MS 3406 Short-Term Budgeting Additional Financing Needed and Forecasting
MS 3406 Short-Term Budgeting Additional Financing Needed and Forecasting
Since 1977
LECTURE NOTES
Budgeting is the process of preparing budgets, plans, • External forces such as weather or potential
schedules, and forecasts, and the process requires strikes
several important skills, including forecasting, a • Political or legal factors such as litigation or
knowledge of how activities affect costs, and the ability new legislation
to see how the organization's different activities fit • Pricing policies of the organization
together. • Advertising and promotion plans
• Competitors' actions
Budgets aid in determining how to acquire resources, • Potential for new product lines
and when and how these resources should be used. In • Market research studies
simple terms, a formal budgeting program is a key
ingredient to effective management. The role of Static versus Flexible Budgets
budgets includes coordination, problem signaling, and 1. Static budgets are set at the beginning of the
problem-solving activities as organization control. The period and remain constant. They are useful
plan for the coming year is called the master budget. for planning and operating purposes but can be
The master budget is known as the static budget. problematic when used for control. Control
The income statement part of the budget is called the requires the comparison of actual outcomes
profit plan. with desired outcomes. When static budgets
are used and actual sales are different from
Purposes of budgeting: budgeted sales, a comparison is inaccurate.
1. develop a plan of action. 2. Flexible budgets take differences in cost due to
2. facilitate communication of the plan and volume differences out of the analysis by
coordinate various views within an budgeting based on actual production. They
organization. can be accurately used for control purposes
3. allocate limited resources effectively and because any differences in cost caused by
efficiently. differences in volume of production have been
4. sets benchmark to control profit and removed.
operations.
5. evaluate performance and provide incentives Planning involves developing objectives and preparing
to managers. various budgets to achieve those objectives. Control is
6. provides resource information for decision the process of setting standards, receiving feedback on
making.
actual performance, and taking corrective action
7. uncovers potential bottlenecks before they
whenever actual performance deviates significantly from
occur.
8. coordinates the activities of the entire planned performance. Budgets are the standards, and
organization by integrating the plans and they are compared with actual costs and revenues to
objectives of the various parts. provide feedback.
Incremental budgeting is an approach to developing Pay suppliers in 60 days, rather than 30 days?
appropriations for discretionary expenditures that Decrease AFN: Trade creditors supply more
assumes that the starting point for each capital (i.e., L*/S0 increases).
discretionary expenditure item is the amount spent
“Percent of Sales Forecasting” vs. “Financial
on it in the previous budget.
Statement Forecasting”
Zero-Base Budgeting - requires managers to start at
• Equation method assumes a constant profit
zero budget levels every year and justify all costs as margin, a constant dividend payout, and a
if all programs were being proposed for the first constant capital structure.
time. This process differs from traditional budgeting, • Financial statement method is more flexible.
in which changes in budgets from one year to the More important, it allows different items to
next are subject to the greatest scrutiny. grow at different rates.
Authoritative budgeting occurs when superiors simply
tell subordinates what their budgets will be. STRAIGHT PROBLEMS
stretch budgeting which means that the organization
PROBLEM NO. 1.
attempts to reach much higher goals than those
The current year sales of Pinansing Company amounted
attained previously.
to P4 million. The dividend payout ratio is 20%. The
Participative budgeting involves a joint decision- percent of sales in each balance sheet item that varies
making process in which all parties agree about directly with sales are expected to be as follows:
setting budget targets. It involves the use of input Current assets 30%
from lower and middle. Net fixed assets 45%
Consultative budgeting occurs when managers ask Accounts payable & accrued expenses 25%
subordinates to discuss their ideas but no joint Net profit rate 15%
decision making occurs.
Requirements:
Financial forecasting is looking ahead to develop a 1. Suppose that next year sales are expected to
financial plan for the future. It is very important for the increase by 25% percent. How much additional
strategic growth of a firm. (external) capital will be required?
2. What would happen to capital requirements if Alas
Pattern in Financial Planning can increase its sales by 50% and the payout ratio
is maintained.
• Forecasting sales 3. What would happen to additional capital
• Projecting the assets and internally generated requirement if the payout ratio is raised to 40% and
funds there was an increase in sales by 25%?
• Projecting outside funds needed 4. Compute the sustainable growth rate.
• Deciding how to raise funds
PROBLEM NO. 2.
Percentage of sales forecasting method is a simple but Ey-ef-en Company’s sales are forecasted to increase
practical procedure for forecasting financial statement from P1M this year to P2M next year. Hereunder is
variables (The “quick and dirty” approach). The the balance sheet in the current year:
procedures are based on two assumptions: (a) that all
variables are tied directly with sales; and, (b) that the Cash P 100,000
current levels of most balance sheet items are optimal Accounts receivable 200,000
for the current sales level. Inventories 200,000
Steps: Net fixed assets 500,000
1. Identify assets and liabilities that will vary Total assets P1,000,000
spontaneously with sales.
2. Estimate the amount of net income that will be Accounts payable P 50,000
retained. Notes payable 150,000
3. Compute the amount of External Financing Needed Accruals 50,000
(EFN) by subtracting increase in spontaneous Long-term debt 400,000
liabilities and income retained from increase in total Common stock 100,000
financing required (increase in assets due to increase Retained earnings 250,000
in sales). Total Liabilities & Equity P1,000,000
AFN = S x (SA/So) - S x (SL/So) – (ROS x 1 - Payout Ey-ef-en’s fixed assets were used to only 50 percent of
% x S1) capacity during the current year, buts its current assets
Where: SA/S0 = percentage relationship of were at their proper levels. All assets except fixed
spontaneous assets (variable assets) to sales at period assets increase at the same rate as sales, and fixed
zero. assets would also increase at the same rate if the current
SL/S0 = percentage relationship of spontaneous excess capacity did not exist. Heart’s after-tax profit
liabilities (variable liabilities) to sales at period 0 margin is forecasted to be 5 percent, and its payout ratio
will be 60 percent. What is Heart’s additional funds
Variables that affect the AFN needed for the coming year?
Higher dividend payout ratio? Increase AFN: Less
retained earnings. PROBLEM NO. 3.
Higher profit margin? Decrease AFN: Higher What is the forecast for July based on a three-month
profits, more retained earnings. weighted moving average applied to the following past
Higher capital intensity ratio? Increase AFN: Need demand data and using the weights: 4, 3 and 3 (largest
more assets for given sales. weight is for most recent data)? Show all of your
computations for April through July.
Requirement: Determine the ending cash balance in one of the following is not a significant reason for
August and September both before and after any planning?
necessary financing or debt retirement. a. Providing a basis for controlling operations.
b. Forcing managers to consider expected future
PROBLEM NO. 11. trends and conditions.
NE Enterprises reported the following cash collections in c. Ensuring profitable operations.
July and August from credit sales: d. Checking progress toward the objectives of the
July August organization.
June receivables P33,000
July sales 105,000 P45,000 6. When developing a budget, an external factor to
August sales 168,000 consider in the planning process is
The company sells a single product for P20, and all sales a. A change to a decentralized management
are collected over a two-month period. system.
b. New product development.
Requirements: c. The implementation of a new bonus program.
1. Determine the number of units that were sold in d. The merger of two competitors.
July.
2. Determine the percent of credit sales collected in 7. A firm develops an annual cash budget in order to
the month of sale and the percent of sales a. Support the preparation of its cash flow
collected in the month following sale. statement for the annual report.
3. How many units were sold in August? b. Ascertain which capital expenditure projects
4. Determine the accounts receivable balance as of are feasible and which capital expenditure
August 31. projects should be deferred.
c. Determine the opportunity costs of alternative
sales and production strategies.
MULTIPLE CHOICE QUESTIONS d. Avoid the opportunity costs of noninvested
excess cash and minimize the cost of interim
1. Which of the following represents a general financing.
framework for guiding management’s operating
decisions containing projected activity levels for 8. The primary reason why managers impose a
the next year? minimum cash balance in the cash budget is
a. organizational goals implementation plan. a. because management needs discretionary cash
b. strategic long-range profit plan. for unforeseen business opportunities.
c. master budget. b. managers lack discipline to control their
d. none of the above. spending.
c. that it protects the organization from the
2. Which of the following is not a benefit of uncertainty of the budgeting process.
participative or grassroots budgeting? d. that it makes the financial statements look
a. The process of participative budgeting can be more appealing to creditors.
time consuming.
b. Participating budgeting enhances employee 9. The major feature of zero-based budgeting is that
motivation and acceptance of goals. it
c. Patricipative budgeting provides information a. Takes the previous year’s budgets and adjusts
that enables employees to associate rewards them for inflation.
and penalties with performance. b. Questions each activity and determines
d. Participative budgeting yields information that whether it should be maintained as it is,
employees know but managers do not know. reduced, or eliminated.
c. Assumes all activities are legitimate and
3. Budget slack occurs when: worthy of receiving budget increases to cover
a. employees refuse to abide by the budget. any increased costs.
b. the budget is so difficult to meet that employees d. Focuses on planned capital outlays for
slack off from work. property, plant and equipment.
c. employees ask for resources in excess of what
they need to meet budget objectives. 10. The budget that is usually the most difficult to
d. employees ask for fewer resources than they forecast is the
need to meet budget objectives. a. Cash budget
b. Manufacturing overhead budget
4. A continuous budget: c. Expense budget
a. drops the current month or quarter and adds a d. Sales budget
future month or a future quarter as the current
month or quarter is completed. 11. Which of the following represents the normal
b. presents a statement of expectations for a period sequence in which the indicated budgets are
but does not present a firm commitment. prepared?
c. presents the plan for only one level of activity a. Direct Materials, Cash, Sales
and does not adjust to changes in the level of b. Production, Cash, Income Statement
activity. c. Sales, Balance Sheet, Direct Labor
d. presents the plan for a range of activity so that d. Production, Manufacturing Overhead, Sales
the plan can be adjusted for changes in activity.
12. Which of the following statements is true?
5. Each organization plans and budgets its A. All organizations have the same set of budgets.
operations for slightly different reasons. Which B. All organizations are required to budget.
C. Budgets are a quantitative expression of an
Use the following information for the next two questions. 30. The cost of goods sold for the month of June is
Sloan Company, a wholesaler, budgeted the following anticipated to be
sales for the indicated months: A. P2,232,000. C. P2,356,000.
June July August B. P2,325,000. D. P2,475,000.
Sales on account P2,790,000 P2,860,000 P2,980,000
Cash sales 180,000 200,000 260,000
Total sales P2,970,000 P3,060,000 P3,240,000
All merchandise is marked up to sell at its invoice cost
plus 20%. Merchandise inventories at the beginning of
each month are at 30% of that month's projected cost of
goods sold.
29. Merchandise purchases for July are anticipated to
be
A. P2,448,000.
B. P3,114,000.
C. P2,550,000.
D. P2,595,000.
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