chapter 7 planning for profit and cost control. the mcgraw-hill companies, inc....

CHAPTER 7

Planning for Profit and Cost

Control

The McGraw-Hill Companies, Inc. 2008McGraw-Hill/Irwin

7-2

Learning Objective

LO1LO1

To describe the budgeting process and the benefits it

provides


7-3

Three Levels of Planning

1.1. Strategic planningStrategic planning involves making long-term involves making long-term decisions such as defining the scope of the decisions such as defining the scope of the business, determining which products to business, determining which products to develop or discontinue and identifying the develop or discontinue and identifying the most profitable markets.most profitable markets.

2.2. Capital budgetingCapital budgeting focuses on intermediate- focuses on intermediate-range planning and involves decisions such as range planning and involves decisions such as whether to buy or lease equipment, whether to whether to buy or lease equipment, whether to stimulate sales, or whether to increase stimulate sales, or whether to increase company assets.company assets.

3.3. The Operations budgetThe Operations budget describes short-term describes short-term objectives in specific amounts of sales targets, objectives in specific amounts of sales targets, production goals, and financing plans.production goals, and financing plans.

1.1. Strategic planningStrategic planning involves making long-term involves making long-term decisions such as defining the scope of the decisions such as defining the scope of the business, determining which products to business, determining which products to develop or discontinue and identifying the develop or discontinue and identifying the most profitable markets.most profitable markets.

2.2. Capital budgetingCapital budgeting focuses on intermediate- focuses on intermediate-range planning and involves decisions such as range planning and involves decisions such as whether to buy or lease equipment, whether to whether to buy or lease equipment, whether to stimulate sales, or whether to increase stimulate sales, or whether to increase company assets.company assets.

3.3. The Operations budgetThe Operations budget describes short-term describes short-term objectives in specific amounts of sales targets, objectives in specific amounts of sales targets, production goals, and financing plans.production goals, and financing plans.


7-4

Advantages of Budgeting

BudgetingBudgetingBudgetingBudgeting

PromotesPromotesPlanningPlanningPromotesPromotesPlanningPlanning

PromotesPromotesCoordinationCoordination

PromotesPromotesCoordinationCoordination

EnhancesEnhancesPerformance Performance MeasuremenMeasuremen

tt

EnhancesEnhancesPerformance Performance MeasuremenMeasuremen

tt

EnhancesEnhancesCorrective Corrective

ActionsActions

EnhancesEnhancesCorrective Corrective

ActionsActions


7-5

Learning Objective

LO2LO2

To explain the relationship

between budgeting and human

behavior


7-6

Budgeting and Human Behavior

Upper management must be sensitive to the impact of the budgeting process on employees.

Budgets are Budgets are constraining. constraining.

They limit They limit individual individual

freedom in favor freedom in favor of an established of an established

plan.plan.

Budgets are Budgets are constraining. constraining.

They limit They limit individual individual

freedom in favor freedom in favor of an established of an established

plan.plan.

Many people find Many people find evaluation based evaluation based

on budget on budget expectations expectations

stressful. Think of stressful. Think of students and students and

exams.exams.

Many people find Many people find evaluation based evaluation based

on budget on budget expectations expectations

stressful. Think of stressful. Think of students and students and

exams.exams.Upper management must demonstrate Upper management must demonstrate

that budgets are sincere efforts to that budgets are sincere efforts to express realistic goals employees are express realistic goals employees are

expected to meet.expected to meet.

Upper management must demonstrate Upper management must demonstrate that budgets are sincere efforts to that budgets are sincere efforts to

express realistic goals employees are express realistic goals employees are expected to meet.expected to meet.


7-7

Cashpaymentsfor S & A

Cashpayments

for inventory

Inventorypurchases

budget

Incomestatement

S & Aexpensebudget

Balancesheet

Cashreceipts

Salesbudget

Cashbudget

Statement ofcash flows

Cash Receiptsand Payments

Schedules

OperatingBudgets

Pro formaFinancial

StatementsStartStart


7-8

Learning Objective

LO3LO3

To prepare a sales budget and related schedule of cash

receipts


7-9

Sales Budget

Detailed schedule prepared by the marketing department showing expected

sales for the coming periods and expected collections on those sales. It is critical to

the success of the entire budgeting process.


7-10

Sales Budget

Hampton Hams (HH) is preparing a sales Hampton Hams (HH) is preparing a sales budget for the last quarter of the year. Sales of budget for the last quarter of the year. Sales of hames are expected to peak in the months of hames are expected to peak in the months of

October, November and December (the holiday October, November and December (the holiday seasons). The store sales for October are seasons). The store sales for October are

expected to total $160,000 ($40,000 in cash expected to total $160,000 ($40,000 in cash sales, and $120,000 in sales on account). Sales sales, and $120,000 in sales on account). Sales are expected to increase by 20% per month for are expected to increase by 20% per month for

November and December.November and December.

Let’s prepare a sales budget.Let’s prepare a sales budget.

Hampton Hams (HH) is preparing a sales Hampton Hams (HH) is preparing a sales budget for the last quarter of the year. Sales of budget for the last quarter of the year. Sales of hames are expected to peak in the months of hames are expected to peak in the months of

October, November and December (the holiday October, November and December (the holiday seasons). The store sales for October are seasons). The store sales for October are

expected to total $160,000 ($40,000 in cash expected to total $160,000 ($40,000 in cash sales, and $120,000 in sales on account). Sales sales, and $120,000 in sales on account). Sales are expected to increase by 20% per month for are expected to increase by 20% per month for

November and December.November and December.

Let’s prepare a sales budget.Let’s prepare a sales budget.


7-11

Sales Budget

$40,000 $40,000 × 120% = $48,000× 120% = $48,000$40,000 $40,000 × 120% = $48,000× 120% = $48,000$120,000 $120,000 × 120% = $144,000× 120% = $144,000$120,000 $120,000 × 120% = $144,000× 120% = $144,000

Accounts receivable at December 31Accounts receivable at December 31stst are are $172,800, the uncollected sales on $172,800, the uncollected sales on

account.account.

Accounts receivable at December 31Accounts receivable at December 31stst are are $172,800, the uncollected sales on $172,800, the uncollected sales on

account.account.


7-12

Schedule of Cash Receipts

Hampton Hams (HH) will collect cash sales in Hampton Hams (HH) will collect cash sales in the month of sale. Past experience shows the the month of sale. Past experience shows the company will collect cash from its credit sales company will collect cash from its credit sales in the month following the month of the sale in the month following the month of the sale

(October credit sales will be collected in full in (October credit sales will be collected in full in November).November).

Let’s prepare the cash receipts budget.Let’s prepare the cash receipts budget.

Hampton Hams (HH) will collect cash sales in Hampton Hams (HH) will collect cash sales in the month of sale. Past experience shows the the month of sale. Past experience shows the company will collect cash from its credit sales company will collect cash from its credit sales in the month following the month of the sale in the month following the month of the sale

(October credit sales will be collected in full in (October credit sales will be collected in full in November).November).

Let’s prepare the cash receipts budget.Let’s prepare the cash receipts budget.


7-13

Schedule of Cash Receipts

Sales revenue on the income statement Sales revenue on the income statement will be the sum of the monthly sales will be the sum of the monthly sales

($582,400).($582,400).

Sales revenue on the income statement Sales revenue on the income statement will be the sum of the monthly sales will be the sum of the monthly sales

($582,400).($582,400).


7-14

Learning Objective

LO4LO4

To prepare an inventory purchases budget and related schedule of cash

payments


7-15

Inventory Purchases Budget

The total amount of inventory needed for each month is equal to the amount of the cost of budgeted sales plus the desired

ending inventory.


7-16


HH’s policy is that ending inventory should be HH’s policy is that ending inventory should be equal to 25% of next month’s projected cost of equal to 25% of next month’s projected cost of goods sold. At HH, cost of goods sold normally goods sold. At HH, cost of goods sold normally

equal 70% of sales.equal 70% of sales.

Suppliers require HH to pay 60% of inventory Suppliers require HH to pay 60% of inventory purchases in the month goods are purchased purchases in the month goods are purchased and the remaining 40% in the month after the and the remaining 40% in the month after the

purchase.purchase.

Let’s prepare the inventory purchases budget Let’s prepare the inventory purchases budget and the schedule of cash payments for and the schedule of cash payments for

inventory purchases.inventory purchases.


7-17


$134,400 × 25% = $33,600$134,400 × 25% = $33,600

$155,960 × 40% = $62,384 Accounts Payable

$155,960 × 40% = $62,384 Accounts Payable


7-18

$145,600 × 40% = $58,240

$145,600 × 40% = $58,240$145,600 × 60% = $87,360$145,600 × 60% = $87,360


7-19

Learning Objective

LO5LO5

To prepare a selling and administrative

expense budget and related schedule of

cash payments


7-20

Selling and Administrative Expense Budget

The details of the Selling and Administrative (S&A) Budget are shown on the next two screens. It is important to note that sales

commission (based on 2% of sales) is paid in the month following the sale, while supplies

expense (based on 1% of sales) is paid in the month of the sale. The utility expense is paid

in the month following the usage of the electricity, gas, and water.

The details of the Selling and Administrative (S&A) Budget are shown on the next two screens. It is important to note that sales

commission (based on 2% of sales) is paid in the month following the sale, while supplies

expense (based on 1% of sales) is paid in the month of the sale. The utility expense is paid

in the month following the usage of the electricity, gas, and water.


7-21

Selling and Administrative Expense Budget


7-22


7-23

Learning Objective

LO6LO6

To prepare a cash budget


7-24

Cash Budget

HH plans to purchase, for cash, store fixtures HH plans to purchase, for cash, store fixtures with a cost of $130,000 in October. HH with a cost of $130,000 in October. HH

borrows or repays principal and interest on the borrows or repays principal and interest on the last day of each month. Any money borrowed last day of each month. Any money borrowed from the bank bears interest at an annual rate from the bank bears interest at an annual rate of 12% (1% per month). The management at of 12% (1% per month). The management at

HH wants to maintain a cash balance of at HH wants to maintain a cash balance of at least $10,000 at the end of every month.least $10,000 at the end of every month.

HH plans to purchase, for cash, store fixtures HH plans to purchase, for cash, store fixtures with a cost of $130,000 in October. HH with a cost of $130,000 in October. HH

borrows or repays principal and interest on the borrows or repays principal and interest on the last day of each month. Any money borrowed last day of each month. Any money borrowed from the bank bears interest at an annual rate from the bank bears interest at an annual rate of 12% (1% per month). The management at of 12% (1% per month). The management at

HH wants to maintain a cash balance of at HH wants to maintain a cash balance of at least $10,000 at the end of every month.least $10,000 at the end of every month.


7-25

Cash Budget


7-26

Cash Budget


7-27


7-28

Check Yourself

Astor Company expects to incur the following Astor Company expects to incur the following operating expenses during September: Salary operating expenses during September: Salary Expense, $25,000; Utility Expense, $1,200; Expense, $25,000; Utility Expense, $1,200; Depreciation Expense, $5,400, and Selling Expense, Depreciation Expense, $5,400, and Selling Expense, $14,000. It pays operating expenses in cash in the $14,000. It pays operating expenses in cash in the month in which it incurs them. Based on this month in which it incurs them. Based on this information, the total amount of cash outflow information, the total amount of cash outflow reported in the Operating Activities section of the pro reported in the Operating Activities section of the pro forma Statement of Cash Flows would be:forma Statement of Cash Flows would be:

a.a. $45,600.$45,600.

b.b. $31,600.$31,600.

c.c. $40,200.$40,200.

d.d. $44,400$44,400

Depreciation Expense is a non-cashDepreciation Expense is a non-cashcharge to income and will not appearcharge to income and will not appear

on the Statement of Cash Flows.on the Statement of Cash Flows.

Depreciation Expense is a non-cashDepreciation Expense is a non-cashcharge to income and will not appearcharge to income and will not appear

on the Statement of Cash Flows.on the Statement of Cash Flows.


7-29

Learning Objective

LO7LO7

To prepare a pro forma income

statement, balance sheet, and

statement of cash flows


7-30

Pro Forma Income Statement

The pro forma income statement gives management an estimate of the expected

profitability of HH. If the project appears to be unprofitable, management can make the

decision to abandon it. Although managers remain responsible for data analysis and

decision making, computer technology offers powerful tools to assist in those tasks.


7-31

Pro Forma Income Statement


7-32

Pro Forma Balance SheetThe new store has no contributed capital because its operations will be financed

through debt (line-of-credit) and retained earnings. The amount of retained earnings

will be equal to the net income because there are no prior periods. The fixtures purchased in October will be depreciated for a full three months. Total accumulated depreciation will

be $3,000.


7-33


7-34

Pro Forma Statement of Cash Flows

Almost all the information for the Pro Forma Statement of Cash Flows can be found on the

Cash Budget.


7-35


7-36

End of Chapter 7

chapter 7 planning for profit and cost control. the mcgraw-hill companies, inc....

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