The Use of Budgets in Planning and Decision Making

1
Chapter 9

• The Use of Budgets in Planning and Decision
  Making

2
Topics to be Discussed
Introduction The Budget Development
Process Budgets for Planning, Operating and
Control Advantages of Budgeting
3
Introduction
Budgets are plans dealing with the acquisition
and use of resources over a specified time period.
4
Introduction
Budgets can be in terms of Monetary or
financial Time Acquisition and use of thousands
of materials Manufacturing of hundreds of
products Attendance at a baseball game
5
Introduction
Pause and Reflect Have you ever prepared a
budget? Was it a monetary or nonmonetary budget?
How did you use it?
6
The Budget Development Process
Traditionally, budgeting is a bottom-up process
dependent on departmental managers to provide
detailed plans for the upcoming month, quarter or
year.
7
The Budget Development Process
Zero-Based Budgets require managers to build
budgets from the ground up each year rather than
just add a percentage increase to last years
numbers.
Why shouldnt I just use 10 more than last year
for everything?
8
The Budget Development Process
Key Concept Budgets must start with a top-down
strategic plan that guides and integrates the
whole company and its individual budgets.
9
The Budget Development Process
Key Concept Budgeting is a management task, not a
bookkeeping task.
10
The Budget Development Process
Budgeting is an integral part of the planning,
operating, and control activities of managers.
Planning developing objectives and goals
Operating Day-to-Day management decisions
BUDGETING
Control Insuring that objectives and goals are
met, comparing actual to budget
11
The Budget Development Process
Key Concept Budgets are used throughout the
planning, operating, and controlling activities
of managers.
12
The Budget Development Process
The operating cycle focuses on cash, thus
budgeting for cash needs is crucial.
Disbursement of cash for manufacturing costs or
purchases of inventory
Cash on hand
Sale of Product
Collection of cash from customers
13
Advantages of Budgeting
The budgeting process forces communication
throughout the organization. The budgeting
process forces managements to focus of the future
and not be distracted by daily crisis in the
organization.
14
Advantages of Budgeting
The budgeting process can help management
identify and deal with potential bottlenecks or
constraints before they become major
problems. The budgeting process can increase the
coordination of organizational activities and
help facilitate goal congruence. The budgeting
process can define specific goals and objectives
that can become benchmarks, or standards of
performance for evaluating future performance.
15
More Topics to Discuss
Budgeting for Sales Operating Budgets-An
Example Budgeting for a Traditional Manufacturing
Company with Inventory Manufacturing Overhead
Budget Cash Budgets
16
Budgeting for Sales
In large companies, preparation of the sales
forecast is usually accomplished by the marketing
department and requires significant effort in the
area of market research to arrive at an accurate
forecast of expected sales. In smaller companies,
the sales forecast may be made by an individual
or small group of managers.
17
Budgeting for Sales Some Ways to Forecast Sales
Anticipated marketing or advertising plans The
impact of new products or changes in product mix
on the entire product line Other factors such as
political and legal events and weather changes.
18
Budgeting for Sales
Pause and Reflect What unique factors might a CPA
firm specializing in tax planning and the
preparation of tax return consider in forecasting
sales?
19
Budgeting for Sales
Key Concept Budgets are future oriented and make
extensive use of estimates and forecasts.
20
Operating Budgets An Example
Produces bottled orange juice from fruit
concentrate Only ingredients are water and juice
concentrate Juice is blended, pasteurized and
bottled Process is heavily automated Each machine
is run by one employee and can process 10 bottles
of juice per minute or 600 bottles per hour
21
Operating Budgets An Example
Pause and Reflect What kind of costing system is
Tinas likely to use?
22
Operating Budgets An Example
Sales Forecast
January February March
250,000 Bottles 325,000 Bottles 450,000 Bottles
23
Operating Budgets An Example
Sales Budget
January 250,000 1.05 262,500
February 325,000 1.05 341,250
March 450,000 1.05 472,500
1st Quarter 1,025,000 1.05 1,076,250
Projected Sales (bottles) Price per bottle Total
Projected Sales
24
Operating Budgets An Example
Basic Production Budget Sales forecast (in
units) Projected ending inventory Total projected
production needs Beginning Inventory Projected
production volume

-
25
Operating Budgets An Example
Production Budget
Jan 250,000 32,500 282,500 25,000 257,500
Feb 325,000 45,000 370,000 32,500 337,500
March 450,000 50,000 500,000 45,000 455,000
Total Qtr. 1,025,000 50,000 1,075,000 25,000 1,050
,000
Sales Forecast (bottles) Projected ending
Inventory () Total projected production
needs Beginning inventory (-) Projected
production bottles
26
Operating Budgets An Example
Materials Purchases Budget - Bottles
Jan 257,500 67,500 325,000 51,500 273,500 27,350
Feb 337,500 91,000 428,500 67,500 361,000 36,100
March 455,000 98,000 553,000 91,000 462,000 46,20
0
Total Qtr. 1,050,000 98,000 1,148,000 51,500 1,096
,500 109,650
Projected production (bottles) Projected ending
Inventory () Total projected needs Projected
beginning Inventory (-) Bottles to be
purchased Projected purchases x .10/bottle
27
Operating Budgets An Example
Direct Labor Budget
Jan 257,000 1 hour 429.17 15/hr 6,438
Feb 337,500 1 hour 562.5 15/hr 11,375
March 455,000 1 hour 758.33 15/hr 11,375
1st Qtr. 1,050,000 1 hour 1,750 hrs 15/hr 26,250
Projected production (bottles) Direct labor time
per 600 bottles Direct labor hours for
production Direct labor rate per hour Projected
DL cost Projected production/600
28
Operating Budgets An Example
Pause and Reflect Why are we not concerned with
inventories in the direct labor purchases budget?
29
Operating Budgets An Example
Manufacturing Overhead Budget
Jan 429.17 54.75 23,497 123,333 146,830
Feb 562.5 54.75 30,797 123,333 154,130
March 758.33 54.75 30,797 123,333 164,852
1st Qtr. 1,750 54.75 95,813 123,333 465,813
Budgeted Machine Hrs Variable Overhead
Rate Projected Variable OH Budgeted Fixed
OH Total Projected Manufacturing OH
30
Operating Budgets An Example
Total Manufacturing Cost Budget
Jan 41,027 27,350 6,348 146,830 221,645
Feb 54,150 36,100 8,438 154,130 252,818
March 69,300 43,200 11,375 164,852 291,727
1st Qtr. 164,477 109,650 26,250 465,813 766,189
Projected material cost-concentrate PMC
bottles Projected DL costs Projected MO
costs Total projected manufacturing costs
31
Cash Budgets
Many managers consider managing the cash flow to
be the single most important consideration in
running a successful business.
32
Cash Budgets
All of the sales of Tinas are on account.
Collections are estimated as follows 50 in the
month of the sale 35 in the month following the
sale 15 in the second month following the sale
33
Cash Budgets

• Nov Dec
  Jan Feb Mar
• Sales 200,000 250,000 262,500
  341,250 472,500
• Cash Receipts
• Nov sales 50 35
  15
• Dec sales 50
  35 15
• Jan sales
  50 35 15
• Feb sales
  50 35
• March sales 50

Cash Receipts for 1st Qtr.
34
Cash Budgets

• Cash Receipts
• Jan Feb March 1st Qtr.
• 15 Nov 30,000 30,000
• 35 Dec 87,500 87,500
• 15 Dec 37,500 37,500
  
• 50 Jan 131,250 131,250
• 35 Jan 91,875 91,875
• 15 Jan 39,375 39,375
• 50 Feb 170,625 170,625
• 35 Feb 119,438 119,438
• 50 March 236,250 236,250
• Total 248,750 300,000 395,063 943,183
  

35
Cash Budgets
Cash Disbursement Budget- Operating
Activities Cash Disbursements include Material
Purchases for Concentrate Material Purchases for
Bottles Direct Labor Manufacturing
Overhead Selling and Administrative Costs
36
Cash Budgets
Pause and Reflect Can you trace each of the
amounts in the cash disbursements budget back to
the original budget in which it appears?
37
Cash Budgets
Summary Cash Budget Beginning cash balance Cash
flows from operating activities Cash
receipts Cash disbursements Cash flows from
investing activities Equipment purchases
38
Cash Budgets
Summary Cash Budget, continued Cash flows form
financing activities Payment of
dividends Interest on long-term debt Borrowing
from line of credit Repayments of line of
credit Final cash balance
39
More Budget Topics
Budgeted Financial Statements Budgets for a
Manufacturing Company in a JIT Environment Budgets
for Merchandising Companies and Service
Companies Life Cycle Costs, the Value Chain and
Budgeting
40
More Budget Topics
Using the budgets, management prepares pro-forma
(budgeted) financial statements. They are used
for internal planning purposes and to provide
information to external users, such as a bank
when requesting a loan.
What do I do with all of these budgets?
41
Budgeted Financial Statements
Pro-forma Statements include Cost of Goods
Manufactured Income Statement Balance Sheet
42
Budgeted Financial Statements
If the budget is prepared as a template using
spreadsheet software, changes in assumptions can
be reflected in the entire budget in a few
seconds.
43
Other Budgeting Topics
Life Cycle Costs, the Value Chain, and
Budgeting Budgeting in an International
Environment Nonmonetary Budgets Static Versus
Flexible Budgets ABC and Flexible Budgets
44
Life Cycle Costs, the Value Chain and Budgeting
In making decisions to introduce new products,
the forecasted sales over the life of the product
must exceed its life cycle costs. Given that a
significant of total costs are incurred before
a new product is actually produced and sold,
early and accurate budgeting is critically
important in making good decisions regarding the
introduction of new products.
45
Budgeting in an International Environment
Considerations Translating foreign
currency Predicting inflation rates and prices in
unstable economies Predicting sales in countries
with different consumer preferences Dealing with
different labor laws, social customs, and norms
affecting wage rates and the productivity of
workers
46
Nonmonetary Budgets
Time Budgets to plan the number of hours
expected to be incurred in each engagement (CPA
firm and law offices) Customer Satisfaction
Measures includes the number of retuned or
defective items, the number of customer
complaints, time waiting to be served
47
Static vs Flexible Budgets
Static budgets are set at the beginning of the
period and remain constant throughout the budget
period. Flexible budgets take differences in cost
and revenue due to volume differences out of the
analysis by budgeting for labor (and other costs)
based on the actual number of units produced.
What if my sales are not what I projected?
I know. Ill use flexible budgets.
48
Static vs Flexible Budgets
Key Concept Flexible budgets are based on the
actual number of units produced rather than the
budgeted units of production.
49
Static vs Flexible Budgets

• 
  Static Budget Actual
• Projected production (bottles)
  57,000 250,000
• Projected direct labor costs
  6,438 6,300
• Difference
  138

Flexible Budget Actual Projected
production (bottles) 250,000
250,000 Projected direct labor costs
6,250
6,300 Difference
50
50
ABC and Flexible Budgets
Tinas would budget costs for moving materials
based on the budgeted cost per move and the
actual number of moves made during the
month. Tinas would compute the per-unit budget
amounts for other batch-level and product-level
costs and include those in the flexible budget
along with the regular variable costs and fixed
costs.
51
End of Chapter 9
The budgeting process is worth the effort.