1. BUDGETING
CHAPTER 6

2. PURPOSES
Budgets are proposed as having two uses
PLANNING
CONTROL

3. PLANNING I agree that budgets are useful for planning.
Everyone budgets, it is simply a question of how formally.
By formalizing the budget process, one is more likely to plan and have a direction in which to go.

4. CONTROL
I don’t agree. If one uses the budget for control purposes, I think they damage the use of budgets for planning.
If someone is held to the budget, then they will “play games with their estimates.”
For example, assume that you are the sales manager and for year X you estimate that sales will be $10 million. Sales for year X are only $9.7 million. The CEO asks, “what went wrong?” Two weeks later, you are asked for your estimate of sales for year Y. You think sales will probably be $10.5 million. What estimate would you give?
I believe that planning is so important, one should not do anything that might interfere with it.

5. ADVANTAGES OF BUDGETS Compels strategic planning
Provides a basis for measuring performance
Motivates managers and employees
Promotes coordination and communication among subunits

6. MY SOLUTION TO PERFORMANCE MEASURES
Compare actual results with what you think they should have been, given the information you now have.
That is, in year Y, decide what you think performance should have been. You have more information in year Y than you had in year W (the year before year X).
E.g., a new competitor may have entered the market or an old competitor may have left the market. You also know more about year X’s economic situation in year Y than in year W.

7. BUDGET PROCESS Prepare the sales budget
Estimate beginning inventory and determine the desired levels of ending inventory
Prepare the production/purchases budget
Prepare the labor budget
Prepare the overhead budget
Prepare the operating budget
Prepare the cash budget

8. OTHER OPERATING BUDGETS
BUDGETING PROCESS
SALES BUDGET
PRODUCTION BUDGET
OTHER OPERATING BUDGETS
CASH BUDGET

9. OTHER OPERATING BUDGETS
PROCESS
SALES BUDGET
OTHER OPERATING BUDGETS
BUDGETED
INCOME
STATEMENT
BUDGETED
BALANCE
SHEET

10. CASH BUDGET An extremely important budget
Consider how a lender (banker) would view a loan request if you provided a cash budget long before you requested the loan.
It is important to have enough cash, to pay bills, but not have excess cash, it should be invested.

11. CASH BUDGET JAN FEB MAR BEG. BALANCE 10 RECEIPTS 230 240 225 25 30
DISBURSEMENTS
END. BALANCE 25 30 30 25 20

12. EXAMPLE OF CASH RECEIPTS BUDGET
Cash is expected to be $10,000 on Oct. 31.
Collection on sales has been:
10% in month of sale
50% in next month
35% in next month
5% is never collected
Expected sales are:
Sept. $50,000
Oct. $60,000
Nov. $70,000

13. SOLUTION for NOVEMBER CASH BUDGET
Cash collected from sales in:
Cash Balance: Nov $10,000
November Receipts ,500
Cash Available $64,500
Nov.
Oct.
Sept
Total
0.1 X 70,000
7,000
0.5 X 60,000
30,000
0.35 X 50,000
17,500
54,500

14. KAISAN BUDGETING
Incorporates continuous improvement into the process. The budget estimates improved sales or reduced costs over time.
An alternative is to set goals of reduced costs or improved revenues.

15. ACTIVITY BASED BUDGETING
Prepare the budget on the basis of activities, e.g., costs that are based on labor hours, rather than functions, e.g., material purchases.

16. BUDGET BY TYPE OF CENTER
Cost Centers
Compares actual costs with budgeted costs
Revenue Centers
Compares actual revenues with budgeted revenues
Profit Centers
Compares actual profits with budgeted profits
Investment Centers
Measures profits in relation to investments

17. BUDGETING FOR RETAIL PURCHASES
Estimate retail value of beginning inventory
Determine targeted ending inventory, at retail
Forecast (budget) sales for period, at retail
Ending inventory
+ Sales
- Beginning inventory
= Amount of goods needed
Divide amount of goods needed by estimated percentage of orders delivered
=OPEN TO BUY (at retail)
Times Cost Ratio = OPEN TO BUY (at cost)

18. EXAMPLE OF RETAIL PURCHASES BUDGET
Estimated beginning inventory ($10,000)
Estimated sales ,000
Targeted ending inventory ,000
Goods needed $45,000
Estimated delivery is 80% of goods ordered
OPEN TO BUY = $56,250 at retail
Cost to retail ratio is 45%
OPEN TO BUY = $25,312 at cost

19. PRODUCTION BUDGET
Same process as the retail budget process except that we would use units instead of dollars.

20. EXAMPLE OF PRODUCTION BUDGET
Estimated beginning inventory (4,000)
Forecasted (budgeted) sales ,000
Targeted ending inventory ,000
Production budget ,000

21. OTHER BUDGETS
All budgets use the same basic process.