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Chapter 21 Learn why managers use budgets Develop strategy Control Plan Act Copyright 2009 Prentice Hall. All rights reserved. 3 Forces managers to plan Promotes coordination and communication Provides a benchmark Copyright 2009 Prentice Hall. All rights reserved. 4 Understand the components of the master budget Set of budgeted financial statements and supporting schedules Three types: ◦ Operating ◦ Capital expenditures ◦ Financial Copyright 2009 Prentice Hall. All rights reserved. 6 Sales budget Inventory budget Purchases and cost of goods sold budget Operating expenses budget Budgeted income statement Copyright 2009 Prentice Hall. All rights reserved. 7 Budgeted income statement Capital expenditures budget Cash budget Budgeted balance sheet Budgeted statement of cash flows Financial budget Copyright 2009 Prentice Hall. All rights reserved. 8 Prepare an operating budget Forecast of sales revenues Cornerstone of master budget ◦ Level of sales affects all elements Budgeted total sales Sales price Expected number of units sold Copyright 2009 Prentice Hall. All rights reserved. 10 Cost of goods sold = Beginning inventory + Purchases – Ending inventory Purchases = Cost of goods sold + Ending inventory – Beginning inventory Copyright 2009 Prentice Hall. All rights reserved. 11 SALES BUDGET Quarter ended March 31 June 30 Sept. 30 Nine-month total Cash sales 30% $30,000 $45,000 $37,500 $112,500 Credit sales 70% 70,000 105,000 87,500 262,500 $150,000 $125,000 $375,000 Total sales $100,000 Copyright 2009 Prentice Hall. All rights reserved. 12 Inventory, Purchases and Cost of Goods Sold Budget March 31 June 30 Sept. 30 9-month total Cost of goods sold (60% of total sales) $60,000 $90,000 $75,000 $225,000 + Desired ending inventory ($25,000 plus 10% next quarter’s cost of goods sold) 34,000 32,500 37,000 Total inventory required 94,000 122,500 112,000 - Beginning inventory (11,000) (34,000) (32,500) = Budgeted purchases $83,000 $88,500 $79,500 Copyright 2009 Prentice Hall. All rights reserved. 13 Expenses can be either fixed or variable Includes items such as: ◦ ◦ ◦ ◦ Salaries Rent Insurance Advertising Copyright 2009 Prentice Hall. All rights reserved. 14 Prepare a financial budget Cash Budget Budgeted Balance Sheet Budgeted Statement of Cash Flows Copyright 2009 Prentice Hall. All rights reserved. 16 Details how the business expects to go from the beginning cash balance to the desired ending balance Four major parts: ◦ ◦ ◦ ◦ Cash collections from customers Cash payments for purchases Cash payments for operating expense Cash payments for capital expenditures Copyright 2009 Prentice Hall. All rights reserved. 17 Cash collections from customers ◦ Cash sales from the sales budget ◦ Collections of previous month’s credit sales Accounts receivable Cash payments for purchases ◦ Payment of current month purchases from the purchases budget ◦ Payment of prior month purchases Accounts payable Copyright 2009 Prentice Hall. All rights reserved. 18 Payments for operating expense ◦ Use data from operating expense budget ◦ Do not include noncash expenses such as depreciation Payments for capital expenditures ◦ Use budgeted data Copyright 2009 Prentice Hall. All rights reserved. 19 Cash Budget Beginning cash balance $ 10 Cash collections 8 Cash available 18 Cash payments: Purchases of inventory 10 Operating expenses 2 Capital expenditures 4 Total cash payments 16 Ending cash balance before financing 2 Less: minimum cash balance (4) Cash excess (deficiency) (2) Financing of cash deficiency Borrowing 2 Payments Total effects of financing 2 Ending cash balance $ 4 $ 4 12 16 8 2 1 11 5 (4) 1 $ (1) (1) 4 Copyright 2009 Prentice Hall. All rights reserved. 20 (a) Book value of equipment: Cost Less: Accumulated depreciation Book value Plus: Gain Expected cash receipt $22,000 (7,000) $15,000 4,000 $19,000 Copyright 2009 Prentice Hall. All rights reserved. 21 August Expected sales in units September 7,800 9,100 $13 $13 $101,400 $118,300 Cash sales (30%) 30,420 35,490 Credit sales (70%) 70,980 82,810 Selling price Expected sales Cash sales $35,490 September credit sales collected 82,810 x ¾ 62,108 August credit sales collected 70,980 x ¼ 17,745 Expected cash collections in September $115,343 Copyright 2009 Prentice Hall. All rights reserved. 22 Sales commissions & selling expenses August 25% of sales September $25,350 $29,575 Rent and property taxes Sales commissions & selling expense: September: (9,100 x 13 x 25%) x 2/3 August: (7,800 x 13 x 25%) x 1/3 Expected cash payments for expenses $4,000 19,717 8,450 $32,167 Copyright 2009 Prentice Hall. All rights reserved. 23 Use sensitivity analysis in budgeting Actual results often differ from budgeted amounts Sensitivity analysis ◦ What-if technique that determines the result if predicted amounts differ from those budgeted Spreadsheet programs used for budgeting make sensitivity analysis cost-effective Copyright 2009 Prentice Hall. All rights reserved. 25 Companywide budget Department A Budget Department A1 Budget Department B Budget Department A2 Budget Department Sub – B Budget Copyright 2009 Prentice Hall. All rights reserved. 26 Company’s individual operating units roll up budgets to prepare company-wide budget Budget management software used ◦ Often part of Enterprise Resource Planning (ERP) system Software allows managers to spend more time analyzing data Copyright 2009 Prentice Hall. All rights reserved. 27 Prepare performance reports for responsibility centers Subunit of organization whose manager is accountable for specific activities Four types: Cost center Revenue center Profit center Investment center Copyright 2009 Prentice Hall. All rights reserved. 29 Cost center ◦ Managers accountable for costs only Goal – to control costs Revenue center ◦ Managers primarily accountable for revenues Goal – increase revenues Profit center ◦ Managers accountable for both revenues and costs Goal – increase profits Copyright 2009 Prentice Hall. All rights reserved. 30 Investment center ◦ Managers accountable for investments, revenues, and costs ◦ Responsible for: Generating sales Controlling expenses Managing investment needed to earn the income ◦ Goal – increase return on investment, residual income, or economic value added Copyright 2009 Prentice Hall. All rights reserved. 31 Performance reports compare budgeted and actual amounts Reporting at all levels: ◦ ◦ ◦ ◦ Division (investment centers) Product lines (profit centers) Production (cost centers) Sales (revenue centers) Management by exception ◦ Shows variances between actual and budgeted amounts Copyright 2009 Prentice Hall. All rights reserved. 32