Budgeting & Profit Planning

1. Budgeting & Profit Planning

2. April 20, 2010 • What is a budget • Why and how organizations budget • Budgeting • Sales • Production • Sales & Administration • Balance Sheet Budget Items • Working Capital • Capital Equipment • Financing • Financial Statements

3. Budget • A budget is a detailed quantitative plan for acquiring and using financial and other resources over a specified forthcoming time period • Its purpose is to plan for the future and control behaviour and costs • Planning to prepare for objectives and setting out a framework to achieve the objectives • Providing incentives to managers to achieve the objectives • Control by holding people to account with respect to their objectives • Cost control • Revenue generation

4. Advantages of Budgeting • The budgeting process forces managers to think through a plan from their perspective • It provides a forum for people to interact and determine how to best allocate limited resources • Defines a set of consistent goals and objectives • Communicated throughout the organization for common understanding and cooperation • The budget provides a document against which to measure performance

5. Self-Imposed Budget A participative budget is prepared with the full cooperation and participation of managers at all levels. A participative budget is also known as a self-imposed budget.

6. Factors in Budgeting • There are a number of human factors in budgeting: • Requires the full support and commitment from senior management • People who are engaged in the process are more likely to support it • Managers and executives need to be reasonable • Managers may feel they should lower their own targets to reduce expectations • Executives may feel they should pressure managers to unachievable levels • Be reasonable (set budgets for different audiences) – Board, Fall-back, Management Incentive, Stretch • Work to root out personal ambitions

7. Managing the Budgeting Process • Usually driven by the CFO • Establishes a leadership team • Builds up the data through meetings with all profit and cost centers • Note: The system (ABC, Process Costing, Account mapping) is already assumed to have been done by this time

8. The Master Budget: An Overview Sales budget Selling and administrative expense budget Endinginventory budget Production budget Direct labor budget Direct materials budget Manufacturing overhead budget Cash budget Budgetedincomestatement Budgetedbalancesheet

9. Key Budget Segments • There are a few critical budget segments to get in place • Each organization may have its own twists to the approach • Sales Budget • Production Budget • Direct Labour, Direct Materials, Manufacturing Overhead • Selling, General and Administration • Working Capital Budget • Capital Budget • With the assumptions in these budgets in place, full cash flow, income statement and balance sheet plans can be published

10. Sales Budget • Understand your market • Size, growth rate, market share • Cyclicality, seasonality • Competitive position for each product/service • New entrant, established player • Put forward and discuss a reasonable matrix of targets for the circumstances • This budget proposes no price increases • 10% growth in Motorbike sales • 5% growth in car sales • no seasonality • What might this quarterly budget look like?

11. Sales Budget • After discussions with the sales team, we would look to have them sign off on the final version • Commissions would be put in place • To incentivize them to meet the targets • To ensure they emphasize the products with the highest contribution

12. Production Budget • The Production Budget must deliver the final product committed to in the Sales Budget, in the time frame it calls for

13. Production Budget • Production budgets can complex • There would of course be build ups behind each of the accounts • Direct Labour – based on units of labour per production unit • Direct Materials - “ “ “ “ • Manufacturing Overhead • Fixed and Variable • Furthermore, there are production lead times to be managed • Long lead time parts can constrain production • Inflation, expected pay hikes, etc. will also impact each cost function • As there were challenges to the sales force, there may be challenges in production to reduce cost, defects, inventory

14. Sales & Administration Budget • The Sales & Administration budget must support the level of business activity planned in the Sales Budget and Production Budget • Sales are budgeted to increase 5%-10% • Bad economic climate calls for challenges • Do not increase spending from last year unless unavoidable • Carry on with same level of advertising and promotion • Non-discretionary variable costs must increase with sales • Obtain sign off from those in control of these costs • Develop a compensation structure that rewards being within budget

15. Sales & Administration Budget • Sales & Administration Budget • If the promotional campaign supporting the increase in sales cost $150 million, was it justified?

16. Sales & Administration Budget • Promotional campaign analysis • Break even ($ sales) = fixed cost / contribution margin (%) • The campaign is justified as it supports incremental sales of much more than $320 million required to cove the cost

17. Sales & Administration Budget • Sales Budget, Production Budget and Sales & Administration Budget in place • We can exhibit the Operating Profit and Cash Flow from Operations • Budget forecasts $1.5 billion Operating Profit • 21% Operating Margin

18. Interlude • We are working towards building a Cash Budget and Financial Statements, including a Cash Flow Statement • Cash Flow Statements have different categories of sources and uses of cash • Cash Flow from Operations • Sales Budget • Production Budget • S&A Budget • Cash Flow from Changes in Working Capital • Balance Sheet Budget • Cash Flow from Investing Activities • Balance Sheet Budget

19. Balance Sheet Budget • Working Capital Assumptions • Can be made at very detailed or high level • Try to balance for practicality • Accounts Receivable • Assume # of days sales outstanding • Challenge collections department to get cash in earlier • Inventory • Forecast demand • Assume # of days COGS outstanding • Accounts Payable (including payroll) • Payroll is under corporate control – eg pay every 30 days • Assume # days of Direct Materials and other outstanding • Other (Prepaid assets; Accrued liabilities) • Similar methodologies can be applied

20. Balance Sheet Budget • Balance Sheet Model • We have run the assumptions (from sales straight through to these balance sheet assumptions) • We learn there will be a requirement for cash of $57 million in the first quarter • This is required to fund increased A/R and inventory from sales growth

21. Balance Sheet Budget • Investments/Capital assumptions • By investment, we primarily mean Property, Plant & Equipment • As with Working Capital, can be made at very detailed or high level • Organizations will have detailed asset schedules, including depreciation • Decisions to purchase assets are based upon a number of factors • Capacity utilization • Forecast volume • Financing • For our purposes, we will assume the following: • Factory capacity is at 80% - no need to expand • Machinery & Equipment is at full capacity and must be increased in proportion to sales • Depreciation on new M&E flows through Variable Manufacturing Overhead

22. Balance Sheet Budget • Balance Sheet Model – Capex • We learn there will be a requirement for cash of $12 million in the first quarter • This is required to fund increased machinery and equipment to produce the incremental volume

23. Financial Statements • Final budgeted Income and Cash Flow Statements

24. Financial Statements • Final budgeted Balance Sheet

25. Review • What is a budget • Why and how organizations budget • Budgeting • Sales • Production • Sales & Administration • Balance Sheet Budget Items • Working Capital • Capital Equipment • Financing • Financial Statements

26. Tutorial