Budgeting Example

Royal Company is preparing budgets for the

quarter ending June 30.
Budgeted sales for the next five months
are:
April
May
June

20,000 units
50,000 units
30,000 units

July
August

25,000 units
15,000 units.

Expected Cash Collections

All sales are on account.
Royals collection pattern is:
70% collected in the month of sale,
25% collected in the month following
sale, 5% is uncollectible.

The March 31 accounts receivable

balance of $30,000 will be collected in
full.

The selling price is $10 per unit.

McGrawHill/Irwin

The McGraw-Hill Companies,

Inc., 2003

The Production Budget

The management at Royal Company
wants ending inventory to be equal to 20%
of the following months budgeted sales in
units.
On March 31, 4,000 units were on hand.

Lets prepare the production budget.

McGrawHill/Irwin

The McGraw-Hill Companies,

Inc., 2003

Expected Cash Disbursement for

Materials
Royal pays $0.40 per pound for its
materials.
One-half of a months purchases are
paid for in the month of purchase; the
other half is paid in the following month.
The March 31 accounts payable
balance is $12,000.

Lets calculate expected cash

disbursements.

McGrawHill/Irwin

The McGraw-Hill Companies, Inc.,

2003

The Direct Materials Budget

At Royal Company, five pounds 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 months production.
On March 31, 13,000 pounds of material
are on hand. Material cost is $0.40 per
pound.
Lets prepare the direct materials budget.
McGrawHill/Irwin

The McGraw-Hill Companies, Inc.,

2003

The Direct Labor Budget

At Royal, each unit of product requires 0.05

hours of direct labor.

agreed to a wage rate of $10 per hour regardless of the

hours worked (No overtime pay).

The Company has a no layoff policy so all

employees will be paid for 40 hours of work each
week.

For the next three months, the direct labor workforce will
be paid for a minimum of 1,500 hours per month.

Lets prepare the direct labor budget.

In exchange for the no layoff policy, workers

McGrawHill/Irwin

The McGraw-Hill Companies,

Inc., 2003

Manufacturing Overhead
Budget
Royal Company uses a variable
manufacturing overhead rate of $1 per
unit produced.
Fixed manufacturing overhead is $50,000 per
month and includes $20,000 of noncash
costs (primarily depreciation of plant assets).

McGrawHill/Irwin

Ending Finished Goods Inventory

Budget
Now, Royal can complete the
ending finished goods inventory
budget.
At Royal, manufacturing overhead is
applied to units of product on the basis
of direct labor hours.

Lets prepare the manufacturing

overhead budget.
McGrawHill/Irwin

The McGraw-Hill Companies,

Inc., 2003

Selling and Administrative Expense

Budget

The McGraw-Hill Companies, Inc.,

2003

Lets calculate ending finished goods

inventory.
McGrawHill/Irwin

The McGraw-Hill Companies, Inc.,

2003

The Cash Budget

At Royal, variable selling and

administrative expenses are $0.50 per unit
sold.

Royal:

Fixed selling and administrative expenses are

$70,000 per month.

Maintains a 16% open line of credit for

$75,000.

The fixed selling and administrative expenses

include $10,000 in costs primarily depreciation
that are not cash outflows of the current month.

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.

Lets prepare the companys selling

and administrative expense
budget.

Pays a cash dividend of $49,000 in April.

Purchases $143,700 of equipment in May

and
$48,300 in June paid in cash.

The McGraw-Hill Companies,

Inc., 2003

McGrawHill/Irwin

The Budgeted Income

Statement
Cash

Budget

Budgeted
Income

Statement

McGrawHill/Irwin

we can prepare the budgeted income

statement for Royal.
McGrawHill/Irwin

The McGraw-Hill Companies,

Inc., 2003

The McGraw-Hill Companies, Inc.,

2003

The Budgeted Balance Sheet

Royal reported the following account

balances prior to preparing its
budgeted
financial statements:
l

After we complete the cash budget,

Has an April 1 cash balance of $40,000.

Land - $50,000

Common stock - $200,000

Equipment - $175,000

McGrawHill/Irwin

Retained earnings - $146,150

The McGraw-Hill Companies, Inc.,

2003

The Master Budget - worksheet - Chapter 9 - Accounting 230

The Sales Budget:

page 1

April

May

June

Quarter

April

May

June

Quarter

April

May

June

Quarter

April

May

June

Quarter

Budgeted Sales (units)

SP/unit
Total Sales
The Production Budget:
Budgeted Sales (units)
Add: desired ending Inventory
Total needed
Less: Beg. Inventory
Required Production
Expected Cash Collections
Accounts Receivable 3/31
April Sales:

May Sales:

June Sales:

Total Cash collections:

The Direct Materials Budget:
Production (units)
Materials per unit
Production Needs
Add: desired ending Inventory
Total needed
Less: Beg. Inventory
Materials to be purchased

The Master Budget - worksheet - Chapter 9 - Accounting

230
Expected Cast Disbursements
April
May

page 6
June

Quarter

Accounts Payable 3/31

April Purchases:

May Purchases:

June Purchases:

Total Cash disbursements:

The Direct Labor Budget

April

May

June

Quarter

April

May

June

Quarter

Production (units)
Direct labor hours
Labor hours required
Guaranteed labor hours:
Labor hours paid
Wage rate
Total direct labor cost
Manufacturing Overhead Budget
Production (units)
Variable mfg OH rate
Variable mfg OH costs
Fixed mfg OH costs
Total mfg OH costs
Less: noncash costs
Cash disbursements for mfg. OH

Ending Finished Goods

Inventory Budget

Quantity

Costs

April

May

Total

Production costs per unit:

Direct Materials
Direct Labor
Manufacturing OH
Budgeted finished goods
inventory
Ending inventory in units
Unit product cost
Ending finished goods inventory

Selling & Administration Budget

Budgeted Sales (units)
Variable S&A rate per unit
Variable Expense
Fixed S&A Expense
Total Expense
Less: Non Cash Expenses
Cash Disbursements for S&A

June

Quarter

page 4
The CASH Budget
Beginning cash balance
Add: cash collections
Total available:
Less: Disbursements
Materials
Direct labor
Mfg. Overhead
S&A
Equipment purchase
Dividends
Total disbursements
Excess (deficiency) of cash
available over disbursements
Financing:
Borrowing
Repayments
Interest
Total Financing
Ending cash balance:

April

May

June

Quarter

The Master Budget - worksheet - Chapter 9 - Accounting 230

5 The Budgeted Income Statement & Balance Sheet

Sales (100,000 @$10)

page

1,000,000

43,000

Cost of goods sold

Gross margin
Selling & Administrative expenses
Operating Income
Interest expense
Net Income

Current Assets:
Cash
Accounts Receivable
Raw materials inventory
Finish Goods inventory
Total current assets
Property and equipment
Land
Building
Equipment
Total property and equipment
Total Assets
Accounts Payable
Common stock
Retained earnings
Total Liabilities and Stockholders' Equity

HAYES CORPORATION
CASH BUDGET
FOR THE YEAR ENDED 12/31/2000
BEGINNING CASH BALANCE

Q1
38,000

Q2
25,500

Q3
15,000

Q4
19,400

ADD: CASH RECEIPTS

TOTAL AVAILABLE CASH

170,000
208,000

198,000
223,500

228,000
243,000

258,000
277,400

LESS: CASH DISBURSEMENTS (ITEMIZED)

Materials
Salaries
Selling and Administrative
Purchase of Equipment
Income tax expense
TOTAL DISBURSEMENTS

23,200
62,000
94,300
3,000
182,500

27,200
72,000
99,300
10,000
3,000
211,500

31,200
82,000
104,300
3,000
220,500

35,200
92,000
109,300
3,000
239,500

EXCESS(DEFICIENCY) OF AVAILABLE CASH

OVER CASH DISBURSEMENTS

25,500

12,000

22,500

37,900

FINANCING
Add: Borrowings
Less: Repayments
ENDING CASH
BALANCE

3000
0

0
0
$

25,500

What if I said to keep a MINIMUM cash balance of $15,000?

SOUND CASH MANAGEMENT:

1. Increase speed of collection on ACCOUNTS RECEIVABLE.

2. Keep INVENTORY levels low (but at optimal levels)

3. Delay payment of LIABILITIES.
4. Plan the timing of MAJOR EXPENDITURES.
5. INVEST IDLE CASH--but pick liquid investments!, e.g., US Gov't Securities

15,000

0
3100
$

19,400

0
0
$

37,900

Budgeting Lessons:
Note: this is a true story although some of the details were altered due to memory failure of the writer.
Some of the names are changed.
Once upon a time in the late 80s there was a small hi-tech company located in the Bay Area (California) with some 200
employees at its corporate office. Well call it the GuyTech. It had 380 employees worldwide located in sales/service
offices and one remote R&D office in Japan. It had the usual organization structure:
President (background in R&D and Engineering), CFO, COO (background in Manufacturing), VP-Engineering, VPOperations (Manufacturing, Planning/Purchasing, Shipping/Receiving), R&D, VP-Sales & Marketing, VP-Human
Resources.
The Budgeting process consisted of the following:
Accounting would provide information for each VP above which included:
o Current costs (salary by employee plus other actual expensestravel, supplies, depreciation) for the past
3 quarters
o Managers were told to assume a 6% across the board salary increase (to be allocated to the
employees based on performance)
o Managers were told that the Sales Budget would assume a 15% increase in Sales Volume over the
prior year
Managers were to work with their accounting liaison and jointly prepare a budget for each of their functional
areas, with proposed headcount increases, and other expenses.
Steve (VP of Engineering) and Jack (VP of Manufacturing) individually worked with one of the Accounting Managers,
Ray, to develop their proposed budgets and take it into the Executive Committee (President, CFO, and COO) along
with Ray. Note: Ray is 28 years old and considered to be one of the more green (inexperienced) managers.
Here is how each of them prepared for and conducted their meeting with the Executive Committee:
Jack: Jack worked closely with Ray, having her check and double check his arithmetic and logic (I dont want to look
ridiculous in there!). He met with Ray the morning of his Executive Committee meeting and ran through his
presentation. He went into the meeting with all the required documents and a few backup documents. During the meeting
the President, CFO, and COO had a few questions and Jack was ready with his answers:
Why does travel go up from last year? Jack could easily refer to a supporting schedule and note the 4-5 trips
planned for conferences, or customer visits, or visits to remote offices. There were a few more questions
along
this line.
Why are you adding headcount in Planning/Purchasing? Jack discussed that with the 15% increase in
Sales Volume, he felt it was reasonable to add on another Purchasing Agent.
Why is there an additional Manufacturing supervisor? Jack gave the same reason as the previous question,
supported this time by handwritten spreadsheets which showed the ratio of number of work orders per
supervisor and how a 15% increase in work orders (to go along with the 15% in sales).
Jacks meeting was punctual; the Executive Committee recommended he eliminate about 10% of his costs, specifically
identifying a few areascut trips in half, and skip the headcount increases. Jacks budget was approved (after the
10% cuts). Jack left the meeting congratulating himself that all had gone well and that he hadnt looked stupid.
Steve: Steves department was one of the first to have desktop computers, Macintoshes, which came preloaded with Word
and Excel. Steve quickly mastered Excel and took the budget data provided by Accounting and re-keyed it into Excel. He
created a multi-dimensional spreadsheet with page one representing all of his departments, and the other pages
representing the individual departments (drafting, design, pre-production, software engineering, etc.).
Ray attempted to work with him and ended up just getting an Excel lesson on how to link spreadsheets. Steve came to the
meeting with multiple copies of his spreadsheets for all attendees. As the format was original, much of the meeting was
spent in explaining how to read his spreadsheets. As the spreadsheets were not stapled together, some of the managers
C:\Users\jpaquett\Documents\AASpring 2012\handouts\Budget - Jack Steve.doc

were on the wrong page, and this also had to be explained. As everyone got comfortable (sort of) with Steves
documents, the President, CFO, and COO had a few questions.
Why does travel go up from last year?

C:\Users\jpaquett\Documents\AASpring 2012\handouts\Budget - Jack Steve.doc

Why are you adding headcount in Software Engineering?

Why is there an additional CAD design supervisor?
Steve answered all questions with reference to an engineering project (while manufacturing works on work orders,
engineering focuses on key projects, with the intent of turning them into a viable product sometime in the future). At
GuyTech, many of the projects were customer driven, ideas from companies such as IBM, Motorola, etc. which Steve also
made reference to. The President was very emphatic that we review all projects and, if necessary make cuts, however, he
wanted to be able to support the maximum level of projects as this is our future.
The COO asked which of Steves department were working on which projects and Steve responded that all of his
department were working on all the projects, dividing up their time and resources on each project, as necessary. The COO
then suggested that Steve re-cast his budget, instead of by department, come back with an individual spreadsheet by
project, so that the Executive Committee could get a better idea of the budget needs of each project. Everyone thought
this was a good idea and an additional meeting was scheduled for Steve, giving him a week to re-cast the numbers into a
new spreadsheet.
As Steve and Ray left the meeting and discussed how it went, Steve suggested she accompany him to his office. He sat
down at his desk and fired up his computer, only to reveal that he had already prepared his budget by project,
anticipating this request.
Ray asked, Why didnt you tell them this?
Steve, Why should I? It buys me time, gets em off my back and I look good.
A week later Steve and Ray returned to the budget meeting. Steve fumbled with some numbers and the COO found an
error in some of his math. The meeting was mostly spent in explaining the format of the new spreadsheets and, when
the error was discovered, adjourned and rescheduled for a 3rd meeting.
rd

A week later Steve and Ray returned for a 3 budget meeting. Steves budget was reviewed, by project. Some minor cuts
to Steves budget were suggested; Steve reminded them that this would have an impact on some key projects. One trip
was cut from the travel budget. The President then reminded Steve of another project he had omitted and suggested that
Steve keep with his proposed budget (less the one trip for a conference) but also add on another $50,000 just in case a
new project came up.
Steves budget was approved. When Steve left the meeting he bragged to Ray, That cut is okay, I just stuck it in as
an extra. They always cut something.
1. Which manager, in your opinion, is the successful one here? How do you define success?

2. From the point of view of Ray, what could she have learned in terms of how to successfully obtain budget approval
for her own department in the future.
3. From the point of view of the CFO, based on the experiences of Jack and Steve, how could you improve the budget
process to assure the maximum level of fairness, efficiency, motivation, compliance with overall company
goals/objectives.

C:\Users\jpaquett\Documents\AASpring 2012\handouts\Budget - Jack Steve.doc