P1 SEC B - Planning, Budgeting, and Forecasting

A set of 100 vocabulary flashcards focused on planning, budgeting, and forecasting concepts, terminology, and strategies.

Budget

A detailed plan for executing both long-term and short-term goals.

Reason why sales budget is developed first before the production budget

Because the company only wants to produce as many units as it expects to sell.

Depreciation and bad debt expenses

Excluded from cash budget as they are both non-cash expenses.

Corporate admin costs

Not considered in a project budgeting system as such system only focuses on factors directly related to a specific project such as building new distribution center.

Expenditures

A not-for-profit organization plans their master budget; the accountant is likely to obtain information first from the organization’s _______.

Measurement surrogation

Managers focus too much on a particular measure and start making decisions strictly to move up that measure.

Stock-outs

Means disappointed customers, sales lost to competitors; may lead to rush production, incurring overtime, more errors, rush shipments of materials.

Component Budgets of Operational Budget (in order)

Sales, production, direct materials purchased, cost of goods manufactured, income statement, capital expenditures, cash, and balance sheet.

90%

A manufacturing company notices that when its cumulative production doubles, it observes a 10% decrease in the time it takes to produce one unit of product. Based on a cumulative average-time learning model, this decrease in unit production time implies a learning curve of:

Labor-intensive industries with repetitive tasks and long production runs

Learning curve analysis is most common in companies that operate in:

Factors that will create behavior problems in budgeting

• Top management authoritarian attitude toward the budget process

• The inclusion of non-controllable costs such as depreciation

• The lack of consideration for factors such as seasonality

3 Components of Sales Budget

• Forecasted sales volume

• Forecasted sales mix

• Budgeted selling prices

How budgeting can facilitate communication among manufacturing, marketing, and finance units

Budget can coordinate activities by considering how the functions of various departments are interrelated. Planned changes to product focus will affect how the product is manufactured and how it is marketed and will affect the financing needed to fund operations. Failure to achieve goals by one function may cause another function to adjust its goals.

Factors to consider when preparing a sales budget

• Current sales levels and trends

• General economic conditions

• Pricing policies

• Credit policies

• Unfilled back orders

• Advertising and promotional activities

Financial budget

Consists of the capital expenditure budget, cash budget detailing inflows, outflows, and borrowing needs, and the balance sheet. These statements combined with the budgeted income statement produce the SCF.

Beginning Finished Goods Inventory

Would have been produced in a prior period and therefore, should not be included on a projected schedule of COGSM.

Freight charges

Generally associated with the cost of making a product (paid for delivery of raw materials) and not included as part of overhead.

Step cost

An expense that remains constant over a certain range of activity or production levels but then increases or decreases in fixed increments when a new threshold is crossed, appearing like steps on a graph.

More realistic comparison

When compared to static budgets, flexible budgets offer managers a _________ of budget and actual revenue and costs items under their control.

Learning Curve Doubling Rule

Each time cumulative production doubles, the average time per unit = prior average × learning rate.

Shortcut Sequence:

• 1 unit → average = 100% (time for the first unit)

• 2 units → average = learning rate × first unit

• 4 units → average = learning rate × average at 2 units

• 8 units → average = learning rate × average at 4 units

• 16 units → average = learning rate × average at 8 units

DM Budget

While the production budget is dependent on the amount of projected sales, the _______ is based on the forecasted production quantity.

Chronological order of budget preparation

1. Production budget

2. Purchases budget

3. Cost of goods sold budget

4. Administrative budget

Production & Purchases Budget

Must be completed first before the COGS budget can be completed.

Administrative budget

Dependent on the planned sales and manufacturing activity and is generally completed after all production revenues and costs have been budgeted.

3 criteria for selecting independent variable using linear regression

1. Economic plausibility

2. Goodness of fit

3. Slope of the regression line

Multiple vs. Simple Regression Analysis

Simple regression uses only one independent variable, while multiple regression uses more than one independent variable.

Disadvantages of authoritative budgeting

• May result in a budget that us not possible to achieve

• May limit the acceptance of proposed goals and objectives

• Reduces the communication between employees and management

Per-unit basis

Standard costing traces direct costs to a cost object. As a result, standard costs are most often stated on a _____.

Total costs

Budgeted costs are generally presented as _______ as one of the objectives of budgeting is to forecast the overall financial condition.

Lack of top management support

Will most likely cause the planning and budgeting system to fail.

Major objectives of budgeting

To foster the planning of operations, provide a framework for performance evaluation, and promote communication and coordination among the organization’s segments.

Advantages of the use of budgets in a management control system

• Force management planning

• Provide performance criteria

• Promote communication and coordination within the organization

Limit unauthorized expenditures

A budget has no control of because it is usually caused by weak internal controls.

Successful budget with positive motivation and goal congruence

The result from where the divisional and senior management jointly develop goals and the divisional manager develops the implementation plan.

Long-term profitability and the competitive intensity of the industry

The concurrent action of basic competitive forces as defined by Porter’s Five Forces Model determines the:

Explaining tactics for increasing market share

Least appropriate for a company’s mission statement because it does not announce specific operating plans. These are tasks for operating management.

Internal environmental factors

Include a company’s culture, structure and resources

External environmental factors

Include economic forces, political-legal forces, technological forces and sociocultural forces

Learning Curve Analysis

A method that shows how labor hours per unit decline as units of production increase due to workers learning and becoming more efficient with its processes.

Cumulative average-time learning model

The cumulative average time per unit declines by a constant percentage each time the cumulative quantity of units produced doubles. Utilized by learning curve analysis.

Expected Value Computations

Combine several possible future outcomes to forecast an expected future value of all possible outcomes.

Expected Value Formula

EV = Σ (rp)

• r = result of the outcome

• p = probability of the outcome

Production Volume

Sales Volume + Ending Inventory - Beginning Inventory

Multiple R

It is the correlation of total costs and volume of activity.

Expected results

The forecasted budget does not quantify the effect of unexpected adverse circumstances. Employing a forecasted budget as a plan allows for the use of the _______ as the benchmark.

Forecasted budget

It takes into account future conditions that were not present in past years.

Benefit of using forecasted budget instead of historical results

Past performance is not always indicative of future results.

Adjusted R Square

The R Square metric adjusted for the size of the data set. Compared to R Square, it is more accurate measure to use when explaining variance in cost data.

Purpose of Regression Analysis

Mainly for better accuracy in forecasting and cost estimation compared to simpler methods, as it uses all available data points.

Regression vs. Conservatism

• Regression analysis → tries to be statistically accurate (best fit, least error).

• Conservatism principle → deliberately avoids “best guess” accuracy and instead errs on the safe side:

  • record higher expenses (so you don’t understate them)

  • record lower revenues (so you don’t overstate them)

95% Confidence Level

Approximately ±2 standard errors around the predicted value.

99% Confidence Level

Approximately ±3 standard errors around the predicted value.

68% Confidence Level

Approximately ±1 standard error around the predicted value.

Statistical significance

Evaluates if the cost estimate is real.

• t stat > 3

• p-value < 0.05

2 Sides of Budgeting

Periodic planning for long-term capital investing (project budgeting) and constant planning for short-term operational spending (operational budgeting)

Downside of using rolling budget

The rolling budget requires commitment across the organization to be in continuous budgeting mode.

Approaches to solving cash needs

• Increase the amount of cash generated by operations or reduce the amount of cash used in operations.

• Take out a short-term loan.

• Speed up collections, slow down payments.

• Carefully balance slower cash payments with better supply prices and availability.

Relationship between CapEx budget, Cash budget, Pro Forma B/S

The capital expenditure budget affects the cash budget, which affects the pro forma balance sheet.

Manufacturing costs

The selling and administrative budget should not contain any _________.

Components of the selling and administrative expense budget

• The costs of advertising products

• The transportation costs of delivering purchased products to customers

• The depreciation of the administration building

Traditional COGS formula

Begins with direct materials purchases, which is adjusted by adding beginning and subtracting ending direct materials inventory to compute the cost of direct materials used in production. This cost is combined with direct labor used and manufacturing overhead costs applied in production. The total production costs (i.e., total manufacturing costs) are adjusted by adding beginning and subtracting ending finished goods inventory

How maintaining an inventory of DM impacts the DM budget

The budgeted production needs will not equal the quantity of direct materials that will need to be purchased. As a result, the relationship between production needs and materials to be purchased is:

Production needs + Ending inventory – Beginning inventory = Materials to purchase

Materials to purchase

Production needs + Ending inventory – Beginning inventory 

Reconciliation shortcut (if FMOH is constant)

Inventory change (Beg. Inventory - End. Inventory) = Inventory Increase/Decrease x Fixed MOH Rate

Relationship between sales budget and production budget

The production budget is dependent on the sales budget.

Common tools used to reduce uncertainty around the sales forecast

• Cross-functional research teams

• External consultants

• Market surveys

• Customer focus groups

• Leading economic indicators

• Controlled test markets

• Big data analytics

Environmental scanning

It is a process in which an organization continuously gathers and evaluates information that could impact its ability to compete.

Most skilled and efficient employees

Ideal standards allow for no work delays, interruptions, waste, or machine breakdowns. It requires a level of effort that can be attained only by the _________ working at their best efficiency all of the time.

Operational Budget

The core of the master budget which is driven by the sales budget schedule.

Strategic Planning

A long-term plan that outlines an organization's path to achieve its goals, vision, and mission.

Goal congruence

The bottom-up (participative) approach to budgeting assumes that everyone involved in establishing cost standards share the same goals and objectives. This is an important concept called ________.

Steps to reducing budgetary slack

• Limiting performance evaluation to controllable costs

• Periodically reviewing and adjusting the budget when outside factors cause the original cost standards to become less representative or irrelevant.

Cost standards

The basis of the organization’s budget. These are used for both planning and evaluation purposes.

Ideal (theoretical) cost standards

Represent the expected cost per input and input quantity based on an assumption that prices paid for materials, labor, and overhead are at the absolute lowest possible level, assuming that the product cost is absolutely efficient without ant waste or error. They are created in a top-down budgeting approach. Actual results are consistent and less likely to be biased.

Attainable (practical) cost standards

These are based on more reasonable expectations about average prices and usage. They are created in a bottom-up budgeting approach. Actual results have higher likelihood of error or bias.

Standard cost sheet

Essentially a “recipe card” that specifies standard prices and standard quantities to build a single product or service.

Bottom-up (participating) Budgeting

Involves more time and resources, but results in a more informed budget with higher ownership by the employees.

Top-down (authoritative) Budgeting

Takes less time and resources and doesn’t exhaust the employees as much, but the budget may have blind spots and may be resisted by the employees.

Best Practice Guidelines for Budgeting

• Link the budget to strategy.

• Design budgeting process that allocate resources strategically.

• Establish budget targets based on realistic expectations and based on stretch goals.

• Reduce budget complexity and budget cycle time.

• Periodic reviews to adjust budgets as needed.

Traditional budget process

Follows a cycle of budget proposals that are submitted, negotiated, and revised until the final budget is established and approved by the organization’s leadership.

Learning feedback process

Budgeting is a _____. Every budgeting cycle should be assessed to understand what was unanticipated or misunderstood, and that insight should then inform and improve the next budgeting cycle.

Purpose of Budgeting

• Planning → sets financial & operational goals.

• Control → provides benchmarks for performance evaluation.

• Coordination & Communication → aligns departments with strategy.

• Motivation → sets performance targets.

• Performance Evaluation → compares actual vs. budgeted results.

The Budget Process

1. Form budget committee (CFO, controller, key SBU directors)

2. Establish budget guidelines (strategic objectives, goals)

3. Submit budget proposals

4. Negotiate budget proposals

5. Review and approve final budget

Important elements of a successful budgeting process

• Strongly representative and supportive of the organization’s strategy

• Focuses the spending of money and the investing of resources on the organization’s strategy

• Based on short-term operational objectives that align with organization’s strategy

• Prioritize accurate forecasts and expectations

• Continuously improves by gathering insights on current budgeting successes and failures

• Uses appropriate incentives and stretch targets to motivate employees

Budgeting

It is part of an overall decision-making and management process that involves planning, controlling, and evaluating processes. These processes connect together as a feedback learning cycle.

Strategic Implementation

Involves identifying short-term objectives and then establishing processes to achieve those objectives. Short-term objectives must be constantly evaluated and adjusted to ensure alignment with organization’s long-term objectives and overall strategy as the latter evolves to address new economic and competitive conditions.

Flexibility

A good budget must have the ______ to respond appropriately to changing conditions.

Ex: PESTLE analysis tool represents different conditions that can affect the budget. Porter’s 5 Forces for assessing competitive conditions.

Functional strategy

Defines activities and processes to help the organization maximize its competitive position.

Sales budget

The operating budget usually begins with the ________. It is the foundation of the master budget and the key driving force for the overall operational budget.

Corporate strategy

Defines the organization's values, expressed in financial and nonfinancial terms; determines how organizational resources will be allocated among the firm's businesses; centers on identifying and building key resources.

Example of a cash cow

After leading the market for the past decade, the growth of product ABC is slowing down. In this stage of its life cycle, the product is still generating significant amounts of cash flows that cover the company’s investment into new product innovations.

Vision statement

A vision statement expresses an organization's success in terms of its contribution to society while a mission statement provides a clear statement about how the organization will work toward achieving its vision. This means an organization's mission statement is based on its _________.

Ending cash balance

Available Cash − Expected Cash Disbursements + Required Financing

Situational Analysis

Based on scenario analysis and contingency planning, helps an organization analyze both its internal and external environments. Situational analysis can employ specific tools such as SWOT analysis, Porter's Five Forces analysis, and PESTLE analysis.

Automobile industry

Industry that faces the least threat of competition and profitability harm from the entry of a new competitor as it is difficult for a new entrant to establish business.

Long-range planning but not budgeting

A country's political environment will likely affect

Long-range planning

It is used to review progress rather than as a basis for control as it lacks the detail of a budget.

Ex. A country's political environment includes items such as regulatory action and taxes. These items are likely to impact long-range decisions more than short-run decisions.

Sustainability, economic, and regulatory

Primary areas usually examined when conducting environmental scanning include:

Financial ratios

The organization can assess planned performance based on various ______ to determine if expected results will be acceptable to stakeholders.

Percentage-of-sales approach

The pro forma FS can be built in to determine expenses that are a function of sales revenue or those accounts that are assumed to adjust based on sales revenue.