Chapter 7 Notes
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This 5 page Class Notes was uploaded by Kaitlyn West on Thursday March 12, 2015. The Class Notes belongs to BUS-A 202/207 at Indiana University taught by Geoffrey Sprinkle in Winter2015. Since its upload, it has received 45 views.
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Date Created: 03/12/15
Chapter 7 Operating BudgetsBridging Planning and CL EI Ol I What is a Budget 1 Budget a plan for using limited resources a Specify the goals for a period and how to achieve them b A budget is the outcome of a decision process A Why do rms use budgets 1 Planning a Compels managers to choose the best course of action from available options b Budgets can span many different time horizons c Operating budgets bridge shortterm decisions and longterm plans i Help companies reach long term goals d Financial Budgets quantify the outcomes of operating budgets in summary nancial statements e Master Budget a plan that presents the expected revenues costs and pro t corresponding to the expected sale volume as of the beginning of the period 2 Coordination a Centralized Decision Making an environment in which one leader the owner is able to make all of the rm s decisions b Decentralized Decision Making an environment in which one leader delegates decision making to individuals with relevant expertise and knowledge i Departments must communicate and coordinate with each other to ensure that everyone is working toward the same corporate goals ii Highlights linkages between each department and forces each department to consider how its actions in uence the actions of other departments 3 Control Performance Evaluation and Feedback a Budgets provide a basis or benchmark for evaluating actual performance b A company cannot evaluate whether it made the right decision or identify problems if it does not have a benchmark 4 Complements and Con icts a Dual planning and control roles for budgets can create con icts in the budgeting process b Employees that have the most uptodate information lowerlevel may not be forthright in sharing the data c Employees may underpredict future outcomes so that actual outcomes seem more appealing ll Preparing a Master Budget A Revenue Budget 1 The natural starting point for the master budget 2 3 Market conditions dictate volume of operations which drives costs Accuracy is crucial B Production Budget 1 2 Combines the demand information provided by the revenue budget and the company s inventory policy regarding nished goods to determine production levels in the coming period Requires marketing and production managers to coordinate and address some important questions C Direct Materials Usage Budget 1 2 3 4 Use the output targets from the production budgets to derive the budgets for materials labor and overhead a Usage budgets are used to estimate xed and variable costs Must make decisions such as FIFO or LIFO regarding cost ows to determine the cost of materials used Purchasing and production managers coordinate closely to prepare the materials budget because it requires both price and quantity estimates Direct materials prices depend on the conditions in the marketplace for materials D Direct Labor Budget 1 Depending on a company s production technology different grades of labor may be necessary forjobs requiring different skills and expertise 2 Separately identify the demand for each type of labor 3 4 Helps plan for working capital needs Human Resources department is responsible for the cost of labor E Manufacturing Overhead Cost Budget 1 2 3 Consists of both variable and xed costs Most likely direct labor is used to measure manufacturing activity and nd variable costs Fixed costs are usually a large fraction of total costs F Variable Cost of Goods Manufactured Budget 1 Calculate the total variable manufacturing budget using direct materials direct labor and variable manufacturing overhead G Variable Cost of Goods Sold Budget 1 COGS Beg COGS Inventory COGM Ending COGS Inventory H Marketing and Administrative Costs Budget 1 Some costs relate to the volume of sales activity link to the revenue budget 2 Some costs salaries and office space are xed I Iterative Nature of the Budgeting Process 1 Most companies rework their budget numerous times 2 Also reexamine the budget to see if they have made the correct assumptions 3 A careful review of operating assumptions and estimates adds value to the budgeting process 4 Well prepared budgets allow the rm to make the best possible decisions and extract the maximum value from its available resources 5 Companies prepare numerous other budgets for subun s III Cash Budget A Cash Budget allows companies to determine whether they will have enough money on hand to sustain projected operations 1 Manage cash shortfalls by accelerating revenues deferring payments altering timing of cash in ows or borrowing 2 Three Major Components a In ows from operations b Out ows from operations c Special Items B Cash In ows from Operations 1 Proceeds from sales are primary cash in ows from operations 2 Credit policies effect when cash is received by customers 3 Firms often have to deal with uncollectible credit sales because some customers default on their payments C Cash Out ows from Operations 1 FourTypes a Purchases of Direct Materials b Payments for Labor c Expenditures of Manufacturing Overhead d Out ows for Marketing and Administration costs 2 Purchases of Direct Materials a The company expects credit from its suppliers i First calculate expected direct material purchases then plan for cash out ows based on credit expectations 3 Labor Costs a Cash out ow for labor depends on production volume and not on sales volume 4 Manufacturing Overhead a Depreciation is a substantial part of Fixed Manufacturing Overhead but is not a cash out ow 5 Nonmanufacturing Costs a Adjust this expense for noncash related items D Net Cash Flow from Operations 1 If the expected cash ow is negative the company must have a reserve of cash at the beginning of the year or in ows from special items to account for the cash out ow E Pulling it All Together 1 Special Items a Purchasing a machine that will last for several years leads to a cash out ow i Not included in cash out ows from operations ii Neither are dividends or loan payments b Sales of machines or stock are not included in cash in ows either Factors In uencing the Budgeting Process A Organizational Structure 1 Firms delegate decisions to individuals likely to have the best information pertinent to that decision 2 Responsibility Accounting concepts surrounding decentralization 3 Responsibility Center each organization subunit a Cost Center organizational units that have control over the costs incurred in offering products or services b Pro t Centers organizational units that have control over both revenue and costs c Investment Centers organizational units that have control over revenue costs and longterm investment decisions 4 Decentralization of decision making comes at a cost a Employees may not always take actions that are in the rms best interests b Managers must hold employees accountable for the revenue and cost items that they control B Management Styles 1 TopDown Budgeting re ects an authoritarian style of management a Senior managers nalize the budget with limited input from lower organizational levels b Not time consuming c Does not use organizationwide input or take advantage of the superior information that individuals at lower levels in the organization possess d May not re ect best available information e Most suitable in smaller organizations 2 BottomUp Budgeting encourages organization wide input a Relies on having good forecasts b Takes advantage of employees intimate knowledge or operations when formulating plans c Increases employees commitment to achieving bottomup budget goals d Employees set goals low because they are easier to meet