M Ch. 5 - Master Budgets

Budgeted financial statements include:

1. Budgeted Income Statement 2. Budgeted Balance Sheet Look exactly like ordinary financial statements except they list budgeted (projected) amounts rather than actual amounts

Budgets require companies to complete many calculations and technology can make it more cost effective for managers to

1. Conduct sensitivity analysis 2. Combine individual unit budgets to create the companywide master budget

Managers use budgets in fulfilling their major responsibilities:

1. Develop strategies - overall business goals 2. Company plans and budgets for specific actions to achieve those goals 3. Direct the company on how to act or how to carry out the plans 4. After acting, managers compare actual results with the budget and use the information to make control decisions. Feedback allows them to determine what if any corrective action to take. (Cut other costs or increase revenues) Decisions affect the company's future strategies and plans

If managers use the budget as a benchmark to evaluate employee's performance, managers must first motivate employees to accept the budget's goals. Ways to do this:

1. Managers must support the budget themselves or no one else will 2. Managers must show employees how budgets can help them achieve better results 3. Managers must have employees participate in developing the budget so that employees feel the goals are realistic and achievable

Master Budget includes 3 types of budgets:

1. Operating Budget 2. Capital Expenditures Budget 3. Financial Budget

Strategic Budget

A long-term financial plan used to coordinate the activities needed to achieve the long-term goals of the company. Often span 3 to 10 years Because of their longevity, often are not as detailed as budgets for shorter periods

Operational Budget

A short-term financial plan used to coordinate the activities needed to achieve the short-term goals of the company. Usually much more detailed than strategic budgets Most often 1 year in length (fiscal year usually) but can be a week, month, or quarter depending on company's needs Some companies develop a variation of the operational budget that maintains a continuous projection into the future

Operational indicates a short term goal

After the company develops strategies and creates a strategic budget, the next step is to plan for shorter periods

Zero-Based Budget (ZBB)

All revenues and expenses must be justified for each new period. Assumes all operations are being started for the first time and the previous year's actual results are ignored Effective way to limit the inflation of budgets and control unnecessary expenses

Budgets should always be compared to actual results

Areas where actual results differed from the budget should be evaluated in order to explain why the amounts differed. This function helps to highlight any problems and provides opportunities for management to implement new strategies to meet its goals

Total Columns of the Cash Budget are simply not sums across the entire row since this is summary for the entire year

As with production budget and direct materials budget think carefully and look at the pictures

Coordination and Communication

Budget coordinates a company's activities. Creating a budget facilitates coordination and communication by requiring managers at different levels and in different functions across the entire value chain to work together to make a single, unified, comprehensive plan for the business

Budgeting requires managers to plan, promotes coordination and communication, and provides a benchmark for evaluating actual performance.

Budget represents the plan the company has in place to achieve its goals

In a merchandising company, just as with a manufacturing company, the forecast of sales revenue is the cornerstone of the master budget because the level of sales affects expenses and almost all other elements of the master budget.

Budgeted total sales for each product equal the sales price multiplied by the expected number of units sold

Planning

Budgeting requires managers to plan for the company's future. Decisions are based on this formalized plan which helps prevent haphazard decision making. Budgets are plans for future activities and may need to be modified. The better the plan and the more time the company has to act on the plan, the more likely it will be to find a way to meet the target

Benchmarking

Budgets provide a benchmark that motivates employees and helps managers evaluate performance. Companies might compare budgeted numbers with the previous year's performance or the company might compare their budgets to other leading companies through the use of industry averages Benchmarking helps companies determine where a company can improve and helps companies plan how to meet performance goals Through the benchmarking process, companies are able to create budgets that present a detailed road map of how performance goals will be achieved

Order for the last budgets

Capital expenditures budget -> Cash Budget -> Budgeted Financial Statements

Cash Payments

Company has cash payments for capital expenditures, product costs (DM purchases, DL costs, and MO costs), and selling and administrative expenses. Calculations for cash payments require reference to several previously developed budgets: - Direct Materials - Could be purchases on account or with cash - Direct Labor - Manufacturing Overhead - Non-cash expenses are not included in the cash budget (depreciation) - Selling and Administrative Expenses - Be sure non-cash expenses such as depreciation on office equipment are not included in the cash budget - Income Tax Expense - Capital Expenditures Schedule of Cash Payments - Total quarterly cash payments for each category are carried to the cash budget, The accounts payable balance will be carried to the budgeted balance sheet

Short term financing

Compiled info for cash receipts and cash payments so can insert amounts into cash budget so we can determine the amount of short-term financing needed Borrows cash to meet the minimum cash balance desired at start of each quarter

Cost of Goods Sold Equation

Cost of Goods Sold = Beginning Merchandise Inventory + Purchases - Ending Merchandise Inventory

The cash outflow for long-term assets, such as manufacturing equipment, is at the time of purchase.

Depreciation is the allocation of the asset cost to an expense account over the life of the asset. The allocation does not affect cash and is not included in the cash budget

Cash Budget

Details how the business expects to go from the beginning cash balance to the desired ending cash balance and feeds into the budgeted financial statements.

Direct Labor Budget Equations

Direct Labor Hours Needed for Production = Budgeted Units to be Produced * Direct Labor Hours per Unit Budgeted Direct Labor Cost = Direct Labor Hours Needed for Production * Direct Labor Cost per Hour

Direct Materials Budget Equations

Direct Materials Needed for Production = Budgeted Units to be Produced * Direct materials per Unit Total Direct Materials Needed = Directed Materials Needed for Production + Desired Direct Materials in Ending Inventory Budgeted Purchases of Direct Materials = Total Direct Materials Needed - Direct Materials in Beginning Inventory Budgeted Cost of Direct Materials Purchases = Budgeted Purchases of Direct Materials * Direct Materials Cost per Pound

Cash Budget

Estimates the cash receipts and cash payments for a period of time and pulls information from the other operating budgets previously prepared. Includes 3 sections: 1. Cash Receipts 2. Cash Payments 3. Short-term financing

Cash Budget for Merchandising Companies

Estimates the cash receipts and cash payments for the time period. Pulls information from the other budges previously prepared and has three sections: 1. Cash Receipts 2. Cash Payments 3. Short-term financing

Inventory, Purchases, and Cost of Goods Sold Budget

Estimates the cost of goods sold, ending Merchandise Inventory, and merchandise inventory purchases needed for the company's projected sales

Capital Expenditures Budget

Estimates the purchases of property, plant, and equipment such as delivery trucks, computer systems, office furniture, and manufacturing equipment. Decision to purchase these expensive long term assets is part of strategic plan

Capital Expenditures Budget for Merchandising Companies

Estimates the purchases of property, plant, and equipment. Cash payments shown on the cash budget

Budgeted Financial Statements

Financial statements based on budgeted amounts rather than actual amounts

Most important part of a budgeting system?

Getting managers and employees to accept the budget so the company can benefit from the control and feedback

Do not want to end the period with zero inventory; wants enough on hand to begin next period

Have minimum amount of inventory to be sure company balances providing adequate amounts of goods and services while turning over the inventory efficiently. Keeping inventory at the minimum level that meets these needs helps reduce inventory storage costs, insurance costs, warehouse costs, and reduces the potential for inventory to become obsolete

Software allows managers to conduct sensitivity analyses on their own segment's data and when the manager is satisfied with his or her budget, he or she can easily enter it in the companywide budget

His or her segment's budget automatically integrates with budgets from all other business segments - around the building, state, country, or world.

Spend it or lose it

If a business segment has a budgeted expense item and does not spend as much as expected for the item, there is a fear the budgeted item will have a lower amount in future budget periods. Employees are then motivated to purchase unneeded supplies which reduces the actual operating income for the company

Interest Expense Equation

Interest Expense = Principal x Rate x Time

Budgeted Financial Statements need several amounts that are provided in the cash budget

Interest expense calculations are carried to the budgeted income statement and ending cash balance is carried to the budgeted balance sheet. If borrowed amount not repaid in full then the balance would be carried to the budgeted balance sheet as the balance for Notes Payable

Strategic means long term goal. A company will develop strategies such as becoming the cost leader in a particular market or expanding into international markets

It may take several years to achieve these goals

To achieve the benefit of motivating employees, the budget should include input from all levels

Many companies choose to develop the budget from the bottom up (participative budget)

Budgeted Balance Sheet

One remaining calculation is Retained Earnings. Retained Earnings is increased by the amount of net income earned and decreased by the amount of dividends declared. Only shows the ending balances of each account

When a company uses participative budgeting, budgets tend to be more achievable since those directly impacted by the budget help to create the plan

Preliminary budgets are developed at the departmental level and then flow up to the higher levels of the company for review by managers, VPs, and presidents. This bottom-up approach is better for employee morale and tends to result in more buy-in from employees as opposed to budgets that are imposed on employees by senior management

Selling and Administrative Expense Budget for Merchandising Companies

Prepared next and estimates the selling and administrative expenses needed to meet the company's projected sales

Cash Receipts

Primary source of cash is from customers. Some sales are cash sales and the others on account. The on account sales have differing periods for when the cash will be collected Bad debt expense is not significant and not considered. Keep an eye out for it though The total cash receipts from customers for each quarter will be carried to the cash budget

Cash Receipts for Merchandising Company

Primary source of cash is from customers. Process repeated for all months of budget

Companies with multiple business segments must combine budget data from each of the segments to prepare the companywide budgeted income statement and budgeted balance sheet

Process can be difficult for companies whose business segments use different spreadsheets to prepare the budgets

Budgeted Balance Sheet for Merchandising Company

Pulls amounts from the various budgets previously completed. One remaining calculation is retained earnings. Retained Earnings is increased by the amount of net income earned and decreased by the amount of dividends declared.

Purchases Equation

Purchases = Cost of Goods Sold + Desired Ending Merchandise Inventory - Beginning Merchandise Inventory

Short Term Financing for Merchandising Company

Require minimum cash balances at the end of each month. Need to borrow in increments to maintain the minimum ending cash balance and nothing more Total interest expense will vary as the amount of borrowing varies from month to month. Borrowing and all principal and interest payments occur at the end of the month

Whether at HQ or on the road, top executives can log into the budget system through the Internet and conduct their own sensitivity analyses on individual business segments' budgets or on the companywide budget

Result is that managers spend less time compiling and summarizing data more time analyzing and making decisions that ensure the budget leads the company to achieve its key strategic goals

First component of operating budget is sales budget why?

Sales affect most other components of the master budget. Company should not produce products it does not expect to sell. Variable product and period costs are projected based on sales and production levels

First part of operating budget is preparing the sales budget.

Sales budget estimates the amount of sales revenue and is the cornerstone of the master budget because the level of sales affects production costs and almost all other elements of the master budget Budgeted total sales for each product equal the sales price multiplied by the expected number of units sold

Actual results often differ from plans and management therefore wants to know how budgeted income and cash flows would change if key assumptions turned out to be incorrect

Sensitivity analysis as a what if technique that asks what a result will be if a predicted amount is not achieved or if an underlying assumption changes.

Budgeting process varies from company to company

Small companies may have budgeting be simple and informal Larger companies can have the process be very complex with a budget committee coordinating the process.

Many different ways to create budgets

Some companies will use the previous year's results and modify for expected changes. In this traditional format, managers must only justify changes to the budget from the previous year's actual results

How prepare cash budget for Merchandising Company

Start with beginning cash balance from past balance sheet and add the budgeted cash receipts to determine the cash available. Then subtract cash payments for purchases, selling and administrative expenses, and any capital expenditures. This yields the ending cash balance before financing. Then compare this balance with the minimum cash balance desired to see if financing needs to be done.

In creating the master budget, managers must think carefully about pricing, product lines, job assignments, needs for additional equipment, and negotiations with banks

Successful managers take this opportunity to make decisions that affect the future course of business

Capital Expenditures Budget

The budget that presents the company's plan for purchasing property, plant, equipment, and other long-term assets.

For many people budgeting is not a formal process where plans are written and carefully followed

The failure to formalize the plans often results in a failure to achieve financial goals

Part of long-term planning companies develop a corporate strategy and set goals to meet their objectives

The goals will be integrated into the budgeting process to ensure that the company achieves its long-term strategy

Master Budget

The set of budgeted financial statements and supporting schedules for the entire organization; includes the operating budget, capital expenditures budget, and financial budget. Operational and static

Operating Budget

The set of budgets that projects sales revenue, cost of goods sold, and selling and administrative expenses, all of which feed into the cash budget and then the budgeted financial statements.

Merchandising companies purchase the products they sell rather than manufacture them

Therefore the master budget for a merchandising company will be slightly different from the master budget for a manufacturing company The inventory, purchases, and cost of goods sold budget replaces the production budget, direct materials budget, direct labor budget, manufacturing overhead budget, and cost of goods sold budget.

Technology makes it cost effective to perform more comprehensive sensitivity analyses.

Today managers are armed with a better understanding of how changes in sales and costs are likely to affect the company's bottom line and they can react quickly if key assumptions underlying the master budget (sales price or quantity) turn out to be wrong

Many companies use computer spreadsheet programs like Excel to prepare master budget schedules and statements

Today what if budget questions are easily answered in Excel with a few keystrokes

Master budget models the company's planned activities

Top management pays special attention to ensure that the results of the budgeted income statement and budgeted balance sheet support key strategies

Budgeted number of units to be produced equation

Total units needed = Number of units projected to be sold + desired number of units in ending inventory Budgeted number of units to be produced = Total units needed - units in beginning inventory

Cash Payments for Merchandising Company

Use inventory, purchases, and cost of goods sold budget to compute budgeted cash payments for purchases of inventory Use selling and administrative expense budget and payment information to compute cash payments for selling and administrative expenses. Prepaid insurance had the cash payment paid before the budget period and depreciation is a non-cash expense so it is not included in budgeted cash payments for selling and administrative expenses

Manager's performance is evaluated by comparing actual results to the budget

When they develop the company's budget, they may be tempted to participate in budgetary "gaming" and build in budgetary slack

Static Budget

a budget prepared for only one level of sales volume Ex. Expect to sell 2000 tablets and nothing else

Flexible Budget

a budget prepared for various levels of sales volume. Useful for what if analysis

Participative Budget

a budgeting process where those individuals who are directly impacted by a budget are involved in the development of the budget. Requires significant coordination among the company's various business segments. Then the budgeting process usually begins several months before the beginning of the period

Production Budget

a detailed plan showing the number of units that must be produced during a period in order to satisfy both sales and inventory needs Basis for production costs budgets: 1. Direct Materials Budget 2. Direct Labor Budget 3. Manufacturing Overhead Budget Used the to complete the Cost of Goods Sold Budget

Budget

a financial plan that managers use to coordinate a business's activities with its goals and strategies

Continuous Budget

a type of operational budget that involves continuously adding one additional month as each month goes by When using this, the company revises the budget by replacing the month that just ended with a month at the end so there is always a continuous 12-month period. Allows company to constantly monitor the budget and keep track of current and future amounts

Beginning merchandise inventory is known from last month's balance sheet and

budgeted ending merchandise inventory is a computed amount

Financial Budgets include

cash budget, budgeted financial statements - budgeted income statement and budgeted balance sheet

Direct Materials Budget

estimates the amount of materials to purchase to meet the company's production needs

Cost of Goods Sold Budget

estimates the cost of goods sold based on the company's projected sales First calculate the projected manufacturing cost to produce each unit

Direct Labor Budget

estimates the direct labor hours and related cost needed to support the production budget

Selling and Administrative Expense Budget

estimates the selling and administrative expenses needed to meet the company's projected sales Cost behavior also consider for this budget with costs designated as variable or fixed

Manufacturing Overhead Budget

estimates the variable and fixed manufacturing overhead needed to meet the company's production needs

Budget management software solves this problem and is often designed as a component of the company's Enterprise Resource Planning (ERP) system to

help managers develop and analyze budgets

Budgetary Slack

occurs when managers intentionally understate expected revenues or overstate expected expenses to increase the chances of receiving favorable performance evaluations. Adding in this slack makes the budget less accurate and less useful for planning and control

Companies use budgets to

plan, direct, and control actions and the related revenues and expenses

Financial decisions large and small

require some type of planning (budgeting)

Just as the FG Inv must be considered when calculating the amount of tablets to produce,

the RM Inv must be considered when calculating the amount of materials to be purchased

Financial Budget

the budget that includes the cash budget and the budgeted financial statements Prior components of the master budget provide information for the first element of the financial budget: cash budget

Benchmarking definition

the practice of comparing a company with its prior performance or with best practices from other companies

Because there are many different ways budgets are created and many different purposes,

there are many different types of budgets

Company would only repay the loan when

there is enough excess cash available. Borrow in increments of $1000

Predetermined Overhead Allocation Rate Equation

total estimated overhead costs / total estimated quantity of the overhead allocation base

An alternative to this traditional budgeting is

zero-based budget (ZBB)