related to the non-manufacturing activities of the company, such as accounting, research and development, legal or administrative functions. Like other budgets, it also includes expected cash payments during each budget period.

Unlimited Decadence G&A Expenses Budget

Capital Expenditures Budget The capital expenditures budget is a set of schedules that shows the effect that each new project to be undertaken is expected to have on other master budget schedules. Managers use information gathered during project evaluation to show the expected timing of project-related cash receipts and payments and other items. The capital expenditures budget is more complex that other budgets and will be discussed in Chapter 20.

Cash Budget The cash budget shows the company’s expected cash inflows and outflows as well as its beginning and ending cash for the budget period. The cash budget is key to projecting cash surpluses, financing needs, and cash requirements through the budget period. Too high: idle resources not invested in operations Cash on hand Too low: can’t fund operations; no buffer; unanticipated borrowings

Projected Cash Flow Statement This statement summarizes the cash receipts and payments by operating, investing, and financing activities. It is the cash budget of the company’s planned activities. Operating activities Cash receipts and payments from planned operations Cash receipts and payments from planned financing activities Cash receipts and payments from planned investing activities Financing activities Investing activities

Unlimited Decadence Cash Budget

Projected Income Statement This statement summarizes the company’s expected profitability if it follows all of its plans and if all the anticipated conditions occur. The data is derived from the sales budget, production budget, and the various expenses budget. For a corporation, an estimate of income tax is included on the projected income statement. The cash payments for income taxes are included on the cash budget.

Unlimited Decadence Income Statement

Projected Balance Sheet Before implementing their plan of action, managers develop a projected balance sheet. This statement summarizes the company’s expected financial position on a particular date, based on the planned activities. Like other projected financial statements, its purpose is to project a future result, completing the financial description set forth in the budget plan.

Unlimited Decadence Actual Balance Sheet

Unlimited Decadence Projected Balance Sheet

Technology and Budgeting The budgeting process involves plenty of number crunching. It is not uncommon for managers to have to revised budgets several times over before they are finalized. Luckily, technological developments have made this process easier and less time- consuming as well as minimizing errors. Spreadsheet programs such as EXCEL or an enterprise resource planning system (ERPS) provide budgeting and planning technology tools to aid this process.

Responsibility Centers Responsibility centers involves the concept of reporting revenues and costs (where relevant) on the basis of the manager who has the authority to make the day-to-day decisions about the items. Under this concept, a manager’s performance is evaluated on matters directly under that manager’s control. A responsibility center is an identifiable portion or segment of a company’s operations, the activities of which are the responsibility of a particular manager.

Responsibility Centers Depending on the decision-making authority, a responsibility center may be evaluated as a: COST CENTER REVENUE CENTER Decision-making over costs only Decision-making over revenues only

Responsibility Centers Depending on the decision-making authority, responsibility centers may also include: PROFIT CENTER INVESTMENT CENTER Decision-making over revenues and costs Decision-making over revenues, costs, and invested operating assets

Flexible Budgets One of the benefits of budgeting is to provide a benchmark against which managers can measure results. When budgeted costs are involved, a flexible budget projects expected costs that should be incurred at various levels of activity. Flexible budgets help to identify true variances is costs that arise from other than activity level.

Unlimited Decadence Flexible Manufacturing Cost Budget