Chapter 16 Forecasting Short-Term (Operating) Financial Requirements Requirements Budget – is a plan which sets forth the projected expenditures for a certain activity and explains where the required funds will come from. (i.e., production budget presents a detailed analysis of the required investments in materials, labor, and plant necessary to support the forecasted sales level.)
- A financial plan of the resources needed to carry carry out tasks and meet financial goals. It is also a quantitative expression of the goals of the organizations wishes to achieve and the costs of attaining these goals. Budgetary Control - use of budget to control a firm’s activities. Purposes of Budgets:
1. Defining broad objectives and goals and formulating strategies to achieve such objectives. 2. Coordinating the activities of the organization by integrating the plans of the various parts thereby pulling every one in the same direction. 3. Allocating resources to those parts of the organization where they can be used most effectively. 4. Communicating management’s approved plans throughout the organization. 5. Uncovering and preparing for potential bottleneck in in the operations before they occur. 6. Motivating managers to achieve the desired results and 7. Setting a standard or benchmark for for evaluating actual performance. Advantages of Budgets:
1. It forces planning and exposes situations in which plans of subcomponents are inadequate to attain the total organization’s objectives. 2. It allows a reiterative process to bring the goals of the organization and the subcomponents into agreement. 3. It provides a means of communicating organization goals down through the organization and sub-unit operational limitations up through the organization. 4. It provides basis for financial planning , sub-unit coordination, resource acquisition, inventory policy, scheduling, and output distribution. 5. It provides a basis by which activity can be monitored, with actual results being compared to the planned results. Disadvantages of Budgets:
1. Budgets tend to oversimplify the real situation and fail to allow for variations in external factors. They do not reflect qualitative variables. Financial Management 1 Technological Institute of the Philippines - Manila
2. It is difficult to prepare a detailed budget for an organization that has never existed or f or a new division, product, or department of an existing firm. 3. There may be lack of higher and lower management commitment because of lack of understanding of the fundamentals of budget preparation and utilization. Types of Budget:
1. The Operating Budget 2. The Financial Budget 3. The Capital Budget A. Operating Budget
1. Budgeted Income Statement a. Sales Budget b. Production Budget – (1) Materials Cost Budget, (2) Direct Labor Cost Budget, (3) Factory Overhead Budget, (4) Inventory Levels 2. Cost of Sales Budget 3. Selling and Administrative Expenses Budget 4. Financial Expense Budget B. Financial Budget
1. Budgeted Statement of Financial Position 2. Cash Budget 3. Budgeted Statement of Sources and Uses of Funds C. Investment Budget Steps in Developing a Master Budget
1. Establish basic goals and long-range plans for the company. These will serve as guidelines in the preparation of budget estimates. 2. Prepare a sales forecast for the budget period. 3. Establish the cost of goods sold and operating expenses. 4. Determine the effect of budgeted operating results on assets, liabilities, and ownership equity accounts. The cash budget is the largest part of this step, since changes in many asset and liability accounts will depend upon the cash flow forecast. 5. Summarize the estimated data in the form of a projected income statement for the budget period and the projected statement of financial position as of the end of the budget period.
Financial Management 1 Technological Institute of the Philippines - Manila
Operating Budget: A. Sales Budget – foundation on which all other short-term budgets are built, - triggers a chain reaction that leads to the development of many other budget figures in an organization - provides the revenue predictions from which cash receipts from customers can be estimated and supplies the basic data for constructing budgets for production costs and selling and administrative expenses. *The sales forecast is made after consideration of the ff. factors: past volume sales, general economic and industry condition, relationship of sales to economic indicators, relative product profitability, market research studies and competition, pricing, advertising, and other promotion policies, production capacity, quality of sales force, seasonal variations, and long term sales trends for various products. Formula for Desired Sales Revenue: Sales Revenue = Desired Sold Units x Sales Price per Unit B. Production Budget – after the sales budget has been set , a decision can be made on the level of
production that will be needed for the period to support sales and the production budget can be set as well. -becomes a key factor in the determination of other budgets, including the direct materials budget, the direct labor budget, and the manufacturing overhead budget which in turn are needed in
formulating a cash budget. Formula for Desired Production (units):
Units to be sold Plus: Desired Ending Finished Goods Inventory Less: Desired Beginning Finished Goods Inventory Units to be produced
xx xx (xx) xx
B.1 – Raw Materials Budget – prepared after the determining the number of units to be produced Formula for Raw Materials needed in Production Raw Materials needed in Production = Units to be produced x no. of raw materials needed to produce
finished oods inventor
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Formula for Purchases of Raw Materials:
Units required for production = materials required per unit production X desired production units
Units required for Production
xx
Add: Ending Materials Inventory
xx
Less: Beginning Materials Inventory
(xx)
Units to be purchased
xx
Multiply:Unit Cost
xx
Total Cost of Materials Purchases
xx
B.2 – Direct Labor Budget –computed on the budgeted production during the period.
Total Direct Labor Hours = Budgeted Quantity Production (units) X Direct Labor Hours/unit
Direct Labor Cost = Direct Labor rate/hour X Total Direct Labor Hours
B.3 –Factory Overhead Budget –Unlike direct materials and direct labor which are usually classified as
purely variable costs, factory overhead costs are composed of both variable and fixed costs elements. Some overhead items may be projected on the basis of direct labor hours or on materials costs or on machine hours. Budgeted Variable Manufacturing Overhead = Desired Production X Variable MBudanufacturing
Unit Cost
Total Budgeted Manufacturing Overhead = Budgeted Variable MOH +Budgeted Fixed MOH
2. Cost of Sales Budget – is computed using the figures for production, materials, labor, factory
overhead and the beginning and ending inventories of finished goods.
Budgeted Direct Materials Plus: Budgeted Direct Labor Plus: Budgeted Factory Overhead Total Manufacturing Costs Plus: Beginning WIP inventory Less: Ending WIP inventory Total Total Cost of Goods Manufactured Plus: Expected Finished goods beginning inventory Less: Management Desired Finished Financial 1 goods ending inventory CostInstitute of Sales of the Philippines - Manila Technological
xx xx xx xx xx (xx) xx xx (xx) xx
3. Selling and Administrative Expenses – As with overhead costs, marketing and administrative
expenses are also made up of fixed and marketing variable components. Total Selling and Administrative Expenses = Variable SAE + Fixed SAE
B. Financial Budget 1. Cash Budget – is a vital part of the financial budget because with this, management can more or less
foresee possible cash shortage or overage which may have a great impact on t he overall operations during the budget period. Expected Cash Balance, Beginning
xxx
Add: Budgeted Cash Receipts
xxx
Total Cash Available
xxx
Less: Budgeted Cash Disbursements Expected Cash Balance, ending
(xxx) xxx
Cash Receipts may come:
-Cash Sales -Collection of Accounts Receivable -Loan Proceeds -Additional Investment of owners/stockholders -Sale of company’s assets other than finished goods or merchandise -Donations -Interest or dividends on investments Cash Disbursements may come: -Cash Purchases of materials or merchandise
-Other manufacturing Costs -Payment of Accounts Payable -Operating Expenses -Payment of Loans -Dividends or withdrawals by owners/partners -Acquisition of assets other than materials or merchandise (fixed assets) -Donations -Interest on Loans
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2. Budgeted Income Statement – 3. Budgeted Statement of Financial Position – is developed by beginning with the current stateme nt of
financial position and adjusting it for the data contained in other budgets.
Financial Management 1 Technological Institute of the Philippines - Manila
