Hilton Maher Selto

15 Budgeting & Financial Planning McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.

15-3 Every enterprise has a set of goals Profitability Growth Public Service Public Service Strategic Planning Strategic Planning Achieving and Maintaining a Competitive Advantage Achieving and Maintaining a Competitive Advantage CRITICAL SUCCESS FACTORS The key strengths that are most responsible for making the organization successful CRITICAL SUCCESS FACTORS The key strengths that are most responsible for making the organization successful Strategic Planning

15-4 Express the specific steps required to achieve the organization’s goals. Discuss the major capital investments required to: Express the specific steps required to achieve the organization’s goals. Discuss the major capital investments required to: Maintain Present Facilities Maintain Present Facilities Increase Capacity Increase Capacity Diversify Products or Processes Diversify Products or Processes Develop Particular Markets Develop Particular Markets Strategic Long-Range Plans

15-5 A detailed plan, expressed in quantitative term, that specifies how an organization will acquire and use resources during a particular period of time. A detailed plan, expressed in quantitative term, that specifies how an organization will acquire and use resources during a particular period of time. What is a budget? What is a budgeting system? The procedures used to develop a budget What Are The Key Purposes Of Budgeting Systems?

15-6 Managing Financial & Operating Performance Facilitating Communication and Coordination Facilitating Communication and Coordination Evaluating Performance & Providing Incentives Planning Allocating Resources Allocating Resources What Are The Key Purposes Of Budgeting Systems?

15-7 MASTER BUDGET A comprehensive set of budgets covering all phases of the organization’s operations for a period of time MASTER BUDGET A comprehensive set of budgets covering all phases of the organization’s operations for a period of time PRO FORMA FINANCIAL STATEMENTS Show how the organization’s financial statements will appear at a specified time if operations proceed according to plan PRO FORMA FINANCIAL STATEMENTS Show how the organization’s financial statements will appear at a specified time if operations proceed according to plan CAPITAL BUDGET A plan for the acquisition of capital asset CAPITAL BUDGET A plan for the acquisition of capital asset FINANCIAL BUDGET Shows how the organization will acquire its financial resources FINANCIAL BUDGET Shows how the organization will acquire its financial resources ROLLING BUDGET Continually updated by periodically adding a new incremental time period, such as a quarter, and dropping the period just completed ROLLING BUDGET Continually updated by periodically adding a new incremental time period, such as a quarter, and dropping the period just completed Organizations Use Many Types Of Budgets

15-8 Sales Budget Production Budget Direct Material Budget Budgeted schedule cost of goods manufactured and sold Capital Budget Budgeted balance Statement Direct Labor Budget Mft. Overhead Budget Cash budget Budgeted income Statement Budgeted Statement of Cash Flows Sales Budget Selling, General and Administrative Budget R&D Budget Marketing Budget Customer Service Budget Operational Budget Exh Master Budget Components

15-9 Among the major factors considered when forecasting sales are : Sales forecasting is the process of predicting sales of goods and services. Sales Forecasting 1. Past sales levels and trends 2. General economic trends 3. Economic trends in the company’s industry 4. Other factors expected to affect sales in the industry 5. Political and legal events 6. The intended pricing policy of the company 7. Planned advertising and product promotion 8. Expected action of competitors 9. New products contemplated by the company or other firms 10. Market research studies

15-10 The sales level of the prior year Sales staff Market researchers Delphi technique Econometric models Starting Point Sales Forecasting

15-11 OPERATIONAL BUDGETS Specify how the company’s operations will be carried out to meet the demand. OPERATIONAL BUDGETS Specify how the company’s operations will be carried out to meet the demand. Prepared from the sales budget MANUFACTURING Production Budget shows the number of product units to be manufactured MANUFACTURING Production Budget shows the number of product units to be manufactured MERCHANDISING Merchandise Purchases Budget used instead of a production budget MERCHANDISING Merchandise Purchases Budget used instead of a production budget SERVICE INDUSTRY Set of budgets that shows how the firm will meet the demand for its services SERVICE INDUSTRY Set of budgets that shows how the firm will meet the demand for its services Operational Budgets: Meeting Demand For Goods & Services

15-12 OPERATIONAL BUDGETS Specify how the company’s operations will be carried out to meet the demand for its goods or services OPERATIONAL BUDGETS Specify how the company’s operations will be carried out to meet the demand for its goods or services Cash Budget Cash Budget Shows expected cash receipts from selling goods and services, and disbursements to pay bills Shows expected cash receipts from selling goods and services, and disbursements to pay bills Capital Budget Capital Budget Details plans for major acquisitions and disposals of assets Details plans for major acquisitions and disposals of assets Operational budgets encompass a plan for using the basic factors of production (material, labor, and overhead) to produce a product or provide a service Operational budgets encompass a plan for using the basic factors of production (material, labor, and overhead) to produce a product or provide a service Operational Budgets: Meeting Demand For Goods & Services

15-13 The sales budget displays the projected sales in units and the projected sales return Seasonal Pattern in Sales Sales Budget

% of next quarter’s expected sales 10% of next quarter’s expected sales 10% of first quarter of next year’s expected sales of 15,000 10% of first quarter of next year’s expected sales of 15,000 Production Budget Total units required - Expected beginning finished goods inventory = Units to be produced Total units required - Expected beginning finished goods inventory = Units to be produced Sales in units + Desired ending finished goods inventory = Total units required

15-15 Raw materials required for production + Desired ending inventory = Total raw material required Shows the number of units and the cost of material to be purchased and used Total raw material required - Expected beginning inventory of raw material = Raw material to be purchased Total raw material required - Expected beginning inventory of raw material = Raw material to be purchased Direct Material Budget

15-16 Shows the number of hours and the cost of direct labor to be used during the budget period For either strategic business reasons or ethical concerns, many companies try to maintain a relatively stable labor force. If production employees are retained when production declines, the labor force will not be a unit-level cost. Direct-Labor Budget

15-17 Shows the cost of overhead expected to be incurred in the production process during the budget period Indirect material Electricity for machinery Setup Purchasing & material handling Inspection Supervisory salaries Insurance and property taxes Maintenance Utilities Depreciation Supervisory salaries Insurance and property taxes Maintenance Utilities Depreciation Design Manufacturing Overhead Budget

15-18 Shows the planned amounts of expenditures for selling, general, and administrative expenses during a budget period Shows the planned amounts of expenditures for selling, general, and administrative expenses during a budget period Sales commissions Freight-out Sales commissions Freight-out Licensing fees for use of universities’ names and logos Licensing fees for use of universities’ names and logos Sales salaries, Advertising, & Clerical wages Sales salaries, Advertising, & Clerical wages Selling, General, & Administration (SG&A) Expense Budget

15-19 Details the expected cash collections during a budget period 80% of revenue 18% x $240,000 (prior quarter’s revenue) Cash Receipts Budget

nd quarter X 80% $48,000 $32,400 $80,400 X 18% $180,000 $60,000 1st quarter Total cash receipts ($48,000 + $32,400) Total cash receipts ($48,000 + $32,400) Collections in quarter following sale (18% of sales) Collections in quarter following sale (18% of sales) Collections in quarter of sale (80% of sales) Total revenue Uncollectible accounts 2% X $60,000 = $1,200 Uncollectible accounts 2% X $60,000 = $1,200 Budgeting Cash Receipts

15-21 Details the expected cash payments during a budget period 60% of current quarter’s purchases 60% of current quarter’s purchases 40% of prior quarter’s purchases 40% of prior quarter’s purchases Cash Disbursements Budget

nd quarter X 60% $10,890 $15,780 $26,670 X 40% $39,450 $18,150 1st quarter Total ($10,890 + $15,780) Total ($10,890 + $15,780) Payments made during the quarter following (40% of purchases) Payments made during the quarter following (40% of purchases) Payments made during the same quarter as purchases (60% of sales) Total purchase on account Total purchase on account Budgeting Cash Disbursements

15-23 A short- term loan was taken out on Jan. 2, 20x1 A short- term loan was taken out on Jan. 2, 20x1 The loan was used for construction The loan was used for construction Details the expected cash receipts and disbursements Unpaid principal x 10% Unpaid principal x 10% Cash Budget: Combining Receipts And Disbursements

15-24 Details the direct material, direct labor, and manufacturing overhead costs to be incurred and the cost of the goods to be sold Details the direct material, direct labor, and manufacturing overhead costs to be incurred and the cost of the goods to be sold 1,500 units x $9 absorption manufacturing cost (direct material = $3, direct labor = $2, and overhead = $4) 1,500 units x $9 absorption manufacturing cost (direct material = $3, direct labor = $2, and overhead = $4) Budgeted Schedule Of Cost Of Goods Manufactured & Sold

15-25 Shows the expected revenue and expenses for the budget period $600,000 x 2% $600,000 x 2% Budgeted Income Statement

15-26 Shows the expected end of period balances for the company’s assets, liabilities, and owner’s equity Budgeted Balance Sheet

15-27 Shows the expected end of period balances for the company’s assets, liabilities, and owner’s equity Budgeted Balance Sheet

15-28 Managers make assumptions and predictions in preparing budgets because organizations operate in a world of uncertainty Managers make assumptions and predictions in preparing budgets because organizations operate in a world of uncertainty FINANCIAL PLANNING MODEL a set of mathematical relationships that expresses the interactions among the various operational, financial, and environmental events that determine the overall results of an organization’s activities FINANCIAL PLANNING MODEL a set of mathematical relationships that expresses the interactions among the various operational, financial, and environmental events that determine the overall results of an organization’s activities Uncollectible accounts expense = 2% (Sales revenue) Uncollectible accounts expense = p (Sales revenue) The budget staff can run the financial planning model as many times as desired with p = a different value each time Financial Planning Models

15-29 Designate a BUDGET DIRECTOR (usually the controller) who specifies the process by which budget data will be gathered, collects the information, and prepares the master budget The BUDGET DIRECTOR develops & disseminates a BUDGET MANUAL indicating who is responsible for providing various types of budget information, when the information is required, and what form the information is to take A BUDGET COMMITTEE, consisting of key senior executives, often is appointed to advise the budget director during the preparation of the budget A BUDGET COMMITTEE, consisting of key senior executives, often is appointed to advise the budget director during the preparation of the budget Responsibility For Budget Administration

15-30 A budget affects virtually everyone in an organization: those who prepare it, those who use it to facilitate decision-making, and those who are evaluated using the budget Budgetary Slack Budgetary Slack Participativ e Budgeting Participativ e Budgeting PADDING THE BUDGET Intentionally underestimating revenue or overestimating costs in order to enhance the person’s performance evaluation PADDING THE BUDGET Intentionally underestimating revenue or overestimating costs in order to enhance the person’s performance evaluation People perform better and make greater attempts to achieve a goal if they have been consulted in setting the goals Behavioral Implications Of Budget

15-31 END OF CHAPTER 15