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I'm Larry Walther.
This is principalsofaccounting.com, c hapter 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 the 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, the information about the pattern of collections.
And so, we expect to collect two-thirds of sales in the quarter of sales and
one-third in the subsequent quarter.
So, the $262,500 in sales will result in a 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 cells 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 1,500 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 1,500 for
sales this period and 750 in ending inventory.
So, we need to have total units for the period 2,250 to meet current sales and
one-fourth of the next period's sales minus the anticipated beginning
inventory of 375.
So all of that becomes fairly complicated to determine that we need to produce 1,875
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 1,875 units scheduled 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 quarter's 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 material
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 pay partially in the next period.
Labor, we're going to produce 1,875 units, 3 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 a period incurred.
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 materials, 35 square feet at $1.40 per foot.
The labor, 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 our
inventory needs showed we need an ending inventory from 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 then to our selling general administrative budget.
It details expected selling, general and administrative expenses both variable and
fixed in nature.
Here's our second quarter.
We're expecting to sell 1,500 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 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 saying, sales exclamation.
That's a reference to our sales sheet in the complete spreadsheet that include
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 closer.
But importantly, let me call your attention to the second quarter here.
We actually had a planned deficit for the quarter of $85,584.
That takes into 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
that we have some cash leftover at the end of the period.
One of the very important uses for cash budgets is to be able to plan for
these periods of shortfall and take remedial action.
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 statements
for the period and we know that we're going to have sales for the year.
Less our various expense categories, all drawn from components in the budget.
We have a budgeted income for the year of $131,500.
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 part of the comprehensive master budgeting process and
you can now see the importance of this to the organization.
This information should not be used externally.
Budgeted information is normally internal use only.
Occasionally, an external user may request budgeted information.
Great care must be taken in allowing externals to 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 professional accounting standards dictate the nature of reports
that need to accompany forward-looking or prospective information.
Indeed, the Securities and Exchange Commission and
US laws 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, pro forma financial information is generally internal use only.
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