The three pooled their resources to include The Home-O-Nize Co. They planned to make a revolutionary design of steel kitchen cabinets, but the post-war steel shortage delayed operations. Managers engaged in strategic planning must identify the key variables believed to be the direct causes of the achievement or non-achievement of the organization's goals and objectives. The collection and dissemination of data - the traditional functions of a financial group - will be subsumed, with financial staff being transformed into analysts, strategists and lawyers.
Because of the budgetary interrelationships illustrated in Exhibit 13-3, all departmental components must interact in a coordinated manner. The budget process shown in Appendix 13-3 presents the interaction between the different functional areas in a production organization involved in preparing a master budget. The process begins with the sales department's estimates of the types, quantities, and timing of demand for the company's products.
The December 31, 2000 balance sheet presented in Exhibit 13–5 shows the account balances necessary to begin preparing the master budget. Therefore, the next part of the chapter is devoted to the preparation of the main budget.
Production Budget
Purchases Budget
Peter Pallans, director and production manager for Forbes, Inc., in New York, discusses developing a magazine production budget in the accompanying news note. Companies may have different policies for material directly related to different products or for different seasons of the year. For example, a company may maintain only a minimal ending inventory of a direct material that is constantly available in the desired quantity and quality.
Alternatively, if a material is difficult to obtain during certain times of the year (such as certain components for the preparation of spices), a company can store that material for use in future periods. The purchasing budget is first expressed in whole units of finished goods and then converted into direct material component requirements and dollar amounts. Manufacturing a Better Brackets unit requires only one direct material: four ounces of metal.
Note that the beginning and ending inventory quantities are first expressed in parentheses and then converted to the appropriate measure of quantity (ounces of metal).
Personnel Budget
Direct Labor Budget
Factory direct labor costs are based on the standard labor hours required to produce the number of units specified in the production budget. The average wage rate includes both the direct labor wage rate and the payroll taxes and benefits associated with direct labor (because these items usually add between 25 and 30 percent to basic labor costs).
Overhead Budget
Selling and Administrative Budget
Capital Budget
Cash Budget
This pattern takes into account the collection patterns experienced in the recent past and management's assessment of changes that may disrupt current collection patterns. Better Brackets has determined from historical data that the collection pattern shown in Exhibit 13-13 is applicable to its customers. Collections from the remaining credit customers are as follows: 20 percent in the month of sale; 50 percent in the month after the sale; and 29 percent in the second month after the sale.
Management needs to have sales information for November and December because collections for credit sales extend over three months, meaning that collection of a portion of the previous year's sales occurs early in the current year. The individual calculations refer to the alternative collection patterns and associated percentages shown in Figure 13–13. The amounts for November and December collections can be compared to the December 31, 2000 balance sheet (Exhibit 13-5), which showed an accounts receivable balance of $24,000.
The second of these two rules relates to the remaining 20 percent of credit customers who paid in the month of sale but did not receive the discount. Using the purchases information from Exhibit 13–8, management can prepare a cash disbursement schedule for Accounts Payable. So the remaining 60 percent of each month's purchases is paid in the month following the month of purchase.
Given the cash receipts and disbursements information for Better Brackets, the cash budget model is used to formulate the cash budget shown in Exhibit 13–16. N" stands for "Net of Discount." The total amount of gross purchases paid for in the month of purchase is the sum of the net of discount payment plus the amount shown on the same line in the Discount Column. Interest is calculated using assuming an annual rate of 12 percent (1 percent per month) and investments and sales of investments are made in $1,000 increments at the end of the month.
Exhibit 13–16 shows that Better Brackets has a cash surplus of $27,829 available over disbursements in January. Exhibits 13–17 provide some suggestions in this regard for small businesses, although the same recipes are applicable to businesses of all sizes. Better payment terms from suppliers are the easiest way to slow down a company's cash flow.
Budgeted Financial Statements
Information found in the income statement, balance sheet, and cash budget is also used to prepare a Statement of Cash Flows (SCF). Further, because SCF identifies the relationship between net income and net cash flow from operations, it assists managers in judging the quality of a company's earnings. While the cash budget is central to actual cash management, the budgeted SCF gives managers a more global view of cash flows by reorganizing them into three distinct main activities (operating, investing and financing).
The operational part of the SCF prepared on a direct or indirect basis is acceptable for external reporting. Exhibit 13–21 summarizes the cash flows for the better tranches, using information from the cash budget in Exhibit 13–16; the second, indirect presentation of the operating part uses the information from the income statement in Figure 13-19 and the balance sheets in Figures 13-5 and 13-20. Sales forecasts should include the type and quantity of products that will be sold, the geographic locations of the sales, the types of buyers, and when the sales will occur.
If actual results differ from plans, managers should look for the causes of the differences and then consider revising the budget. If actual performance is significantly worse than expected, the budget may or may not be adjusted, depending on the causes of the variance. If the causes are internal (such as a sales force not selling the product), management may leave the budget in its original form so that the lack of operational control is visible in comparisons.
If actual performance is significantly better than expected, changes can also be made to the budget, although management may decide not to change the budget so that positive performance is emphasized. Regardless of whether the budget is revised, managers should praise those responsible for positive performance and communicate the effects of such performance to other related departments. After the budget is developed, the executive staff is informed of the budget objectives and constraints.
The budgeting process in a given company is usually determined by the extent to which the process is imposed or participatory. Top management can try to reduce slack by linking actual performance to the budget through a bonus system. This type of budget can help management become more aware of the budgeted costs of proposed non-value-added activities, and can make managers question why such costs are planned.
REVISITING
An example of a general statement of budget purpose is: “The cash budget provides a basis for planning, reviewing and controlling cash flows from and to various activities; this budget is essential to the preparation of the pro forma statement of cash flows." Specific statements could include references to minimum desired cash balances and periods of intense cash needs. The last section of the budget manual contains the budgets created during the budgeting process. What are the different sections of the budget manual and why each section is necessary.
Production budget) The sales budget for Leno Company shows the following sales forecasts (in units) for the quarters of the calendar year 2000:. The inventory of finished goods at the end of each production period is expected to be 30 percent of the budgeted unit sales for the following quarter. Because the company terms are 1 percent EOM (end of month), net 30, all collections within the month of sale are exclusive of the 1 percent discount.
The remaining 30 percent is collected in the second month after the month of sale. Aurora Products uses five pounds of material A and three gallons of material B to produce each unit of this product. The company has no work-in-process inventory. The West Indies Tea Company generally holds 3 percent of the next month's finished goods requirements in stock.
Management plans to have enough hats on hand at the end of each month to satisfy 25 percent of the following month's sales. Purchases each month are 55 percent of the current month's sales and 45 percent of the next month's expected sales. Sales are billed twice a month, on the 10th of the month for the last half of the previous month's sales and on the 20th of the month for the first half of the current month's sales.
Tim's purchases merchandise for resale to meet the current month's sales demand and to maintain a desired monthly ending inventory of 25 percent of the next month's sales. Raw materials inventory at the beginning of the year consists of 1,000 gallons of direct materials at a standard cost of $0.80 per gallon. Prepare a master budget for each month of the first quarter of 2000 and pro forma financial statements as of the end of the first quarter of 2000.
The second input for determining the desired level of net income is more complicated. This portion of the desired net income is based on the value of the net assets owned by the accounting firm.
