CHAPTER 9 Financial Planning and Analysis: The Master Budget Copyright

CHAPTER 9 Financial Planning and Analysis: The Master Budget Copyright 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Financial Planning and Analysis (FP&A) Systems A financial financial planning planning and and analysis analysis (FP&A) (FP&A) system system helps managers assess the company’s future and know if they are reaching their performance goals. A complete FP&A system includes subsystems for (1) planning, (2) measuring and recording results, and (3) evaluating performance. The planning component of the FP&A system is called the master budget. It is intended to help ensure that plans are consistent and yield a result that makes sense for the organization. 9-2

Purposes of Budgeting Systems Budget Budget 1. Planning a detailed plan, 2. Facilitating expressed in Communication and quantitative terms, that specifies how resources Coordination will be acquired and 3. Allocating Resources used during a specified 4. Controlling Profit and period of time. Operations 5. Evaluating Performance and Providing Incentives 9-3

Types of Budgets Materials Production Covering all phases of a company’s operations. Sales Master Budget Detail Budget Detail Budget Detail Budget 9-4

Types of Budgets Income Statement Budgeted Financial Statements Balance Sheet Statement of Cash Flows 9-5

Types of Budgets Capital Capital budgets budgets with with acquisitions acquisitions that that normally normally cover cover several several years. years. Financial Financial budgets budgets with with financial financial resource resource acquisitions. acquisitions. Long Range Budgets Continuous or 2011Rolling Budget2012 2013 2014 This This budget budget is is usually usually aa twelve-month twelve-month budget budget that that rolls rolls forward forward one one month month as as the the current current month month is is completed. completed. 9-6

Sales of Services or Goods Ending Inventory Budget Production Budget Work in Process and Finished Goods Ending Inventory Budget Direct Materials Direct Materials Budget Direct Labor Budget Overhead Budget Cash Budget Selling and Administrative Budget Budgeted Income Statement Budgeted Balance Sheet Budgeted Statement of Cash Flows 9-7

Sales of Services or Goods Ending Inventory Budget Production Budget Work in Process and Finished Goods When the interactions of the elements Ending Direct budget Directare expressedSelling of the master as and Overhead Inventory Materials Labor Administrative Budget a set of mathematical relations, it Budget Budget Budget Budget Direct Materials becomes a financial planning model that can be used to answer “what if” Cash Budget questions about unknown variables. Budgeted Income Statement Budgeted Balance Sheet Budgeted Statement of Cash Flows 9-8

Sales Budget Breakers, Breakers, Inc. Inc. is is preparing preparing budgets budgets for for the the quarter quarter ending ending June June 30. 30. Budgeted Budgeted sales sales for for the the next next five five months months are: are: April April May May June June July July August August 20,000 20,000 units units 50,000 50,000 units units 30,000 30,000 units units 25,000 25,000 units units 15,000 15,000 units. units. The The selling selling price price is is 10 10 per per unit. unit. 9-9

Sales Budget Budgeted Budgeted sales sales (units) (units) Selling Selling price price per per unit unit Total Total Revenue Revenue April April May May 20,000 20,000 50,000 50,000 10 10 200,000 200,000 10 10 500,000 500,000 June June Quarter Quarter 30,000 30,000 10 10 300,000 300,000 100,000 100,000 10 10 1,000,000 1,000,000 9-10

Production Budget The The management management of of Breakers, Breakers, Inc. Inc. wants wants ending ending inventory inventory to to be be equal equal to to 20% 20% of of the the following following month’s month’s budgeted budgeted sales sales in in units. units. On On March March 31, 31, 4,000 4,000 units units were were on on hand. hand. Let’s Let’s prepare prepare the the production production budget. budget. 9-11

From sales budget Production Budget Sales Sales in inunits units Add: Add: desired desired end. end. inventory inventory Total Total needed needed Less: Less: beg. beg. inventory inventory Units Units to tobe be produced produced April April 20,000 20,000 May May 50,000 50,000 June June 30,000 30,000 Quarter Quarter 100,000 100,000 10,000 10,000 30,000 30,000 Ending inventory becomes 6,000 5,000 6,000 5,000 5,000 beginning 5,000 inventory the next 56,000 35,000 105,000 month 56,000 35,000 105,000 4,000 4,000 10,000 10,000 6,000 6,000 4,000 4,000 26,000 26,000 46,000 46,000 29,000 29,000 101,000 101,000 March 31 ending inventory 9-12

Direct-Material Budget At At Breakers, Breakers, five five pounds pounds of of material material are are required required per per unit unit of of product. product. Management Management wants wants materials materials on on hand hand at at the the end end of of each each month month equal equal to to 10% 10% of of the the following following month’s month’s production. production. On On March March 31, 31, 13,000 13,000 pounds pounds of of material material are are on on hand. hand. Material Material cost cost .40 .40 per per pound. pound. Let’s Let’s prepare prepare the the direct direct materials materials budget. budget. 9-13

From our production budget Direct-Material Budget 10% of the following month’s production March 31 inventory 9-14

Direct-Material Budget July July Production Production Sales Salesin in units units Add: Add:desired desired ending ending inventory inventory Total Total units unitsneeded needed Less: Less:beginning beginning inventory inventory Production Production in in units units 25,000 25,000 3,000 3,000 28,000 28,000 5,000 5,000 23,000 23,000 June Ending Inventory July production in units 23,000 Materials per unit 5 Total units needed 115,000 Inventory percentage 10% June desired ending inventory 11,500 9-15

Direct-Labor Budget At Breakers, each unit of product requires 0.1 hours of direct labor. The Company has a “no layoff” policy so all employees will be paid for 40 hours of work each week. In exchange for the “no layoff” policy, workers agreed to a wage rate of 8 per hour regardless of the hours worked (No overtime pay). For the next three months, the direct labor workforce will be paid for a minimum of 3,000 hours per month. Let’s prepare the direct labor budget. 9-16

Direct-Labor Budget From our production budget This is the greater of labor hours required or labor hours guaranteed. 9-17

Overhead Budget Here is Breakers’ Overhead Budget for the quarter. 9-18

Selling and Administrative Expense Budget At At Breakers, Breakers, variable variable selling selling and and administrative administrative expenses expenses are are 0.50 0.50 per per unit unit sold. sold. Fixed Fixed selling selling and and administrative administrative expenses expenses are are 70,000 70,000 per per month. month. The The 70,000 70,000 fixed fixed expenses expenses include include 10,000 10,000 in in depreciation depreciation expense expense that that does does not not require require aa cash cash outflow outflow for for the the month. month. 9-19

Selling and Administrative Expense Budget From our Sales budget 9-20

Cash Receipts Budget At At Breakers, Breakers, all all sales sales are are on on account. account. The The company’s company’s collection collection pattern pattern is: is: 70% collected in the month of sale, 70% collected in the month of sale, 25% collected in the month following the sale, 25% collected in the month following the sale, 5% is uncollected. 5% is uncollected. The The March March 31 31 accounts accounts receivable receivable balance balance of of 30,000 30,000 will will be be collected collected in in full. full. 9-21

Cash Receipts Budget 9-22

Cash Disbursement Budget Breakers Breakers pays pays 0.40 0.40 per per pound pound for for its its materials. materials. One-half One-half of of aa month’s month’s purchases purchases are are paid paid for for in in the the month month of of purchase; purchase; the the other other half half is is paid paid in in the the following following month. month. No No discounts discounts are are available. available. The The March March 31 31 accounts accounts payable payable balance balance is is 12,000. 12,000. 9-23

Cash Disbursement Budget 140,000 lbs. .40/lb. 56,000 9-24

Cash Disbursement Budget Breakers: Breakers: Maintains Maintains aa 12% 12% open open line line of of credit credit for for 75,000. 75,000. Maintains Maintains aa minimum minimum cash cash balance balance of of 30,000. 30,000. Borrows Borrows and and repays repays loans loans on on the the last last day day of of the the month. month. Pays Pays aa cash cash dividend dividend of of 25,000 25,000 in in April. April. Purchases Purchases 143,700 143,700 of of equipment equipment in in May May and and 48,300 48,300 in in June June paid paid in in cash. cash. Has Has an an April April 11 cash cash balance balance of of 40,000. 40,000. 9-25

From our Cash Receipts Budget (Collections and Disbursements) Cash Budget From our Cash Disbursements Budget From our Direct Labor Budget From our Overhead Budget From our Selling and Administrative Expense Budget To maintain a cash balance of 30,000, Breakers must borrow 35,000 on its line of credit. 9-26

Cash Budget (Collections and Disbursements) 9-27

Cash Budget (Collections and Disbursements) 9-28

Cash Budget Ending cash balance for April is the beginning May balance. (Financing and Repayment) 9-29

Cost of Goods Manufactured April May Direct material: Beg.material inventory 5,200 9,200 Add: Materials purchases 56,000 88,600 Material available for use 61,200 97,800 Deduct: End. material inventory 9,200 5,800 Direct material used 52,000 92,000 Direct labor 24,000 36,800 Manufacturing overhead 56,000 76,000 Total manufacturing costs 132,000 204,800 Add: Beg. Work-in-process inventory 3,800 16,200 Subtotal 135,800 221,000 Deduct: End.Work-in-process inventory 16,200 9,400 Cost of goods manufactured 119,600 211,600 June 5,800 56,800 62,600 4,600 58,000 24,000 59,000 141,000 9,400 150,400 17,000 133,400 Quarter 5,200 201,400 206,600 4,600 202,000 84,800 191,000 477,800 3,800 481,600 17,000 464,600 9-30

Cost of Goods Sold Cost of goods manufactured Add: Beg. finished-goods inventory Cost of goods available for sale Deduct: End. finished-goods inventory Cost of goods sold April May 119,600 211,600 18,400 46,000 138,000 257,600 46,000 27,600 92,000 230,000 June Quarter 133,400 464,600 27,600 18,400 161,000 483,000 23,000 23,000 138,000 460,000 9-31

Budgeted Income Statement Breakers, Breakers, Inc. Inc. Budgeted BudgetedIncome Income Statement Statement For Forthe the Three Three Months MonthsEnded EndedJune June 30 30 Revenue Revenue (100,000 (100,000 10) 10) Cost Costof ofgoods goodssold sold Gross Grossmargin margin Operating Operatingexpenses: expenses: Selling Sellingand andadmin. admin. expenses expenses Interest Interestexpense expense Total Total operating operatingexpenses expenses Net Netincome income 1,000,000 1,000,000 460,000 460,000 540,000 540,000 260,000 260,000 838 838 260,838 260,838 279,162 279,162 9-32

Budgeted Statement of Cash Flows April May Cash flows from operating activities: Cash receipts from customers 170,000 Cash payments: To suppliers of raw material (40,000) For direct labor (24,000) For manufacturing-overhead expenditures (56,000) For selling and administrative expenses (70,000) For interest Total cash payments (190,000) Net cash flow from operating activities Cash flows from investing activities: Purchase of equipment Net cash used by investing activities Cash flows from financing activities: Payment of dividends Principle of bank loan Repayment of bank loan Net cash provided by financing activities Net increase in cash Balance in cash, beginning Balance in cash. end of month (20,000) - Quarter 400,000 335,000 (72,300) (36,800) (76,000) (85,000) - (72,700) (24,000) (59,000) (75,000) (838) (185,000) (84,800) (191,000) (230,000) (838) (270,100) (231,538) (691,638) 129,900 (143,700) - (143,700) (25,000) 35,000 - June 103,462 905,000 213,362 (48,300) (192,000) (48,300) (192,000) 13,800 - (48,800) (25,000) 48,800 (48,800) 10,000 13,800 (48,800) (25,000) (10,000) 40,000 - 30,000 6,362 30,000 (3,638) 40,000 30,000 30,000 36,362 36,362 9-33

Budgeted Balance Sheet Breakers Breakers reports reports the the following following account account balances balances on on March March 31 31 prior prior to to preparing preparing its its budgeted budgeted financial financial statements statements for for June June 30: 30: Land Land -- 50,000 50,000 Building Building (net) (net) -- 148,000 148,000 Common Common stock stock -- 217,000 217,000 Retained Retained earnings earnings -- 46,400 46,400 9-34

25%of June sales of 300,000 11,500 lbs. at .40 per lb. 5,000 units at 4.60 per unit. 50% of June purchases of 56,800 9-35

Budget Administration The Budget Committee is a standing committee responsible for . . . overall overall policy policy matters matters relating relating to to the the budget. budget. coordinating coordinating the the preparation preparation of of the the budget. budget. 9-36

International Aspects of Budgeting Firms Firms with with international international operations operations face face special special problems problems when when preparing preparing aa budget. budget. 1. 1. Fluctuations Fluctuations in in foreign foreign currency currency exchange exchange rates. rates. 2. 2. High High inflation inflation rates rates in in some some foreign foreign countries. countries. 3. 3. Differences Differences in in local local economic economic conditions. conditions. 9-37

Behavioral Impact of Budgets Budgetary Slack: Padding the Budget People often perceive that their performance will look better in their superiors’ eyes if they can “beat the budget.” 9-38

Participative Budgeting Top M anagem ent M id d le M anagem ent S u p e rv is o r S u p e rv is o r M id d le M anagem ent S u p e rv is o r S u p e rv is o r Flow of Budget Data 9-39

End of Chapter 9 9-40