Presentation by Chapter.ppt

BUDGETING BASICS AND BEYOND (4 th Edition) Jae K. Shim Joel G. Siegel Allison I. Shim

CHAPTER 1

THE WHAT AND WHY OF BUDGETING: AN INTRODUCTION

Budget?



A budget is defned as the formal expression of plans, goals, and objectives of management that

covers all aspects of operations

for a designated time period



A budget is a fnancial plan to control future operations and results

Efective Budgeting

Efective budgeting requires the existence

of the following: 

Predictive ability 

Clear channels of communication, authority, and responsibility 

Accounting-generated accurate, reliable, and timely information 

Compatibility and understandability of

information 

Support at all levels of the organization

Types of Budgets



 Supplemental Budget

 Probabilistic Budget

 Target Budget

 Activity-Based Budget (ABB)

 Strategic Budget

 Stretch Budget

 Bracket Budget

 Add-On Budget

Master Budget 

 Rolling Budget

Program Budget 

Capital Expenditure Budget 

Cash Budget 

Operating and Financial Budgets 

Flexible (Expense) Budget 

Static (Fixed) Budget 

 Life-cycle budget

The Budgetary Process

 Setting objectives.  Analyzing available resources. 

Negotiating to estimate budget

components.



Coordinating and reviewing components

 Obtaining fnal approval.  Distributing the approved budget.

Actual Costs vs. Budget

Costs 

At the beginning of the period, the budget is a plan. At the end of the period, the budget is a control instrument to assist management in measuring its performance against plan so as to improve future performance. Budgeted revenue and

costs are compared to actual revenue

and costs to determine variances

Budget Issues



Bottom-up (Participative) versus Top- down



Advantages and Disadvantages of Budgets



Budgetary Slack: Padding the Budget

CHAPTER 2 STRATEGIC PLANNING AND BUDGETING:

PROCESS, PREPARATION, AND CONTROL

Planning and Budgeting?



Planning should link short-term, intermediate-term, and long-term goals. The objective is to make the best use of the companies’ available resources over

the long term. Budgeting is simply one

portion of the plan.

 The plan is the set of details

implementing the strategy. The plan of

ex ecution is typically explained in sequential steps including costs and

timing for each step. Deadlines are set.

Strategic Planning



Strategic plans are long-term, broad plans ranging from 2 to 30 years, with 5 to 10 years being most typical



The strategic plan is the mission of

the company and looks to existing and prospective products and markets. Strategic plans are designed to direct the company’s activities, priorities, and goals.

Short-term and Long-

term Plans



Short-range plans are typically for one year

(although some plans are for two years). The plans examine expected earnings, cash fow, and capital expenditures

 Long-term planning is usually of a broad, strategic (tactical) nature to accomplish objectives. A long-term plan is typically 5-10 years (or more) and looks at the future

direction of the company. It also considers

Budget Accuracy The accuracy of budget preparation may be

determined by comparing actual numbers to

budget numbers in terms of dollars and units. Budget accuracy is higher when the two fgures are closer to each other. Ratios showing budget accuracy include:

 Sales Accuracy = Actual Sales/Budgeted Sales

 Cost Accuracy = Actual Cost/Budgeted Cost

 Proft Accuracy = Actual Proft/Budgeted Proft

CHAPTER 3

ADMINISTERING THE BUDGET: REPORTS, ANALYSES, AND EVALUATIONS

Types of Reports

 Planning reports may be short term, looking at the company as a whole, each division, each department, and each responsibility center within the department

 Control reports concentrate on performance efectiveness and areas needing improvement.

 Information reports assist in planning and policy formulation. The re ports show areas of growth or contraction

More on Reports

Budget reports should contain the following data:



Trends over the years



Comparison to industry norms

 Comparison of actual to budget

with explanation and responsible

party for variances. Follow-up procedures are needed for control.

More Report Types

 Periodic Reports. These are reports prepared at regular intervals



Advance Reports. Important partial

information may be reported before all information is available for a periodic report

 Special Studies. Special reports are issued for a specifc, nonroutine purpose



A budget manual describes how a budget is to be prepared. The manual includes:



Standardized forms, lists, and reports

 Instructions



Format and coverage of performance

reports

 Administrative details

 The Budget Manual

The Budget Sheet

A budget sheet should be designed to record the information used by the op erating manager and budget preparer. The budgeting sheet should include the following information:



Historical cost records used



Cost formulas



Changes in operating conditions



The Budget Committee



A standing budget committee is usually responsible for overall policy relating to the budget program and for coordinating the preparation of the budget itself. This committee may consist of the president; vice presidents in charge of various functions such as sales, production, purchasing, CFO, and the controller.

Budget Calendar



The budget planning calendar is the schedule of activities for the development and adoption of the budget. It should include a list of dates indicating when specifc information is to be provided by each information source to others.

CHAPTER 4 BREAK-EVEN AND CONTRIBUTION

MARGIN ANALYSIS: PROFIT, COST, AND

VOLUME CHANGES

Questions Answered by Break-

even and Contribution Margin

Analysis

 What sales volume is required to break even?

 What sales volume is necessary to earn a desired proft?

 What proft can be expected on a given sales volume?

 How would changes in selling price, variable costs, fxed costs, and output afect profts?

 How would a change in the mix of products sold afect the break-even and target income volume and proft potential?

 Economic analysis of new product.  Labor contract negotiations.  Choice of production process.  Pricing policy.  Location selection.  Financing decisions. 

 Capital budgeting analysis.

Applications of the CVP

Model

Make or buy decision

Some Applications of Contribution Margin Analysis and “What-If” Analysis



Sales Mix Analysis



Contribution Margin Analysis and Nonproft Organizations



CVP Analysis with Step-function

Costs

 CVP-based Strategies



Assumptions Underlying

Break-even and Contribution

Margin Analysis

 The selling price per unit is constant throughout the entire relevant range of activity.

 All costs are classifed as fxed or variable.  The variable cost per unit is constant. 

There is only one product or a constant sales mix.

 Inventories do not change signifcantly from period to period.

 Volume is the only factor afecting variable

CHAPTER 5

PROFIT PLANNING: TARGETING AND REACHING ACHIEVABLE GOALS

Proft Planning



Profts are planned, they just do

not happen. Proft planning involves setting realistic and attainable proft objectives and

targets, and then accomplishing

them

Objectives in the Proft Plan



The objective must be defnite and specifc



An objective states what is going to be done. The objective must be clear, quantifable, compatible, practical, strong, realistic, and attainable (not too easy or too difcult). A general and vague objective is of little value. The objective should be in writing

CHAPTER 6 MASTER BUDGET: GENESIS OF

FORECASTING AND PROFIT PLANNING

Master Budget Flowchart Structure

Master (Comprehensive)

Budgeting 

Obviously these budgets cannot be prepared independently. Production is scheduled to meet the sales demand. Materials, labor, and factory overhead

costs are related to production. Selling and

administrative ex penses are based on

sales. Cash receipts and disbursements can

be esti mated only after sales revenue and costs are known. It is obvious that all of these separate budgets must be closely

Sales Planning Compared

with Forecasting  Sales planning and forecasting often are confused.

Although related, they have distinctly diferent purposes.



A forecast is not a plan; rather it is a statement and/or

a quantifed assessment of future conditions about a particular subject (e.g., sales revenue) based on one or more explicit assumptions.



A sales plan incorporates management decisions that

are based on the forecast, other inputs, and management judgments about such related items as sales volume, prices, sales efects, production, and

Types of Budgets



Sales budget 

Production budget 

Materials requirement budget 

Materials purchases budget 

Direct labor budget 

Factory overhead costs budget 

Selling and administrative expenses budget



Cash budget



Budgeted income statement



Budgeted balance sheet

_{Expected Desired} _Producti _on _{= Planned} _sales _{+ Ending — Beginning} _inventory Volume Inventory

The Production Budget

CHAPTER 7

COST BEHAVIOR:

EMPHASIS ON FLEXIBLE BUDGETS

An understanding of cost -

behavior is helpful to

managers for four reasons:

An understanding of cost -behavior is helpful to managers for four reasons:



Flexible budgeting



Break-even and contribution margin analysis



Appraisal of divisional performance



Short-term choice decisions

Costs by Behavior



VARIABLE COSTS. Variable costs, also

known as engineered costs, vary in total

with changes in volume or level of activity



FIXED COSTS. Fixed costs do not change

in total regardless of the volume or level

of activity

 MIXED (SEMI-VARIABLE) COSTS. As previously discussed, mixed costs contain

both a fxed element and a variable one.

Analysis of Mixed

(Semi-variable) Costs

Since the mixed costs contain both fxed and variable elements, the analysis takes the

following mathematical form, which is called a

fexible budget formula: Y = a + bX where Y = the mixed cost to be broken up (dependent variable). X = any given measure of activity (cost driver) such as direct labor hours, machine hours, or production volume (independent variable). a = the fxed cost component (constant). b = the variable rate per unit of X (slope).

The Contribution Income

Statement 

An alternative format of income

statement, known as the contribution

income statement, organizes the costs by behavior rather than by function. It shows the relationship of

variable costs and fxed costs a given

cost item is associated with, regardless of the functions .

More on Contribution

Income



Contribution margin is available to cover fxed costs

 The statement highlights the concept of contribution margin, which is the diference between sales and variable

costs. The traditional format, on the

other hand, emphasizes the concept

of gross margin, which is the

diference between sales and cost of

goods sold.

CHAPTER 8

EVALUATING PERFORMANCES: THE USE OF VARIANCE ANALYSIS

Variances



Variance analysis compares standard to actual costs or performances

 There are two types of variances: material and immaterial

Defning a Standard Cost



Standard cost, which is the predetermined cost of manufacturing, servicing, or marketing an item during a given future period. It is based on current and projected conditions. This norm is also dependent upon quantita tive and qualitative measurements (e.g., working conditions ).

Setting Standards

There are four types of standards 

Basic. These are not changed from period

to period

 Maximum efciency. These are perfect standards, which assume ideal, optimal conditions

 Currently attainable. These are based on efcient activity

 Expected. These are expected fgures, which should come very close to actual fgures

Cost Variances

Three cost measures:



Quantity per unit of work times actual units of work produced



Standard cost equals standard price

times standard quantity, where standard quantity equals standard quantity per unit of work times actual units of work produced.

 Total cost variance equals actual cost less standard cost

Flexible Budgets



The fexible budget is geared toward a

range of activities rather than a single level of activity. A fexible budget employs budgeted fgures at diferent capacity levels. It allows you to choose the best expected (normal) capacity level (100%) and to assign pessimistic (80%), optimistic (110%), and full (150%) capacity levels

CHAPTER 9 MANUFACTURING COSTS: SALES

FORECASTS AND REALISTIC BUDGETS

Manufacturing Cost

Budgets

 In order to budget for manufacturing costs, a production budget needs to be established, which in turn requires a sales budget. Manufacturing costs are subdivided

 into direct materials, direct labor, and factory overhead.

Planning and Control of

Material Purchases and

Usage

After determining the number of units to be produced, the company prepares the materials requirement budget and the materials purchase budget. Purchase of materials depends on production requirements and inventories. The direct materials budget involves a balancing of raw material needed for production, the raw

material inventory balances, and the purchase of

raw materials. The budget may provide for allowances for waste and spoilage.

Sales Budget



The sales budget is the starting point in preparing the master budget, since estimated sales volume infuences nearly all other items appearing in the master budget. The sales budget, which ordinarily indicates the quantity of each product expected to be sold, allows all departments to plan their

Sales Forecasts

 Sales forecasts are especially crucial aspects of many fnancial management activities, including budgets, proft planning, capital expenditure analysis, and

acquisition and merger analysis. It

is the key to other forecasts and



Percentage of sales or

proft



Objective-task method

Budgeting Advertising

Unit sales method



Trend in advertising cost to sales



Advertising cost per unit sold



Advertising cost per sales dollars



Advertising cost per customer



Advertising cost per transaction



Advertising cost by product, media, and territory

Measures of Advertising

CHAPTER 11

RESEARCH AND DEVELOPMENT: BUDGETS FOR A LONG-TERM PLAN

Research and Development

(R&D) 

Research and development (R&D)

is needed to develop new products and services or to signifcantly improve existing ones in order to remain competitive and grow

The R&D Budget The R&D budget may be based on:

 Estimated cost of specifc projects

 A percentage of expected sales

 A percentage of current year and/or prior year sales

 A percentage of proft

 A percentage of operating income

 A percentage of investment in capital assets

 A percentage of cash fow

 R&D per unit

Costs and Planning



There are direct and indirect costs associated with R&D projects



Any project limitations have to be

noted

 In R&D, individual projects have to be planned, appraised, and controlled

General and Administrative

Expenses 

Administrative departments include general administration, personnel, accounting, legal,

insurance, computer services, and

treasury. Administration is

personnel existing because of the

organization structure. Examples

Headcount Forecasting



In the nonmanufacturing functions of a business (such as general administration, R&D, marketing, and product engineering), the most signifcant expense usually is salaries. Some companies have developed formal procedures for projecting and controlling such expenses. These methods are known as headcount

Capital Expenditures



Capital expenditures include replacing machinery to economize on costs, expanding production to increase volume, marketing of a new product, improving the quality of products or services, and manufacturing under proposed contracts. Capital expenditures should take into account current and needed facilities. Commitments must also be considered.

Capital Budget Process

The four steps in the capital

expenditure budgetary process are:



Approving the project



Approving the estimate



Authorizing the project

 Follow-up

Who Uses Forecasts?

 Forecasts are needed for marketing, production, purchasing, manpower, and fnancial planning. Further, top management

needs forecasts for planning and implementing

long-term strategic objectives and planning for

capital expenditures. More specifcally, marketing managers use sales forecasts to determine optimal sales force allocations, set sales goals, and plan promotions and advertising. Market share, prices, and trends in new product development are also required.

Sales Forecasts and

Managerial Functions

Qualitative Forecasting

Methods

Qualitative approach—forecasts

based on judgment and opinion 

Expert opinions



Delphi technique



Sales force polling

 Consumer surveys

Quantitative Forecasting

Methods

a. Forecasts based on historical data 

Naive methods 

Moving average 

Exponential smoothing 

Trend analysis 

Classical decomposition

b. Associative (causal) forecasts 

Simple regression 

Multiple regression



Exponential smoothing

Quantitative Forecasting

Naive models

Moving averages

Exponential Smoothing



Exponential smoothing is a popular technique for

short-run forecasting by managers. It uses a weighted

average of past data as the basis for a forecast. The procedure gives heaviest weight to more recent

information and smaller weight to observations in the

more distant past. The reason is that the future is more dependent on the recent past than on the distant past.

 The method is known to be efective when there is

randomness and no seasonal fuctuations in the data.

One disadvantage of the method, however, is that it

does not include industrial or economic factors such as market conditions, prices, or the efects of competitors’ actions.

Least-Squares Method



The least-squares method is widely used in regression analysis for estimating the parameter values in a regression equation. The regression method includes all the -observed data and attempts to fnd a line of best ft. To fnd this line, a technique called the least-squares method is used.

Regression Statistics



Correlation coefcient (r) and ₂ coefcient of determination (R )



Standard error of the estimate (S e ) and prediction confdence interval



Standard error of the regression coefcient (S ) and t-statistic _b

Using Regression on

Excel

Excel has an easy-to-use

regression routine. To utilize Excel

2010, for example, for regression analysis, three steps need to be followed:  Click the Data menu.

 Click Data Analysis. 

Excel on Regression

Regression Output

SUMMARY OUTPUT _Regression _Statistics _{R Square 0.6084} Multiple R 0.7800 _{Adjusted R 0.5692} _Square _Observati _Error _ons Standard 2.3436 ₁₂ _{Coefci Standa t Stat P- Lower Upper} _{ents rd Error value 95%} _{Intercept 10.583 2.1796 4.855 0.000 5.7272 15.44} _* 95%

Cash Flow Forecasting



A forecast of cash collections and potential write-ofs of accounts receivable is essential in cash

budgeting and in judging the appropriateness of current credit and

discount policies. The critical step in

making such a forecast is estimating

the cash collection and bad debt percentages to be applied to sales or accounts receivable balances.

The Cash Budget

 The cash budget presents the

amount and timing of the expected

cash infow and outfow for a

designated time period. It is a tool

for cash planning and control and should be detailed so that your know how much is needed to run

Cash Budget

Components



The cash receipts section, which is cash

collections from customers and other cash

receipts such as royalty income and investment income.

 cash disbursements section, which comprises all cash payments made by purpose.

 cash surplus or defcit section, which simply shows the diference between the total cash available and the total cash needed including a minimum cash balance if required

 fnancing section, which provides a detailed account of the borrowings, repayments , and interest payments

A Financial Model

A fnancial model is one in which: 

One or more fnancial variables appears (expenses, revenues, investment, cash fow, taxes, and earnings).

 The model user can manipulate (set and alter) the value of one or more fnancial variables.

 The purpose of the model is to infuence

strategic decisions by revealing to the decision

maker the implications of alternative values of

these fnancial -variables.

Use of Financial Modeling

in Practice 

The use of fnancial modeling, especially a computer-based fnancial modeling system, is in wide use. The simple reason is the growing need for improved and quicker support as a decision support system (DSS) and enterprise resource planning (ERP) and wide and easy availability of computer

Use of a Spreadsheet Program

for Financial Modeling and

Budgeting

 Spreadsheet programs such as Excel and a

stand-alone package such as Up Your Cash Flow

can be used to develop a fnancial model. These

packages are an efective tool for sensitivity analysis. Sensitivity analysis is a "what-if" technique that examines how a result will change if the original predicted data are not achieved or if an underlying assumption changes. to For illustrative purposes, we

present some examples of projecting an income

Construction of a Rolling

Budget 

A Rolling budget, often called continuous or perpetual

budget is a 12-month (four-quarter) budget that rolls forward one month (or quarter) as the current month (or quarter) is completed. In other words, one month

(or quarter) is added to the end of the budget as each

month (or quarter) comes to a close. This approach keeps managers focused at least one year ahead so that they do not become too narrowly focused on

short-term results. Also, markets are changing so fast

that the traditional budget is quickly out of date within

weeks of its publication. Many companies adopt a

rolling-forecast process so that budget allocations can

be constantly adjusted to meet changing market

Rolling Budget Example

_{March April May June July August Total} Six-Month Budget (March through August) _{$210,0 $216,0 $224,0 $208,0 $190,0 $180,00 $1,228,0} ₀₀ ₀₀

₀₀

₀₀ ₀₀ ₀₀ _{Gross margin} _sold Cost of goods _{126,00 129,60 134,40 124,80 114,00} _{84,000 86,400 89,600 83,200 76,000 72,000$491,200} _{108,000$736,800} _Operating _{G&A expenses 26,000 27,000 27,000 25,000 24,000 24,000 153,000} _expenses Selling _{48,000 49,600 52,400 48,800 41,000 37,000 276,800} _{52,000 53,000 55,000 51,000 49,000 47,000 307,000} _{Income (before} _expenses _Interest income _{47,000 48,600 51,200 47,600 40,100 36,100 270,600} _{1,000 1,000 1,200 1,200 900 900 6,200} _(40%) _{Income taxes} taxes) _{18,800 19,440 20,480 19,040 16,040 14,440 108,240}

Rolling Budget Example

2 _{April May June July August Total} Revised Six-Month rolling Budget (April through September) _Septem _ber _Sales _sold _{Cost of goods} $220,0 $225,0 $210,0 $192,0 $182,0 $195,00 $1,224, _{88,000 90,000 84,000 76,800 72,800 78,000} ₀₀ ₀₀

₀₀

₀₀ _{00 000} _$489,60 _{Gross margin} _Selling _expenses _{53,000 55,000 51,000 49,000 47,000 50,100 305,100} 132,00 135,00 126,00 115,20 109,20 $734,40 _117,000 _Interest _income _Operating G&A expenses 27,000 27,000 25,000 24,000 24,000 25,000 152,000 _{52,000 53,000 50,000 42,200 38,200 41,900 277,300} _taxes) _{Income (before} _expenses _{51,000 52,000 48,800 41,100 37,100 40,800 270,800} 1,000 1,000 1,200 1,100 1,100 1,100 6,500

E-budgeting



The e in e-budgeting stands for both electronic

and enterprisewide; employees throughout an

organization, at all levels and around the globe, can submit and retrieve budget information electronically via the Internet.

 Budgeting software is utilized and made available on the Web (in a cloud computing environment), so that budget information

electronically submitted from any location is in

a consistent companywide format.

E-budgeting Software



There are much user-oriented software specifcally designed for corporate planners, treasurers, budget preparers, managerial accountants, CFOs, and business analysts.



Web-based (Web-enabled)



Intranet or Internet



Cloud computing



Enterprise Resource Management (ERM)

CHAPTER 20

CAPITAL BUDGETING: SELECTING THE OPTIMUM LONG-TERM INVESTMENT AND REAL OPTIONS

 Rate of return

 Budget ceiling

 Probability of success

 Competition

 Tax rate

 Dollar amounts

 Time value of money

 Risk

 Liquidity

 Long-term business strategy

 Forecasting errors Factors to Consider in Determining Capital Expenditures



Accounting Rate of Return (ARR)



Payback Period



Payback Reciprocal



Net Present Value (NPV)



Internal Rate of return (IRR)



Probability Index

Evaluation Methods

Real Options



Almost all capital budgeting proposals can be viewed as real options. Also, projects and operations contain implicit options, such as the option as to when to take a project, the option to expand, the option to abandon, and the option to suspend or contract operations. Deciding when to take a project is called the investment timing option.

Capital Budgeting under

Risk Several methods to incorporate risk into capital budgeting are 

Simulation 

Sensitivity analysis 

Decision (probability) trees Other means of adjusting for uncertainty include 

Decreasing the expected life of an investment 

Use of pessimistic estimates of cash fow 

Comparison of the results of optimistic, pessimistic,

and best-guess estimates of cash fows

CHAPTER 21 BUDGETING FOR COST MANAGEMENT:

ACTIVITY-BASED BUDGETING AND LIFE-

CYCLE BUDGETING

Activity-Based Budgeting



In contrast to functional budgeting,

Activity-based Budgeting (ABB) is activity-oriented. Activity-based budgets focus on the budgeted cost of activities required to produce and sell products and services. An activity-based budgetary system emphasizes the planning and control purpose of cost management.

ABB Example _Quarter _Year

_{Electricity ($.18 per unit) 3,240 1,728 2,484 3,888 11,340}

_{Indirect material ($.20 per unit) $3,600 $1,920 $2,760 $4,320 $12,600}

_{Units 18,000 9,600 13,800 21,600 63,000}

_{Unit-Level Costs} 1st 2nd 3rd 4th

Total unit-level costs $6,840 $3,648 $5,244 $8,208 $23,940

_{Production runs} _{Batch-Level Costs}

_{Setup ($110 per run) $3,300 $1,760 $2,530 $3,960 $11,550}

_{Purchasing and material handling} ₃₀ ₁₆ ₂₃ _{36 105}

_{Total batch-level costs $9,300 $4,960 $7,130 $11,16 $32,550}

_{($125 per unit)}

_{Inspection ($75 per run) 2,250 1,200 1,725 2,700 7,875}

3,750 2,000 2,875 4,500 13,125 _{Engineering designs}

_{Total product-level costs $1,800 $1,800 $1,800 $1,800 $7,200}

_{Facility-Level Costs} Product-Level Costs+A42

_{Design ($600 per design) $1,800 $1,800 $1,800 $1,800 $7,200}

₃ ₃ ₃ ₃ ₁₂ _{Maintenance 2,600 2,600 2,600 2,600 10,400}

_{Property taxes 1,000 1,000 1,000 1,000 4,000}

_{Insurance 1,400 1,400 1,400 1,400 5,600}

_{Supervisory salaries} $14,00 $14,00 $14,00 $14,00 _{0 $56,000}

_{Depreciation 15,000 15,000 15,000 15,000 60,000}

Utilities 2,500 2,500 2,500 2,500 10,000

Life-cycle Budgeting

A relatively recent focus of the budgeting process

is to plan for all of the costs that will be incurred throughout a product's life cycle, before a

commitment is made to the product. Product life-

cycle costs encompass the following three phases

in a product's life cycle.



Development (product planning, concept design



preliminary design. detailed design, and testing)

 Manufacturing (conversion activities)

 Logistics (distribution and customer service)

Life-cycle Budget Example

_Item

Budgeted Costs

_2X12 _2X13 _{2X14 Total} _Item Units produced

_{Development costs $195,000 $195,000}

_{Manufacturing costs} _{240,000 360,000 600,000} ^{40,000 60,000}

_{After-purchase costs 80,000 120,000 200,000}