Budgeting planning We use budgets as a target that we hope or expect to achieve. These are financial and non-financial in nature, but typically offer some quantitative measure We will begin by talking about the building of a STATIC BUDGET. A static budget is the basic PLAN that you are expecting. For a manufacturing firm, you typically start with SALES and work your way back to PRODUCTION and then to PURCHASING of raw materials. Breakers, Inc. is preparing budgets for the quarter ending June 30. Budgeted sales for the next five months are: April May June July August 20,000 units 50,000 units 30,000 units 25,000 units 15,000 units. The selling price is $10 per unit. The management of Breakers, Inc. wants ending inventory to be equal to 20% of the following month s budgeted sales in units. On March 31, 4,000 units were on hand. At Breakers, five kilograms 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 kilograms of material are on hand. Material cost $.40 per kilogram. 1
At Breakers, each unit of product requires 0.1 hours of direct labor. 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 $8 per hour regardless of the hours worked (No overtime pay). For the next three months, the direct-labor workforce will be paid for a minimum of 3,000 hours per month. At Breakers, variable selling and administrative expenses are $0.50 per unit sold. Fixed selling and administrative expenses are $70,000 per month. The $70,000 fixed expenses include $10,000 in depreciation expense that does not require a cash outflow for the month. Overhead Budget (taken as given) Indirect labor $ 25,700 $ 35,900 $ 26,100 $ 61,900 Indirect material 7,000 12,600 8,600 28,200 Utilities 4,200 8,400 5,200 17,800 Rent 13,300 13,300 13,300 39,900 Insurance 5,800 5,800 5,800 17,400 Depreciation 8,200 9,400 8,200 25,800 $ 64,200 $ 85,400 $ 67,200 $ 191,000 2
At Breakers, all sales are on account. The company s collection pattern is: 70% collected in the month of sale, 25% collected in the month following sale, 5% is uncollected. The March 31 accounts receivable balance of $30,000 will be collected in full. Breakers pays $0.40 per kilogram 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. No discounts are available. The March 31 accounts payable balance is $12,000. Maintains a 12% 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 $25,000 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. 3
Here is the solution to that problem. First, we prepare a REVENUE BUDGET (or SALES BUDGET) Sales Sales 20,000 50,000 30,000 100,000 Price 10.00 10.00 10.00 10.00 Revenue 200,000 500,000 300,000 1,000,000 We must also know our Sales for July and August, since June s ending inventories will depend on July production and July s production will depend on August Sales. July August Sales 25,000 15,000 Price 10.00 10.00 Revenue 250,000 150,000 Next, we prepare a production budget using the fact that we have 4,000 units on hand as of March 31 and the fact that we require 20% of the next month s sales on hand in Ending FGI (20% of 20,000 units of April sales is 4,000 units our March 31 ending inventory): 4
Production July August Sales 20,000 50,000 30,000 100,000 25,000 15,000 Less Beginning Inventory 4,000 10,000 6,000 4,000 5,000 16,000 40,000 24,000 96,000 20,000 Add Ending Inventory 10,000 6,000 5,000 5,000 3,000 Produced 26,000 46,000 29,000 101,000 23,000 Now, we use the production budget to compute our purchases of Raw Materials. We have 13,000 Kg of materials on hand and require 10% of the following month s production on hand in ending inventory. Each unit produced requires 5 Kg of materials. Materials cost $.40 per Kg. The beginning inventory of 13,000 Kg is: 26,000 units produced in April X 5 Kg = 130,000 (our total needs for April production) X 10%. Direct Materials July August Produced 26,000 46,000 29,000 101,000 23,000 15,000 Materials required 130,000 230,000 145,000 505,000 115,000 Less Beginning Inventory 13,000 23,000 14,500 13,000-117,000 207,000 130,500 492,000 23,000 Add Ending Inventory 23,000 14,500 11,500 11,500 - Units purchased 140,000 221,500 142,000 503,500 23,000 Price per pound 0.40 0.40 0.40 0.40 Purchases (cost) 56,000 88,600 56,800 201,400 Next, we budget for Direct Labor. An hour of direct labor costs $8. Direct Labor is a minimum of 3,000 hours and is otherwise based upon.1 hour per unit produced. We work off of the production budget above. 5
Direct Labor Produced 26,000 46,000 29,000 101,000 Labor required 2,600 4,600 2,900 Minimum labor 3,000 3,000 3,000 3,000 4,600 3,000 10,600 Price per hour 8.00 8.00 8.00 8.00 Direct Labor Cost 24,000 36,800 24,000 84,800 The overhead budget was given: Overhead Indirect labor 25,700 35,900 26,100 87,700 Indirect material 7,000 12,600 8,600 28,200 Utilities 4,200 8,400 5,200 17,800 Rent 13,300 13,300 13,300 39,900 Insurance 5,800 5,800 5,800 17,400 Depreciation 8,200 9,400 8,200 25,800 64,200 85,400 67,200 216,800 That completes the components of production (Direct Materials, Direct Labor, and Overhead). Now we will base our selling and administrative expense budget on sales for the period. It is pretty straight-forward. 6
Selling and Administrative Sales 20,000 50,000 30,000 100,000 Variable S and A rate 0.50 0.50 0.50 0.50 Variable Selling and Admin 10,000 25,000 15,000 50,000 Fixed S and A 60,000 60,000 60,000 180,000 Total Selling and Admin 70,000 85,000 75,000 230,000 Now, we start putting together our CASH BUDGET. First, based upon the sales budget, our beginning Accounts Receivable of $30,000, and our collection expectations, we budget for Cash Receipts. Cash Receipts Sales 20,000 50,000 30,000 100,000 Price 10.00 10.00 10.00 10.00 Revenue 200,000 500,000 300,000 1,000,000 Collections from previous month 30,000 50,000 125,000 205,000 Collections from this month 140,000 350,000 210,000 700,000 Total Collections 170,000 400,000 335,000 905,000 Our cash disbursements (outflows of cash) are based upon payments for direct materials, payments for direct labor, and our CASH payments for overhead, as well as our payments for selling and administrative expenses and any DIVIDENDS or CASH PURCHASES that we may make in a period. 7
Our cash payments for materials purchases is given below: Cash Disbursements - Materials Purchases (cost) 56,000 88,600 56,800 201,400 Paid from this month 28,000 44,300 28,400 Paid from last month 12,000 28,000 44,300 Total materials payments 40,000 72,300 72,700 185,000 This gives us the following CASH BUDGET Cash Budget Beginning Balance 40,000 30,000 30,000 40,000 Cash from Revenues 170,000 400,000 335,000 905,000 Cash Available 210,000 430,000 365,000 945,000 Cash Disbursements Purchases 40,000 72,300 72,700 185,000 Labor 24,000 36,800 24,000 84,800 Overhead 56,000 76,000 59,000 191,000 Selling and Admin 70,000 85,000 75,000 230,000 Equipment Purchase 143,700 48,300 192,000 Dividends 25,000 - - 25,000 Total 215,000 413,800 279,000 907,800 Excess Cash (5,000) 16,200 86,000 37,200 Borrowing 35,000 13,800 48,800 Repayment (48,800) (48,800) Interest - - (1,326) (1,326) Ending Balance 30,000 30,000 35,874 35,874 8