CH 7
Chapter 7: Planning for Profit and Cost Control
Page 2: Chapter Opening
Planning is crucial for operating a successful business.
Budgeting is the financial expression of business plans, involving coordination of financial plans across all areas of a business.
A company’s master budget is formed by consolidating various specific plans prepared by different departments.
Page 3: Learning Objective 7-1
Objective: Describe the budgeting process and the benefits it provides.
Page 4: Three Levels of Planning
Strategic Planning
Involves long-term decisions.
Key considerations include:
Defining the scope of the business.
Deciding which products to develop or discontinue.
Identifying profitable market niches.
Capital Budgeting
Focuses on intermediate-range planning.
Key decisions include:
Whether to buy or lease equipment.
Whether to stimulate sales.
Whether to increase the company’s asset base.
Operations Budgeting
Concentrates on short-term plans.
Master budget is a key component, outlining short-term objectives such as:
Specific sales targets.
Production goals.
Financing plans.
Page 5: Perpetual Budget
Many companies employ a perpetual budget that covers a 12-month reporting period.
As each current month ends, an additional month is appended, creating a continuous budgeting process.
Advantages of a perpetual budget include:
Keeping management focused on future planning for the next 12 months.
Page 6: Advantages of Budgeting
Budgeting provides several advantages:
Planning: Establishes goals and plans to achieve them.
Coordination: Aligns the efforts of various departments.
Performance Measurement: Assesses actual performance against budgeted expectations.
Corrective Actions: Identifies variances to enact necessary adjustments.
Page 7: Budgeting and Human Behavior
Effective budgeting necessitates upper management's awareness of its impact on employees:
Budgets can be constraining, limiting individual freedom in favor of a set plan.
Budget stress can parallel the anxiety students feel regarding exams.
Upper-level managers should exhibit that budgeting efforts reflect realistic goals expected of employees.
Page 8: Participative Budgeting
Participative budgeting involves input from personnel at all organizational levels, not solely upper management.
Its benefits include increased collaboration, motivation, and reduced fear among employees.
Page 9: Master Budget
The master budget consists of detailed budgets and schedules that represent the company’s operating and financial plans for a future accounting period.
Typically includes three components:
Operating Budgets: Focus on detailed operating activities.
Capital Budgets: Address long-term investments and expenditures.
Pro Forma Financial Statements: Based on projected, budgeted information instead of historical data.
The budgeting process generally starts with creating operating budgets, which are then used to prepare pro forma statements.
Page 11: Hampton Hams Budgeting Illustration
Hampton Hams (HH) is a corporation selling cured hams through retail and online outlets.
By concentrating on one product line and standardized operations, HH maintains strict cost control.
The company has seen significant growth over five years and finances new stores via a line of credit with National Bank.
National's loan officer has requested monthly budgets for the first three months of a new store, initiating the budgeting process with a sales budget.
Page 12: Learning Objective 7-2
Objective: Prepare a sales budget and related schedule of cash receipts.
Page 13: Sales Budget
Accuracy in the sales forecast is vital, as subsequent budgets rely on it.
Projected sales for the new store:
October: Expected sales of $160,000 (split into $40,000 in cash sales and $120,000 on account).
Expected increase of 20% in sales for November and December.
Page 14: Sales Budget - Projected Sales Section
Accounts receivable at December 31 are projected to be $172,800 (uncollected sales on account).
Calculations for projected sales:
October cash sales: $40,000 × 120% = $48,000.
October credit sales: $120,000 × 120% = $144,000.
Page 15: Schedule of Cash Receipts
This section details the cash receipts for projected sales, crucial for preparing the cash budget.
The accountant assumes full collection of accounts receivable from credit sales within the month following the sale.
Page 16: Sales Budget - Schedule of Cash Receipts
Sales revenue on the income statement will total $582,400 across the months reported.
Page 18: Learning Objective 7-3
Objective: Prepare an inventory purchases budget and related schedule of cash payments.
Page 19: Inventory Purchases Budget
Total inventory required each month = Cost of budgeted sales + Desired ending inventory.
Required purchases = Total inventory needed - Beginning inventory.
Page 20: Inventory Information for Hampton Hams
HH’s policy mandates that ending inventory equates to 25% of the next month’s projected cost of goods sold.
Cost of goods sold is typically 70% of sales.
Supplier payment terms:
60% of inventory purchases payable in the month of purchase.
40% in the following month.
For January, the projected cost of goods sold is $140,000.
Page 22: Schedule of Cash Payments for Inventory Purchases
Example calculations for cash payments:
Cash payment for 60% of purchases:
.
Cash payment for the remaining 40%:
.
Page 24: Learning Objective 7-4
Objective: Prepare a selling and administrative expense budget and related schedule of cash payments.
Page 25: Selling and Administrative Expense Budget
Document outlines the S&A expense budget for the new store.
Notable points include:
A capital budget allocates $130,000 for store fixtures, purchased by October 1.
Payment occurred at the end of October following a 30-day inspection period.
Estimated useful life of fixtures: 10 years with a salvage value of $10,000.
Annual depreciation expense is calculated using straight-line depreciation at $12,000:
.Monthly depreciation expense amounts to $1,000.
Interest expense remains unestimated until borrowing projections are finalized.
Page 28: Learning Objective 7-5
Objective: Prepare a cash budget.
Page 29: Cash Budget
Preparing a cash budget helps identify potential cash shortages or excess cash balances.
The cash budget includes three main sections:
Cash Receipts Section
Cash Payments Section
Financing Section
Page 33: Learning Objective 7-6
Objective: Prepare a pro forma income statement, balance sheet, and statement of cash flows.
Page 34: Pro Forma Income Statement
The budgeted income statement offers an advance look at the expected profitability of the new store.
If projected profitability is inadequate, management may opt to abandon or adjust planned activities.
Computer technology aids in data analysis and decision-making, complementing managerial responsibilities.
Page 36: Pro Forma Balance Sheet
The new store will initially have no contributed capital, financed through debt and retained earnings.
Retained earnings will equal net income, as there are no prior earnings or planned distributions.
Page 38: Cash Budget for Hampton Hams Revisited
Information needed for preparing the pro forma statement of cash flows is derived from the cash budget.