L6 - Profit Planning and Control: Budgeting Flashcards
How long are budgets set up for?
•Budgets are short-term (often one-year) plans expressed (mainly) in financial terms
- sometimes they are expressed in the terms of units like forecasting the number of units needed to be made
What do budgets provide?
they provide precise targets in terms of:
- Sales volumes/revenues
- Production requirements
- Cash receipts and payments
What is the management cycle of the budget?
- Formulating Long and Short-term Plans (planning)
- e.g. breaking down a mission statement and thinking of the customers the business should focus on
- How they could provide good value
- Implementing the Plans (Directing and Motivating)
- Directing and motivating the staff –> setting a challenging target but in the capacity of the manager is the most motivating plan
- Measuring Performance (Controlling)
- Got a plan of what targets are expected and costs that need to be kept below
- Comparing Actual to Planned Performance (controlling)
- compare to actual and adjust for the discrepancies that are seen from the budget
What are the advantages of Budgeting?
- Think about the future
- Managers can become involved in day-to-day issues but this forces them to think more long term
- Co-ordinate activities
- no point the marketing team say they are producing more than the production team can actually make
- Communication plans
- lining up different departments plans
- Motivate managers
- organisations with realistic targets perform better
- this contradicts the need for co-ordinating activities, so academic believe there should be two budgets one to motivate and one that’s more realistic
- Control activities
- Evaluate the performance of managers
What is the Basic Framework of Budgeting?
- Master Budget - Summary of company’s plans, this contains the following 3 different documents
- The income statement (profit/loss) -same as FA
- statement of financial position (asset/liabilities) - FA
- Cash statement - different to FA
To get the master budget separate detail budgets (functional budgets) are needed to have been complied:
- Sales
- Admin costs
- Production
- Materials
These are used to configure what should be transcribed the master budget
How is a budget period selected?
- The budget is normally for the next year, which is usually start 8 months early in large organisations
- The annual operating budget may be divided into the quarterly or monthly budget
- you also have continuous or Perpetual Budgets –> the budget is always 12 months and after a month is completely a future month is added
What is a imposed budget?
Also called a top-down budget system
- Senior managers produce a plan and provide the budget for manager further down
- It is called an imposed budget as middle management has no say in the formulation of the budget
What is a participative budget system?
where lower management can be involved in the creation of a budget
- it goes against current literature to not include middle management in budget formation
- This is because if they are involved they are more likely to accept the budget that is finally decided
- it also makes sense to include lower management in the budget correction as they know more specific about the costs and revenues that their department has, this could lead to a more realistic budget plan
What is the actual Budgeting system?
Abit of an imposed and Participative budgeting system
- Senior management would create an initial budget which will get passed down, adjusted by lower management, which is then sent back up the hierarchy
What is the Budget Committee?
A standing committee responsible for:
- overall policy matters relating to the budget
- coordinating the preparation of the budget
- communication of the budget (does a Birmingham store receive the budgets of other stores in the country)
What are the Stages in the Budget Process?
- Communicate objectives and strategy
- Determine the factor that restricts output
- Prepare an initial set of budgets
- Negotiate budgets with line managers
- Co-ordinate and review budgets
- Accept final set of budgets
- Review budgets on an on-going basis
When formulating the Master Budget what do we think of first?
- Start with the limiting factor, what limits the success of the organisation –> usual sales, as there isn’t unlimited demand
- If we know the sales budget we will know the selling budget
- Advertising costs, commission etc.
- Also, know the production budget
- Need to know how much to produce,
- from this budget, we can figure out the Direct Materials, Direct Labour and Manufacturing Overhead budgets
- Need to know how much to produce,
- If we know the sales budget we will know the selling budget
- Each of these will flow into the Cash Budget
- This is how much money is coming in from customers and how much is going out on expenses
What does the Sales Budget look at?
The sales budget is the starting point in preparing the master budget, a detailed schedule showing expected sales for the coming periods expressed in units and pounds.
What is budget comes after the Sales Budget?
The production budget
Production must be adequate to meet budgeted sales and provide for sufficient ending stock
- Usually produce more than what the sales budget intends to sell to create a buffer stock in case of a surge in demand or some units needs discarding as they don’t meet quality standards
How is a Production Budget made?
- start with budgeted sales for that month
- add the desired percentage of ending stock based on next period
- less minimum stock from last period gives required production
- continue for the entire period
beginning stock is based of the first months beginning stock (you consider the whole month)
How do you figure out the expect Cash Collection?
All sales are on account.
•Royal’s collection pattern is:
- 70% collected in the month of sale
- 25% collected in the month following sale
- 5% is uncollectible
The March 31 accounts receivable balance of £30,000 will be collected in full
Complete the budget in the following systematic way
anything that wasn’t received (25% who paid in July) is classed as a current asset on the balance sheet
How do you calculate the Direct Materials budget?
- At Royal Company, five kilos of material are required per unit of product
- •Management wants materials on hand at the end of each month equal to 10% of the following month’s production
- •On March 31, 13,000 kilos of material are on hand. Material cost £0.40 per kilo
Top line is the number of unit produced from the production budget
- multiple this by its material weight
- Add the desired ratio of stock based on the materials of the next period
- minus last months stock in material weight
How do you calculate the expected cash disbursement for materials?
Royal pays £0.40 per kilo for its materials
- •One-half of a month’s purchases are paid for in the month of purchase; the other half is paid in the following month
- •The March 31 accounts payable balance is £12,000 - paid in april
similar to the Cash receipts
- price is from multiplying the amount in kilos from the direct materials budget by the price per kilo( £0.40)
the half not paid in June is put as a liability on the balance sheet
How do you calculate the Direct Labour Budget?
- •At Royal, each unit of product requires 0.05 hours of direct labour
- 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 £10 per hour regardless of the hours worked (No overtime pay)
- or the next three months, the direct labour workforce will be paid for a minimum of 1,500 hours per month
Top line taken from Production Budget
- the predetermined overhead rate is pasted on the labour hours required for the quarter
- take the higher number for labour hours paid between hours required and minimum hours per month
How do you calculate the manufacturing Overhead Budget?
- Royal Company uses a variable manufacturing overhead rate of £1 per unit produced
- Fixed manufacturing overhead is £50,000 per month and includes £20,000 of noncash costs (primarily depreciation of plant assets)
- top line is from production budget
How do you calculate Closing Finished Goods Stocks?
£49.70 is the manufacturing overhead:
- Total Mfg. OH for the quarter/Total labour hours required
How do you calculate the Selling and Administrative Expense Budget?
- At Royal, variable selling and administrative expenses are £0.50 per unit sold
- Fixed selling and administrative expenses are £70,000 per month
- The fixed selling and administrative expenses include £10,000 in costs – primarily depreciation – that are not cash outflows of the current month
How do you calculate the Cash Budget?
- Maintains a 16% open line of credit for £75,000 ▪Maintains a minimum cash balance of £30,000
- Borrows on the first day of the month and repays loans on the last day of the month
- Pays a cash dividend of £49,000 in April
- Purchases £143,700 of equipment in May and £48,300 in June paid in cash
- Has an April 1 cash balance of £40,000
As trying to maintain a minimum cash balance of £30,000 need to borrow £50,000 in April
At the end of June, Roal has enough cash to repay the £50,000 loan plus interest at 16%
How do you calculate the financial and repayment?
