In addition to playing a critical role in creating and achieving a sound business strategy, this book shows how budgets can increase your effectiveness every day of the week. Financial models that show the relationship between all facets of the company's spreadsheet applications for planning, budgeting and control purposes.
About the Authors
And we use step-by-step guidelines to determine what to look for, what to pay attention to, what to do, how to do it and how to apply it to the job. Through step-by-step illustration, we show you how you can use these tools.
The What and Why of Budgeting
The success of the budgeting process requires the cooperation of all levels within the organization. A combination of the bottom-up and top-down approaches may be appropriate in certain cases.
Strategic Planning and Budgeting
There should be a short-term profit plan by area of responsibility (product, service, territory, division, department, project, function and activity). Alternatives must be evaluated and the profit plan must be flexible to accommodate contingencies.
Administering the Budget
The operations department manager should always receive a copy of the budget overview and budget data sheets. A budget calendar should be established for the timing of each aspect or operation of the budget.
Break-even and Contribution Margin Analysis
To calculate the break-even point and perform various price-rate and contribution rate analyses, note these important concepts. The break-even point represents the level of sales revenue that is equal to the total of variable and fixed costs for a given volume of production at a given rate of capacity utilization. Breakdown Point in Units Fixed Costs Unit CM Breakdown Point in Dollars Fixed Costs.
The break-even point is the point where the total sales revenue line intersects the total cost line. In addition to determining the breakeven point, the breakeven and contribution margin analysis determines the sales required to achieve a certain level of revenue or target net income. Margin of safety is a measure of the difference between actual sales and breakeven sales.
The higher the ratio, the safer the situation as there is less risk of reaching the breakeven point. It plans to produce and sell three types of sleeping bags: Economy, Regular and Backpacker. A change in either the selling price or the variable cost per unit changes the CM or the CM ratio and thus the break-even point.
Profit Planning
For example, in a five-year plan, profit targets should be set for each year included in it. A five-year plan should be the longest period of time because the longer the period of time, the more difficult it is to predict. It can take the following form: "The department's goal is to increase sales by 50,000 units of product X in area A for the year 20XX." A leader must clearly communicate goals to subordinates.
A comparison should be made between the salesperson's actual sales versus the cost to acquire those sales. If the assumptions are not realistic - for example, for an increase in the selling price, if there is a high level of competition and/or a recession - the basis of the profit plan is questionable. The chosen alternative must be practical and bring the maximum profit in accordance with the objectives of the non-financial manager.
Subordinates should be rewarded (eg salary increases, merit bonuses) based on results that improve the division's profitability. The plan's expected earnings should be compared with prior years' experience as an indication of reasonableness. The question is "Does IKEA offer a product or a service?" The answer is neither - and both.
Master Budget
The company uses a single material and one type of labor in the manufacture of the product. The entire balance of the $100,000 accounts receivable is assumed to be collectable in the first quarter. The number of units expected to be produced to meet budgeted sales and inventory requirements is indicated in the production budget.
The entire liability balance of $6,275 (from the balance sheet, 20A) is expected to be paid in the first quarter. 50 percent of quarterly purchases are paid in the quarter of purchase; the remaining 50 percent is paid in the following quarter. The production requirements, as specified in the production budget, are also the starting point for the preparation of the direct labor budget.
Like the factory overhead budget, this budget can be developed using the cost volume formula (flexible budget) in the form of y = a + bx. The budgeted income statement summarizes the various sub-projections of revenues and expenses for the budgeting period. To see what financial condition the Putnam Company is expected to be in this fiscal year, an example of financial ratio calculations is in order.
Cost Behavior
Fixed costs do not change as a whole regardless of the volume or level of activity. X any given measure of activity, such as direct labor hours, machine hours, or production volume. It targets a range of activities rather than a single level of activity. It is more dynamic than static in nature.
By using a flexible budget formula, a range of budgets can be easily developed for different levels of activity. A static (fixed) budget is intended for only one level of activity and has difficulty controlling costs. Flexible budgeting distinguishes between fixed and variable costs, allowing for a budget that can be automatically adjusted (by changes in total variable costs) to a given level of activity actually achieved.
The primary use of the flexible budget is to measure performance accurately by comparing actual costs for a given output with the budgeted costs for the same level of output. Note: A flexible budget is appropriate for marketing budgets as well as for production cost budgets. Using the flexible budget formula and generating the budget based on the 5,800 actual units produces the next performance report.
Evaluating Performance
Depending on the nature of the cost item, automated models can be used to substantiate what the standard costs should be. For example, at the beginning of the period, the sales projection may be based on assessing supply and demand. There is a favorable sales variance of $3,700, consisting of the sales price variance and the sales volume variance.
Fixed overhead costs can be analyzed in terms of budget variances (flexible budget, overhead) and volume variances (production volume). The volume variance is a measure of cost deviation from the denominator (budgeted) volume used to set the fixed overhead rate. Material mix variance indicates the impact on material costs of deviation from the standard mix.
Material mix variance measures the impact of deviation from the standard mix on material costs. The calculation of material mix variance and material yield variance for Giffen Manufacturing Company is given below. Changes in gross profit can be considered on a company-wide or product-line basis.
The calculation of the production mix variance is very similar to that of the sales mix variance. In the case of Shim and Siegel, Inc., the sales quantity variance turned out to be favorable—.
Manufacturing Costs
To calculate direct labor requirements, expected production volume for each period is multiplied by the number of direct labor hours required to produce a single unit. The direct labor hours to meet production requirements are then multiplied by the (standard) direct labor cost per hour to obtain budgeted total direct labor cost. The factory overhead budget should provide a schedule of all manufacturing costs except direct materials and direct labor.
Determine the physical units of material required for each item to be produced during the budget period. The following example illustrates a typical method for budgeting the quantities and costs of raw materials to be purchased. Direct labor is paid in piecework, where the factory labor is paid so much per piece, or in day labor, where the labor is paid a fixed hourly rate regardless of the job he is assigned.
First, direct labor operations are usually of a type for which an engineering standard can be established. Second, because almost all direct labor can be identified with a specific product or job, there is relatively little difficulty in determining where and how much direct labor costs should be charged. The budgeting process involving manufacturing costs includes material consumption and purchasing budgets, direct labor budgets, and factory overhead budgets.
Marketing
There should be a monthly breakdown of the target sales expenditure in the budget for control and monitoring purposes. A budget should provide for increased training costs, if additional salespeople are to be employed. The manager must determine how much, when, where and how advertising should be used to obtain the optimum benefit.
There are several ways to determine how much to spend on advertising and sales promotion. There should be a comparison between successive budgeted advertising costs and expected incremental profit per program. Distribution costs and efforts should be increased in those areas that offer the most profitability.
Distribution costs should be planned by function or activity, territory, salesperson, program or project, product, call, and type of sales effort. It is necessary to compare every single cost of distribution with sales, such as transport to the sale. In addition, it is necessary to compare the company's distribution costs with those of competing companies.
Research and Development
This chapter discusses the types of R&D costs, planning, determining the proper funding level, preparing R&D budgets, budget amendments, analyzing and evaluating R&D status, cost control measures, risks associated with R&D efforts, and coordinating R&D policies within the company. Relationship between research and sales; comparison should be made with success of competition in research (eg industry norms). The manager must decide how much to fund research and which specific activities should be funded.
The amount funded depends on how much support is needed to succeed, project priorities, number of programs desired, growth rate, size and capacity of research staff, competition, trade and industry statistics, state of the economy and political concerns.
