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Profit Planning/ Budgeting. ACC 2203 Review Workshop Sindhu Bala. Budgeting – Definitions. Master Budget – a comprehensive plan of all aspects of a firm’s future business and production operations Master budget comprises of many separate budgets. These budgets include:
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Profit Planning/ Budgeting ACC 2203 Review Workshop Sindhu Bala
Budgeting – Definitions Master Budget – a comprehensive plan of all aspects of a firm’s future business and production operations Master budget comprises of many separate budgets. These budgets include: • Sales Budget – forecasts future sales quantities, selling prices, and sales revenues • Production Budget – shows the number of units of each good expected to be produced • Budgeted Manufacturing Costs – prediction of the amounts and costs of each input required to manufacture expected production quantities • Direct Materials Budget • Direct Labor Budget • Manufacturing Overhead Budget • Selling and Administrative Expense Budget – prediction of all selling costs required for attaining forecasted sales levels; prediction of administrative costs • Budgeted Income Statement • Capital Expenditure Budget • Cash Budget • Budgeted Balance Sheet
Budgeting – Definitions All firms make plans and decisions, such as • Deciding what to produce and how much to produce (production capacity) • Deciding what inputs and how much of each input to use • Deciding what prices to charge and what type of a marketing strategy to pursue Budgets allow firms to see the impact of their decisions and plans and to improve on their decisions and plans (planning function of budgets). Firms that systematically prepare budgets can: • See projected earnings and cash flows from the plans • Detect potential problems before they occur • Line-up additional financing that may be needed • Coordinate actions of different division within the firm • Budgets set benchmarks for evaluating subsequent performance (control function of budgeting)
The Master Budget: An Overview Sales Budget EndingFinished Goods Budget Selling and Administrative Budget Production Budget Direct Materials Budget Direct Labor Budget Manufacturing Overhead Budget Cash Budget Budgeted Financial Statements
Master Budget For A Sample Company • The Foster Company is a manufacturer of cashmere sweaters. Each year in October, Foster put together its Master Budget for the four quarters of the following year. • SALES BUDGET – predicts sales quantities and selling prices to determine the amount of sales revenue the company expects to generate • What factors do companies take into account when they decide how many units they can sell and what price to charge for each unit? • Customers tastes • Production and advertising strategies • Competitors • Production capacity • Changes in the economy
Foster Company - Sales Budget The Foster Company has predicted that it can maximize its profits if it charges $200 for its sweaters. The marketing manager of the company has indicated that at a price of $200 the company can sell 1,000 sweaters in the first quarter of 2007. Due to an emerging trend observed in fashion houses toward using cashmere sweaters in their creations, the marketing manager predicts to increase its sales by 100 sweaters each quarter.
Foster Company - Collections Budget SCHEDULE OF EXPECTED CASH COLLECTIONS – when do we expect to receive cash for the sales we have made? Cash collection information: • Of all sales 80% are on credit • 70% of credit sales are collected in the quarter in which the sale is made and 30% are collected in the following quarter • Accounts receivable is estimated to be $60,000 on December 31, 2006; the company expects to collect the outstanding receivables in the first quarter of 2007
Foster Company - Production Budget PRODUCTION BUDGET – predicts the number of units the firm plans to produce during the budget period. Finished Goods Inventory Beginning F.G Inventory Units Sold Units Produced Ending F.G Inventory
Foster Company - Production Budget Note that the number of units a firm plans to produce many not equal the number of units it plans to sell. Explain why?
Foster Company - Production Budget Foster maintains at the end of each quarter an inventory of 10% of the next quarter’s sales. This allows the company to better meet its customers’ needs in case the customers experience a sudden surge in demand.
Foster Company – Manufacturing Costs BUDGETED MANUFACTURING COSTS – Estimated amounts and costs of inputs necessary to produce the budgeted production quantities Companies estimate the amounts and costs of DL, DM, and OH they expect to use to make one unit of a product. These estimates are called standard quantity of input and standard cost of input (per unit of output). Direct Materials (cashmere): Foster expects to use on average ½ lb. of cashmere to make one sweater. Expected price for a pound of raw cashmere is $30. Direct Labor: Although somewhat automated, dying, combing, knitting, and weaving cashmere is a tedious process that requires some direct labor. Each sweater on average requires 1 hour of skilled labor. Foster pays its skilled workers $20/hour. Variable Overhead: Foster expects to incur $1 per machine hour for indirect materials such as lubricants and cooling fluids, $1.5 per machine hour for utilities, and $2.5 per machine hour for indirect labor. On average it takes 2 hours of machine time to make one cashmere sweater (primarily due to the delicate nature of cashmere and the attention it requires)
Foster Company – Manufacturing Costs Fixed Overhead: Foster expects to incur $69,600 in machine depreciation, $60,000 in factory supervisor salary, and $56,000 in factory rent and insurance. Foster allocates OH on the basis of machine hours. FOH = FOH Rate =
Foster Company – DM Budget DIRECT MATERIALS BUDGET – Estimated amounts and costs of direct materials that need to be purchased to manufacture the budgeted units and to maintain a materials inventory Materials Inventory Beginning Inventory Materials used in production Materials Purchased Ending Inventory Foster keeps at the beginning of each quarter a materials inventory of 10% of the quarter’s raw materials needs.
Foster Company – Cash Disbursements SCHEDULE OF EXPECTED CASH DISBURSEMENTS FOR MATERIALS – shows the amount and timing of cash payments the firm has to make to its suppliers. Cash Disbursement Information: • Direct materials are all purchased on credit • Foster usually pays 60% of its purchases in the same quarter as the purchase and the rest is paid in the following quarter • The company expects to have an accounts payable balance of $40,000 on December 31, 2002; and all outstanding payables are expected to be paid in the first quarter of 2007
Foster Company – DL Budget DIRECT LABOR BUDGET – provides an estimate of the amount and cost of direct labor time required to fulfill the budgeted production Each cashmere sweater requires 1 hour of skilled labor. Foster pays its skilled workers $20/hour.
Foster Company – MOH Budget MANUFACTURING OVERHEAD BUDGET - provides an estimate of the cost of variable and fixed overhead required to fulfill the budgeted production Variable overhead rate is $5 per machine hour (costs of indirect materials, utilities, and indirect labor combined). Foster expects to use 2 MHs per unit. Fixed overhead cost is $185,600 ($69,600 in machine depreciation, $60,000 in factory supervisor salary, and $56,000 in factory rent and insurance combined). Fixed overhead is allocated on the basis of machine hours at a predetermined OH rate of $20/MH. Fixed OH rate for cash items: FOH rate = Fixed OH rate for non-cash items: FOH = FOH rate =
Foster Company – S&A Budget SELLING AND ADMINISTRATIVE EXPENSE BUDGET – Estimates of all costs necessary to attain the sales levels in the sales budget and to deliver the goods to the customer (selling expenses) and estimates of all administrative activities (administrative expenses) Variable selling and administrative expenses for each cashmere sweater are 10% sales commission and an average shipping costs of $10 per sweater. Fixed selling and administrative expenses for the year are: Fixed S&A expenses are assumed to be the same in each quarter Fixed cash S&A expenses for each quarter: Fixed non-cash S&A expenses for each quarter:
CASH BUDGET – expected cash outflows to and inflows from operations and financing
Foster Company – Cash Budget The Foster Company has provided the following information for preparing a cash budget: • Expected cash balance on 1/1/2007 = $40,000 (1) Information on cash receipts: • 80% of all sales are on credit. 70% of credit sales are collected in the quarter in which the sale is made and 30% are collected in the following quarter. A/R is estimated to be $60,000 on 12/31/2006; the company expects to collect the outstanding A/R in the 1st quarter of 2007. • In the 1st quarter of 2007, Foster expects to sell marketable securities that are valued at $10,000. (2) Information on cash disbursements: • Direct materials are all purchased on credit. Foster usually pays 60% of its purchases in the same quarter as the purchase and the rest is paid in the following quarter. The company expects to have an accounts payable balance of $40,000 on December 31, 2006; and all outstanding payables are expected to be paid in the first quarter of 2007. • All employees – direct laborers, supervisors, S&A staff – are all paid in the quarter in which their services are used. • Overhead costs and S&A expenses are paid in the quarter in which they are incurred • On April 1, 2007, the company plans to spend $90,000 to buy a high-end knitting machine, which has a 10-year useful life. (3) Information on financing: • The company expects to obtain a loan for the full amount of the knitting machine on April 1, 2007. No principal will be repaid during the year; interest at an annual rate of 10% is due quarterly. The company does not expect to issue stock or pay any dividends in 2007. (4)
Foster Company – Budgeted Income Statement BUDGETED INCOME STATEMENT – projection of net income the company expects to earn as a result of all the budgeted activities
