Chapter 8: Master Budgeting

What are budgets?

A plan that uses the company’s resources to get from where it is to where it wants to be

What do budgets use?

A set of assumptions

What do budgets specify?

Goals and how to achieve them for a specific time period

Who uses budgets?

Everyone

What are budgets prepared for?

Different time periods

What are the two main reasons companies prepare budgets?

Planning and Control

What does Planning involve?

Developing goals and preparing various budgets to achieve those goals

What does Control involve?

Gathering feedback to ensure the plan is working, making changes as needed, verifying all parts of the organization are working together toward the goals

What exists inherently between planning and control?

Tension

What is the goal of the Sales Manager?

Keep sales estimates low so can “beat the budget”

What is the goal of the Production Manager?

Show cost estimates high so can “beat the budget”

What must the budget process do for the goals of the Sales Manager and the Production Manager?

Must recognize and manage this behavior

What does the budget process coordinate?

The various business functions (ex: marketing and manufacturing)

What does the budget process require of managers?

To think of relationships among individual operations, departments, and the company as a whole

What is the end result of the budgeting process?

The guide/benchmark for the company

Are budgeting processes the same across firms and industries?

No, there is wide variation

What do many companies begin with in the budgeting process?

Previous budget as a baselines

What does it mean to say the budget process is iterative?

• Each step goes through multiple revisions

• Examining targets

• Challenging assumptions

• Examining alternatives & making choices

What is the pyramid of the Budget Approach (from top to bottom)?

1. Executives

2. Middle Management

3. Supervisor

What are the Advantages of the Top-Down approach to budgets?

• Time savings

• Reduces “super star” syndrome

What are the Disadvantages of the Top-Down approach to budgets?

• Overlook opportunities

• Underperformance

• Morale

What are the Advantages of the Bottom-Up (Participative) approach to budgets?

• Ownership

• Team

• Motivation

• Accuracy

What are the Disadvantages of the Bottom-Up (Participative) approach to budgets?

• “Super star” syndrome

Where do you start when it comes to budgets?

1. Start with income statements

2. Develop interim budgets to create income statement

3. Begin with revenues

What is the foundational step or cornerstone in every budget?

Budgeting revenue

What does the Revenue Budget require?

Sales and marketing managers to coordinate

What question do we ask when preparing the Revenue Budget?

How much revenue do we expect to generate

How is the question asked when preparing the Revenue Budget answered?

• Price (expected selling price per unit)

• Quantity (number of units expect to sell)

What is the set up for a Revenue Budget?

Units expect to sell

* Selling price per unit

= Budgeted revenues

What kind of info does the Production Budget combine?

Demand info from the revenue budget and the company’s inventory policy regarding finished goods to determine production levels for the coming year

What does the Production Budget require?

Marketing and Production managers to coordinate

What question do we ask when preparing the Production Budget?

• How many units expect to make?

• How many units need in Ending Finished Goods Inventory?

How is the question asked when preparing the Production Budget answered?

• Budgeted sales in units

• Expected beginning Finished Goods in units

• Inventory policy assumption

What is the set up for the Production Budget?

Budgeted sales

+ Desired ending finished goods inventory

= Total needed

- Beginning finished goods inventory

= Budgeted production

Once you know the production budget, what other budgets can you determine?

Budgets for materials, labor, and overhead (input resources)

What does the Direct Material, Direct Labor, and Manufacturing Overhead Budget require?

Production, Purchasing, and HR managers to coordinate

What question do we ask when preparing the Direct Material Budget?

• How much DM expect to purchase?

• How much RM need in RM ending inventory?

• How much RM expect to make a unit?

• How much expect RM to cost?

How is the question asked when preparing the Direct Material Budget answered?

• Budgeted production in units

• Budgeted RM per unit

• Budgeted cost of RM

• Inventory policy assumption

What is the set up for Direct Materials Budget?

Budgeted units (production)

* Materials per unit

= Total materials for production

+ Desired RM ending inventory

= Total needed

- Beginning RM inventory

= Budgeted RM purchases

* Budgeted material price per unit

= Budgeted RM purchases

What question do we ask when preparing the Direct Labor Budget?

• How much is the expected DL cost?

• How many DL hours expect to make a unit?

• How much expect to pay DL per hour?

How is the question asked when preparing the Direct Labor Budget answered?

• Budgeted production in units

• Budgeted DL hours per unit

• Budgeted cost of a DL hour

What is the set up for the Direct Labor budget?

Budgeted units (production)

* Labor hours per unit

= Budgeted direct labor hours

* Budgeted labor cost per hour

= Budgeted direct labor cost

What question do we ask when preparing the Manufacturing Overhead Budget?

• How much is the expected MOH cost?

• What are the expected variable & fixed components?

• What is the expected depreciation?

How is the question asked when preparing the Manufacturing Overhead Budget answered?

• Budgeted production in units

• Budgeted VMOH cost per unit (allocation base)

• Budgeted fixed MOH elements

What is the set up for the Manufacturing Overhead budget?

Units

* Direct Labor Hours

= Budgeted DLH

* VMOH rate per hour

= Budgeted VMOH

+ FMOH

= Budgeted MOH costs

What question do we ask when preparing the Selling & Administrative Budget?

• How much is the expected S&A cost?

• What are the expected variable and fixed components?

• What is the expected depreciation?

How is the question asked when preparing the Selling & Administrative Budget answered?

• Budgeted sales in units

• Budgeted VS&A cost per unit (allocation base)

• Budgeted fixed S&A elements

What is the set up for the Selling & Administrative Expenses budget?

Units (sold)

* VS&A rate

= Budgeted VS&A

+ FS&A

= Budgeted S&A costs

What is the set up for the Budgeted Income Statement?

Revenues

- Variable Costs

= Contribution Margin

- Fixed Costs

= Net Operating Income

What question do we ask when preparing the Cash Budget?

Does the master budget generate enough cash to sustain the projected operations?

How is the question asked when preparing the Cash Budget answered?

• Timing of CR and CD

• Anticipated min cash balance

• Anticipated interest rate

• Anticipated borrowings, repayments, and interests

What are cash budgets NOT?

The statement of cash flows

What question do we ask when preparing the Cash Inflows for the Cash Budget?

How much budgeted revenue will be collected in cash in the current period and in the future?

How is the question asked when preparing the Cash Inflows for the Cash Budget answered?

• Revenue budget

• Collection assumptions: when do we get the cash for a sale

What question do we ask when preparing the Cash Outflows for the Cash Budget?

How much of the budgeted expenditures is expected to be paid in the current period and in the future?

How is the question asked when preparing the Cash Outflows for the Cash Budget answered?

• Expense budgets

• Capital budgets

• Dividend payment (distribution to owner) assumptions

• Payment assumptions: when do we pay the cash

Does the income statement include depreciation?

Yes

Does the cash statement include depreciation?

No

What is the set up for the Cash Budget?

Beginning Balance

+ Inflows (collections from revenue)

= Total cash available

- Outflows (DM, DL, MOH, S&A, Equipment)

= Total Disbursements

= Excess (Deficiency)