Operational Budgeting

Chapter 23

McGraw-Hill/Irwin Copyright © 2010 by The McGraw-Hill Companies, Inc. All

Profit Rich, Yet Cash Poor

Conditions leading to cash

shortages when profits are
high.

Large investments
in assets to support Long operating cycles
rapid revenue (cash-to-cash cycles).
growth.

Consider
Consider the
the following
following cash-to-cash
cash-to-cash cycle.
cycle.

23-2
Profit Rich, Yet Cash Poor
Cash

Inventories
DMWIPFG
166 days
247 Days

Accounts Receivable
81 days

Cash
Even if sales are growing rapidly, cash is tied
up in inventory and receivables for so long that
a cash shortage will be the likely result.
23-3
 Budgeting: The Basis for
Planning and Control
AAbudget
budgetisisaacomprehensive
comprehensivefinancial
financial
plan
planfor
forachieving
achievingthe
thefinancial
financialand
and
operational
operationalgoals
goalsof
ofan
anorganization.
organization.

Planning Control
Developing Steps taken by
objectives for management to
acquisition ensure that
and use of objectives are
resources. attained.

23-4
Benefits Derived from
Budgeting
Enhanced management
responsibility

Coordination Performance
of activities Benefits evaluation

Assignment of decision-
making responsibilities

23-5
Establishing Budgeted
Amounts:
Behavioral Approach
Budget Problems Solution
 Perceived unfair  Reasonable and
or unrealistic achievable
goals. budgets.
 Poor  Employee
management-
participation in
employee
communications. budgeting
process.

23-6
Establishing Budgeted
Amounts:
Total Quality Management
Approach
A commitment to the Budgeted amounts
goal of completely set
eliminating at levels representing
inefficiency. absolute efficiency.

Small failures
to
achieve
budgeted
amounts direct
management to
areas where
improvement is
possible.
23-7
Participation in Budget
Process
T o p M a n a g e m e n

M i d d le M i d d le
M a n a g e m e n Mt a n a g e m

S u p e r Sv i us op re r Sv i us op re r Sv i us op re r

Flow of Budget Data

23-8
The Budget Period
The annual operating budget may be
divided into quarterly or monthly budgets.

2005 2006 2007 2008

Capital Budgets

A continuous budget is usually a twelve-month

budget that adds one month as the current month
is completed.

23-9
The Master Budget

Cost of goods
Sales Production manufactured
budget budgets and sold
budget

Financial
budgets: Cash Selling and
 cash flow
budget administrative
 income
 balance sheet
budget

23-10
Steps in Preparing a Master
Budget
Sales
Budget

Estimated Estimated
Unit Sales Unit Price

Analysis of economic and market conditions

+
Forecasts of customer needs from
marketing personnel
23-11
 Flexible Budgeting

Hmm! Comparing
Consider
Consider the
the following
following costs at different
condensed levels of activity
condensed example
example
from is like comparing
from Barton,
Barton, Inc.
Inc. .. .. ..
apples with oranges.

Performance evaluation is
difficult when actual
activity differs from the
activity originally
budgeted.

23-12
Flexible Budgeting
Original Actual
Budget Results Variances
Units of Activity 10,000 8,000 2,000 U
Variable costs
Indirect labor $ 40,000 $ 34,000 $6,000 F
IndirectUmaterials
= Unfavorable
30,000 variance25,500
– Barton,4,500 F
Power Inc. was unable
5,000 to achieve
3,800 the 1,200 F
Fixed costs budgeted level of activity.
Depreciation
Since
F =cost
Favorable12,000
variances
variance: 12,000 costs
are favorable,
actual have0
Insurance 2,000 2,000 0
we done
are aless
good
than
jobbudgeted
controlling
costs.
costs?
Total overhead costs $ 89,000 $ 77,300 $11,700 F

23-13
Flexible Budgeting
How much of
I don’t think I can the favorable cost
answer the question variance is due to lower
using the original activity, and how much is
budget. due to good cost control?

To answer the question, we must

the budget to the actual level of activity.
Central Concept: If you can tell me what your
activity was for the period, I will tell you what your
costs and revenue should have been.
23-14
Flexible Budgeting
Show expenses that should
have occurred at the actual
level of activity.

May be prepared for any activity

level in the relevant range.

Reveal variances due to cost

control or lack of cost control.

Improve performance
evaluation.

23-15
 Flexible Budgeting
To a budget for different
activity levels, we must know how
costs behave with changes in activity
levels.
 Total variable costs change
in direct proportion to
changes in activity. b le
ar ia
 Total fixed costs remain V
unchanged within the Fixed
relevant range.

23-16
End of Chapter 23

23-17