These lectures cover budgeting process including sales budget, production budget, expected cash collections, cash budget and the budgeted income statement and balance sheet.
This chapter describes the budgeting process and shows how the various operating budgets relate to each other. The sales budget is the foundation for a master budget. Once the sales budget has been set, the production budget and the selling and administrative expense budget can be prepared because they depend on how many units are to be sold. The production budget determines how many units are to be produced, so after it is prepared, the various manufacturing cost budgets can be prepared. All of these budgets feed into the cash budget and the budgeted income statement and balance sheet. The parts of the master budget are connected in many ways. For example, the schedule of expected cash collections, which is completed in connection with the sales budget, provides data for both the cash budget and the budgeted balance sheet.
The material in this chapter is just an introduction to master budgeting. In later chapters, we will see how budgets are used to control day-to-day operations and how they are used in performance evaluation.
An organization’s budget is a quantitative plan that identifies the resources required and commitments to fulfill the organization’s goals for the budget period. Budgeting allows management to plan ahead, communicate the plan and performance expectations to all divisions and employees, and, when properly implemented, motivate employees. A budget can also serve as a basis for performance evaluation. Strategy helps a firm to be more focused in its operations and to take advantage of its strengths and opportunities. A firm executes its strategy through long-range plans and master budgets.
An annual master budget is an extension of the organization’s long-range plan to fulfill organizational goals and objectives. The master budget for a manufacturer includes sales, production, direct materials, direct labor, factory overhead, selling, and administration expense budgets, as well as a cash budget and budgeted financial statements. A service firm prepares a budget following set procedures just as a manufacturing or merchandising firm does. A major difference between budgets for service firms and those for manufacturing or merchandising firms is the absence of a production budget or merchandise purchases budget for service firms.
The budgeting procedures and all other budget items are essentially the same for both service and manufacturing or merchandising firms. Budgets, by definition, are forward-looking and include estimates for key inputs such as sales volume, sales mix, total fixed (capacity-related) costs, variable cost per unit, and selling price per unit. What-if analysis can be performed to determine the effects of alternative scenarios (states of nature) and alternative plans. Sensitivity analysis allows us to determine the extent to which resulting budgets are affected by changes in the input factors. Together, these analyses allow the budget analyst to deal with uncertainty that is inherent in the budgeting process.