Budgetary Planning and Control Chapter Ten Budgetary Planning and Control 1 1 1

Expense Budget An expense budget states the acceptable limits for costs the manager may incur in accomplishing assigned tasks. The two general ways to develop budget allowances for expenses are: Static budget Flexible budget 22 11

Flexible Budget Fixed Amount Variable Amount per Cost per Month Direct Labor Hour Indirect labor $2,400 $0.40 Supplies 200 0.40 Maintenance 1,600 0.20 Depreciation 1,200 0.00 Miscellaneous 700 0.10 Total $6,100 $1.10 The Company is expecting to work 1,000 direct labor hours for the month, but does work 1,300. 22 11

Flexible Budget Performance Report Budget for Budget for Variance Budgeted Actual Actual Costs Favorable Hours Hours Incurred (Unfavorable) Direct labor hours 1,000 1,300 Indirect labor $2,800 $2,920 $2,870 $50 Supplies 600 720 705 15 Maintenance 1,800 1,860 1,900 (40) Depreciation 1,200 1,200 1,200 0 Miscellaneous 800 830 840 (10) Total $7,200 $7,530 $7,515 $15 23 12

KEY CONCEPT Budgets must be adjusted to reflect the costs that should have been incurred given the actual level of activity before performance evaluation can take place

Master Budget A master budget is a set of financial statements and other schedules showing the expected, or pro forma, results for a future period. 10 4

Master Budget A set of interrelated budgets that allows for planning and control throughout the organization Driven by the sales forecast Includes sales budget, production budget, labor and overhead budgets, purchases budget, collections budget, capital spending budget, cash budget, and pro forma balance sheet and income statements

Master Budget + + + + Sales Forecast Assumptions about cost behavior Pro forma income statement + Assumptions about levels of inventory, collections of receivables, and payments of expenses and liabilities Budgets for purchases and production + Balance sheet at beginning of budget period Budgets for cash and requirements for short-term financing + Plans for long-term financing and for capital spending Pro forma balance sheet 15 6

Organization of Budgets Continuous budgets are maintained by adding a budget for a month (or quarter) as one of these periods goes by. Thus, a 12-month budget exists at all times. Project budgets reflect expectations for various stages of completing specific projects. 2005 16 7

Methods Used to Forecast Sales Indicator methods Historical analysis Judgmental methods Your sales will be... 19 8

Interim Period Forecasts Three types of sales forecasts 1. Annual forecasts 2. Longer-term forecasts (3 to 5 years) 3. Quarterly or monthly forecasts

Budget Example April 700 Sales budgets by month: January $400 February 500 March 800 April 700 May 600 Cost of goods sold will be 60 percent of sales dollars. Inventory should be 40% of next month’s cost of sales Total fixed costs will be $150, of which $15 per month is depreciation expense. 30 16

Lag Information Other data: Home effects collects 70% of its sales in the month of sales, 30% in the following month. Home effects pays for purchases 60% in the month of purchase, 40% in the following month. Home effects pays all other expenses requiring cash disbursements as incurred. Home effects tries to keep at least $50 cash as a buffer against unexpected cash needs.

Home Effects Balance Sheet December 31, 2003 Assets: Liabilities: Cash $80 Accounts payable $195 Accounts receivable 120 Stockholder’s equity 1,131 Inventory 96 Fixed assets, net 1,030 Total $1,326 Total $1,326

Purchases Budget Cost of goods sold $240 $300 $480 $1,020 Three-months January February March Total Cost of goods sold $240 $300 $480 $1,020 Budgeted ending inventory 120 192 168 168 Total requirements 360 492 648 1,188 Beginning inventory 96 120 192 96 Purchases 264 $372 $456 $1,092 32 18

Cash Receipts Jan. Feb. Mar. Total Sales for the month $400 $500 $800 $1,700 From prior month, 30% $120 $120 $150 $390 From current month, 70% 280 350 560 1,190 Total receipts $400 $470 $710 $1,580

Cash Disbursements for Purchases Jan. Feb. Mar. Total From prior month, 40% $195 * $105.6 $148.8 $449.4 From current month, 60% 158.4 223.2 273.6 655.2 Total $353.4 $328.8 $384 $1104.6 * from beginning of balance sheet

Cash Disbursements-Total Costs Jan. Feb. Mar. Total For merchandise $353.4 $328.8 $422.4 $1,104.6 Fixed costs requiring cash 135 135 135 405 Total $488.4 $463.8 $557.4 $1,509.6

Minimum-Cash-Balance Policies Financial managers devote considerable attention to determining the needed minimum level of cash. As with most decisions, a trade-off between two conflicting factors is involved. A small minimum balance would lead to a higher probability of running out of cash, while too large a minimum balance would lead to little or no return. 24 18 24

Cash Budget Jan. Feb. Mar. Total Beginning balance $80 $50.6 $50.68 $80 Cash receipts 400 470 710 1,770 Total available $480 $520.6 $760.68 $1,850 Cash disbursements 488.4 463.8 557.4 1509.6 Indicated balance (8.4) 56.8 203.28 203.28 Excess (deficiency 58.4 6.8 153.28 153.28 Borrow 59 59 Interest(at 12%) .12 1.59 1.71 Repay 6 53 59 Ending balance $50.6 $50.68 $98.69 $98.69

Budgeted Income Statement Jan. Feb. March Total Sales $400 $500 $800 $1,700 Cost of goods sold 240 300 480 1,020 Gross profit and contribution margin $160 $200 $320 $680 Fixed costs 150 150 150 450 Income before interest $10 $50 $170 $230 Interest 0.59 0.59 0.53 1.71 Net Income 9.41 49.41 169.47 228.29

Ending Balance Sheet Assets: Liabilities: Cash $148.69 Accounts payable $182.4 Accounts receivable 240 Stockholder’s EQ1,359.29 Inventory 168 Fixed assets, net 985 Total $1541.69 Total $1,541.69