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CHAPTER 11

The Use of Budgets in Planning and Decision Making

© 2009 Cengage Learning

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Introduction

•Budgets are plans dealing with the acquisition and use of resources over a specified time period.

•Who budgets?•Everyone from college students to large multinational companies

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Introduction

•Budgets aren’t just financial, they can be in terms of:

•Time•Acquisition and use of thousands of different materials•Manufacturing of hundreds of products

4Budgets for Planning,

Operating, and Control

Budgets are used throughout the

planning, operating, and control activities of managers.

Key Concept

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Budgets for Planning,

Operating, and Control

Budgeting is an integral part of the planning, operating, and

control activities of managers.Planning:

Developing objectives and goals

Control: Insuring that

objectives and goals are met,

comparing actual to budget

BUDGETINGOperating: Day-to-day management

decisions

6Budgets for Planning,

Operating, and ControlThe operating cycle focuses

on cash; thus, budgeting for cash needs is crucial.

Cash on hand

Collection of cash from

customers

Disbursement of cash for

manufacturing costs or purchases of

inventorySale of Product

7The Budget Development

Process

Budgeting is a management task, not a bookkeeping task.

Key Concept

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The Budget Development Process

Zero-Based Budgets require

managers to build budgets

from the ground up each year

rather than just add a

percentage increase to last year’s numbers.

Why shouldn’t I just use 10% more than last

year for everything?

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The Budget Development Process

•Traditionally, budgeting is a bottom-up process dependent on departmental managers to provide detailed plans for the upcoming month, quarter, or year.

•Participatory budgeting starts with departmental managers and flows up to top management

10The Budget Development

Process

Budgets must start with a top-down strategic plan that guides

and integrates the whole company and its individual

budgets.

Key Concept

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Advantages of Budgeting

1. The budgeting process forces communication throughout the organization.

2. The budgeting process forces management to focus on the future and not be distracted by

daily crises in the organization.

12Advantages of Budgeting(continued)

3. The budgeting process can help management identify and deal with potential bottlenecks or constraints before they become major problems.

4. The budgeting process can increase the coordination of organizational activities and help facilitate goal congruence.

5. The budgeting process can define specific goals and objectives that can become benchmarks, or standards of performance for evaluating future performance.

13The Master Budget

•The master budget consists of an interrelated set of budgets prepared by a business.

•The starting point is forecasting sales and preparing the sales budget.

14Budgeting for Sales

•In large companies, preparation of the sales forecast is usually accomplished by the marketing department

•Requires significant effort in the area of market research

•In smaller companies, the sales forecast may be made by an individual or small group of managers

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Budgeting for Sales

Things to consider

• Anticipated marketing or advertising plans

• The impact of new products or changes in product mix on the entire product line

• Other factors, such as political and legal events and weather changes

16Budgeting for Sales

Budgets are future oriented and make extensive use of estimates and

forecasts.

Key Concept

17Operating Budgets: An

Example

•Tina’s Fine Juices•Produces bottled orange juice from fruit concentrate•Only ingredients are water and juice concentrate•Juice is blended, pasteurized, and bottled•Process is heavily automated•Each machine is run by one employee and can process 10 bottles of juice per minute or 600 bottles per hour

18Operating Budgets

Sales Forecast

January

February

March

250,000 Bottles

325,000 Bottles

450,000 Bottles

19Operating Budgets

Sales Budget

MONTH

Projected sales (bottles)

Price per bottle

Total projected sales

January

250,000

$1.05

$262,500

February

325,000

$1.05

$341,250

March

450,000

$1.05

$472,500

1st Quarter

1,025,000

$1.05

$1,076,250

20Operating Budgets

Basic Production Budget

Sales forecast (in units)

+ Desired ending inventory

= Projected production needs

- Projected beginning inventory

= Projected production volume

21Operating Budgets

Sales forecast (bottles)

Projected ending inventory (+)

Total projected production needs

Beginning inventory (-)

Projected production bottles

Jan

250,000

32,500

282,500

25,000

257,500

Feb

325,000

45,000

370,000

32,500

337,500

March

450,000

50,000

500,000

45,000

455,000

Total Qtr.

1,025,000

50,000

1,075,000

25,000

1,050,000

Production Budget

22Operating Budgets

Projected production (bottles)

Projected ending inventory (+)

Total projected needs

Projected beginning inventory (-)

Bottles to be purchased

Projected purchases x $.10/bottle

Jan

257,500

67,500

325,000

51,500

273,500

$27,350

Feb

337,500

91,000

428,500

67,500

361,000

$36,100

March

455,000

98,000

553,000

91,000

462,000

$46,200

Total Qtr.

1,050,000

98,000

1,148,000

51,500

1,096,500

$109,650

Materials Purchases Budget - Bottles

23Operating Budgets

Projected production (bottles)

Direct labor time per 600 bottles

Direct labor hours for production*

Direct labor rate per hour

Projected DL cost

*Projected production/600

Jan

257,000

1 hour

429.17

$15/hr

$6,438

Feb

337,500

1 hour

562.5

$15/hr

$8,437

March

455,000

1 hour

758.33

$15/hr

$11,375

1st Qtr.

1,050,000

1 hour

1,750 hrs

$15/hr

$26,250

Direct Labor Budget

24Operating Budgets

Budgeted machine hrs.

Variable overhead rate

Projected variable OH

Budgeted fixed OH

Total projected

manufacturing overhead

Jan

429.17

$54.75

$23,497

123,333

$146,830

Feb

562.5

$54.75

$30,797

123,333

$154,130

March

758.33

$54.75

$41,519

123,333

$164,852

1st Qtr.

1,750

$54.75

$95,813

369,999

$465,812

Manufacturing Overhead Budget

25Operating Budgets

Projected material cost--concentrate

PMC – bottles

Projected DL costs

Projected MO costs

Total projected

manufacturing costs

Jan

$41,026

27,350

6,348

146,830

$221,644

Feb

$54,154

36,100

8,437

154,130

$252,821

March

$69,302

43,200

11,375

164,852

$291,729

1st Qtr.

$164,482

109,650

26,250

465,812

$766,194

Total Manufacturing Cost Budget

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Cash Budgets

Many managers consider managing cash flow to be the single most important consideration in running a

successful business.

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Cash Budgets

•Tina’s Fine Juices

•All sales are on account. Collections are estimated as follows:

•50% in the month of the sale

•35% in the month following the sale

•15% in the second month following the sale

28Cash Budgets

Nov Dec Jan Feb Mar

Sales $200,000 $250,000 $262,500 $341,250 $472,500

Nov sales 50% 35% 15%Dec sales 50% 35% 15%Jan sales 50% 35%

15%Feb sales 50%

35%March sales 50%

Cash Receipts for 1st Qtr.

Cash Receipts

29Cash Budgets

Cash ReceiptsJan Feb March 1st Qtr.

15% Nov $30,000 $30,00035% Dec $87,500 87,500 15% Dec $37,500 37,500

50% Jan $131,250 131,25035% Jan $91,875 91,875 15% Jan $39,375 39,375 50% Feb $170,625 170,625 35% Feb $119,438 119,43850% March $236,250 236,250Total $248,750$300,000 $395,063

$943,183

30Cash Budgets

Cash Disbursements Budget- Operating ActivitiesCash disbursements include:

•Material Purchases for Concentrate•Material Purchases for Bottles•Direct Labor•Manufacturing Overhead•Selling and Administrative Costs

31Cash Budgets

Summary Cash Budget

Beginning cash balance

Cash flows from operating activities

Cash receipts

Cash disbursements

Income taxes

Cash flows from investing activities

Equipment purchases

Cash flows from financing activities

Payment of dividends

Interest on long-term debt

Borrowing from line of credit

Repayments of line of credit

Interest on line of credit

Final cash balance

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Budgeted Financial Statements

Using the budgets, management prepares pro forma (budgeted) financial statements. They are used for internal planning purposes and to provide information to external users, such as a bank, when requesting a loan.

What do I do with all of these

budgets?

33Budgeted Financial Statements

Pro forma statements include:

•Schedule of Cost of Goods Manufactured

•Income Statement

•Balance Sheet

34Budgeting in an International Environment

•Considerations:•Translating foreign currency

•Predicting inflation rates and prices in unstable economies

•Predicting sales in countries with different consumer preferences

•Dealing with different labor laws, social customs, and norms affecting wage rates and the productivity of workers

35 Nonfinancial Budgets

Time Budgets: to plan the number of hours expected to be incurred in each engagement (CPA firm and law offices)

Customer-Satisfaction-Measures: includes the number of returned or defective items, the number of customer complaints, time waiting to be served

36Static vs. Flexible Budgets

Static budgets are set at the beginning of the period and remain constant throughout the budget period.

Flexible budgets take differences in cost and revenue due to volume differences out of the analysis by budgeting for labor (and other costs) based on the actual number of units produced.

What if my sales are not

what I projected?

37Static vs. Flexible Budgets

Flexible budgets are based on the actual

number of units produced rather than the

budgeted units of production.

Key Concept

38Static vs. Flexible Budgets

Static Budget ActualProjected production (bottles) 257,500

250,000Projected direct labor costs $6,438 $6,300

Difference $138

Flexible Budget Actual

Projected production (bottles) 250,000 250,000

Projected direct labor costs $6,250 $6,300

Difference

$50

39ABC and Flexible Budgets

Tina’s Fine Juices would:•Budget costs for moving materials based on the budgeted cost per move and the actual number of moves made during the month.

•Compute the per-unit budget amounts for other batch-level and product-level costs and include those in the flexible budget along with the regular variable costs and fixed costs.