BUDGETING

EMBA PresentationOctober 20, 2013

Overview

Budgets Within the Architecture of the Organization

Types of Budgets Budget Preparation Theories Example of Preparing Sales,

Production and Raw Materials Budget Example of Cash Flow Forecast

Budgeting and Organizational Architecture Assigns Decision Rights – Gives

manager the right to spend or use organizational resources

Measures Performance – Actual results to forecast

Rewards Performance – Basis to incentive compensation and recognition for accomplishing goals

Types of Budgets

Strategic Plan Long Term Budget Operating Budget

Theory of Budget Preparation Participation Bottom-up, Top-down has been found to

be a very successful approach In a survey of 219 publicly traded firms,

79% indicated lower-level managers were significantly involved in the budget process

75% stated budgeting was a managerial, not accounting, function

Budget Preparation Theories Budget Ratcheting

Uses past historical data for next year's budget

Usually raises targets from prior year May cause for lower output this year to

avoid higher targets next year

Line Item Budgets Reduce agency problems May restrict good management actions

Steps In Preparing the Operating Budget Develop Sales Forecasts Convert Sales Forecast to Production Budget Prepare Raw Material Budget in Units Prepare Raw Material Budget in Dollars Prepare Selling, General and Administrative

Budgets Prepare Income Statement Convert to Cash Forecast Prepare Pro-forma Balance Sheets

PREPARATION OF THE SALES BUDGET

The First Step to Proper Planning of Production

Getting to the Sales Numbers Input from field sales personnel Get the numbers right!!!! Using the budget as a sales

management tool

Example of Salesperson’s Input

Customer Projected Sales Probability Adjusted Sales

A $1,000,000 .50 $500,000

B $250,000 1.00 $250,000

C $500,000 .75 $375,000

Misc. $1,000,000 .80 $800,000

Sales Projections for Production Budget

January 5,000 Units February 6,000 Units March 8,000 Units April 7,000 Units May 6,000 Units

Production Assumptions

Require 30% of next month’s sales on hand at beginning of month

Project to have 1,000 units on hand at beginning of January

Calculation of Production Required

Production BudgetJan - Apr 2013

Jan Feb Mar Apr MayProjected Sales in Units 5,000 6,000 8,000 7,000 6,000

Projected Ending Inventory 1,800 2,400 2,100 1,800 6,800 8,400 10,100 8,800

Less Beginning Inventory (1,000) (1,800) (2,400) (2,100)

Required Production 5,800 6,600 7,700 6,700

Additional Assumptions

10% of next month’s raw materials must be on hand at beginning of month

Project 5,000 units on hand at begining Production process uses 5 units of raw

product for each unit of finished product Raw product costs $10.00 per unit Direct labor cost is $15.00/hour and it takes

one hour to make each finished product Overhead is applied at $4.00 per DLH

Calculation of Raw Materials Budget

Raw Materials BudgetJan - Apr 2013

Jan Feb Mar AprRequired Production 5,800 6,600 7,700 6,700

Raw Materials 29,000 33,000 38,500 33,500

Projected Ending Inventory 3,300 3,850 3,350

32,300 36,850 41,850

Less Beginning Inventory (5,000) (3,300) (3,850)

Required Purchases 27,300 33,550 38,000

Purchases in Dollars 273,000$ 335,500$ 380,000$

Cost of Goods Manufactured Schedule

Cost of Goods Manufactured ScheduleJan - Mar

Jan Feb MarUnits Produced 5,800 6,600 7,700

Cost of Units Produced:

Raw Material (5800 x 5 x $10) 290,000$ 330,000$ 385,000$

Direct Labor (5800 x 1 x $15.00) 87,000 99,000 115,500

Overhead (5800 x1 x $4.00) 23,200 26,400 30,800

Total Cost 400,200$ 455,400$ 531,300$

Per Unit Cost 69.00$ 69.00$ 69.00$

PREPARING THE CASH FORECAST

Must Be Done Prior to Preparation of Pro-forma

Balance Sheets

Harry's HabadasheryProjected Income StatementsThree Months Ending August 31, 2013

Jun Jul AugSales

Cash Sales 5,000$ 10,000$ 12,000$ On Account Sales 100,000 125,000 130,000 Total Sales 105,000 135,000 142,000

Expenses:Cost of Goods Sold 66,000 81,000 85,200 Salaries/Wages 30,000 35,000 42,000 Rent 10,000 10,000 10,000 Utilities 2,000 2,500 2,200 Total Expenses 108,000 128,500 139,400

Net Income (Loss) (3,000)$ 6,500$ 2,600$

Assumptions for Cash Flow Calculation

Company purchased $72,600 of inventory in May, $89,100 in June, and $93,720 in June

Cash balance was $10,000 on June 1

Salaries are paid on 7th and 22nd of each month

Salaries for May totaled $30,000

Additional Assumptions

Rent is paid on first day of the month Utilities are paid on the 10th day of

month following; May utilities totaled $3,000

All inventory is paid on the 10th day following month of purchase

Company has line of credit at Old Boise National Bank in amount of $100,000

Company always wants $10,000 in cash balance at end of each month

Cash Inflow Assumptions

April sales on account were $80,000 May sales on account were $90,000 Accounts Receivable are collected as

follows: 10% in month of sale 75% in first month following 10% in second month following

Cash Flow ForecastJun - Aug 2013

Jun Jul Aug

Cash Inflows:Cash Sales 5,000$ 10,000$ 12,000$ Sales on Account 85,500 96,500 116,750

Totals 90,500 106,500 128,750

Cash Outflows:Rent 10,000 10,000 10,000 Utilities 3,000 2,000 2,500 Salaries and wages 30,000 32,500 38,500 Inventory 72,600 89,100 93,720

Totals 115,600 133,600 144,750

Cash Over (Short) (25,100) (27,100) (16,000) Add Beginning Balance 10,000 10,900 10,800

(15,100) (16,200) (5,200) Borrowings 26,000 27,000 16,000

Ending Balance 10,900$ 10,800$ 10,800$

Logical Flow of Master Budget

Procurement Budget

SalesBudget

Production Budget

EndingInventory

Budget

DirectMaterials

Budget

DirectLaborBudget

FactoryOverhead

Budget

SG&ABudget

Cost of GoodsManufactured

Budget

CapitalInvestment

Budget

BudgetedIncome

Statement

BudgetedBalance

Sheet

BudgetedCash Flows

Master Budget

Copyright by Frank Ilett, 2012