Chapter Seven
Planning for Profit and
Cost Control
Three Levels of Planning
1. Strategic planning involves making long-term
decisions such as defining the scope of the business,
determining which products to develop or
discounting, and identifying the most profitable
markets.
2. Capital budgeting focuses on intermediate range
planning and involves decisions as whether to buy or
lease equipment, whether to stimulate sales, or
whether to increase company assets.
3. Master budget describes short-term objectives in
specific sales targets, production goals, and financing
plans.
Advantages of Budgeting
Promotes
Planning
Promotes
Coordination
Budgeting
Enhances
Performance
Measurement
Enhances
Corrective
Actions
Budgeting and Human Behavior
Upper management must be sensitive to the impact of
the budgeting process on employees.
Budgets are
constraining. They
limit individual
freedom in favor of
an established plan.
Many people find
evaluation based on
budget expectations
stressful. Think of
students and exams.
Upper management must demonstrate that
budgets are sincere efforts to express realistic
goals employees are expected to meet.
Cash Receipts
and Payments
Schedules
Operating
Budgets
Start
Pro forma
Financial
Statements
Cash
receipts
Sales
budget
Income
Statement
Cash
payments
for inventory
Inventory
purchases
budget
Balance
Sheet
Cash
payments
for S & A
S&A
expense
budget
Statement of
Cash Flows
Cash
budget
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.
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.
Cost of budgeted sales
Plus: Desired ending inventory
Total inventory needed
Less: Beginning inventory
Amount to purchase
XXX
XXX
XXX
(XXX)
XXX
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 commissions (based on
2% of sales) are paid in the month following the
sale, while supplies expense, based on 1% of sales)
are paid in the month of the sale. The utility
expense is paid in the month following the usage of
the electricity, gas, and water.
Check Yourself
Astor Company expects to incur the following operating
expenses during September: Salary Expense, $25,000; Utility
Expense, $1,200; Depreciation Expense, $5,400; and Selling
Expense, $14,000. It pays operating expenses in cash in the
month in which it incurs them. Based on this information, the
total amount of cash outflow reported in the Operating
Activities section of the pro format Statement of Cash Flows
would be:
a. $45,600.
b. $31,600.
c. $40,200.
d. $44,400
Depreciation Expense is a non-cash
charge to income and will not appear
on the Statement of Cash Flows.
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 asset in those tasks.
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.
End of Chapter Seven