Chapter 7: Introduction to Budgets and Preparing the Master Budget
A budget: (reading)


A comprehensive financial overview of planned company operations.
A formal, quantitative expression of management plans.
Advantages of Budgets :( reading)
1. Evaluation of Activities: It provides an opportunity for managers to
reevaluate existing activities and evaluate possible new activities.
2. Formalization of Planning: It forces managers to think ahead.
3. Communication and Coordination: It aids managers in communicating
objectives to units and coordinating actions across the organization.
4. Performance Evaluation: It provides benchmarks to evaluate subsequent
performance.
Types of Budgets:
1.
2.
3.
4.
5.
Strategic plan
Long-range planning
Capital budget
Master budget
Continuous budget
Strategic Plan:
The most forward-looking budget which sets the overall goals and objectives of the
organization.
Long-range planning:
The strategic plan leads to long-range planning, which produces forecasted financial
statements for five- to ten-year periods.
Long-range planning includes decisions about the addition or deletion of product
lines, design and location of new plants, acquisition of buildings and equipment, and
other long-term commitments.
Capital budget:

Detail the planned expenditures for facilities, equipment, new products, and other
long-term investments in coordination with long-range plans.
Master budget (Pro Forma Statements):


Link both long-range plans and short-term budgets.
a detailed and comprehensive analysis of the first year of the long-range plan.
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
It summarizes the planned activities of all subunits of an organization (Sales,
Production, Distribution, and Finance).

It is a periodic business plan that includes a coordinated set of detailed
operating schedules and financial statements.
Continuous Budget (Rolling budgets):
 A common form of master budgets that add a month in the future as the month just

ended is dropped.
This type of budget forces managers to think specifically about the full next year not
just the remained of the current fiscal year.
Managers may also prepare daily or weekly task-oriented budgets that help them
carry out their particular functions and meet operating and financial goals
Components of a Master Budget:
The usual master budget for a nonmanufacturing company has the following
components:
1. Operating Budget (profit plan): focuses on the income statement and its
supporting schedules.
a. Sales budget
b. Purchases budget
c. Cost of goods sold budget
d. Operating expenses budget
e. Budgeted income statement
2. Financial budget focuses on the effects that the operating budget and other plans
(e.g., capital budgets and repayments of debt) will have on cash.
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f.
Capital budget
g.
Cash budget
h.
Budgeted balance sheet
(5 min.)
1. a. Budgeted income statement
b. Budgeted balance sheet
c. Cash budget
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d. Capital budget
2. Sales budget (or operating budget)
3. Continuous (rolling)
4. Overall goals of the organization
Preparing the master budget:
The cooking hut example …p306
The principal steps in preparing the master budget
Step 1: Preparing Basic Data:
b- cash collection from
customers
a- sales budget
:( basically differentiate between cash and credit sales we made)
In preparing it we'll search for the following:
1. Budgeted sales for forthcoming years (total).
2. Selling term:
 Ex: Cash sales 60%, credit sales 40%& and the credit sales (or accounts
receivable) will be collected next month.
: (this reflects the cash that I'll collect this
month from my customers in return for sales that I made during this month or in
prior months)
Form the information given above we understand that:
In April: we'll collect the following:
1. All April (current month) cash sales.
2. All march (previous month) credit sales.
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March
Sales
term
April
May
June July
April-July
total
Schedule a:sales
budget
Credit sales( 40% sales)
+ Cash sales(60% sales)
ooo
xxx
ooo
xxx
ooo
xxx
ooo
xxx
ooo
xxx
Total sales
Schedule b: cash
collections
This month cash sales
+previous month credit
sales
Total collections
c- purchases and cog
budget
d- disbursements for
purchases
aim to provide a picture of my need of
inventory that I'll buy.
Purchases = amount of inventory needed – beginning inventory
Amount of inventory needed = cog + ending inventory
So it can be as following:
Purchases = cog + ending inventory – beginning inventory
will tell how much money I'll pay this month
for the purchases of inventory that I made either in this month or in previous ones.
In preparing these schedules, we need information about:
1. Budgeted sales (total)…. And 3 %:
2. Cog%
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 Ex: 70%... and of course it'll be lower than 100% as it reflect that I buy
the goods at a price lower that S.P by 60%= gross margin %
3. Minimum inventory policy
 Ex: 20,000 + 80% of next month cog….it means that the company has a
policy to finish the month with inventory at its warehouses of 20000 and
80% of the following month purchases… and t do this because it
frightened that the supplier delaying in providing the good it want to
sell…
 Purchasing policy
 Ex: 50% will be paid during the month of purchase and 50%at the
following month… so on April we 'll pay :
Part of the current month purchases (50%)
+ part of purchases not paid on previous month and we will pay it
during this month ( accounts payable of previous month).
March
April
Schedule c: purchases
budget
Budgeted cog( 70% this
month sales)
+ desired ending
inventory[20000+80%next
month cog--- (70% of next
month sales)]
-Beg inventory (ending of
prior month)
xxx
purchases
*
50%
Given
purchase
terms
Schedule d: cash
disbursement for
purchases
50% of previous month
purchases
+50% of this month
purchases
*50%
Ooo
xxx
5
May
June July
April-July
total
Disbursements for
purchases
e- operating expense
budget
f- disbursemnets of
operating expenses
Operating expenses schedule details:
 Variable costs: commissions and miscellaneous expenses.
 Fixed costs:
Cash expenses: amounts of wages, rent..
Noncash expenses: insurance and depreciation expenses for each
month. ---- won't be included on schedule (f), disbursements of
operating expenses
March
Schedule e:operating
expenses budget
Wages ( fixed)
+ Commissions( 15% of
current's month sales)
April
xxx
Total wages and commissions
Miscellaneous expense (5%
of current sales)
Rent
Insurance
fixed
Depreciation
*50%
Total operating expense
Schedule f: cash
collections
Wages and commissions
Miscellaneous expense
rent
Total disbursements
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May
June July
April-July
total
Step 2: Preparing the Operating Budget
totals
Sales
-cog
=gross margin
-operating expenses
=income from operations
-interest expense
Net income
Cash budget
Step 3: Preparation of Financial Budget
(We will focus only on the cash budget)
Cash Budget:
The cash budget is constructed using three major sections:
First: the available cash balance = beg. Cash balance – min cash balance desired
Second: net cash receipts and disbursements:
1. Expected cash receipts (Schedule b)
2. cash disbursements for purchases (Schedule d),
3. disbursements for operating expenses (Schedule f),
4. and other disbursements include outlays for fixed costs, long term
investments, dividends and the like.
third: An excess or deficiency of cash is computed as the difference between the
cash available and the total cash needed in order to determine whether the
company needs to borrow funds or if prior borrowings and interest may be paid
off.
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The available cash balance + net cash receipts and disbursements=
-ve----- cash deficiency
Borrowing is necessary
+ve….loan repayment (for both together)
(Watch if he said borrow in multiplies if 1000)
principal
Interest: part of p repaid * %*no of months this part
remain with me \ 12)
So cash budget shows the patterns of short-term, (self-liquidating) financing. The resulting
loan is (self-liquidating) –as the company uses borrowed money to acquire merchandise
for sale, and uses the proceeds from sale to repay the loan .this (working capital cycle)
moves from cash to inventory to receivables and back to cash.
April
Beginning cash balance ( ending for prior
periods)
- Minimum cash balance desired (fixed, given)
Available cash balance(x)
Cash receipts and disbursements:
1. Collections to customers (Schedule b)
2. cash disbursements for purchases
(Schedule d),
3. disbursements for operating expenses
(Schedule f),
4. and other disbursements include outlays
for fixed costs, long term investments,
dividends and the like( given)
Net cash receipts and
disbursements(y)
Excess (deficiency) of cash before
financing x+y
Financing:
deficit : Borrowing --- ( at the
beginning of the month)
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May
June
July
excess :
Repayments --- ( at the end of the
month)
Interest payments
Total cash increase ( decrease) from
financing
Ending cash balance (beginning
balance +y +x)
Another form of the cash budget (simpler way):
Beginning cash balance
+ cash receipts from customers
-cash disbursements for purchases
-cash disbursements for operating expenses
-any other cash disbursements
The cash we have
- minimum cash we need
= Ending cash balance
If the ending number was negative this means that we 'll borrow to cover this deficit, so 'll
add extra section:
+ Finance / borrowing / loan
= Ending cash balance
And on the next month we have positive ending balance we 'll add extra items to cash
disbursements representing in
 repayment loan
 interest paid = part of loan that we repay during current month * no of
months passed since we take loan /12 * %
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