McGraw-Hill/Irwin

Chapter Seven

Planning for Profit andCost Control

Three Levels of Planning

• Strategic planning involves making long-term decisions such as defining the scope of the business, determining which products to develop, and identifying the most profitable markets.

• Capital budgeting focuses on intermediate range planning and involves decisions such as whether to buy or lease equipment, whether to stimulate sales, or whether to increase investments in company assets

• The Master Budget describes short-term objectives in terms of specific sales targets, production goals, and financing plans.

Advantages of Budgeting

Budgeting

PromotesPlanning

PromotesCoordinatio

n

EnhancesPerformanc

e Measureme

nt

EnhancesCorrective

Actions

Budgeting and Human Behavior

Upper management must be sensitive to the impact of the budgeting process on employees.

Budgets are constraining.

They limit individual freedom in favor of an established

plan.

Many people find evaluation based

on budget expectations

stressful. Think of students and

exams.Upper management must

demonstrate that budgets are sincere efforts to express realistic goals employees are expected to

meet.

Inventorypurchases

budget

S & A expense budget

Salesbudget

Cashbudget

Statement of Cash Flows

Cash Receiptsand Payments

Schedules

OperatingBudgets

Pro formaFinancial

StatementsStart

Cashpaymentsfor S & A

Cashpayments

for inventory

Cashreceipts

Balance Sheet

Income Statement

Sales Budget

Detailed schedule prepared by the marketing department

showing expected sales for the coming periods and expected

collections on those sales. It is critical to the success of the

entire budgeting process.

Sales Budget

Hampton Hams (HH) is preparing a sales budget for the last quarter of the year. Ham sales are expected to peak in the

months of October, November, and December (the holiday seasons). The

store sales for October are expected to total $160,000 ($40,000 in cash sales,

and $120,000 in sales on account). Sales are expected to increase by 20% per month for November and December.

Let’s prepare a sales budget.

Hampton Hams (HH) is preparing a sales budget for the last quarter of the year. Ham sales are expected to peak in the

months of October, November, and December (the holiday seasons). The

store sales for October are expected to total $160,000 ($40,000 in cash sales,

and $120,000 in sales on account). Sales are expected to increase by 20% per month for November and December.

Let’s prepare a sales budget.

$40,000 × 120% = $48,000 $40,000 × 120% = $48,000 $120,000 × 120% = $144,000 $120,000 × 120% = $144,000

Accounts receivable at December 31st are $172,800, the uncollected sales on

account.

Accounts receivable at December 31st are $172,800, the uncollected sales on

account.

Sales Budget

Schedule of Cash Receipts

Hampton Hams (HH) will collect cash sales in the month of sale. Past

experience shows that the company will collect cash from its credit sales in the month following the month of the sale

(October credit sales will be collected in full in November).

Let’s prepare the cash receipts budget.

Hampton Hams (HH) will collect cash sales in the month of sale. Past

experience shows that the company will collect cash from its credit sales in the month following the month of the sale

(October credit sales will be collected in full in November).

Let’s prepare the cash receipts budget.

Schedule of Cash Receipts

Sales revenue on the income statement will be the sum of the

monthly sales ($582,400).

Inventory Purchases Budget

The total amount of inventory needed for each month is equal to the

amount of the cost of budgeted sales plus the desired ending inventory.

Inventory Purchases Budget

HH maintains a policy that ending inventory should be equal to 25% of the

next month’s projected cost of goods sold. At HH, cost of goods sold normally

equal 70% of sales.

Suppliers require HH to pay 60% of inventory purchases in the month goods are purchased and the remaining 40% in

the month after the purchase.

Let’s prepare the inventory purchases budget and the schedule of cash

payments for inventory purchases.

Inventory Purchases Budget

$134,400 × 25% = $33,600

$155,960 × 40% = $62,384 Accounts Payable

$145,600 × 40% = $58,240

$145,600 × 60% = $87,360

Selling and Administrative Expense Budget

The details of the Selling and Administrative (S&A) Budget are shown on the next two screens. It is important to note that sales commissions (based on 2% of sales) are paid in the month

following the sale, while supplies expense (based on 1% of sales) are paid

in the month of the sale. The utility expense is paid in the month following the usage of the electricity, gas, and

water.

The details of the Selling and Administrative (S&A) Budget are shown on the next two screens. It is important to note that sales commissions (based on 2% of sales) are paid in the month

following the sale, while supplies expense (based on 1% of sales) are paid

in the month of the sale. The utility expense is paid in the month following the usage of the electricity, gas, and

water.

Selling and Administrative Expense Budget

Cash Budget

HH plans to purchase, for cash, store fixtures with a cost of $130,000 in

October. HH borrows or repays principal and interest on the last day of each

month. Any monies borrowed from the bank bear interest at an annual rate of

12% (1% per month). The management at HH wants to maintain an end of month

cash balance of at least $10,000.

HH plans to purchase, for cash, store fixtures with a cost of $130,000 in

October. HH borrows or repays principal and interest on the last day of each

month. Any monies borrowed from the bank bear interest at an annual rate of

12% (1% per month). The management at HH wants to maintain an end of month

cash balance of at least $10,000.

Cash Budget

Cash Budget

Check Yourself

Astor Company expects to incur the following operating expenses during September: Salary Expense, $25,000; Utility Expense, $1,200; Depreciation Expense, $5,400; and Selling Expense, $14,000. It pays operating expenses in cash in the month in which it incurs them. Based on this information, the total amount of cash outflow reported in the Operating Activities section of the pro format Statement of Cash Flows would be:

a. $45,600.

b. $31,600.

c. $40,200.

d. $44,400

Depreciation Expense is a non-cashcharge to income and will not appear

on the Statement of Cash Flows.

Depreciation Expense is a non-cashcharge to income and will not appear

on the Statement of Cash Flows.

Pro Forma Income Statement

The pro forma income statement gives management an estimate of the

expected profitability of HH. If the project appears to be unprofitable,

management can make the decision to abandon it. Although managers remain

responsible for data analysis and decision making, computer technology offers powerful tools to asset in those

tasks.

Pro Forma Income Statement

Cost of Goods Sold:

Beg. Inv. $0

Purchases $442,680

CGAS$442,680

End. Inv. $35,000

COGS$407,680

Cost of Goods Sold:

Beg. Inv. $0

Purchases $442,680

CGAS$442,680

End. Inv. $35,000

COGS$407,680

Pro Forma Balance Sheet

This new store has no contributed capital because its operations will be financed through debt (line-of-credit) and earnings. The amount of retained

earnings will be equal to the net income because there are not prior periods. The

fixtures purchased in October will be depreciated for a full three months.

Total accumulated depreciation will be $3,000.

McGraw-Hill/Irwin

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