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 Administrative 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 for advertising, and $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 Advertising 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 General and Administrative Expense Budget Presents the expenses planned in connection with the general administration of the organization Example expenses: Compensation Insurance Depreciation Utilities Miscellaneous General and Administrative 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 Variable overhead Fixed overhead 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) Manufacturing overhead 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.