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Budgetary Planning and Control Slide 2 BudgetsBudgets The formal documents that quantify a companys plans for achieving its goals. For many companies, the planning and control process is built around budgets. Slide 3 Use of Budgets in Planning Enhances communication and coordination Forces managers to consider: Goals Objectives Specify means of achieving them Slide 4 Use of Budgets in Control Provide a basis for evaluating performance by comparing the actual with the planned performance Deviations from planned performance have three potential causes: Plan or budget was poorly conceived Conditions have changed Managers have done a particularly good or poor job managing operations Slide 5 Developing the Budget Budgets are prepared for: Departments Divisions of a company For the entire company Slide 6 Developing the Budget Budget Committee Responsible for approval of various budgets Made up of senior managers (Presidents, CFO, controller, etc.) Typically works with departments to develop realistic plans Slide 7 Role of Budgets in Planning and Control Slide 8 Budget Time Period Management must first decide on a budget time period Long-run budgets (3-year, 5-year) Short-run budgets (month, quarter) Length of time period determines the amount of detail in a budget Slide 9 Five-Year Budgets Slide 10 Better Budgets Slide 11 Zero Base Budgeting Managers must start at zero in developing their budgets and justify budgeted amounts Provides validation for budgeted amounts Time consuming and expensive process Not widely used by business enterprises Slide 12 Master Budget Slide 13 Sales Budget First budget prepared since most budgets cannot be prepared without an estimate of sales A variety of methods are used to estimate sales: Economic models Sales trends Trade journals Sales force estimates Slide 14 Production Budget Quantity to be produced based on following formula: Slide 15 Example Exercise #1 VitaPup produces a vitamin-enhanced dog food that is sold in Kansas. The company expects sales to be 12,600 bags in January, 14,500 bags in February, and 19,000 bags in March. There are 1,260 bags on hand at the start of January. VitaPup desires to maintain monthly ending inventory equal to 10% of next months expected sales. Prepare the production budget for VitaPup for the months of January and February. Slide 16 Example Exercise #1 Solution Production Budget for January Expected Sales12,600 +Desired Ending Inventory 1,450 -Beginning Inventory(1,260) Total Production12,790 Production Budget for February Expected Sales 14,500 + Desired Ending Inventory 1,900 -Beginning Inventory (1,450) Total Production14,950 Slide 17 Direct Material Purchase Budget Depends upon the amount needed for production and the amount needed for ending inventory The following formula can be used: Slide 18 Direct Labor Budget Direct labor can be calculated using the following formula: Number of units produced x Labor hours per unit x Rate per hour Once calculated, can be used to determine the approximate number of employees needed Slide 19 Manufacturing Overhead Budget Variable Costs Multiply variable cost per unit by quantity produced Fixed Costs Remain relatively constant Depreciation could fluctuate based on planned acquisitions Slide 20 Selling and Administrative Expense Budget Includes the following: Salaries Advertising Office Expenses Other General Expenses Slide 21 Budgeted Income Statement Compilation of information provided by previously prepared budgets Sales Budget Direct Materials Budget Direct Labor Budget Manufacturing Overhead Budget Selling and Administrative Expense Budget Slide 22 Capital Acquisitions Budget Acquisitions include: Property Plant Equipment Must be carefully planned due to the large amounts of cash that could be used Slide 23 Cash Receipts and Disbursements Budget Managers must plan for two items: Amount of Cash Flows Timing of Cash Flows Importance Differences between cash flows and income Anticipate cash shortages or surpluses Slide 24 Example Exercise #2 The Warrenburg Antique Mall budgeted credit sales in the first quarter of 2009 to be as follows: January$150,000 February$160,000 March$172,000 Credit sales in December of 2008 are expected to be $200,000. The company expects to collect 75% of a months sales in the month of sale and 25% in the following month. Estimate the cash receipts for January and February. Slide 25 Example Exercise #2 Solution January Estimated Cash Receipts December (200,000 x 25%) $50,000 January (150,000 x 75%)$112,500 Total$162,500 February Estimated Cash Receipts January (150,000 x 25%) $37,500 February (160,000 x 75%)$120,000 Total$157,500 Slide 26 Budgeted Balance Sheet Last budget prepared Sometimes referred to as the pro forma balance sheet Used to assess the effect of planned decisions on the future financial position of the firm Slide 27 Study Break #1 Which of the following statements regarding budgets is false? a.They are formal documents that quantify a companys plans. b.They enhance communication and coordination. c.They are useful in planning but not in control. d.They provide a basis for evaluating performance. Answer: c. They are useful in planning but not in control Slide 28 Study Break #2 Which of the following items do not require a cash outflow? a.Salaries b.Purchase of raw materials c.Advertising d.Depreciation Answer: d. Depreciation Slide 29 Use of Computers in the Budget Planning Process Extremely useful in budgeting process Excel Spreadsheet Other specialized program Allows for company to determine effects of a decision on entire budget What if Analysis Slide 30 Budgetary Control Budgets as a Standard for Evaluation Actual amounts are compared with budgeted amounts Differences between actual and budgeted amounts are referred to as budget variances Budget variances should be investigated when they are material Slide 31 Budgetary Control Management must make sure the level of activity in the budget is equal to the actual level of activity Static Budget Not adjusted for the actual level of production Flexible Budget A set of budget relationships that can be adjusted for various production activity levels Slide 32 SpreadsheetsSpreadsheets Slide 33 Investigating Budget Variances Causes of Budget Variances Budget may not have been well conceived Conditions may have changed Managers may have performed particularly well or poorly Slide 34 Investigating Budget Variances Management by Exception Economical approach Only exceptional variances are investigated Must investigate both unfavorable and favorable exceptional variances Slide 35 Unfavorable Budget Variance Slide 36 Conflict in Planning and Control Uses of Budgets Budgets used for planning and control Focus of management on meeting or beating budgeted targets Compensation could be dependent upon this Creates an inherent conflict Slide 37 Common Budget-based Compensation Scheme Slide 38 Issues With Budget-based Compensation Managers have incentive to pad a budget Lower sales forecasts and increasing cost forecasts Makes budget targets easier to achieve creating budget slack Managers may have incentive to shift income from one period to another Slide 39 Study Break #3 Differences between budget and actual amounts are referred to as: a.An error b.A variance c.A flexible budget d.A static budget Answer: b. A variance Slide 40 Study Break #4 A ____ budget is not adjusted for the actual level of production. a.Static b.Flexible c.Pro forma d.None of the above Answer: a. Static Slide 41 Budget Padding