The Budgeting Process

The Budgeting Process • What is budgeting? • It is the coordinating the combined intelligence of an entire organization into a plan of action. Budgets include operating budget and financing budget. • Budgeting is a formal quantitative expression of management plan.

Operating budget is the budget that focuses on the acquisition and use of scarce resources. • On the other hand financing budget is the budget that focuses on acquiring to obtain resources.

Advantages of budgets • Enhance the decision making process by helping mangers meet uncertainties. • Enhance communication between mangers because in the initial phase of budgeting mangers are forced to communicate with each other.

Budgets encourage coordination among segments. Mangers through budgeting are forced to exchange views and hence coordination is achieved. • Budgeting is a formal commitment to take corrective action.

Provides performance standards and grantees effective performance. • Difference between actual and budgeted operations indicates the areas lacking control and enhances corrective actions.

Principles of budgeting • Top management support. • Budgeting must be considered important by all management levels • A budget must not be a scapegoat to management or company problems.

Management must consider a budget an excellent means of planning so that it can gain numerous benefits. • If there are new external or internal conditions that require revision of budgets, top management must make budget revision.

Types of budgets • Budgets or planning horizon can vary from one year (less) to many years, depending on the objectives and the uncertainties involves. • Short term: normally twelve or less months. • Long range: more than a year, normally 5-10 years. These are prepared for special purposes. Eg equipment purchase, addition of product lines.

Master budget consolidate an organization plan for shorter time span and are usually prepared on an annual basis. They are sub-divided month to month, monthly basis for the first quarter and then quarterly for the remaining of the year. • Continuous budget these are master budgets that perpetually add a month as the month just ended is dropped.

Budgets forecast two types of activities • Operating activities are forecasted in the operating budget. This include: • Sales budget • Production budget ( units) • Material use • Direct labor • Indirect manufacturing.

Change in inventory level. • Cost of goods sold budget • Selling expense budget • Budgeted income statement • Financial Budget • Capital Budget • Administrative expense budget

Cash budget Budgeted balance sheet

Sales budget • This is the starting point of the budgeting process, because inventory levels ,purchases, and operating expenses are generally geared to the rate of the sales activity. The sales budget includes cash sales, credit sales and their total.

Sample of sales budget • Company Name • Sales Budget April May June • Credit sales(40%) 160 200 240 • Cash sales(60%) 240 300 360 • Total 400 500 600

After the sales budget is prepared, the purchase budget can be prepared. The total merchandise needed is the sum of desired ending inventory plus the amount needed to fulfill the budgeted sales demand. The total needed is partially met by the beginning inventory; the reminder must come from planned purchases.

Therefore these purchases are computed as follows: • Purchases= desired ending inventory + Production needs- beginning inventory.

Sample of Purchase Budget • Purchase Budget April May June • Ending inventory 648 536 480 • PN 350 560 420 • Total needed 998 1096 900 • Beg- inventory 480 648 536 • Purchases 518 448 364 • Purchases in $ = cost x Units

Operating expense budget • This is dependent on various factors. many operating expenses are directly influenced by month-to-month fluctuations in sales volume (sales commission). Others are not directly influenced by the volume of sales( rent, insurance)

Sample of operating expense budget • Expense budget April May June • Wages 250 250 250 • Commission 750 1200 900 • Total 1000 1450 1150 • Rent 250 250 250 • Depreciation 200 200 200 • Other costs ---- ---- ---- • Total O. Expenses ---- ---- ----

Sample of budgeted P&L • Budgeted Income Statement • Sales • -CGS • -Operating expenses • Income from operations -Interest • Net income

At this stage we have completed the operating budget. • Therefore the steps are as follows: • 1. Prepare the sales budget • 2. Prepare the purchase budget • 3. Prepare the operating expenses budget • 4. Prepare the income statement budget.

Examples • 1. A retail store has the following data • Monthly forecasted sales for the month form June to September are 2500, 2200’ 2800, 3100 respectively. Sales consist of 40% cash and 60% credit. Uncollectible amounts may be ignored.

Prepare the sales budget • Sales Budget June July August September • Cash sales(40%) 1000 880 1120 1240 • Credit sales(60%) 1500 1320 1680 1860 • Total 2500 2200 2800 3100

Example • A retail store has the following data • Monthly forecasted inventory levels for the month from May to August are 170000, 150000, 190000 and 160000 respectively. Sales are expected to be 350000for June, 250000 for July and 330000 for August. Cost of sales is 60% of sales. Purchases in April has been 190000, May 160000. Prepare the budget for June, July and August.

Purchase Budget • June July August • End.Inv. 150000 190000 160000 • +CGS 210000 150000 198000 • Total 360000 340000 358000 • Beg. Inv 170000 150000 190000 190000 190000 168000

A retail store has the following data • Monthly forecasted sales for the month form May to August are 300000, 250000 220000, 280000 respectively. Salaries amount to 12000 monthly. Commission is 10% of current sales. Other expenses are rent 3000 per month, miscellaneous expenses 6% of sales, depreciation 1900 per month. Prepare the operating budget for the month June, July and August.

Operating budget • June July August • Sales 250000 220000 280000 • - OP • Salaries 12000 12000 12000 Rent 25000 22000 28000 • Micell 15000 13200 16800 • Elect 3000 3000 3000

Dep 1900 1900 1900 Net I 193100 167900 218300

Material purchase budget • Units needed in production • Add desired direct production • Less beginning inventory • Units to be purchased • Units purchase price • Total purchase cost

Problem 1. • Alex Company manufactures products X, Y and Z. each product required different quantities of input. Planned unit production of each product in 1991 is 10000 units for X, 40000 for Y and 30000 for Z. the direct material for each product are

Unit material requirement • Product A B C D • X 3 _ 2 _ • Y 1 1 _ 4 • Z 2 2 1 3

Beginning and desired ending inventory as well as unit costs for each direct material is as follows: • Inventory /unit A B C D • Jan 1. 20000 5000 3000 10000 • Dec 31. 8000 1000 6000 30000 • unit cost $ 4 7 8 2 • Required: prepare a direct material purchases budget for 1991

Solution • Direct material A units • Product X 10000 units @ 3 30000 • Product Y 40000 units @ 1 40000 • Product Z 30000 units @2 60000 • Production needs 130000 • Scheduled inventory decrease (12000) • Required to be purchased 118000

Direct material B • Product Y 40000 unit@ 1 40000 • Product Z 30000 unit@ 2 60000 • Production needs 100000 • Schedule inventory decrease (4000) • Required to purchase 96000

Direct material C • Product X 10000 units @ 2 20000 • Product Z 30000 units @ 1 30000 • Production needs 50000 • Schedule inventory increase 3000 • Required to purchase 53000

Direct material D • Product Y 40000 unit @ 4 160000 • Product Z 30000 unit @ 3 90000 • Production needs 250000 • Schedule inventory increase 20000 • Required to purchase 270000

material Q Price Totat purchase price • A 118000 4 $472000 • B 96000 7 672000 • C 53000 8 424000 • D 270000 2 540000 • Total $2108000

Direct labor budget • It reflects the number of units to be produced according to the production budget. Labor budget includes only direct labor as indirect labor is included in the overhead budget. In this budget the direct labor hours have to be specified so that management has to translate this into dollars by applying the appropriate labor rate.

Sample • ABC Co. • Direct labor budget • Date • Units Hours Total hour’s Total budget@ rate • Product A 1650 3 4950 59400 • Product B 16130 5 80650 967800 • Product C 9400 10 940001128000 • 179600 2155200

Practice 1. • Emilio and Sons Company manufactures products 1,2 and 3. each product required different quantities of input. Planned unit production of each product in 2001 is 20000 units for 1, 30000 for 2 and 40000 for 3. The direct material for each product are

Unit material requirement • Product A B C D • 1 - 3 2 1 • 2 1 1 3 2 • 3 5 2 - 4

Practice 2. • Mohd and Sons Company manufactures products 1,2 and 3. Each product required different quantities of input. Planned unit production of each product in 2003 is 10000 units for 1, 15000 for 2 and 20000 for 3. The direct material for each product are

Unit material requirement • Product A B C D • 1 1 2 3 1 • 2 1 1 3 3 • 3 3 1 1 4

Q. 2 A retail store has the following data • Monthly forecasted inventory levels for the month from May to August are 160000, 140000, 180000 and 170000 respectively. Sales are expected to be 350000 for June, 260000 for July and 330000 for August. Cost of sales is 70% of sales. Purchases in April has been 190000, May 160000. Prepare the budget for June, July and August.

CGS Budget Company Name Cost of Goods Sold Budget Date Direct materials Inventory1.1 Add: net material purchase Direct material available for use Less direct material inventory 31.12 Direct material used

Direct labor Factory overhead Total manufacturing costs for the period Add work in process 1.1 Less work in process 31.12 Cost of goods manufactured

Finished goods inventory 1.1 • Cost of goods available for sale • Less finished goods inventory 31.12 • Cost of goods sold

Marketing & Administrative Expense Budget • Company Name • Marketing and Administrative expenses • Date • Variable marketing expenses • Wages • Sales commission • Advertising • Traveling • Total variable expenses

The Budgeting Process