CHAPTER © jsnyderdesign / iStockphoto 5 PLANNING AND FORECASTING

5 WHAT IS THE FUTURE FOR C&C? ► Cash flow has been a problem. Is $7,000 in cash enough to operate on? ► C&C has borrowed money to finance operations ► An increase in award jacket sales may be the answer to more cash ► C&C’s president, George Douglas, wants to decrease inventory levels, but he is concerned that customer satisfaction will be affected

PLANNING AND THE BUDGETING PROCESS Unit Unit 5.2Unit 5.3Unit 5.4 © Tomwang112 / iStockphoto Unit 5.5

5 WHAT IS A BUDGET? ► An operating plan expressed in dollars ► Shows how resources will be committed during the coming period ► Helps plan for the future ► Communicates corporate direction and coordinates corporate efforts

5 THE ROLES OF BUDGETING

5 BUDGETING INFORMATION FLOWS

5 TOP-DOWN BUDGETS: ADVANTAGES ► Increase probability that the organization’s strategic plans will be incorporated in planned activities ► Enhance coordination among divisional plans and objectives ► Use top management’s knowledge of overall resource availability ► Reduce the time frame for the budgeting process

5 TOP-DOWN BUDGETS: DISADVANTAGES ► May result in dissatisfaction, defensiveness, and low morale among individuals who must work under the budget ► Reduces the feeling of teamwork ► May limit the acceptance of the stated goals and objectives ► May create a view of the budget as a punitive device

5 BOTTOM-UP BUDGETS: ADVANTAGES ► Gathers information from persons most familiar with the needs and constraints of organizational units ► Allow organizational units to coordinate with one another ► Lead to better morale and higher motivation ► Develop a high degree of acceptance of and commitment to organizational goals and objectives by operating management

5 BOTTOM-UP BUDGETS: DISADVANTAGES ► Require significantly more time ► Effects of managerial participation may be negated by top-management changes ► Managers may be ambivalent or unqualified to participate, creating an unachievable budget ► May cause managers to introduce slack into the budget

PERFORMANCE STANDARDS Unit Unit 5.2 Unit 5.3Unit 5.4 © Tomwang112 / iStockphoto Unit 5.5

5 WHAT IS A STANDARD? ► Benchmark for measuring performance – an expectation ► What are some examples of standards you are familiar with? ► In accounting, you can think of it as a budget of a single unit of output

5 THE STANDARD CONTINUUM PRACTICAL IDEAL Tight, but attainable Perfection, “Factory Heaven” Where do you want to be?

5 IDEAL STANDARDS ADVANTAGES ► Motivational tool ► Constant reminder to workers of need for increased efficiency DISADVANTAGES ► De-motivating because you know you can never achieve the standard ► Employees may take shortcuts and reduce effectiveness ► Poor planning tool

5 PRACTICAL STANDARDS ADVANTAGES ► Motivate employees to perform ► Good planning tool DISADVANTAGES ► ???

5 SETTING STANDARDS ► Standards are set for both quantity and price of each input (materials, labor and overhead) ► Estimated cost to manufacture a single unit of product or perform a single service ► A budget for a single unit of output

5 HOW DO YOU SET MATERIALS STANDARDS? ► What are the inputs? ► How much of each input is required? ► What is the required quality of each input? ► How much does each unit of input cost?

5 C&C DIRECT MATERIALS STANDARDS

5 HOW DO YOU SET LABOR STANDARDS? ► What are the operations required to produce the product? ► How long does it take to perform each operation? ► Who performs each operation and how much are they paid?

5 C&C DIRECT LABOR STANDARDS ItemRate Base hourly rate$8.00 Payroll taxes 0.60 Fringe benefits 1.00 Standard direct labor rate$9.60 ActivityDirect Labor Hours Cutting.02 Sewing.18 Machine down-time.01 Rest period.03 Standard direct labor hours.25 $9.60 per direct labor hour x.25 direct labor hours = $2.40

5 HOW DO YOU SET OVERHEAD STANDARDS? ► The predetermined overhead rate

BUILDING THE MASTER BUDGET: THE OPERATING BUDGET Unit Unit 5.2 Unit 5.3 Unit 5.4 © Tomwang112 / iStockphoto Unit 5.5

5 COMPONENTS OF THE MASTER BUDGET

5 SALES BUDGET ► Shows budgeted sales revenue for the period, which flows to the budgeted income statement for the period ► Begins with the sales forecast, which typically will be prepared by the sales and marketing departments ► Requires a forecasted sales price in addition to the sales volume forecast ► Is prepared for each product

5 C&C’S SALES BUDGET Notice that the individual sales budget amount flows to the overall sales budget.

5 SELLING & ADMINISTRATIVE EXPENSE BUDGET ► Shows expenses to be incurred to support the budgeted level of sales ► Includes variable and fixed expenses ► Pay special attention to non-cash expenses such as bad debt expense and depreciation expense. These expenses do not flow to the cash budget.

5 C&C’S S&A EXPENSE BUDGET

5 PRODUCTION BUDGET ► Shows when and how many units to produce in order to meet budgeted sales volume ► Includes budgeted ending inventory of finished goods to provide a cushion for unexpected sales ► A retail establishment will have a purchases budget rather than a production budget

5 C&C’S PRODUCTION BUDGET Budgeted Sales Budgeted End. Inv. Budgeted Beg. Inv. Budgeted Production + _ =

5 DIRECT MATERIALS PURCHASES BUDGET ► Shows when and how much of each direct material to purchase in order to meet the production budget ► Includes budgeted ending inventory of direct materials to provide a cushion for production errors or supply shortfalls ► Is prepared for each direct material input used in the production process

5 C&C’S DIRECT MATERIALS BUDGET Notice that you must convert from units of finished goods to units of the direct material – here from pants to yards of fabric. Budgeted inventory levels are calculated using the same principle as in the production budget.

5 DIRECT LABOR BUDGET ► Shows when and how much of each direct labor category to employ in order to meet the production budget ► May use average standard wage rates for each class of direct laborer rather than actual wage rates for each employee

5 C&C’S DIRECT LABOR BUDGET NOTE:If the standard production time is stated in minutes, you must convert to the hour decimal equivalent since the standard wage rate is stated on an hourly basis.

5 MANUFACTURING OVERHEAD BUDGET ► Is based on budgeted production levels of the overhead application base ► Uses the predetermined overhead rate for variable overhead ► Assumes budgeted fixed overhead cost is incurred evenly throughout the budget period ► Pay special attention to non-cash expenses such as depreciation expense that do not flow to the cash budget

5 C&C’S OVERHEAD BUDGET Don’t forget to subtract the non-cash expenses to determine the amount of cash expenditures that will carry through to the cash budget.

5 ENDING INVENTORY AND COGS BUDGET ► Shows desired levels of ending inventory ► Assists in the preparation of budgeted balance sheet and income statement

5 C&C’S ENDING RAW MATERIALS BUDGET DM usage is based on budgeted production and standard DM cost per unit

5 C&C’S ENDING FINISHED GOODS BUDGET

5 C&C’S COST OF GOODS SOLD BUDGET

BUILDING THE MASTER BUDGET: THE OPERATING BUDGET Unit Unit 5.2Unit 5.3 Unit 5.4 © Tomwang112 / iStockphoto Unit 5.5

5 THE CASH BUDGET Cash available to spend -Cash disbursements =Cash excess or cash needed +Short-term financing =Ending cash balance

5 CASH AVAILABLE TO SPEND

5 CASH RECEIPTS BUDGET ► Based on sales budget ► Requires knowledge of historical accounts receivable collection patterns ► Distinguishes between cash sales and credit sales ► Provides ending accounts receivable balance for the budgeted balance sheet

5 C&C’S CASH RECEIPTS BUDGET

5 CASH DISBURSEMENTS

5 CASH PAYMENTS FOR MATERIALS BUDGET ► Shows when payments for materials purchases will be made ► Requires knowledge of past accounts payable payment patterns ► Calculates ending accounts payable balance for the budgeted balance sheet

5 C&C’S CASH PAYMENTS FOR MATERIALS BUDGET

5 CASH EXCESS (NEEDED) ► Cash available minus cash disbursements ► Many banks require a minimum cash balance, and that must be figured into the amount of cash excess (needed)

5 C&C’S CASH EXCESS (NEEDED)

5 SHORT-TERM FINANCING ► This section is only prepared if there is a need to borrow money or repay previously borrowed money ► Shows principal and interest amounts ► Provides the ending cash balance for the budgeted balance sheet and interest expense for the budgeted income statement

5 C&CS’ SHORT-TERM FINANCING

C&c’s cash budget

PRO-FORMA FINANCIAL STATEMENTS Unit Unit 5.2Unit 5.3Unit 5.4 © Tomwang112 / iStockphoto Unit 5.5

5 PRO-FORMA FINANCIAL STATEMENTS ► Reports “as-if” results rather than actual results ► Shows the financial position of the company assuming the budget is achieved

5 C&C’S PRO-FORMA INCOME STATEMENT