Chapter Seven
Planning for Profit and
Cost Control
McGraw-Hill/Irwin
Three Levels of Planning
• Strategic planning involves making long-term decisions
such as defining the scope of the business, determining
which products to develop, and identifying the most
profitable markets.
• Capital budgeting focuses on intermediate range
planning and involves decisions such as whether to
buy or lease equipment, whether to stimulate sales, or
whether to increase investments in company assets
• The Master Budget describes short-term objectives in
terms of specific sales targets, production goals, and
financing plans.
Advantages of Budgeting
Promotes
Planning
Promotes
Coordination
Budgeting
Enhances
Performance
Measurement
Enhances
Corrective
Actions
Budgeting and Human Behavior
Upper management must be sensitive to the impact of
the budgeting process on employees.
Budgets are
constraining. They
limit individual
freedom in favor of
an established plan.
Many people find
evaluation based on
budget expectations
stressful. Think of
students and exams.
Upper management must demonstrate that
budgets are sincere efforts to express realistic
goals employees are expected to meet.
Cash Receipts
and Payments
Schedules
Operating
Budgets
Start
Pro forma
Financial
Statements
Cash
receipts
Sales
budget
Income
Statement
Cash
payments
for inventory
Inventory
purchases
budget
Balance
Sheet
Cash
payments
for S & A
S & A expense
budget
Statement of
Cash Flows
Cash
budget
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.
Sales Budget
Hampton Hams (HH) is preparing a sales budget for
the last quarter of the year. Ham sales are expected to
peak in the months of October, November, and
December (the holiday seasons). The store sales for
October are expected to total $160,000 ($40,000 in
cash sales, and $120,000 in sales on account). Sales are
expected to increase by 20% per month for
November and December.
Let’s prepare a sales budget.
Sales Budget
Accounts receivable at December 31st are $172,800,
the uncollected sales on account.
$40,000 × 120% = $48,000
$120,000 × 120% = $144,000
Schedule of Cash Receipts
Hampton Hams (HH) will collect cash sales in the
month of sale. Past experience shows that the
company will collect cash from its credit sales in the
month following the month of the sale (October
credit sales will be collected in full in November).
Let’s prepare the cash receipts budget.
Schedule of Cash Receipts
Sales revenue on the income statement will be
the sum of the monthly sales ($582,400).
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.
C ost of bud g eted sales
Plus: Desired end ing
Total inventory need ed
Less: B eg inning inventory
Amount to p urc hase
XXX
XXX
XXX
(XXX)
XXX
Inventory Purchases Budget
HH maintains a policy that ending inventory should
be equal to 25% of the next month’s projected cost of
goods sold. At HH, cost of goods sold normally equal
70% of sales.
Suppliers require HH to pay 60% of inventory
purchases in the month goods are purchased and the
remaining 40% in the month after the purchase.
Let’s prepare the inventory purchases budget and the
schedule of cash payments for inventory purchases.
Inventory Purchases Budget
$134,400 × 25% = $33,600
$155,960 × 40% = $62,384 Accounts Payable
$145,600 × 60% = $87,360
$145,600 × 40% =
$58,240
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 commissions (based on
2% of sales) are paid in the month following the
sale, while supplies expense (based on 1% of sales)
are paid in the month of the sale. The utility expense
is paid in the month following the usage of the
electricity, gas, and water.
Selling and Administrative Expense Budget
Cash Budget
HH plans to purchase, for cash, store fixtures with a
cost of $130,000 in October. HH borrows or repays
principal and interest on the last day of each month.
Any monies borrowed from the bank bear interest at
an annual rate of 12% (1% per month). The
management at HH wants to maintain an end of
month cash balance of at least $10,000.
Cash Budget
Cash Budget
Check Yourself
Astor Company expects to incur the following operating
expenses during September: Salary Expense, $25,000; Utility
Expense, $1,200; Depreciation Expense, $5,400; and Selling
Expense, $14,000. It pays operating expenses in cash in the
month in which it incurs them. Based on this information, the
total amount of cash outflow reported in the Operating
Activities section of the pro format Statement of Cash Flows
would be:
a. $45,600.
b. $31,600.
c. $40,200.
d. $44,400
Depreciation Expense is a non-cash
charge to income and will not appear
on the Statement of Cash Flows.
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 asset in those tasks.
Pro Forma Income Statement
Cost of Goods Sold:
Beg. Inv.
$0
Purchases
$442,680
CGAS
$442,680
End. Inv.
$35,000
COGS
$407,680
Pro Forma Balance Sheet
This new store has no contributed capital because its
operations will be financed through debt (line-ofcredit) and earnings. The amount of retained
earnings will be equal to the net income because
there are not prior periods. The fixtures purchased in
October will be depreciated for a full three months.
Total accumulated depreciation will be $3,000.
Questions?
McGraw-Hill/Irwin