Chapter Seven

1. Chapter Seven Planning for Profit andCost Control

2. Three Levels of Planning • Strategic planning involves making long-term decisions such as defining the scope of the business, determining which products to develop or discounting, and identifying the most profitable markets. • Capital budgeting focuses on intermediate range planning and involves decisions as whether to buy or lease equipment, whether to stimulate sales, or whether to increase company assets. • Master budget describes short-term objectives in specific sales targets, production goals, and financing plans.

3. Advantages of Budgeting PromotesPlanning PromotesCoordination Budgeting EnhancesPerformance Measurement EnhancesCorrective Actions

4. Budgeting and Human Behavior Upper management must be sensitive to the impact of the budgeting process on employees. Budgets are constraining. They limit individual freedom in favor of an established plan. Many people find evaluation based on budget expectations stressful. Think of students and exams. Upper management must demonstrate that budgets are sincere efforts to express realistic goals employees are expected to meet.

5. Cash receipts Cash paymentsfor inventory Inventorypurchasesbudget IncomeStatement Cashpaymentsfor S & A S & Aexpensebudget BalanceSheet Cashbudget Statement ofCash Flows Cash Receipts and Payments Schedules Operating Budgets Pro formaFinancialStatements Start Sales budget

6. Sales Budget Detailed schedule prepared by the marketing department showing expected sales for the coming periods and expected collections on those sales. It is critical to the success of the entire budgeting process.

7. Inventory Purchases Budget The total amount of inventory needed for each month is equal to the amount of the cost of budgeted sales plus the desired ending inventory.

8. Selling and Administrative Expense Budget The details of the Selling and Administrative (S&A) Budget are shown on the next two screens. It is important to note that sales commissions (based on 2% of sales) are paid in the month following the sale, while supplies expense, based on 1% of sales) are paid in the month of the sale. The utility expense is paid in the month following the usage of the electricity, gas, and water.

9. Check Yourself • Astor Company expects to incur the following operating expenses during September: Salary Expense, $25,000; Utility Expense, $1,200; Depreciation Expense, $5,400; and Selling Expense, $14,000. It pays operating expenses in cash in the month in which it incurs them. Based on this information, the total amount of cash outflow reported in the Operating Activities section of the pro format Statement of Cash Flows would be: • $45,600. • $31,600. • $40,200. • $44,400 Depreciation Expense is a non-cashcharge to income and will not appearon the Statement of Cash Flows.

10. Pro Forma Income Statement The pro forma income statement gives management an estimate of the expected profitability of HH. If the project appears to be unprofitable, management can make the decision to abandon it. Although managers remain responsible for data analysis and decision making, computer technology offers powerful tools to asset in those tasks.

11. Pro Forma Statement of Cash Flows Almost all the information for the Pro Forma Statement of Cash Flows can be found on the Cash Budget.

12. End of Chapter Seven