Ch2 Budgeting - Mster and Cash Budgets

Question 1

Master budget

Answer 1

Step 1: sales budget
Step 2: production budget
Step 3: DM, DL and MOH budgets
Step 4: COGM and COGS budgets
Step 5: S&A budget
Step 6: Cash collections and disbursements
Step 7: Cash budget
Step 8: Budgeted financial statements

Question 2

Cash budget

Answer 2

include cash flows:
1. sales of goods and services
2. product costs
3. selling and administrative costs
4. capital assets purchased or sold
5. investments (including use of idle cash)
6. debt and equity financing (including a line of credit if appropriate)

Question 3

Cash budget assumptions

Answer 3

1. Budgeted income statement - Cash budget
2. Sales revenue - Cash from sales
3. Cost of goods sold - Product costs paid
4. G&A expenses - G&A costs paid
5. IT expense - IT paid
6. G/L on disposal - Cash paid/received from cap. assets
7. Investment earnings - Cash paid/received from investments
8. Interest expense incurred - Cash paid/received for debt and quity financing

Question 4

Working capital assumptions

Answer 4

explore impact of individual working capital assumptions: receivables, inventories, and payables

Question 5

Cash conversion cycle

Answer 5

of days that cash is “tied up” in working capital

Inventory holding period \+ AR collection period - AP payment period

1. Positive cash conversion cycle
   - The cash conversion cycle calculation indicates that it has a gap of 29 days between inflows and outflows. This gap must be financed with debt or covered with surplus cash.
2. Negative cash conversion cycle
   - indicates the company typically has excess cash available.

Question 6

Operating cycle

Answer 6

Inventory holding period
+ AR collection period

Question 7

Uses of excess cash available

Answer 7

1. pay down short-term or long-term debt
2. invest in short-term deposits
3. distribute to shareholders in the form of dividends or share repurchases

Question 8

Budgeting methods

Answer 8

1. Traditional budgeting
   - assign a % up/down across all line items
   - simple and easy to implement
   - foundamentally flawed: additional resources for ineffective department instead of high-performing department
2. Priority budgeting
   - resources allocated based on strategic plan
   - require a strong understanding of the organization and the different subunits and their contributions
3. Top-down and participative budgeting
   - top level managers decide
   - simple and quick
   - lack of co-operation between high / low managers, causing resentment and may demote lower-level management
   - high level managers unlikely to understand detailes required to make accurate budget
4. Participative budgeting
   - top mgmt sets overall operating targets based on strategic objectives, and lower lever mgmt prepare their own departmental budgets based on what they believe achievable
   - lead to manipulation by lower level mgers and timing consuming
5. Bottom-up budgeting
   - more effective, but depending on where specialized knowledge is located
6. Zero-based budgeting
   - need to consider cost structure, and analyze each activity (what levels and freqency) - time consuming

• help align resource allocation with strategic goals

7. Activity-based budgeting
   - detailed budgeting of costs
   - developed from the activities for each functional area, e.g. indirect/ direct costs and admin and support
   - more accurate but requiring detailled understanding of costs and cost drivers - not practical to all organizations
   - time consuming and benefits not quantifiable
8. Static and flexible budgeting
   - good for communicating to external stakeholders
   - based on planned level of sales / production, and not adjusted for actual units or activity level

Flexible budgeting
- adjusted automatically to reflect planned costs for actual level of activity
- provides more depth into an organization’s activities