0 CHAPTER 11 The Use of Budgets in Planning and Decision Making © 2009 Cengage Learning

1 Introduction Budgets are plans dealing with the acquisition and use of resources over a specified time period. Who budgets? Everyone from college students to large multinational companies

2 Introduction Budgets aren’t just financial, they can be in terms of: Time Acquisition and use of thousands of different materials Manufacturing of hundreds of products

3 Budgets for Planning, Operating, and Control Budgets are used throughout the planning, operating, and control activities of managers. Key Concept

4 Budgets for Planning, Operating, and Control 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 BUDGETING Operating: Day-to-day management decisions

5 Budgets for Planning, Operating, and Control 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

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

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 Traditionally, budgeting is a bottom-up process dependent on departmental managers to provide detailed plans for the upcoming month, quarter, or year. Participatory budgeting starts with departmental managers and flows up to top management

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

10 Advantages of Budgeting 1.The budgeting process forces communication throughout the organization. 2. The budgeting process forces management to focus on the future and not be distracted by daily crises in the organization.

11 Advantages of Budgeting (continued) 3.The budgeting process can help management identify and deal with potential bottlenecks or constraints before they become major problems. 4.The budgeting process can increase the coordination of organizational activities and help facilitate goal congruence. 5.The budgeting process can define specific goals and objectives that can become benchmarks, or standards of performance for evaluating future performance.

12 The Master Budget The master budget consists of an interrelated set of budgets prepared by a business. The starting point is forecasting sales and preparing the sales budget.

13 Budgeting for Sales In large companies, preparation of the sales forecast is usually accomplished by the marketing department Requires significant effort in the area of market research In smaller companies, the sales forecast may be made by an individual or small group of managers

14 Budgeting for Sales Things to consider 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

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

16 Operating Budgets: An Example Tina’s Fine Juices 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

17 Operating Budgets Sales Forecast January February March 250,000 Bottles 325,000 Bottles 450,000 Bottles

18 Operating Budgets Sales Budget MONTH 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 1 st Quarter 1,025,000 $1.05 $1,076,250

19 Operating Budgets Basic Production Budget Sales forecast (in units) + Desired ending inventory = Projected production needs - Projected beginning inventory = Projected production volume

20 Operating Budgets Sales forecast (bottles) Projected ending inventory (+) Total projected production needs Beginning inventory (-) Projected production bottles Jan 250,000 32, ,500 25, ,500 Feb 325,000 45, ,000 32, ,500 March 450,000 50, ,000 45, ,000 Total Qtr. 1,025,000 50,000 1,075,000 25,000 1,050,000 Production Budget

21 Operating Budgets 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, ,000 51, ,500 $27,350 Feb 337,500 91, ,500 67, ,000 $36,100 March 455,000 98, ,000 91, ,000 $46,200 Total Qtr. 1,050,000 98,000 1,148,000 51,500 1,096,500 $109,650 Materials Purchases Budget - Bottles

22 Operating Budgets 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 257,000 1 hour $15/hr $6,438 Feb 337,500 1 hour $15/hr $8,437 March 455,000 1 hour $15/hr $11,375 1 st Qtr. 1,050,000 1 hour 1,750 hrs $15/hr $26,250 Direct Labor Budget

23 Operating Budgets Budgeted machine hrs. Variable overhead rate Projected variable OH Budgeted fixed OH Total projected manufacturing overhead Jan $54.75 $23, ,333 $146,830 Feb $54.75 $30, ,333 $154,130 March $54.75 $41, ,333 $164,852 1 st Qtr. 1,750 $54.75 $95, ,999 $465,812 Manufacturing Overhead Budget

24 Operating Budgets Projected material cost-- concentrate PMC – bottles Projected DL costs Projected MO costs Total projected manufacturing costs Jan $41,026 27,350 6, ,830 $221,644 Feb $54,154 36,100 8, ,130 $252,821 March $69,302 43,200 11, ,852 $291,729 1 st Qtr. $164, ,650 26, ,812 $766,194 Total Manufacturing Cost Budget

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

26 Cash Budgets Tina’s Fine Juices All sales 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

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

28 Cash Budgets Cash Receipts JanFebMarch1st Qtr. 15% Nov$30,000$30,000 35% Dec$87,500 87,500 15% Dec$37,500 37,500 50% Jan$131, ,250 35% Jan$91,875 91,875 15% Jan$39,375 39,375 50% Feb$170,625170,625 35% Feb $119,438119,438 50% March$236,250236,250 Total$248,750$300,000$395,063$943,183

29 Cash Budgets Cash Disbursements Budget- Operating Activities Cash disbursements include: Material Purchases for Concentrate Material Purchases for Bottles Direct Labor Manufacturing Overhead Selling and Administrative Costs

30 Cash Budgets Summary Cash Budget Beginning cash balance Cash flows from operating activities Cash receipts Cash disbursements Income taxes Cash flows from investing activities Equipment purchases Cash flows from financing activities Payment of dividends Interest on long-term debt Borrowing from line of credit Repayments of line of credit Interest on line of credit Final cash balance

31 Budgeted Financial Statements 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?

32 Budgeted Financial Statements Pro forma statements include: Schedule of Cost of Goods Manufactured Income Statement Balance Sheet

33 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

34 Nonfinancial 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 returned or defective items, the number of customer complaints, time waiting to be served

35 Static vs. Flexible Budgets Static budgets are set at the beginning of the period and remain constant throughout the budget period. 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. What if my sales are not what I projected?

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

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

38 ABC and Flexible Budgets Tina’s Fine Juices would: Budget costs for moving materials based on the budgeted cost per move and the actual number of moves made during the month. 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.