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Profit Planning
(Operating Budgeting
& Cash Budget)
McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc.
The Basic Framework of Budgeting

A budget is a detailed quantitative plan


for acquiring and using financial and other
resources over a specified forthcoming time
period.
1. The act of preparing a budget is called
budgeting.
2. The use of budgets to control an
organization’s activity is known as
budgetary control.
Planning and Control

Planning – Control –
involves developing involves the steps
objectives and taken by
preparing various management that
budgets to achieve attempt to ensure
these objectives. the objectives are
attained.
Advantages of Budgeting

Define goal
and objectives
Communicate Think about and
plans plan for the future

Advantages
Coordinate Means of allocating
activities resources

Uncover potential
bottlenecks
Responsibility Accounting

Managers should be held responsible for those


items — and only those items — that
the manager can actually control
to a significant extent.
Choosing the Budget Period

Operating Budget

2006 2007 2008 2009

The annual operating budget A continuous budget is a 12-


may be divided into quarterly month budget that rolls forward
or monthly budgets. one month (or quarter) as the
current month (or quarter) is
completed.
Zero Based Budgeting

A zero-based budget requires managers to


justify all budgeted expenditures, not just
changes in the budget from the prior year.

Most
Most managers
managers argue
argue that
that
zero-based
zero-based budgeting
budgeting is
is too
too
time
time consuming
consuming and
and costly
costly to
to
justify
justify on
on an
an annual
annual basis.
basis.
The Budget Committee

A standing committee responsible for


 overall policy matters relating to the
budget
 coordinating the preparation of the
budget
Sample Master Budget,
Illustrated
Operating Budget & Cash Budget

Sales
Budget
Ending
Finished
Goods Selling and
Budget Production
Administrative
Budget
Budget

Direct Direct Manufacturing


Materials Labor Overhead
Budget Budget Budget

Cash
Budget
Budgeting Example

 Royal Company is preparing budgets for the


quarter ending June 30.
 Budgeted sales for the next five months are:
April 20,000 units
May 50,000 units
June 30,000 units
July 25,000 units
August 15,000 units.
 The selling price is $10 per unit.
The Sales Budget

The individual months of April, May, and June are


summed to obtain the total projected sales in units
and dollars for the quarter ended June 30th
Detailed Sales Budget

Foundational step
Customer / region / product
forecasts

Just to look
Expected Cash Collections

•• All
All sales
sales are
are on
on account.
account.
•• Royal’s
Royal’s collection
collection pattern
pattern is:
is:
70%
70% collected
collected in
in the
the month
month of
of sale,
sale,
25%
25% collected
collected in
in the
the month
month following
following sale,
sale,
5%
5% uncollectible.
uncollectible.
•• The
The March
March 3131 accounts
accounts receivable
receivable balance
balance of of
$30,000
$30,000 will
will be
be collected
collected in
in full
full within
within April
April..
Expected Cash Collections
Expected Cash Collections

From the Sales Budget for April.


Expected Cash Collections

From the Sales Budget for May.


Quick Check 

What will be the total cash collections for the


quarter?
a. $700,000
b. $220,000
c. $190,000
d. $905,000
Quick Check 

What will be the total cash collections for the


quarter?
a. $700,000
b. $220,000
c. $190,000
d. $905,000
Expected Cash Collections
CMA Case study
• Information pertaining to Brenton Corporation’s sales
revenue is presented in the following table.
• February March April

• Cash sales $160,000 $150,000 $120,000


• Credit sales 300,000 400,000 280,000
• Total sales $460,000 $550,000 $400,000

• Management estimates that 5% of credit sales are not collectible. Of


the credit sales that are collectible, 60% are collected in the month of
sale and the remainder in the month following the sale.
[CMA Adapted]

• Brenton’s budgeted total cash receipts in April


are:
• a. $448,000.
• b. $437,000.
• c. $431,600.
• d. $328,000.
The Production Budget

Sales Production
Budget Budget
ed
and l et
p
Expected
o m
C
Cash
Collections

Production must be adequate to meet budgeted


sales and provide for sufficient ending inventory.
The Production Budget

• The management at Royal Company wants


ending inventory to be equal to 20% of the
following month’s budgeted sales in units.

• On March 31, 4,000 units were on hand.

Let’s prepare the production budget.


The Production Budget
The Production Budget

March 31
ending inventory
Quick Check 

What is the required production for May?


a. 56,000 units
b. 46,000 units
c. 62,000 units
d. 52,000 units
Quick Check 

What is the required production for May?


a. 56,000 units
b. 46,000 units
c. 62,000 units
d. 52,000 units
The Production Budget
The Production Budget

Assumed ending inventory.


Sales Production
BUDGETS
• In solving budgeting exercises, we repeatedly use the “inventory
equation.” In its simplest form, the inventory equation is:
• Beginning balance + What we put in – What we take out =
Ending balance.
• We replace these terms with the appropriate account-specific terms
when computing specific revenue and cost budgets.
• For EXAMPLE,IF we have:
• Beginning inventory 1,750 Windows
• + Production 8,000
• - Sales ?
• = Ending inventory 2,500 windows
• Thus, we find Sales for March = 7,250 windows.
• Multiplying 7,250 windows by the $60 price per window gives
budgeted March revenue of $435,000.
Input Resources
The Direct Materials Budget

•• At
At Royal
Royal Company,
Company, fivefive pounds
pounds of of material
material
are
are required
required per
per unit
unit ofof product.
product.
•• Management
Management wants
wants materials
materials on on hand
hand at
at
the
the end
end of
of each
each month
month equal
equal toto 10%
10% ofof the
the
following
following month’s
month’s production
production needs.
needs.
•• On
On March
March 31,
31, 13,000
13,000 pounds
pounds of of material
material
are
are on
on hand.
hand. Material
Material cost
cost is
is $0.40
$0.40 per
per
pound.
pound.
Let’s
Let’s prepare
prepare the
the direct
direct materials
materials budget.
budget.
The Direct Materials Budget

From production budget


The Direct Materials Budget
The Direct Materials Budget

March 31 inventory

10% of following months Calculate the materials to


production needs. by purchased in May.
Quick Check 

How
How much
much materials
materials should
should be
be purchased
purchased in
in May?
May?
a.
a. 221,500
221,500 pounds
pounds
b.
b. 240,000
240,000 pounds
pounds
c.
c. 230,000
230,000 pounds
pounds
d.
d. 211,500
211,500 pounds
pounds
Quick Check 

How
How much
much materials
materials should
should be
be purchased
purchased in
in May?
May?
a.
a. 221,500
221,500 pounds
pounds
b.
b. 240,000
240,000 pounds
pounds
c.
c. 230,000
230,000 pounds
pounds
d.
d. 211,500
211,500 pounds
pounds
The Direct Materials Budget
The Direct Materials Budget

Assumed ending inventory


Expected Cash Disbursement for Materials

•• Royal
Royal pays
pays $0.40
$0.40 per
per pound
pound for
for its
its materials.
materials.
•• One-half
One-half ofof aa month’s
month’s purchases
purchases is is paid
paid for
for in
in
the
the month
month of
of purchase;
purchase; the
the other
other half
half is
is paid
paid
in
in the
the following
following month.
month.
•• The
The March
March 31 31 accounts
accounts payable
payable balance
balance is is
$12,000.
$12,000.

Let’s
Let’s calculate
calculate expected
expected cash
cash disbursements.
disbursements.
Expected Cash Disbursement for Materials
Expected Cash Disbursement for Materials

Compute the expected cash


disbursements for materials
for the quarter.

140,000 lbs. × $.40/lb. = $56,000


Quick Check 

What are the total cash disbursements for the


quarter?
a. $185,000
b. $ 68,000
c. $ 56,000
d. $201,400
Quick Check 

What are the total cash disbursements for the


quarter?
a. $185,000
b. $ 68,000
c. $ 56,000
d. $201,400
Expected Cash Disbursement for Materials
CMA EXAM

The following data apply to questions 1 and 2.


• Alex Company budgets on an annual basis for its fiscal
year. The following beginning and ending inventory
levels (in units) are planned for the fiscal year of July 1,
2008 through June 30, 2009.
• July 1, 2008 June 30, 2009
• Raw material1 40,000 10,000
• Work in process 8,000 8,000
• Finished goods 30,000 5,000
• 1 Three (3) units of raw material are needed to
produce each unit of finished product.
Continued CMA EXAM
• 4. If Alex Company plans to sell 500,000 units during
the 2008–2009 fiscal year, the number of units it would
have to manufacture during the year would be
a.505,000 units.
b.500,000 units.
c.480,000 units.
d.475,000 units.
• 5. If 450,000 finished units were to be manufactured
during the 2004–2005 fiscal year by Hester Company,
the units of raw material needed to be purchased would
be
a.1,350,000 units.
b.1,360,000 units.
c.1,320,000 units.
d.1,330,000 units.
The Direct Labor Budget

•• At
At Royal,
Royal, each
each unit
unit of
of product
product requires
requires 0.05
0.05
hours
hours (3
(3 minutes)
minutes) ofof direct
direct labor.
labor.
•• The
The wage
wage rate
rate is
is $10
$10 per
per hour
hour ..
•• For
For the
the next
next three
three months,
months, the
the guaranteed
guaranteed labor
labor
hours
hours are
are 1,500
1,500 hours
hours per
per month.
month.
Let’s
Let’s prepare
prepare the
the direct
direct labor
labor budget.
budget.
The Direct Labor Budget

From production budget


The Direct Labor Budget
The Direct Labor Budget

Greater
Greater of
of labor
labor hours
hours required
required
or
or labor
labor hours
hours guaranteed.
guaranteed.
The Direct Labor Budget
Quick Check 

What would be the total direct labor cost for the


quarter if the company follows its no lay-off policy,
but pays $15 (time-and-a-half) for every hour
worked in excess of 1,500 hours in a month?
a. $79,500
b. $64,500
c. $61,000
d. $57,000
Quick Check 

What would be the total direct labor cost for the


quarter if the company follows its no lay-off policy,
but pays $15 (time-and-a-half) for every hour
worked in excess of 1,500 hours
April in a month?
May June Quarter
Labor hours required 1,300 2,300 1,450
a. $79,500 Regular hours paid 1,500 1,500 1,500 4,500

b. $64,500 Overtime hours paid - 800 - 800

c. $61,000 Total regular hours 4,500 $10 $ 45,000


Total overtime hours 800 $15 $ 12,000
d. $57,000 Total pay $ 57,000
Manufacturing Overhead Budget

• At Royal manufacturing overhead is applied to units


of product on the basis of direct labor hours.
• The variable manufacturing overhead rate is $20 per
direct labor hour.
• Fixed manufacturing overhead is $50,000 per month
and includes $20,000 of noncash costs (primarily
depreciation of plant assets).

Let’s prepare the manufacturing overhead budget.


Manufacturing Overhead Budget

Direct Labor Budget


Manufacturing Overhead Budget

Total mfg. OH for quarter $251,000


= $49.70 per hour*
Total labor hours required 5,050

*rounded
Manufacturing Overhead Budget

Depreciation
Depreciation is
is aa noncash
noncash charge.
charge.
Ending Finished Goods Inventory Budget

Production costs per unit Quantity Cost


Direct materials 5.00 lbs. $ 0.40
Direct labor
Manufacturing overhead

Budgeted finished goods inventory


Ending inventory in units
Unit product cost
Ending finished goods inventory
Direct materials
budget and information
Ending Finished Goods Inventory Budget

Production costs per unit Quantity Cost


Direct materials 5.00 lbs. $ 0.40
Direct labor 0.05 hrs. $10.00
Manufacturing overhead

Budgeted finished goods inventory


Ending inventory in units
Unit product cost
Ending finished goods inventory
Direct labor budget
Ending Finished Goods Inventory Budget

Production costs per unit Quantity Cost Total


Direct materials 5.00 lbs. $ 0.40 $ 2.00
Direct labor 0.05 hrs. $ 10.00 0.50
Manufacturing overhead 0.05 hrs. $ 49.70 2.49
$ 4.99
Budgeted finished goods inventory
Ending inventory in units
Unit product cost $ 4.99
Ending finished goods inventory ?

Total mfg. OH for quarter $251,000


= $49.70 per hour*
Total labor hours required 5,050
Ending Finished Goods Inventory Budget

Production costs per unit Quantity Cost


Direct materials 5.00 lbs. $ 0.40
Direct labor 0.05 hrs. $10.00
Manufacturing overhead 0.05 hrs. $49.70

Budgeted finished goods inventory


Ending inventory in units
Unit product cost
Ending finished goods inventory
Production Budget
Selling and Administrative Expense Budget

•• At
At Royal,
Royal, thethe selling
selling and
and administrative
administrative expenses
expenses budget
budget is
is
divided
divided into
into variable
variable and
and fixed
fixed components.
components.
•• The
The variable
variable selling
selling and
and administrative
administrative expenses
expenses are are $0.50
$0.50
per
per unit
unit sold.
sold.
•• Fixed
Fixed selling
selling andand administrative
administrative expenses
expenses are
are $70,000
$70,000 per
per
month.
month.
•• The
The fixed
fixed selling
selling and
and administrative
administrative expenses
expenses include
include
$10,000
$10,000 in in costs
costs –– primarily
primarily depreciation
depreciation –– that
that are
are not
not cash
cash
outflows
outflows of of the
the current
current month
month..

Let’s
Let’s prepare
prepare the
the company’s
company’s selling
selling and
and administrative
administrative
expense
expense budget.
budget.
Selling and Administrative Expense Budget

Calculate the selling and administrative


cash expenses for the quarter.
Quick Check 

What are the total cash disbursements for selling


and administrative expenses for the quarter?
a. $180,000
b. $230,000
c. $110,000
d. $ 70,000
Quick Check 

What are the total cash disbursements for selling


and administrative expenses for the quarter?
a. $180,000
b. $230,000
c. $110,000
d. $ 70,000
Selling and Administrative Expense Budget
Format of the Cash Budget

The cash budget is divided into four sections:


1. Cash receipts listing all cash inflows excluding
borrowing
2. Cash disbursements listing all payments
excluding repayments of principal and interest
3. Cash excess or deficiency
4. The financing section listing all borrowings,
repayments and interest
The Cash Budget

Royal:
Royal:
●Maintains
● Maintains aa 16%
16% open
open line
line ofof credit
credit for
for $75,000
$75,000
●Maintains
● Maintains aa minimum
minimum cashcash balance
balance of of $30,000
$30,000
●Borrows
● Borrows on
on the
the first
first day
day ofof the
the month
month andand repays
repays
loans
loans on
on the
the last
last day
day of
of the
the month
month
●Pays
● Pays aa cash
cash dividend
dividend ofof $49,000
$49,000 in in April
April
●Purchases
● Purchases $143,700
$143,700 of of equipment
equipment in in May
May and
and
$48,300
$48,300 in
in June
June paid
paid in
in cash
cash
●Has
● Has an
an April
April 11 cash
cash balance
balance of of $40,000
$40,000
The Cash Budget

Schedule
Schedule of
of Expected
Expected
Cash
Cash Collections
Collections
The Cash Budget

Schedule
Schedule of
of Expected
Expected
Cash
Cash Disbursements
Disbursements

Direct Labor
Budget

Manufacturing
Overhead Budget

Selling and Administrative


Expense Budget
The Cash Budget

Because Royal maintains


a cash balance of $30,000,
the company must borrow
$50,000 on it line-of-credit.
The Cash Budget

Ending cash balance for April


is the beginning May balance.
The Cash Budget
Quick Check 

What is the excess (deficiency) of cash available


over disbursements for June?
a. $ 85,000
b. $(10,000)
c. $ 75,000
d. $ 95,000
Quick Check 

What is the excess (deficiency) of cash available


over disbursements for June?
a. $ 85,000
b. $(10,000)
c. $ 75,000
d. $ 95,000
The Cash Budget

$50,000 × 16% × 3/12 = $2,000


Borrowings on April 1 and
repayment on June 30.
The Budgeted Income Statement

Cash Budgeted
Budget Income
Statement
t ed
e
pl
om
C

After we complete the cash budget,


we can prepare the budgeted income
statement for Royal.
The Budgeted Income Statement

Sales
Sales Budget
Budget
Royal Company
Budgeted Income Statement
For the Three Months Ended June 30
Ending
Ending Finished
Finished
Sales (100,000 units @ $10) $ 1,000,000 Goods
Cost of goods sold (100,000 @ $4.99) 499,000
Goods Inventory
Inventory
Gross margin 501,000
Selling and administrative expenses 260,000 Selling
Selling and
and
Operating income 241,000 Administrative
Administrative
Interest expense 2,000
Expense
Expense Budget
Budget
Net income $ 239,000

Cash
Cash Budget
Budget
THE END