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Chapte11 r
Operational Operational Budgeting Budgeting
Prepared Preparedby by

Pepperdine Pepperdine University University

Douglas Douglas Cloud Cloud

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Objectives Objectives
1. 2. 3. 4. Discuss whyAfter budgets are important. studying After studying this this Describe thechapter, basic approaches to budgeting. you should chapter, you should Develop an activity-based budget. be be able able to: to: Explain the interrelationships between the elements of a master budget and develop a basic budget. 5. Discuss the interrelationship between budget development and human behavior.

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General General Approach Approach to to Budgeting Budgeting

1. Budgeting with unit level cost drivers 2. Budgeting with unit and nonunit level cost drivers

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Reasons Reasons for for Budgeting Budgeting

Budgets compel planning Budgets improve communication and coordination Budgets provide a guide to action Budgets provide a basis of performance

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Some Some of of the the Characteristics Characteristics of of a a Good Good Multi-User Multi-User Budgeting Budgeting System System
1. Support changes to hierarchy to that different levels of budgets can be examined. 2. Shared access to common data warehouses. 3. Automatic mapping of imported data for use in multiple applications. 4. Lots of what-if commands.

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In In the the output/input output/input approach approach physical physical inputs inputs and and costs costs are are budgeted a of budgeted as a function function approach of planned planned The incremental budgets Theas incremental approach budgets unit level activities. unit level activities. costs for a coming period as a dollar costs for a coming period as a dollar Using the minimum level Using the minimum level or percentage change from the or percentage change from the approach ,, an organization approach an organization amount budgeted for (or spent amount budgeted for (or spent establishes a base amount for establishes a base amount for during) some previous period. during) some previous period. budget budget items items and and requires requires explanation explanation or or justification justification for for any any budgeted budgeted amount amount above above the the minimum minimum (base). (base).

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Activity-Based Activity-Based Budgeting Budgeting

Atlantic Magnetic, Inc. Activity-Based Budget for Compact Disks For the Year Ending December 31, 2004 Unit level costs: Direct materials $180,000 Assembly 245,000 Packaging 380,000 Distribution 60,000 $ 865,000 Continued Continued

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Activity-Based Activity-Based Budgeting Budgeting

Batch level costs: Procurement Setup Inspection $ 30,000 80,000 70,000 $ 180,000

Product level costs: Development and design $ 50,000 Product advertising 120,000 170,000 Total product costs $1,215,000

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Activity-Based Activity-Based Budgeting Budgeting

Atlantic Magnetic, Inc. Activity-Based Budget for Purchasing Dept. For the Year Ending December 31, 2004 Budgeted activities: New vendors screened 130 Orders placed 1,200 Shipments received and inspected 1,400

Continued Continued

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Activity-Based Activity-Based Budgeting Budgeting

Activity-based budgeting Budgeted costs: Activity-based budgeting focuses on redesigning focuses on redesigning Vendor screening and quality products or improving products or improving certification (unit level per vendor)$ 30,000 processes rather than processes rather Procurement (unit level per pur.than order): simply cutting costs. simply cutting costs. Placing orders $50,000 Verifying orders 25,000 Receiving orders 16,000 Inspecting orders 8,000 99,000 General administration and maintenance (facility level) 25,000 Total purchasing department costs $154,000

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The The Master Master Budget Budget

The The master master budget budget groups groups all all budgets budgets and and supporting supporting schedules schedules together together and and coordinates coordinates all all financial financial and and operational operational activities, activities, placing placing them them into into an an organization-wide organization-wide set set of of budgets budgets for for a a given given time time period. period. A major goal of developing a master budget is to ensure the smooth functioning of a business throughout the budget period and the organizations operation cycle.

Operating Operating Cycle Cycle of of a a Manufacturing Manufacturing or or Merchandising Merchandising Operation Operation
Collection Cash Purchases or merchandise function

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Accts. Rec.

Inventory Sales or Services

Overview Overview of of Budget Budget Assembly Assembly Process Process in in a a Merchandising Merchandising Firm Firm
Sales Budget Purchases Budget Selling Expense Budget General and Administrative Expense Budget

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Cash Budget Continued Continued

Overview Overview of of Budget Budget Assembly Assembly Process Process in in a a Merchandising Merchandising Firm Firm
from Sales Budget Cash Budget Other Special Budgets: Taxes, Dividends, Capital Improvements, etc. from Purchases, Selling Expense, and General and Administrative Expense Budgets

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Pro Forma Statements: Income Statement and Balance Sheet

Initial Initial Balance Balance Sheet Sheet

Backpacks Galore, Inc. Balance Sheet December 31, 2004 Assets Current assets: Cash Accounts receivable (net) Inventory School backpacks Hiking backpacks Property and equipment: Land Buildings and equipment Less accum. depreciation Total assets

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Continued Continuedon on next nextslide slide $ 15,000 21,600 $ 50,000 96,000 60,000 260,000 124,800 146,000 $182,600

135,200

195,200 $377,800

Initial Initial Balance Balance Sheet Sheet

Liabilities and stockholders equity Current liabilities: Accounts payable Stockholders equity: Capital stock Retained earnings Total liabilities and stockholders equity

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$ 40,000 $150,000 187,800 337,800 $377,800

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Sales Sales Budget Budget

Backpacks Galore, Inc. The The sales sales budget budget Sales Budget contains a forecast contains a forecast For the Year Ending December 31, 2005 First Quarter Second Quarter Quarter Quarter

of of unit unit sale sale volume volume Third Fourth Year and revenue. and sale sale revenue.

Total

Sales (units); School backpacks 4,000 3,400 3,650 3,950 15,000 Hiking backpacks 1,100 1,600 2,500 1,300 6,500 Sales (dollars): School backpacks $ 80,000 $ 68,000 $ 73,000 $ 79,000 $300,000 Hiking backpacks 110,000 160,000 250,000 130,000 650,000 Total $190,000 $228,000 $323,000 $209,000 $950,000

Assumptions Assumptions for for Purchases Purchases Budget Budget

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Management Management desires desires to to have have all all inventory inventory needed needed to to fill fill the the following following quarters quarters sales sales in in stock stock at at the the end end of of the the previous previous quarter. quarter. To To provide provide for for a a possible possible delay delay in in the the receipt receipt of of inventory, inventory, BGI BGI also also carries carries a a safety safety stock stock of of 1,000 1,000 stock stock backpacks backpacks and and 500 500 hiking hiking backpacks. backpacks.
Continued Continued

Assumptions Assumptions for for Purchases Purchases Budget Budget

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The The total total inventory inventory needs needs are are equal equal to to current current sales sales plus plus desired desired ending ending inventory, inventory, including including the the safety safety stock. stock. Budgeted Budgeted purchases purchases are are computed computed as as total total inventory inventory needs needs less less the the beginning beginning inventory. inventory.

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Partial Partial Purchases Purchases Budget Budget

Backpacks Galore, Inc. Purchases Budget For the Year Ending December 31, 2005 First Second Third Quarter Quarter Quarter Purchases (units): School backpacks: Current qtr. sales Desired end. inv. Total needs Less beg. inv. Purchases 4,000 4,400 8,400 -5,000 3,400 3,400 4,650 8,050 -4,400 3,650 3,650 4,950 8,600 -4,650 3,950

Four Year Quarter Total

3,950 5,100 9,050 -4,950 4,100 15,100

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Partial Partial Selling Selling Expense Expense Budget Budget

Backpacks Galore, Inc. Selling Expense Budget For the Year Ending December 31, 2005 First Second Third Fourth Year Quarter Quarter Quarter Quarter Total Budgeted sales $190,000 $228,000 $323,000 $209,000 $950,000 Variable costs: Setup/Display $ 1,900 $ 2,280 $ 3,230 $ 2,090 $ 9,500 Commissions 3,800 4,560 6,460 4,180 19,000 Miscellaneous 1,900 2,280 3,230 2,090 9,500 Total 7,600 9,120 12,920 8,360 18,000 Fixed costs (total) 4,500 4,500 4,500 4,500 4,500 Total selling exp. $12,100 $13,620 $17,420 $12,860 $56,000

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Assumptions Assumptions for for Cash Cash Budget Budget

The The cash cash budget budget summarizes summarizes all all cash cash receipts receipts and and disbursements disbursements expected expected to to occur occur during during the the budget budget period. period. Cash Cash is is critical critical to to survival. survival.

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Partial Partial Cash Cash Budget Budget

Backpacks Galore, Inc. Cash Budget For the Year Ending December 31, 2005

First First Quarter Quarter

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Partial Partial Cash Cash Budget Budget

Cash balance, beginning Collection on sales: Cash sales From credit sales: Current quarter Prior quarter Total Total available from operations
Continued Continued

$ 15,000 $ 95,000 71,250 21,500 $187,850 $202,850

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Total available from operations Less budgeted disbursements: Purchasing, current quarter Purchasing, previous quarter Total Selling General and administrative Other: Income taxes Dividends Total disbursements
Continued Continued

$202,850 $ 65,000 40,000 $105,000 12,100 31,000 22,000 20,000 -$190,100

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Total disbursements Excess cash available for disbursements Short-term financing: New loans Net cash flow from financing Cash balance, ending

-$190,100 $ 12,750 $ 3,000 $ 3,000 $ 15,750

This amount becomes the beginning balance for the second quarter.

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Budgeted Budgeted Income Income Statement Statement

Backpacks Galore, Inc. Budgeted Income Statement (Functional Format) For the Year Ending December 31, 2005 Sales $950,000 Expenses: Cost of goods sold: Beginning inventory $146,000 Purchases 547,000 Cost of merchandise avail. $693,000 Ending inventory -153,000 $540,000 Selling operations 56,000 General and administrative 132,000 Bad debt expense 4,750 -732,750 Income from operations $217,250 continued continued

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Income from operations Other expenses: Interest expense Net income before taxes Allowance for income taxes Net income

$217,250 - 1,590 $215,660 - 77,200 $138,460

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Budgeted Budgeted Balance Balance Sheet Sheet

Backpacks Galore, Inc. Budgeted Balance Sheet December 31, 2005 Assets Current assets: Cash Accounts receivable (net) Merchandise inventory Property and equipment: Land Building and equipment Less accumulated depr. Total assets

$ 77,480 25,080 153,000 $255,560 $ 60,000 $260,000 - 132,800 127,200 187,200 $442,760

continued continued

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Liabilities and stockholders equity Current liabilities: Accounts payable Stockholders equity: Capital stock Retained earnings Total liabilities and stockholders equity

$ 56,500 $150,000 236,260 386,260 $442,760

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Finalizing Finalizing the the Budget Budget

Is the Is Before the proposed proposed finalizing the Before finalizing the Is the proposed Is the proposed budget budget, budget two questions budget, two questions budget feasible? budget feasible? acceptable? acceptable? must must be be addressed. addressed.

Types Types of of Forecasts Forecasts Used Used in in Budgeting Budgeting

The The sales sales forecast forecast is is primary primary to to most most

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organizations. organizations. The The collection collection period period for for sales sales on on account. account. Percent Percent of of uncollectible uncollectible sales sales on on account. account. Cost Cost of of materials, materials, supplies, supplies, utilities, utilities, etc. etc. Employee Employee turnover. turnover. Time Time required required to to perform perform activities. activities. Interest Interest rates. rates. Development Development time time for for new new products products or or services. services.

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Developing Developing Budgets Budgets that that Work Work

1. Emphasize the importance of budgeting as a planning device. 2. Encourage wide participation in budget preparation at all levels of the organization. 3. Demonstrate that the budget has the complete support of top management. 4. Recognize that the budget is not unalterable.
Continued Continued

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Developing Developing Budgets Budgets that that Work Work

5. Use budget performance reports not just to identify poor performers, but also to recognize good performance. 6. Conduct programs in budget education to provide new managers with information about the purposes of budgets and to dispel erroneous misconceptions that may exist.

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Chapte11 r
The The End End

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