master budgeting
strategic cost management lesson 5
The Basic Framework of Budgeting A 12-month budget that rolls forward
one month (or quarter) as the current
A budget is a detailed quantitative plan for
month (or quarter) is completed
acquiring and using financial and other One month/quarter is added at the end
resources over a specified forthcoming time
of the budget as each month/quarter
period
comes to a close
1. The act of preparing a budget is called
Gives the managers focus on at least
budgeting.
one year ahead so they do not become
2. The use of budgets to control an
too narrowly focused on short-term
organization’s activities is known
results
as budgetary control.
Understanding the Key Components of Master
Advantages of Budgeting
Budget in Manufacturing, Merchandising, and
1. Communicate plans Service Industries
2. Think about and plan for the future
First step: budget the revenue, whether it is
3. Means of allocating resources
a sales budget for providing goods or
4. Uncover potential bottlenecks
services or a funding budget
5. Coordinate activities of the entire
Although operational budgets are adapted
organization by integrating the plans of its
according to the industries, they are very
various parts
similar and typically comprise of budgets for:
6. Ensures that everyone in the organization is
Income Statement
pulling in the same direction
Cash
7. Define goals and objectives that serve as
Balance sheet
benchmarks for evaluating subsequent
Major differences of different industries
performance
include:
Choosing the Budget Period 1. Manufacturing – production budget is
involved
1. Operating Budget 2. Merchandising – no production budget;
Ordinarily cover a one-year period only purchase budget of merchandise
corresponding to a company’s fiscal 3. Service industries – budget for revenue
year. Many companies divide their and cost of providing services
annual budget into four quarters. 4. Not-for-profit – expected funding
The first quarter is subdivided into available and plan usage of funding
months and monthly budgets are
developed The Master Budget: An Overview
The last 3 quarters may be carried into
budget as quarterly totals only
As the year progresses, the 2 nd quarter
figures are broken down into months
and the 3rd quarter figures are also
broken down, and so forth
Has the advantage of requiring periodic
review and reappraisal of budgets
throughout the year
2. Continuous/Perpetual Budget
Sales Budget – includes selling and August 4,000,000 – 25% of 2,000,000 from
administrative budget and production July + 70% of 5,000,000
budget September 3,350,000 – 25% of 5,000,000
Production/Purchases Budget – production from August + 70% of 3,000,000
for manufacturing and purchases for
merchandising The Production Budget
Production Budget – dictates DM, DL, The production budget must be adequate to
MOH budget meet budgeted sales and to provide for the
Cash Budget – DM, DL, MOH, selling and desired ending inventory
administrative budget Prepared after the completion of the Sales
Budgeted Income Statement and Budget
Budgeted Balance Sheet – cash budget
Preparing the Production Budget
Preparing a Sales Budget
Budgeted Sales xx
The individual months of July, August, and Add: Desired Ending Inventory xx
September are summed to obtain the total Total Needs xx
budgeted sales in units and dollars for the Less: Beginning Inventory (xx)
quarter ended September 30th Required Production xx
Expected Cash Collections
Presented in units
The desired ending inventory of the
previous month is the beginning inventory
of the following month
The total column represents the end of the
quarter
Total Ending Inventory is the ending
inventory of September
Whatever the ending inventory is at the
The figures are computed based on the Sales last month of the quarter, that is the
Budget presented earlier total ending inventory for the quarter
Ending AR for June will be collected in full in Total Beginning Inventory is the beginning
July, which is why it is part of July inventory of July
July 1,400,000 – 70% of 2,000,000
The beginning inventory of the first Preparing the Expected Cash Disbursement for
month of the quarter is forwarded to Materials
the total column
Preparing the Direct Materials Budget
Anchored to the production budget
Required production xx
Multiplied by materials/unit xx
Total material needs for production xx Calculated based on the total materials to be
Add: Desired RM, end xx purchased computed in the DM Budget
Total material needs for the period xx Example: July disbursements are computed
Less: Beginning RM (xx) as follows:
Total materials to be purchased xx 1,400,000 total materials to be
purchased (per DM Budget) X $0.40 =
$560,000
One-half is payable during the month,
so recognize only $280,000 + $120,000
full payment of the June AP = $400,000
Example: August disbursements are
computed as follows:
2,215,000 total materials to be
purchased X $0.40 = $886,000
Desired RM, end is 10% of the total
$443,000 (half of $886,000) +
materials needs for production of the
$280,000 balance from July = $723,000
following month
It is as if you are paying for 2 months
Beginning raw materials is the desired RM,
end of the previous month Preparing the Direct Labor Budget
Total Desired RM, end is the ending
inventory of September
Whatever the ending inventory is at the
last month of the quarter, that is the
total ending inventory for the quarter
Total Beginning RM is the beginning
inventory of July
Units of production (per Prod. Budg.) xx Always deduct noncash costs as they do not
Multiplied by DL/unit xx represent actual disbursement
Labor hours required xx
VS Guaranteed labor hours xx Preparing the Ending Finished Goods Inventory
Budgeted DLH xx Budget
Multiplied by hourly wage rate xx
Direct labor cost xx Production cost per unit:
DM needed per unit x cost
DL hours/unit x cost
MOH rate x cost
Units of production is from the Production
Budget’s Required production
No layoff policy – use the guaranteed labor
hours; however if there is no such policy,
then we use the labor hours required
If the labor hours required exceeds the Ending inventory (units) is based on the data
guaranteed labor hours, use the labor hours from the Production Budget
required
Preparing the Selling and Administrative Expense
Preparing the Manufacturing Overhead Budget Budget
From the $700,000, only $600,000
Budgeted DLH xx
represent actual outflow for the month as
Multiplied by Variable MOH rate xx
the $100,000 represent non-cash outflows
Variable MOH cost xx
Budgeted sales (units) xx
Fixed MOH cost xx
Total MOH cost xx Multiplied by Variable S&A rate xx
Less: Non-cash Costs (xx) Variable S&A expenses xx
Cash disb. for manuf. cost xx Fixed S&A expenses xx
Total S&A expenses xx
Less: Noncash expenses (xx)
Cash S&A expenses xx
Use the labor hours required and not the
guaranteed labor hours
Preparing the Cash Budget
Divided into four sections:
1. Cash Receipts – lists all cash inflows
excluding cash received from financing
2. Cash Disbursements – all cash
payments excluding prepayments of
principal and interest
3. Cash excess or deficiency – determines
if the company will need to borrow
money or if it will be able to repay funds
previously borrowed
4. Financing – details the borrowings and
repayments projected to take place
during the budget period
Cash in excess – will not only determine
whether you can repay funds you have
previously borrowed but will also determine
if you have enough cash you can set aside
for either a short-term or long-term
investment
The ending cash balance must be able to
satisfy the minimum cash balance, which is
why the borrowing amounted to $500,000
Open line of credit – for borrowing purposes to compensate for the deficit and to satisfy
Beginning cash balance xx the minimum cash balance requirement
Add: Cash collections xx
Total cash available xx
Less: Cash disbursements
Materials xx
Direct labor xx
Manuf. Overhead xx
Selling and admin exp. xx
Equipment purchase xx
Dividend xx
Total disbursements (xx)
Excess (deficiency) xx
Financing:
Borrowing xx
Interests xx
Repayments xx
Total financing (xx)
Ending cash balance xx
All information is based on the preceding
budgets prepared
If your cash excess is equal to the minimum
cash balance (in this case, $300,000), then
you cannot set aside that excess for the
payment of interest. However, if you have Preparing the Budgeted Balance Sheet
more than your desired ending cash balance,
then you can pay some of the interest
accrued
If the problem is silent, the general
assumption is that the payment of the
principal is done at a lump sum, meaning you
cannot pay a portion of it. It is paid in a one-
time amount
You can pay the interest monthly but
the payment of the principal is done at
one time.
We can only pay via installment for the
principal if it is explicitly stated in the
problem
We pay off the interest first. No lender will
allow you to pay the principal without paying
the interest first
To get the $20,000 interest payment on
September: $500,000 x 16% x 3/12
(start counting from July 1 up to
September 31)
The treatment of the excess cash against the
minimum cash balance requirement will
depend on the policy of the company,
whether they will invest it in a short-term
investment or long-term investment
At the end of the quarter, the ending cash
balance of the total column should be equal
to the ending cash balance of September as
this is the last month of the quarter
The beginning cash balance is the beginning
cash balance of July (start of the quarter)
Preparing the Budgeted Income Statement
With the interest expense from the cash
budget, we can prepare the budgeted
income statement
The unit cost used in computing the COGS is
based on the Ending Finished Goods
Inventory Budget RMI – multiply the number of units/pound
Included in the selling and administrative by the cost per pound
expense are the noncash disbursements (i.e.
depreciation)
