2. Budgets
• A budget is a financial plan of the resources needed
to carry out activities and meet financial goals.
• Budgets play an important role in managing cash flows.
• Critical success factors are the strengths of a
company that enable it to outperform competitors.
LO1
L.O. 1 Understand the role of budgets in overall organization plans.
13 - 2
3. Human Element in Budgeting
L.O. 2 Understand the importance of people in the budgeting process.
Organization
goals
Individual
goals
Goal congruence
• Participative budgeting:
Use of input from lower- and middle-management
employees; also called grass roots budgeting
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4. Sales Forecasting
L.O. 3 Estimate sales.
• Forecasting sales is the most difficult aspect of budgeting.
Sales staff
Market researchers
Delphi technique
Trend analysis
Econometric models
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5. Forecasting Production
L.O. 4 Develop production and cost budgets.
• A production budget is a plan of resources needed
to meet current sales demand and ensure that
inventory levels are sufficient for future sales.
Beginning balance
BB
Transfers in
TI
Transfers out
TO
+ – = Ending balance
Units in beginning
inventory
Required
production
Budgeted
sales
+ – =
Units in ending
inventory
13 - 5
6. Cash Budget
L.O. 5 Estimate cash flows.
• The cash budget is a statement of cash on hand at
the start of the budget period, expected cash receipts,
expected cash disbursements, and the resulting cash
balance at the end of the budget period.
• Cash receipts:
– Collection of accounts receivable
– Cash sales
– Sales of assets
– Borrowing
– Issuing stock
– Other
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7. Cash Budget
LO5
• Cash disbursements:
– Materials purchases
– Manufacturing costs
– Operating activities
– Debt repayment
– Acquisition of new assets
– Income taxes
– Dividends
– Other activities
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8. Cash Collections Example
LO5
Santiago Pants
Monthly Collection Experience
Sales on Credit
Cash collected from current month's sales 20%
Cash collected from last month's sales 75
Cash discounts taken (percentage of gross sales) 2
Written off as bad debt 3
Total disposition of credit sales in current month 100%
Expected Sales for Three Months
January sales $500,000
February sales $450,000
March sales $600,000
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9. Cash Collections Example
LO5
Santiago Pants
Multiperiod Schedule of Cash Collections
For the Quarter Ended March 31
Beginning accounts receivable,
January 1, $540,000
January sales, $500,000a
February sales, $450,000b
March sales, $600,000c
Total cash collections
$540,000
100,000
$640,000
$375,000
90,000
$465,000
$337,500
120,000
$457,500
January
$ 540,000
475,000
427,500
120,000
$1,562,500
Month
February March
Total for
Quarter
a 20% collected in January, 75% collected in February, and 5% not collected
b 20% collected in February, 75% collected in March, and 5% not collected
c 20% collected in March, 75% collected in April, and 5% not collected
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10. Cash Disbursements Example
LO5
Santiago Pants
Monthly Disbursements for Purchases Experience
Cash disbursement for current month's purchases 50%
Cash disbursement for prior month's purchases 48
Cash discounts taken 2
Total cash disbursement for purchases 100%
Expected Purchases for Three Months
January sales $120,000
February sales $200,000
March sales $250,000
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11. Cash Disbursements Example
LO5
Santiago Pants
Multiperiod Schedule of Cash Disbursements
For the Quarter Ended March 31
Beginning accounts payable,
January 1, $256,000
January purchases, $120,000a
February purchases, $200,000b
March purchases, $250,000c
Additional cash payments
Total cash disbursements
$256,000
60,000
250,000
$566,000
$ 57,600
100,000
250,000
$407,600
$ 96,000
125,000
250,000
$471,000
January
$ 256,000
117,600
196,000
125,000
750,000
$1,444,600
Month
February March
Total for
Quarter
a 50% paid in January, 48% paid in February, and 2% discounts taken
b 50% paid in February, 48% paid in March, and 2% discounts taken
c 50% paid in March, 48% paid in April, and 2% discounts taken
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12. Budgeted Balance Sheet Example
L.O. 6 Develop budgeted financial statements.
Assets
Current assets:
Cash
Accounts receivable
Inventories
Other current assets
Total current assets
Long-term assets:
Property, plant, equipment
Less: Accumulated depreciation
Total assets
Budget Year
$ 830
540
155
161
$1,686
1,866
(1,246)
$2,306
$ 6,940
7,200
4,265
-0-
$18,405
1,470
(220)
$19,651
$ 7,399
6,840
3,995
100
$18,334
-0-
-0-
$18,334
$ 371
900
425
61
$1,757
3,336
(1,470)
$3,623
Balance
Jan 1 Additions Subtractions
Balance
Dec 31
Santiago Pants
Budget Balance Sheet
For the Budget Year Ended December 31 ($000)
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13. Budgeted Balance Sheet Example
LO6
Liabilities and Shareholders Equity
Current liabilities:
Accounts payable
Taxes payable
Current portion of long-term debt
Total current liabilities
Long-term liabilities
Total liabilities
Shareholders' equity
Common stock
Retained earnings
Total shareholders
Total liabilities and shareholders equity
Budget Year
$ 256
187
23
$ 466
258
$ 724
$ 437
1,145
$1,582
$2,306
$1,715
550
23
$2,288
-0-
$2,288
$ -0-
1,149
$1,149
$3,437
$1,694
350
23
$2,067
23
$2,090
$ -0-
30
30
$2,120
$ 277
387
23
$ 687
235
$ 922
$ 437
2,264
$2,701
$3,623
Balance
Jan 1 Additions Subtractions
Balance
Dec 31
Santiago Pants
Budget Balance Sheet
For the Budget Year Ended December 31 ($000)
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14. Budgeting in Service Organizations
Marketing and
administrative
cost budget
Sales forecast
Budgeted cost
of services
Budgeted
income
statement
Cash budget
Budgeted
balance sheets
L.O. 7 Explain budgeting in merchandising and service organizations.
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15. Ethical Problems in Budgeting
L.O. 8 Explain why ethical issues arise in budgeting.
• Budgets can create serious ethical issues
for many people.
• The company must recognize the trade-off
between encouraging unbiased reporting by
managers and the use of budget information
in performance evaluation and rewards.
13 - 15
16. Budgeting Under Uncertainty
L.O. 9 Explain how to use sensitivity analysis
to budget under uncertainty.
• Budgets allow management to explore many
alternatives.
• Spreadsheets are helpful in preparing budgets
and quantifying “what-if” conditions.
13 - 16
Budgeting is necessary for success. In Chapter 13 we discuss the planning purpose of the budgeting process. We show how a master budget is developed and how it fits into the overall plan for achieving the organizational goals.
A budget is a financial plan of the resources needed to carry out activities and meet financial goals. The budget ties together
the goals of the organization, the plans for achieving those goals, the decisions that are made, and finally, the performance
evaluation. By identifying a company’s critical success factors, those strengths that enable the company to outperform competitors,
and incorporating those factors into the strategic plan, companies are able to improve their overall competitiveness.
Using input from lower- and middle management, a participative budget facilitates goal congruence between the organization and individual goals.
Forecasting sales is the most difficult aspect of budgeting, and the rest of the budget depends upon sales. A participative sales budget, including input from staff, along with the use of other techniques and analyses is often used to reduce subjectivity.
After completing the sales budget, the production budget can be developed. The production budget plans resources needed to meet current sales demand and ensure that inventory levels are sufficient for future sales. Required production can be computed using the basic cost flow model. The units in beginning inventory (the units already available) plus budgeted units produced minus budgeted units sold equals budgeted units in ending inventory.
Regardless of budgeted profits, a company requires cash to operate. Cash budgeting is important to ensure company solvency, maximize interest earned on cash balances, and determine whether the company is generating enough cash for operations. Preparing a cash budget requires that all revenues, costs, and other transactions be examined in terms of their effects on cash. Budgeted cash receipts are computed from collections of accounts receivable, cash sales, sales of assets, borrowing, issuing stock, and other cash-generating activities.
Cash disbursements are computed by determining cash required for materials purchases, manufacturing costs,
operating activities, debt repayment, acquisition of new assets, income taxes, dividends, and other activities.
Assume that Santiago Pants collects 20% of the cash on credit sales in the month of the sale and 75% in the following month.
2% of sales are taken as a discount by customers and 3% is written off as bad debt. Notice, a total of 5% is never collected
(2% taken in discounts and 3% written off as bad debt). Let’s look at cash receipts from sales for the first quarter if expected
sales for January, February, and March are $500,000, $450,000, and $600,000 respectively.
Accounts receivable on January 1 total $540,000 (net of discounts and bad debt) all of which is anticipated to be collected during January. Santiago Pants also expects to collect 20% of the $500,000 January sales during January, so cash collections budgeted for January total $640,000. In February, 75% of January sales (75% of $500,000 equals $375,000), and 20% of February sales (20% of $450,000 or $90,000) are expected to be collected for total cash collections of $465,000 in February. Finally, in March, total collections are $457,500, 20% of March sales and 75% of February sales. Total budgeted cash collections for the first quarter are $1,562,500.
We also need to analyze cash disbursements for the quarter. Santiago pays suppliers 50% in the month of purchase, 48% in the following month, and takes advantage of a 2% discount. Expected purchases for the quarter are $120,000 in January, $200,000 in February, and $250,000 in March.
Total cash disbursements for purchases in January include the beginning accounts payable balance of $256,000 and 50% of the
January purchases of $120,000, or $60,000, and $250,000 cash disbursements for items other than inventory purchases. Total cash disbursements for January are $566,000. Total cash disbursements for February are $407,600 and total cash disbursements for March are $471,000. Total cash disbursements for the first quarter are $1,444,600. Now, reviewing the schedule of cash receipts and the schedule of cash disbursements, Santiago Pants can determine if cash is available each month for operations.
The next step in the budgeting process is the budgeted balance sheet. The budgeted balance sheet combines an estimate of financial position at the beginning of the budget period with the budgeted results of operations for the period and estimated changes in assets and liabilities. Santiago Pants’ budgeted balance sheet shows total assets at the beginning of the year of $2,306,000 and at the end of the year of $3,623,000.
The budgeted liabilities and shareholders’ equity are also $2,306,000 at the beginning and $3,623,000 and end of the year.
Budgeting in a service organization follows the same process except that a service organization does not produce products and, therefore, has no production budget. A significant part of the cost budget is the cost of labor. Again, start with the sales forecast and end with the budgeted balance sheets.
Budgeting creates serious ethical issues for many people. Managers and employees provide much of the information for the budget and their performance is then compared to the budget. For example, as a manager, suppose that you believe that although it is possible to achieve a 10% increase in sales in your department, a 2% increase is virtually certain. If you budget a 10% increase and fall short of your budget you may lose the opportunity for merit pay or for a promotion. If you budget a 2% increase, however, the company will not provide enough capacity to fill orders if sales actually increase 10%. As the manager, how do you budget sales? Do you do what is in your interest, budget a 2% increase knowing you can meet budget (and perhaps get that merit pay or promotion) or do what is in the interest of the company and budget a 10% increase?
All types of uncertainties exist. Management may use sensitivity analysis to determine what will happen under changing market conditions.
