[MUSIC] I'm Larry Walther,
this is principlesofaccount.com,
Chapter 21 on Budgeting.
In this module, we are going to look at really the nuts and bolts, or
mechanics of budgeting by looking at the master budget.
A master budget consists of many individual building blocks that are tied
together in logical harmony, and reflect the organization's financial plan.
The foundation of the master budget is the level of sales.
Sales, you see, drive the level of production, as well as the necessary
anticipated expenditures for selling general administrative cost.
Production then drives materials, labor and overhead.
Sales is the starting point for all of this activity.
Here's a graphic that reflects the sales budget.
The sales budget drives the production budget and the SG&A budget.
The production budget drives the need for materials and labor.
And the production budget and labor, sometimes taken together,
drive the need for the factory overhead budget.
So, all of these are interrelated components in the master budget.
They're the building blocks, in other words,
for the organization's financial plan and financial outcomes.
They drive, or relate to, the cash budget, the budgeted income statement, and
the budgeted balance sheet.
All of this collectively then forms up the master budget for the organization.
Starting with the sales budget, the sales budget reflects forecasted sales.
It's influenced by sales patterns, current and expected economic conditions,
the anticipated actions of competitors, and so forth.
It also shows expected cash collections from sales.
So, all of these spreadsheets are repeated in your textbook.
And so, it's gonna be hard on the screen to point out all of the necessary
detail here.
However, notice I'm going to look at the second quarter.
We have anticipated sales of 1,500 units at $175 per unit.
So, anticipated sales for the second quarter of the year then are $262,500.
But in the book, it says that information about the pattern of collections.
And so we expect to collect two-thirds of sales in the quarter sales, and
one-third in the second quarter.
So the 262,500 sales will result in the cash
inflow of 175,000 in the second quarter, and 87,500 in the third quarter.
Notice I'm referencing the cell, C11 there, the cell of cash collections
in the second quarter refers to sales in cell C7 times two-thirds.
So, two-thirds of the sales are collected for this particular quarter.
Sales, as we noted, drives production.
We need a detailed plan of production that takes into account not only sales for
the period, but our anticipated beginning and ending inventory levels.
And so, let's see how this works for this particular case.
Again, we anticipated 1,500 units in sales, but our business plan calls for
ending each quarter with 25% in inventory of the anticipated next quarter sales.
So, knowing that we had 1500 in planned sales in the second quarter required
us to plan to have the first quarter end with one-fourth of that, or 375.
So, that follows to the next period.
In other words, we need to have 1500 for sales
this period ,and 750 in ending inventory, so we need to have total units for
the period 2250 to meet the current sales, and one-fourth of the next period sales,
minus the anticipated beginning inventory of 375.
So, all of that becomes fairly complicated
to determine that we need to produce 1875 units this quarter.
Of course, that's the level of production.
Production requires material, labor, and overhead.
And so, here's our direct material needs.
We know we need 1875 units to schedule production.
Each unit requires 35 square feet of material.
So now we're knowing that we need to have available 65,625 square feet in inventory.
Again, given in the book, there's a fact that says 20% of the following quarters
needs are to be carried in inventory.
And so, total units needed, plus the anticipated ending inventory, minus
the anticipated beginning inventory, would give us the fact that we need to buy or
plan to buy during the quarter 72,450 feet.
So, you can see how we started with sales, it drove inventory needs,
which drives production, which is driving materials in this case, and
that also drives the cash payments for material.
Here, the facts are that we pay for part of the material in the current quarter,
and then we have accounts payable we carry and paid partially in the next period.
Labor, we're going to produce 1875 units, three hours per unit,
it gives me the total anticipated labor.
And I'm assuming that I'm paying $14 a labor hour,
and I'm paying that in the period occurred.
Labor for this company is the allocation base for overhead.
And so, here we have the direct labor hours.
Our variable factory overhead rate is $5 per hour, so
we have total variable factory overhead, plus our
anticipated fixed factory overhead, gives us total overhead, or factory overhead.
Of that amount, 3,000 is depreciation.
The rest, I'm assuming you need to fund with cash.
Importantly, you'll notice that the total overhead for the year is expected to be
357,825 divided by the anticipated number of hours,
27,525, gives me an overhead application rate of $13.
Remember from prior chapters,
we need to know an application rate to apply overhead to production.
So, we're using our entire budget process to determine or
derive what that application rate should be.
When we go to calculate our ending finished goods inventory,
we're determining that it's $130 per unit,
that's the material, 35 square feet at $1.40 per foot.
The labor of three hours at $14 an hour, and
then we're applying overhead on three hours of labor.
And the application rate that we just saw was $13 per unit.
And so, we've got total cost of $130 per unit, times our 700 units that
are inventory needs showed that we needed ending inventory for the production sheet.
And we come up with our ending finished goods inventory for the balance sheet,
and income statement calculations of $91,000.
This turns into our selling general administrative budget.
It tells expected selling general administrative expenses, both variable and
fixed in nature.
Here's our second quarter.
We're expecting to sell for 1500 units.
And our variable cost is $10 a unit.
We also have various fixed costs that total 34,000 we're planning for
the second quarter.
And we get our total 49,000 SG&A budget for the period.
Let's next turn our attention to the cash budget,
which details the planned cash receipts, disbursements, and financing activities.
Recognize, first of all,
that almost all of the information in the cash budget is drawn from elsewhere.
Here I'm showing, for example,
our cash receipts being pulled from the sales sheet.
So, I'm showing for that particular line of information.
We're referencing back, and notice at the top of the screen,
we're seeing sales exclamation.
That's a reference to our sales sheet in the complete spreadsheet,
that includes sheets for each of our budgeted categories.
That sort of formula reference is included in each component within this spreadsheet.
You should be able to cross-reference or index or find those in each of the sheets.
Again, this is in your textbook for flipping back and forth, and
looking at it closer.
But importantly, let me draw your attention to the second quarter here.
We actually had a planned deficit for the quarter of $85,584.
That takes in account our beginning cash balance, our cash inflows, and
our cash outflows.
We can't accept that condition.
And so, by knowing this well in advance, we know we need a line of credit, or
plan to borrow $150,000 during the second quarter, so
we have some cash left over at the end of the period.
One of the very important uses of cash budgets is to plan for
these periods of short fall, and take remedial action accordingly.
The income statement and balance sheet budgeted are called Pro Forma,
or as if financial statements.
Almost every item in the budgeted statements is drawn directly
from some element in the budget.
And so again, this becomes fairly complex, but
here's the budgeted income statement for the period.
And we know that we're going to have sales for the year of 1,575,000,
less our various expense categories, all drawn from components from the budget.
We have a budgeted income for the year of $134,000.
The budgeted balance sheet, again, becomes fairly complicated, but
we're able to determine our ending cash balance from the cash sheet.
We're able to determine our ending accounts receivable from the sales sheet,
and so forth.
So, we're able to work through that, and a few additional notes there,
even in some cases pulling information from our income statement
to determine what we expect our balance sheet to look like at the end of 20X9.
So, this is all heart of the comprehensive, or
master budgeting process.
And you can now see the importance of this to the organization.
This information should not be used externally.
Budget information is normally internal use only, occasionally,
an external user may request budget information, great care must be taken in
allowing the externals have access to that documentation.
And when that occurs,
there should be a reasonable basis for estimates that are used in the budget.
Recognize that the professional accounting standard dictate the nature
of reports that need to accompany forward-looking perspective information.
Indeed, the Securities and
Exchange Commission can hold managers accountable if they fail to
include appropriate precautionary language and forward-looking comments.
Furthermore, when forward-looking statements are made to any party, there's
additional regulations that may require full disclosure to a broad set of parties.
So, proforma of financial information is generally internal use only.
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