Module 20
Budgeting
and Profit Planning
(omit pp: 20-1 to 20-6)
1
What is a Budget?
• A budget is a detailed plan for the acquisition and
use of financial and other resources over a
specified period of time. Good budgeting practice
should provide facilitate planning, operating and
control activities.
• Planning - developing objectives and preparing
various budgets to achieve these objectives.
• Operating - daily decisions facilitated by a budget.
• Control - the steps taken by management to
increase the likelihood that the objectives set
down at the planning stage are attained, and to
ensure that all parts of the organization function in
a manner consistent with organizational policies
(budgeting for control in Chapter 21).
2
The Master Budget
• Master budget - a financial plan of an organization
for the coming year or other planning period. It
generally culminates in a cash budget, a budgeted
income statement, and a budgeted balance sheet.
• The master budget is also called the static budget.
• The master budget reflects the sales levels, cost
levels, income and cash flows anticipated for the
coming year.
• Developing a master budget is a dynamic process
that ties together goals, plans, decision making,
and performance evaluation.
3
Advantages and Disadvantages of Budgeting
• Advantages:
– forces managers to focus on the planning
aspects of the business.
– helps management
– provides benchmarks against which
performance can be evaluated.
– promotes communication and coordination
within the organization.
• Disadvantages:
– consumes a good deal of time.
– may lead to excessive reliance on
extrapolation of current trends.
– may promote a “slash and burn” mentality in
tough times.
– may lead to budget slack if used for
performance evaluation.
4
Steps in Preparing the Budget
1.
2.
3.
4.
5.
6.
7.
Sales budget.
Purchases budget.
Selling and administrative expense budget.
Cash receipts budget.
Cash disbursements budget.
Summary cash budget.
Budgeted (pro forma) financial statements
– Budgeted income statement.
– Budgeted balance sheet.
– Budgeted statement of cash flows.
Note: manufacturing budgets are complicated
by the need for raw materials as an input to
the manufacturing activity.
5
Sales Budget
• The sales budget is the basis for all other budget
components.
• Units to be sold are a function of the forecasted
selling price.
• The budget requires a forecast of sales, typically
involving sales staff and market research.
Various statistical techniques may also be used.
Sales will be forecasted in units and in dollars.
• Budgeted revenues are computed as:
Forecasted sales (in units)
x Forecasted selling price.
Budgeted revenues are used to calculate
expected cash collections for cash budget, and
any A/R that might exist at the end of the period.
6
Inventory Purchases
• We use the following relationship to forecast inventory
purchase requirements:
In Units:
BI + Purchases - EI = Units Sold
or:
Purchases = Sales +/- change in inv.
• Beginning and ending inventory levels in units are
estimated using some inventory model (e.g., percentage of
next month’s sales).
• Multiplication of each component by the forecasted cost
per unit converts these amounts to dollars.
• Payment schedules are applied, and the cash outflow is
included in the cash disbursements budget.
• Any estimated unpaid amounts at the end of the period are
reflected in Accounts Payable.
7
Selling and Administrative Costs
• The budgeting objective is to estimate the
amount of selling and administrative costs
required to:
– operate the organization at its projected
level of sales and production.
– achieve long-term company goals.
• These estimates are often based on prior
period expenditures or planned expenditures,
but adjusted for inflation, changes in
operations, etc.
• Note: some costs, such as depreciation, are
included for the budgeted income statement,
but excluded when calculating cash
disbursements.
8
Cash Budget
Cash budget - a statement of cash on hand at the start
of the budget period, expected cash receipts,
expected cash disbursements, and the resulting cash
balance at the end of the period.
• Cash disbursements - amounts required to pay for
purchases, operating expenses, taxes, interest,
dividends, etc.
• Cash receipts - collections from accounts receivable,
cash sales, sales of assets, borrowing, issuing stock,
etc.
• The cash budget requires that all revenues, costs,
expenses, and other transactions be examined in
terms of their effects on cash.
9
Budgeted Income Statement
• The budgeted income statement is easily
generated using information from the
previous budgets.
• To complete the computation of net income,
an estimate must be made of tax expense.
• The computed net income is then
incorporated into the calculation of budgeted
retained earnings.
10
Budgeted Balance Sheet
• Budgeted balance sheet - a statement of
budgeted financial position.
• The ending balance in a given account equals
the beginning balance plus any estimated
change.
• The cash budget provides the ending cash
balance on the balance sheet.
• The ending inventory for the period is reported
on the balance sheet.
• Ending accounts receivable/accounts payable
are derived from the cash budgets (the amount
of payment or receipt that is yet to happen).
11
Budgeted Statement of Cash Flows
• The budgeted statement of cash flows explains the
difference between estimated cash at the beginning
of the period and that at the end of the period. The
change in cash is explained as arising from
operating activities, investing activities, and
financing activities.
• Can be created from the other financial statements
using the indirect method, or with the detail from the
cash budget
• Operating section starts with net income, then
backs out the non-cash activity and the changes in
the related assets and liabilities (usually the current
assets and liabilities).
• Represents the operating, investing, and financing
activity that the company has undertaken.
• Different form and different information than the 12
Cash Budget.