Chapter 9 Notes Page 1 Please Send Comments and Corrections to me at [email protected] Budgeting In this chapter we discuss the process of budgeting. A business needs to plan for future contingencies, and it needs to make sure that it can handle them. A budget is an expression of a business’ plans and goals using dollar amounts. You begin by forecasting sales (in dollars and units) and from there you calculate: (i) the expenses that you will need in order to support your sales forecast, (ii) the capital expenditures that you will need to make to support your operations, and (iii) the cash inflows and outflows that your anticipated sales, expenses and expenditures will generate. By engaging in this process you can help make sure that you have the resources that your business will need in the future The budget process is also a tool that can be used in evaluating a business’ personnel. If sales are estimated to be a set amount and fewer sales are generated, then you can ask the personnel responsible for sales to explain why the sales fell short of expectations. Similarly, if expenses or expenditures are higher than anticipated, you can ask the personnel responsible for those outlays to explain why they were above expectations.Chapter 9 Notes Page 2 Please Send Comments and Corrections to me at [email protected] The Master Budget The master budget is a comprehensive financial plan for a business. It is made up of the Operating and Financial budgets, which are in turn made up of supporting schedules (budgets). The Operating Budget The Operating Budget is a Budgeted Income Statement and all supporting schedules. As an example, you would do the following in order to construct a rough operating budget for a manufacturing operation: • You plan on how many units you will sell. I will sell 100,000 units this year. Where will those units come from? How many units do I already have? Will I need any more units for inventory purposes? • You plan on how many units you will produce this year. From this you calculate the cost to produce the units that you will need this year. • You plan on how many salesman you will need, and the other marketing expenses you will need to incur this year in order to sell the units that you want to sell. This tells you how much you will spend on marketing this year. • You plan on how many administrative support people you will need at this level of operation. This tells you how much you will spend on administrative expenses. From all of these numbers you can create a Budgeted Income Statement, which is also called a Pro Forma Income statement. You can break these numbers down by month or quarter in order to produce a quarterly Pro Forma Income Statement.Chapter 9 Notes Page 3 Please Send Comments and Corrections to me at [email protected] Operating Budget for a Manufacturing Enterprise For a manufacturing operation, an Operating Budget will begin with a Sales Budget. A Sales Budget outlines the expected sales for each product in units and dollars: You would then prepare a Production Budget. The Production Budget describes how many units must be produced in order to meet your sales needs and satisfy ending inventory requirements.Chapter 9 Notes Page 4 Please Send Comments and Corrections to me at [email protected] After the production budget is prepared, you can prepare budgets from direct materials, direct labor, and overhead. The Direct Materials Budget ties the production to the Direct Materials that will need to be purchased in order to produce the estimated units:Chapter 9 Notes Page 5 Please Send Comments and Corrections to me at [email protected] The Direct Labor Budget ties the production to the direct labor hours needed to produce the estimated units: The Overhead Budget shows the expected cost of all indirect manufacturing items. The Ending Finished Goods Inventory Budget supplies information needed for the budgeted balance sheet and also serves as an important input for the preparation of the cost of goods budget.Chapter 9 Notes Page 6 Please Send Comments and Corrections to me at [email protected] You estimate all of your selling general and administrative expenses in one Selling, General and Administrative Budget.Chapter 9 Notes Page 7 Please Send Comments and Corrections to me at [email protected] The Financial Budget The remaining budgets that appear in the Master Budget make up the Financial Budget. The Financial Budget typically consists of the Cash Budget, the Budgeted Balance Sheet, and the Budgeted Income Statement. From the prior supporting budgets, you can then produce the Budgeted Income Statement.Chapter 9 Notes Page 8 Please Send Comments and Corrections to me at [email protected] The Cash Budget shows all of the cash inflows and outflows that tie into the numbers indicated in the Financial Budget. In addition, it shows other inflows and outflows, including cash inflows and outflows from financing activities.Chapter 9 Notes Page 9 Please Send Comments and Corrections to me at [email protected] From all of the previous budgets, you can then prepare a Budgeted Balance Sheet.Chapter 9 Notes Page 10 Please Send Comments and Corrections to me at [email protected] Static vs. Flexible Budgets Most Master Budgets suffer from the fact that they are static budgets. A static budget assumes that one level of activity is achieved. It probably would be more beneficial for a budget to assume that different levels are achieved when dealing with variable costs. The following chart indicates how a Flexible Production Budget might be shown:Chapter 9 Notes Page 11 Please Send Comments and Corrections to me at [email protected] Budget Variances It is important to compare the budgeted performance with the business’ actual performance. This is done by calculating budget variances. This is the topic of the next two chapters. Calculating budget variances are important because it verifies the budgeted process. It will become evident that people are using unrealistic budget numbers because large budget variances
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