CHAPTER 7
Planning for Profit and Cost
Control
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Learning Objective
LO1LO1
To describe the budgeting process and the benefits it
provides
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Three Levels of Planning
1.1. Strategic planningStrategic planning involves making long-term involves making long-term decisions such as defining the scope of the decisions such as defining the scope of the business, determining which products to business, determining which products to develop or discontinue and identifying the develop or discontinue and identifying the most profitable markets.most profitable markets.
2.2. Capital budgetingCapital budgeting focuses on intermediate- focuses on intermediate-range planning and involves decisions such as range planning and involves decisions such as whether to buy or lease equipment, whether to whether to buy or lease equipment, whether to stimulate sales, or whether to increase stimulate sales, or whether to increase company assets.company assets.
3.3. The Operations budgetThe Operations budget describes short-term describes short-term objectives in specific amounts of sales targets, objectives in specific amounts of sales targets, production goals, and financing plans.production goals, and financing plans.
1.1. Strategic planningStrategic planning involves making long-term involves making long-term decisions such as defining the scope of the decisions such as defining the scope of the business, determining which products to business, determining which products to develop or discontinue and identifying the develop or discontinue and identifying the most profitable markets.most profitable markets.
2.2. Capital budgetingCapital budgeting focuses on intermediate- focuses on intermediate-range planning and involves decisions such as range planning and involves decisions such as whether to buy or lease equipment, whether to whether to buy or lease equipment, whether to stimulate sales, or whether to increase stimulate sales, or whether to increase company assets.company assets.
3.3. The Operations budgetThe Operations budget describes short-term describes short-term objectives in specific amounts of sales targets, objectives in specific amounts of sales targets, production goals, and financing plans.production goals, and financing plans.
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Advantages of Budgeting
BudgetingBudgetingBudgetingBudgeting
PromotesPromotesPlanningPlanningPromotesPromotesPlanningPlanning
PromotesPromotesCoordinationCoordination
PromotesPromotesCoordinationCoordination
EnhancesEnhancesPerformance Performance MeasuremenMeasuremen
tt
EnhancesEnhancesPerformance Performance MeasuremenMeasuremen
tt
EnhancesEnhancesCorrective Corrective
ActionsActions
EnhancesEnhancesCorrective Corrective
ActionsActions
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Learning Objective
LO2LO2
To explain the relationship
between budgeting and human
behavior
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Budgeting and Human Behavior
Upper management must be sensitive to the impact of the budgeting process on employees.
Budgets are Budgets are constraining. constraining.
They limit They limit individual individual
freedom in favor freedom in favor of an established of an established
plan.plan.
Budgets are Budgets are constraining. constraining.
They limit They limit individual individual
freedom in favor freedom in favor of an established of an established
plan.plan.
Many people find Many people find evaluation based evaluation based
on budget on budget expectations expectations
stressful. Think of stressful. Think of students and students and
exams.exams.
Many people find Many people find evaluation based evaluation based
on budget on budget expectations expectations
stressful. Think of stressful. Think of students and students and
exams.exams.Upper management must demonstrate Upper management must demonstrate
that budgets are sincere efforts to that budgets are sincere efforts to express realistic goals employees are express realistic goals employees are
expected to meet.expected to meet.
Upper management must demonstrate Upper management must demonstrate that budgets are sincere efforts to that budgets are sincere efforts to
express realistic goals employees are express realistic goals employees are expected to meet.expected to meet.
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Cashpaymentsfor S & A
Cashpayments
for inventory
Inventorypurchases
budget
Incomestatement
S & Aexpensebudget
Balancesheet
Cashreceipts
Salesbudget
Cashbudget
Statement ofcash flows
Cash Receiptsand Payments
Schedules
OperatingBudgets
Pro formaFinancial
StatementsStartStart
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Learning Objective
LO3LO3
To prepare a sales budget and related schedule of cash
receipts
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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.
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Sales Budget
Hampton Hams (HH) is preparing a sales Hampton Hams (HH) is preparing a sales budget for the last quarter of the year. Sales of budget for the last quarter of the year. Sales of hames are expected to peak in the months of hames are expected to peak in the months of
October, November and December (the holiday October, November and December (the holiday seasons). The store sales for October are seasons). The store sales for October are
expected to total $160,000 ($40,000 in cash expected to total $160,000 ($40,000 in cash sales, and $120,000 in sales on account). Sales sales, and $120,000 in sales on account). Sales are expected to increase by 20% per month for are expected to increase by 20% per month for
November and December.November and December.
Let’s prepare a sales budget.Let’s prepare a sales budget.
Hampton Hams (HH) is preparing a sales Hampton Hams (HH) is preparing a sales budget for the last quarter of the year. Sales of budget for the last quarter of the year. Sales of hames are expected to peak in the months of hames are expected to peak in the months of
October, November and December (the holiday October, November and December (the holiday seasons). The store sales for October are seasons). The store sales for October are
expected to total $160,000 ($40,000 in cash expected to total $160,000 ($40,000 in cash sales, and $120,000 in sales on account). Sales sales, and $120,000 in sales on account). Sales are expected to increase by 20% per month for are expected to increase by 20% per month for
November and December.November and December.
Let’s prepare a sales budget.Let’s prepare a sales budget.
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Sales Budget
$40,000 $40,000 × 120% = $48,000× 120% = $48,000$40,000 $40,000 × 120% = $48,000× 120% = $48,000$120,000 $120,000 × 120% = $144,000× 120% = $144,000$120,000 $120,000 × 120% = $144,000× 120% = $144,000
Accounts receivable at December 31Accounts receivable at December 31stst are are $172,800, the uncollected sales on $172,800, the uncollected sales on
account.account.
Accounts receivable at December 31Accounts receivable at December 31stst are are $172,800, the uncollected sales on $172,800, the uncollected sales on
account.account.
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Schedule of Cash Receipts
Hampton Hams (HH) will collect cash sales in Hampton Hams (HH) will collect cash sales in the month of sale. Past experience shows the the month of sale. Past experience shows the company will collect cash from its credit sales company will collect cash from its credit sales in the month following the month of the sale in the month following the month of the sale
(October credit sales will be collected in full in (October credit sales will be collected in full in November).November).
Let’s prepare the cash receipts budget.Let’s prepare the cash receipts budget.
Hampton Hams (HH) will collect cash sales in Hampton Hams (HH) will collect cash sales in the month of sale. Past experience shows the the month of sale. Past experience shows the company will collect cash from its credit sales company will collect cash from its credit sales in the month following the month of the sale in the month following the month of the sale
(October credit sales will be collected in full in (October credit sales will be collected in full in November).November).
Let’s prepare the cash receipts budget.Let’s prepare the cash receipts budget.
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Schedule of Cash Receipts
Sales revenue on the income statement Sales revenue on the income statement will be the sum of the monthly sales will be the sum of the monthly sales
($582,400).($582,400).
Sales revenue on the income statement Sales revenue on the income statement will be the sum of the monthly sales will be the sum of the monthly sales
($582,400).($582,400).
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Learning Objective
LO4LO4
To prepare an inventory purchases budget and related schedule of cash
payments
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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.
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Inventory Purchases Budget
HH’s policy is that ending inventory should be HH’s policy is that ending inventory should be equal to 25% of next month’s projected cost of equal to 25% of next month’s projected cost of goods sold. At HH, cost of goods sold normally goods sold. At HH, cost of goods sold normally
equal 70% of sales.equal 70% of sales.
Suppliers require HH to pay 60% of inventory Suppliers require HH to pay 60% of inventory purchases in the month goods are purchased purchases in the month goods are purchased and the remaining 40% in the month after the and the remaining 40% in the month after the
purchase.purchase.
Let’s prepare the inventory purchases budget Let’s prepare the inventory purchases budget and the schedule of cash payments for and the schedule of cash payments for
inventory purchases.inventory purchases.
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Inventory Purchases Budget
$134,400 × 25% = $33,600$134,400 × 25% = $33,600
$155,960 × 40% = $62,384 Accounts Payable
$155,960 × 40% = $62,384 Accounts Payable
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$145,600 × 40% = $58,240
$145,600 × 40% = $58,240$145,600 × 60% = $87,360$145,600 × 60% = $87,360
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Learning Objective
LO5LO5
To prepare a selling and administrative
expense budget and related schedule of
cash payments
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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
commission (based on 2% of sales) is paid in the month following the sale, while supplies
expense (based on 1% of sales) is 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
commission (based on 2% of sales) is paid in the month following the sale, while supplies
expense (based on 1% of sales) is paid in the month of the sale. The utility expense is paid
in the month following the usage of the electricity, gas, and water.
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Selling and Administrative Expense Budget
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Learning Objective
LO6LO6
To prepare a cash budget
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Cash Budget
HH plans to purchase, for cash, store fixtures HH plans to purchase, for cash, store fixtures with a cost of $130,000 in October. HH with a cost of $130,000 in October. HH
borrows or repays principal and interest on the borrows or repays principal and interest on the last day of each month. Any money borrowed last day of each month. Any money borrowed from the bank bears interest at an annual rate from the bank bears interest at an annual rate of 12% (1% per month). The management at of 12% (1% per month). The management at
HH wants to maintain a cash balance of at HH wants to maintain a cash balance of at least $10,000 at the end of every month.least $10,000 at the end of every month.
HH plans to purchase, for cash, store fixtures HH plans to purchase, for cash, store fixtures with a cost of $130,000 in October. HH with a cost of $130,000 in October. HH
borrows or repays principal and interest on the borrows or repays principal and interest on the last day of each month. Any money borrowed last day of each month. Any money borrowed from the bank bears interest at an annual rate from the bank bears interest at an annual rate of 12% (1% per month). The management at of 12% (1% per month). The management at
HH wants to maintain a cash balance of at HH wants to maintain a cash balance of at least $10,000 at the end of every month.least $10,000 at the end of every month.
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Cash Budget
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Cash Budget
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Check Yourself
Astor Company expects to incur the following Astor Company expects to incur the following operating expenses during September: Salary operating expenses during September: Salary Expense, $25,000; Utility Expense, $1,200; Expense, $25,000; Utility Expense, $1,200; Depreciation Expense, $5,400, and Selling Expense, Depreciation Expense, $5,400, and Selling Expense, $14,000. It pays operating expenses in cash in the $14,000. It pays operating expenses in cash in the month in which it incurs them. Based on this month in which it incurs them. Based on this information, the total amount of cash outflow information, the total amount of cash outflow reported in the Operating Activities section of the pro reported in the Operating Activities section of the pro forma Statement of Cash Flows would be:forma Statement of Cash Flows would be:
a.a. $45,600.$45,600.
b.b. $31,600.$31,600.
c.c. $40,200.$40,200.
d.d. $44,400$44,400
Depreciation Expense is a non-cashDepreciation Expense is a non-cashcharge to income and will not appearcharge to income and will not appear
on the Statement of Cash Flows.on the Statement of Cash Flows.
Depreciation Expense is a non-cashDepreciation Expense is a non-cashcharge to income and will not appearcharge to income and will not appear
on the Statement of Cash Flows.on the Statement of Cash Flows.
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Learning Objective
LO7LO7
To prepare a pro forma income
statement, balance sheet, and
statement of cash flows
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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 assist in those tasks.
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Pro Forma Income Statement
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Pro Forma Balance SheetThe new store has no contributed capital because its operations will be financed
through debt (line-of-credit) and retained earnings. The amount of retained earnings
will be equal to the net income because there are no prior periods. The fixtures purchased in October will be depreciated for a full three months. Total accumulated depreciation will
be $3,000.
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Pro Forma Statement of Cash Flows
Almost all the information for the Pro Forma Statement of Cash Flows can be found on the
Cash Budget.
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End of Chapter 7