Module 6: Budgets and Variances (Chp 10) Flashcards
2 things that occur in short run
1) Capacity related costs are fixed
2) The only relevant costs are controllable costs, which are variable costs
what does budgeting process determine
determines the planned level of most variable costs
define budgeting process
approach used to determine how to allocate financial resources to each part of an organization based on planned activities and short run objectives of that part of the org
define budget
a quantitative expression of the money inflows and outflows that reveal whether the current operating plan will meet org financial objectives
5 things budgets do
1) Budget serve as a control for managers within business units of an org
2) Budgets play central role in relationship between planning and control
3) Budgeting is process of preparing budgets
4) Budgets provide a way to communicate the org short-term goals to employees
5) Budgeting also serves to coordinate the many activities of an org
2 things that budgeting activities of each unit can do
1) Reflect how well managers understand org goals
2) Provide opportunity for org senior planners to correct misperceptions about org goals
2 ways budgeting helps to anticipate potential problems
1) Borrowing needs - budget reflects cash cycle and provides info to anticipate cash shortages
2) If budget planning indicates that the org sales potential exceeds its manufacturing potential then the org can develop a plan to put more capacity in place or to reduce planned sales
once authorized, what are discretionary spending budgets?
committed or fixed, they do not vary with levels of production or service
3 things in planning
1) Identify org objectives and short term goals
2) Develop long term strategy and short term plan
3) Develop master budget
2 things in control
1) Measure and assess performance against budget
2) Reevaluate objectives, goals, strategy and plans
budgeting involves forecasting the demand for 4 types of resources over different time periods. The resources are:
1) Flexible resources that create variable costs
2) Intermediate-term capacity resources that create fixed costs
3) Resources that, in the intermediate and long run, enhance the potential of the organization’s strategy
4) Long-term capacity resources that create fixed costs
what are short term flexible resources (4)
1) disposed of and acquired in short run
2) Committed for less than several weeks
3) Provides ability to use existing capacity
4) Raw materials, supplies, hourly paid labour
5) create variable cost
what are Resources that, in the intermediate and long run, enhance the potential of the organization’s strategy
discretionary expenses like R&D, employee training, advertising, promotion, maintenance of capacity resources - do not provide capacity, do not vary with level of org activity
what is inherent in budgeting process?
game playing
explain game playing in budgeting process
If budgets are used to evaluate actual performance, managers have the incentive to misrepresent their info
example of game playing in budgeting process
sales manager might understate sales potential in a region to look better when it is higher
2 major types of budgets comprising master budget
1) operating budget
2) financial budget
explain operating budget
Summarize the level of activities such as sales, purchasing, and production
explain financial budget
Identify the expected financial consequences of the activities summarized in the operating budgets
3 examples of financial budget
income statement, balance sheet, cash flow statement
what happens if initial budgets are infeasible or financially unacceptable
planners repeat budgeting cycle with new set of decisions until results are feasible and financially acceptable
step 1 of master budget
organization goals
master budget - operating budget parts, step 2 - 9
- Sales plan
- Capital spending plan
- Inventory policy
- . Production plan
- Productive capacity plan
- Materials purchasing plan
- Labor hiring and training plan
- Administrative and discretionary spending plan
explain sales plan
1) Identifies the planned level of sales for each product at a specific selling price
2) Provides basis for production plans: labour, materials, production capacity, cash
explain capital spending plan
Specifies the long-term capital investments that must be paid in the current budget period to meet activity objectives
explain production plan
1) Prepared by matching completed sales plan with organization’s inventory policy and capacity level
2) Identifies intended production during each of the interim periods comprising the annual budget period
explain materials purchasing plan
Schedules required purchasing activities
explain labour hiring and training plan
Specifies the number of people the organization must hire or release to achieve its activity objectives
explain admin and discretionary spending plan
Includes administration, staffing, research and development, and advertising
2 ways operations personnel uses operating budgets
1) use the operating budget to guide and coordinate the level of various activities during the budget period.
2) record data from current operations that can be used to develop future budgets.
how do financial planners use projected balance sheet and income statement
to estimate the financial consequences of investment, production, and sales plans
2 ways planners use projected statement of cash flows
1) To plan when excess cash will be generated to make short term investments
2) To plan how to meet any cash shortages
steps in budgeting process
sales plan -> production plan -> spending plan -> choosing capacity levels
3 types of resources determine capacity
1) short term flexible resources
2) intermediate term capacity resources
3) long term capacity resources
3 points to intermediate term capacity resources
1) Committed for several weeks to 6 months
2) General purpose capacity transferable among organizations
3) Employees, general purpose equipment
3 points to long term capacity resources
1) Committed for more than 6 months
2) Special purpose capacity customized for the organization’s use
3) Buildings, special purpose equipment
why are capacity resources considered committed?
because they are the same regardless of much of facility is used and because level of capacities and fixed cost is difficult to change in short term
what is the result of capacity resources being committed?
imposes financial risk on org
what to planners use forecasted demand for?
to plan activity levels and provide required capacity
what does it mean if production plan is infeasible?
demand exceeds capacity
2 things planners can do if production plan is infeasible
1) acquire more capacity or 2) reduce planned level of production
formula for production
lesser of 1) total demand 2) production capacity
what is demand
quantity customers are willing to buy at stated price
formula for production capacity
minimum of 1) long term capacity 2) intermediate term capacity 3) short term capacity
3 factors that drive planning
1) demand
2) capacity levels chosen
3) production output quantity
what is projected balance sheet (2)
1) An overall evaluation of the net effect of operating and financing decisions during the budget period
2) General assessment of operating efficiencies
what is projected income statement (2)
1) An overall test of the profitability of the proposed activities
2) General assessment of operating efficiencies
what is projected cash flow statement (2)
1) Helps an organization identify if and when it will require external financing
2) Determines if any projected cash shortage will be temporary or cyclical, or permanent
3 sections of cash flow statement
1) Cash inflows from cash sales and collections of receivables
2) Cash outflows
3) results of financing operations
explain cash outflows (2)
1) For flexible resources that are acquired and consumed in the short term
2) For capacity resources that are acquired and consumed in the intermediate and long term
explain results of financing operations (2)
1) Summarizes the effects on cash of transactions that are not a part of the normal operating activities
2) Includes the effects of:
- Issuing or retiring stock or debt
- Short-term financing
formula for net cash flow
cash inflow - cash outflow
formula for ending cash
operating cash flow + opening cash + effects of financing operations
what is budget info used for? (using projected results) (3)
1) Identify broad resource requirements
2) Identify potential problems
3) Compare projected operating and financing results
formula for production plan - purchases needed
units to produce (production) + desired units in ending inventory - units in beginning inventory
Determine the sales level in dollars at which the use of the new machine results in a 10% profit on sales (profit/sales) ratio formula
x (sales revenue) = fixed costs / 10%
