### Operational Budgeting and Profit Planning

Module 21
Operational Budgeting
and Profit Planning
Budget

Financial plan for an organization
Operating plans: sales, purchasing, production,
selling, general, and administrative expenses
 Cash inflows/outflows
 Ends with complete financial reports: income
statement & balance sheet, cash flow statement,
stockholders equity.

Typical Process for a Merchandiser
Sales Budget
Purchases
Budget
Special
Budgets
Selling Expense
Budget
General and
Expense Budget
Cash Budget
Pro Forma Statements
Income Statement & Balance Sheet
Sales Budget




Sales plan is the starting point for the budgeting
process
Includes a forecast of sales revenue
Normally includes a forecast of unit sales
The best available information is used to
forecast sales:




Market conditions in sales territories by period
Merchandise lines available
Promotion and advertising plans
Expected pricing policies (markups)
Sales Budget Example
BC Carts sells children’s carts to retailers. For
June, estimated sales are 9,000 carts at a selling
price of \$10 each with an estimated cost of \$4 per
cart.
BC Carts
Sales Budget
For Month of June 2012
Sales in units
Selling price per unit
Sales revenue
9,000
\$ 10.00
\$90,000
Budgeted revenue for June is \$90,000.
Purchases Budget


Indicates the merchandise to be purchased to
meet sales needs and ending inventory
requirements
Considers
Budgeted sales
 Desired ending inventory
 Planned beginning inventory

Purchases Budget Example
BC Carts desires to have 20% of the carts needed for the next month’s
sales in stock at the end of each month. At the beginning of June,
1,800 carts are on hand. Each cart costs \$4. Sales are planned to
increase 10% per month.
BC Carts
Purchases Budget
For Month of June 2012
Units
Sales needs
Desired ending inventory
Total
Less beginning inventory
Purchases
9,000.
1,980.
10,980.
(1,800)
9,180.
Sales for July: 9,000 + (9,000 × 0.10) = 9,900 carts
Ending inventory = 9,900 × 0.20 = 1,980 carts
Dollars
\$36,000.
7,920.
43,920.
(7,200)
\$36,720.
Number of units
times the cost per
unit of \$4
Selling Expense



Presents the expenses the organization plans to
incur in connection with sales and distribution
Costs are broken into variable and fixed costs
Variable selling costs


Developed as a percent of sales or an amount per
unit sold
Fixed selling costs

Often based on an estimate obtained from the sales
manager
Selling Expense Budget Example
BC Carts estimates
commissions at 4%
of sales and
miscellaneous
variable costs at
1.5%. Estimated
fixed selling costs
are \$3,500 for
depreciation, \$2,000
\$1,200 for
miscellaneous costs.
BC Carts
Selling Expense Budget
For Month of June 2012
Budgeted sales
Variable selling expenses
Commissions (4%)
Miscellaneous (1.5%)
Total variable expenses
Fixed selling expenses
Depreciation
Miscellaneous
Total fixed expenses
Total selling expenses
\$90,000
\$3,600
1,350
4,950
3,500
2,000
1,200
Commissions: \$90,000 × 0.04 = \$3,600
Miscellaneous: \$90,000 × 0.015 = \$1,350
6,700
\$11,650
Expense Budget


Presents the expenses planned in connection with
the general administration of the organization
Example expenses:
Compensation
 Insurance
 Depreciation
 Utilities
 Miscellaneous

Expense Budget Example
BC Carts estimates the following monthly general and
administrative costs: \$5,000 for salaries, \$800 for insurance,
\$1,100 for depreciation, \$600 for utilities, and \$900 for
miscellaneous.
BC Carts
General and Administrative Expense Budget
For Month of June 2012
Salaries
Insurance
Depreciation
Utilities
Miscellaneous
Total general and administrative expenses
\$5,000
800
1,100
600
900
\$8,400
Cash Budget


Summarizes all cash receipts and disbursements
expected to occur during the budget period
Because of issues related to the timing of sales
and collections on account


Collections on sales do not equal sales revenue
Because of issues related to the timing of
payments for purchases and other expense items

Disbursements do not equal expenses
Cash Receipts Budget Example
BC Carts budgeted its June sales at \$90,000. It estimates that 40% of
sales are cash and 60% are on credit. 30% of credit sales are collected in
the month of sale and 70% are collected in the following month.
Beginning cash balance is \$15,000 and sales during May were \$86,000.
40% Cash Sales
Sales
60% Credit Sales
30% Collected current month
70% Collected following month
CASH RECEIPTS BUDGET FOR JUNE, 2012
Collections on sales
Cash sales
\$36,000
\$90,000 × 0.40
Credit sales
Current month (30% of credit sales)
16,200
\$90,000 × 0.60 × 0.30 = \$16,200
Prior month (70% of credit sales)
36,120
Total
\$88,320
\$86,000 × 0.60 × 0.70 = \$36,120
Cash Disbursements Budget
Example
BC Carts estimates that 25% of its current month inventory
purchases will be paid during the month incurred and 75% are paid in
the following month. During May, purchases were \$32,000. Budgeted
purchases for June are \$36,720 (from the purchases budget.)
Inventory purchases section of the cash disbursements section
of the cash budget:
CASH DISBURSEMENTS BUDGET FOR JUNE, 2012
Disbursements
Purchases
Current month (25% of purchases)
Prior month (75% of purchases)
Total
\$ 9,180
\$36,720 × 0.25 = \$9,180
24,000
\$32,000 × 0.75 = \$24,000
\$33,180
Continued
Cash Disbursements Budget
Example continued
BC Carts’ general and administrative costs were \$8,200 during May, and
\$8,400 during June, \$1,100 of each which is depreciation. Income taxes
were \$15,500 during May. The company pays for selling costs in the
month incurred, and 60% of the general and administrative costs in the
month incurred with the remaining 40% the following month. Income
taxes are taxed at 30% of income before taxes and are paid the month
following accrual.
CASH DISBURSEMENTS BUDGET FOR JUNE, 2012
Selling expenses
General and administrative expenses
Current month (60%)
Prior month (40%)
Income taxes
General and administrative expenses
0.60 × (\$8,400 – \$1,100) = \$4,380
\$ 8,150
\$4,380
2,840
15,500
22,720
0.40 × (\$8,200 – \$1,100) = \$2,840
Financing Section of Cash Budget
BC Carts’ repays \$5,000 of the principal on its
bank loan on June 30 and December 31, and any
accrued interest.
CASH DISBURSEMENTS BUDGET FOR JUNE, 2012
Short-term financing
Loan repayments
Interest
Net cash used for
financing
\$5,000
750
\$5,750
\$25,000 × 0.06 × 1/2
Budgeted Financial Statements



Pro forma income statement and balance sheet
that reflect the “as-if” effects of the budgeted
activities on the actual financial position of
organization
Reflect the results if all budgetary projections are
correct
If income not good enough for top
management, then start process again
Production Budget

Additional steps are required to develop master
budgets for manufacturing organizations


Due to conversion of raw materials into finished
goods
Must determine production volume
To support sales
 To meet finished goods inventory

Production Budget Example
BC Carts produces plastic carts and has estimated sales of
9,000 carts for June and 9,900 for July. BC wants to have
10% of the materials needed for the next month’s
production and 20% of the carts needed for the next
month’s sales in stock at the end of each month.
BC Carts
Production Budget
For Month of June 2012
Sales in units
Desired ending inventory of carts
Total cart requirements
Less beginning inventory of carts
Budgeted production
9,000.
1,980.
10,980.
(1,800)
9,180.
0.20 × 9,900 (July sales)
0.20 × 9,000 (June sales)
Purchases Budget Example
Assume BC Carts plans to produce 10,098 carts in July. It wants to
have 10% of the materials needed for the next month’s production in
stock at the end of each month. Each cart requires 6 pounds of
plastic resin and two wheels. At June 1, BC had 5,508 pounds of
resin and 1,836 wheels on hand. Wheels cost \$0.30 each and resin
costs \$0.21 per pound.
BC Carts
Purchases Budget
For Month of June 2012
Resin:
Pounds of resin needs (6 lbs. x 9,180 carts)
Desired ending resin inventory
Total resin requirements in pounds
Less beginning resin inventory
Resin purchases in pounds
55,080.
6,059.
61,139.
(5,508)
55,631.
6 × 10,098 × 0.10
given
Continued
Manufacturing Cost Budget Example
BC Carts have the following costs per unit:
Direct materials
Resin:
Wheels:
Direct labor
6 pounds @ \$0.21 a pound
2 @ \$0.30 each
0.075 hrs. @ \$10 per hour
\$0.43 per unit
\$8,262
BC Carts
Manufacturing Cost Budget
For Month of June 2009
Direct materials
Resin used in production (9,180 × 6 lbs. × \$0.21)
Wheels used in production (9,180 × 2 × \$0.30)
Total direct materials
Direct labor (9,180 × 0.075 × \$10)
Variable (\$0.43 per unit)
Fixed
Total manufacturing costs
\$11,567
5,508
17,075
6,885
3,947
8,262
\$36,169
Approaches to Budgeting


Input-output: Planned sales volumes and
required inputs
Incremental: Add an increment to past year




Example: Increase budgets by 3%.
Zero-based: Every \$ justified starting at 0 for
everything.
Activity-based: Project sales volume to activity
and budget the \$ based on activity cost
Rolling (continuous) example: each month, redo
each of the next 12 monthly budgets
Participation

Extent to which lower level personnel involved with the
budget process: participative or bottom up approach



Alternative is top-down or imposed budgets
Both approaches require top management involvement
Since budgets used in performance measures,
participation often results in budgetary slack:
padding built in to expense or revenue estimates.

Slack can provide needed flexibility when situation has
high uncertainty.