U.S.

Small Business Administration FM-8

BUDGETING FOR THE SMALL BUSINESS

Constance Pinney
Certified Public Accountant
Pinney & Company, P.C.
Tempe, Arizona

Charles J. Woelful
Professor of Accountancy
Southern Illinois University
Carbondale, Illinois

Financial Management Series

_______________________________________________________________________________

Budgeting for the Small Business replaces

Budgeting in a Small Service Firm and
Basic Budgets for Profit Planning

"Introduction to Budgeting", Copyright 1991, Constance Pinney. All rights reserved. No part may
be reproduced, transmitted or transcribed without the permission of the author. SBA retains an
irrevocable, worldwide, nonexclusive, royalty-free, unlimited license to use this copyrighted
material.

While we consider the contents of this publication to be of general merit, its sponsorship by the U.S.
Small Business Administration does not necessarily constitute an endorsement of the views and
options of the authors or the products and services of the companies with which they are affiliated.

All of SBA's programs and services are extended to the public on a nondiscriminatory basis.

______________________________________________________________________________

TABLE OF CONTENTS

INTRODUCTION TO BUDGETING - Constance Pinney, CPA

What is a Budget?
 Why Create a Budget?
How to Use a Budget
Basic Budgeting Concepts
Basic Budget Equation
Realistic Estimates
The Budgeting Process
The Master Budget
Summary

BASIC BUDGETS FOR PROFIT PLANNING - Charles J. Woelful

APPENDIX: Information Resources

______________________________________________________________________________

INTRODUCTION TO BUDGETING
Constance Pinney, CPA

What Is a Budget?

Although you might not know it, you prepare a budget each time you estimate how much cash you
will have left at the end of the month after paying your bills.

A budget is a forecast of all cash sources and cash expenditures. It is organized in the same format as
a financial statement, and most commonly covers a 12-month period. At the end of the year, the
anticipated income and expenses developed in the budget are compared to the actual performance of
the business as recorded in the financial statement.

Why Create a Budget?

A budget can greatly enhance your chances of success by helping you estimate future needs and plan
profits, spending and overall cash flow. A budget allows you to perceive problems before they occur
and alter your plans to prevent those problems.

This publication covers the basic concepts of budgeting and takes you through the step-by-step
process of constructing a budget.

How to Use a Budget

In business, budgets help you determine how much money you have and how you will use it, and
help you decide whether you have enough money to achieve your financial goals. As part of a
business plan, a budget can help convince a loan officer that you know your business and have
anticipated its needs.

A budget will indicate

− The cash required for necessary labor and/or materials.

 − Total start-up costs.

− Day-to-day maintenance costs.

− Revenues needed to support business operations.

− Expected profit.

If your budget indicates that you need more revenue than you can earn, adjust your plans by

− Reducing expenditures (e.g., hiring fewer employees, purchasing less expensive

furniture, eliminating a telephone line).

− Expanding sales (e.g., selling additional products or services, conducting an

aggressive marketing campaign).

− Lowering profit expectations (usually the least desirable option).

Every business should create a budget before investing money in new equipment or other assets and
before signing leases. To ensure your goals can be reached, first put all the numbers down on paper
so you can adjust and rework them as many times as necessary. Mistakes are far less costly when
made on paper than with actual dollars.

Basic Budgeting Concepts

The three main elements of a budget are

− Sales revenue

− Total costs

− Profit

Sales Revenue

Sales are the cornerstone of a budget. It is crucial to estimate anticipated sales as accurately as
possible. Base estimates on actual past sales figures. Once you target sales, you can calculate the
related expenses necessary to achieve your goals.

Total Costs

Total costs include fixed and variable costs. Estimating costs is complicated because you must
identify which costs will change and by how much and which costs will remain unchanged. You
also must consider inflation and rising prices when applicable.
Variable Costs

Variable costs are those that vary directly with sales. One example is the purchase cost of inventory.
The more inventory you sell, the higher your purchasing costs; the less you sell, the lower your
purchasing costs. Similarly, freight and special packaging costs will vary directly with sales; these
costs will not be incurred without a sale.

For example, a store owner pays $350,000 for supplies and sells them for $500,000. To calculate the
cost of inventory purchases as a percentage of sales, the owner divides the amount paid by the
amount received in sales (350,000 500,000 = 70 percent). This means 70 percent of sales will go to
pay for the cost of inventory. If the store owner estimates $600,000 in sales for the next year, he or
she should budget 70 percent of $600,000, or $420,000, for inventory purchases.

Fixed Costs

Fixed costs are those that do not change, regardless of sales volume. Rent is considered a fixed cost
because it is totally independent of sales activity and, for the duration of the lease, will not change.
For example, a five-year lease with an annual rent of $24,000 must be paid even if there are no sales.
It doesn't matter whether sales are high or low; the rent is still $24,000.

Semivariable Costs

Semivariable costs, such as salaries, wages and telephone expenses, have both variable and fixed
components. For budgeting purposes, you may need to break semivariable costs into these two
components. The fixed element represents the minimum cost of supplying a good or service. The
variable element is that portion of the cost influenced by changes in activity. Examples of
semivariable costs are the rental of delivery trucks and photocopying machines for a fixed cost per
month plus a variable cost based on the volume of usage.

Inflation and Other Adjustments

A budget will be as good as the numbers used to make it. Therefore, it is important that your
estimates and calculations be as accurate as possible.

Profit

Profit should be large enough to make a return on cash investment and a return on your work. Your
investment is the money you put into the firm when you started it and the profit of prior years that
you have left in the firm (retained earnings). If you can receive 10 percent interest on $25,000 by
investing outside of your business, then you should expect a similar return when investing $25,000
in equipment and other assets within the business. When preparing your budget, add the expected
return on investment to your targeted profits. Check with your trade association, accountant or
banker to make sure that the rate of return on your investment is what it should be.

In targeting profits, you want to be sure you are receiving a fair return on your labor; your weekly
paycheck should reflect what you could be earning elsewhere as an employee.
Basic Budget Equation

Sales = total cost + profit

This equation shows that every sales dollar you receive is made up partly of a recovery of your costs
and partly of profit.

Another way to express the basic budgeting equation is

Sales - total cost = profit

This equation shows that after reimbursing yourself for the cost of producing the product or service,
the remaining part of the sales dollar is profit. For example, if you expect $1,000 in sales income and
you know that it costs $750 to produce, market and sell your product or service, your profit will be
$250.

Realistic Estimates

In calculating an operating budget, you will often make estimates based on past sales and cost
figures. You will need to adjust these figures to reflect price increases, inflation and other changing
factors.

For example, for the past three years, a store owner spent an average of $3,500 for advertising costs.
For the coming year, the owner expects a price increase of 3 percent (.03). To calculate next year's
advertising costs, the owner multiplies the average annual advertising costs by the percentage price
increase (3,500 = 105) and adds that amount to the original, annual cost, (3,500 + 105 = 3,605). A
shortcut method is to multiply the original advertising cost by one plus the rate of increase (3,500
1.03 = 3,605).

If your business is a new venture and has no past financial records, rely on your own experience and
knowledge of the industry to estimate demand for and costs of your product. You may need to enlist
the assistance of a professional accountant or business consultant. If your budget is to be helpful, you
must use realistic estimates.

The Budgeting Process

Before you can create a budget, you must answer three questions:

− How much net profit do you want the business to generate during the calendar year?

− How much will it cost to produce that profit?

− How much sales revenue is necessary to support both profit and costs?

To answer the above questions, consider expected sales and all costs, either direct or indirect,
associated with the product or service. To make the safest estimates when budgeting, most
companies prefer to overestimate expenses; conversely, they prefer to underestimate sales revenue.

Constructing a Budget

Start with either a forecast of sales or a forecast of profits. For practical purposes, most small
businesses start with a forecast of profits. In other words, decide what profit you want to make and
then list the expenses you will incur to make that profit. To create a budget

− Target desired profit.

− Determine operating expenses.

− Calculate gross profit margin.

− Estimate sales revenues.

− Adjust figures.

A sample budget for the A&A Pool Supply Company illustrates the main steps in budget
preparation. As you follow the steps, calculate all the figures yourself. Once you have calculated
projected sales, expenses and profit, organize the figures into the format of an income statement as
shown in Tables 1, 2 and 3. Refer to Table 1 for A&A Pool Supply Company's income statements
for the past three years.

Step 1: Target desired profit. During the three-year period, the company averaged an annual net
profit of $63,100. During Year 2, the company had its highest net profit of $65,000. In Year 3, sales
were up, but net profit declined. For the coming year (Year 4), the company is targeting a net profit
of $65,000.

Step 2: Determine operating expenses. A&A Pool Supply estimates it will have many additional
expenditures in Year 4. It will award a 5 percent wage increase to its two employees and purchase a
more comprehensive medical insurance package for them at an additional annual cost of $2,400. The
company also plans to install additional telephone services at a cost of $1,500.
______________________________________________________________________________
Table 1 -- A&A Pool Supply Company
Historical (Actual) Income Statements For Years 1, 2, and 3

Average
Year Year Year Aver- % of
1 2 3 Total age sales
Sales $490,000 $508,333 $513,233 $1,511,566 $503,855 100%

Cost of
goods
sold $343,000 $355,833 $359,263 $1,058,096 $352,698 70%
Gross
profit
margin $147,000 $152,500 $153,970 $453,470 $151,157 30%

Operating expenses:

Advert-
ising $3,200 $3,700 $3,600 $10,500 $3,500 0.7%

Depre-
ciation $4,000 $4,000 $4,000 $12,000 $4,000 0.8%

Insur-
ance $1,700 $1,700 $1,700 $5,100 $1,700 0.3%

Legal &
accounting
expenses $3,400 $3,605 $3,800 $10,805 $3,602 0.7%

Office
expenses $2,200 $2,400 $2,650 $7,250 $2,417 0.5%

Rent $24,000 $24,000 $24,000 $72,000 $24,000 4.8%

Repair &
maint-
enance $300 $550 $420 $1,270 $424 0.1%

Salaries $33,000 $33,000 $33,000 $99,000 $33,000 6.6%

Telephone &
utili-
ties $6,000 $6,350 $6,200 $18,550 $6,183 1.2%

Miscel-
laneous $9,200 $8,195 $10,300 $27,695 $9,231 1.8%

Total
operating
expenses $87,000 $87,500 $89,670 $264,170 $88,057 17.5%

Net
profit $60,000 $65,000 $64,300 $199,330 $63,100 12.5%
_________________________________________________________________

In addition, the company's accountant has advised it to plan on a 3 percent overall inflation rate next
year. Taking these factors into consideration, A&A Pool Supply Company figures its expenses as
shown in the preliminary budget (Table 2).

Under fixed costs, the company estimates that

− Rent will remain unchanged at $24,000 per year.

 − Depreciation will remain unchanged at $4,000 per year.

− Salaries will be raised by 5 percent (.05). Salary raises are calculated by multiplying
prior salary expenses ($33,000) by 1.05, equaling budgeted salaries of $34,650.

− The annual insurance expense of $1,700 will be increased by $2,400 to provide for
additional medical coverage, so will now be budgeted at $4,100.
______________________________________________________________________________
_________________________________________________________________

Table 2 -- A&A Pool Supply Company

Preliminary Budget, Year 4

Amount ($) Percent of sales

Sales 533,730 100%
Cost of goods sold 373,611 70%
Gross profit margin 160,119 30%

Operating expenses

Advertising 3,605 0.7%

Depreciation 4,000 0.8%
Insurance 4,100 0.8%
Legal and accounting expenses 4,142 0.8%
Office expenses 2,995 0.6%
Rent 24,000 4.5%
Repair and maintenance 437 0.1%
Salaries 34,650 6.5%
Telephone and utilities 7,683 1.4%
Miscellaneous 9,507 1.8%
Total operating expenses 95,119 17.8%

Net profit 65,000 12.2%

_________________________________________________________________

The company calculates variable costs as follows:

− Telephone and utilities expenses will be budgeted for $7,683. This figure includes
average annual cost of $6,183 plus the $1,500 expected increase. (Average annual
cost is used because the amount fluctuated over the three years.)

− Advertising, repair and maintenance, and miscellaneous expenses also fluctuate

annually. These figures are computed by multiplying the three-year average amount
($3,500) by the 3 percent inflation factor (3500 .03 = 105) and adding the amount of
increase to the three-year average amount (105 + 3,500 = 3,605) (or, using the
shortcut explained above, multiplying 3,500 by 1.03).

− Due to company growth, office expenses increased 10 percent each year. To

 compute office expenses for the budget, the company adds the 10 percent growth
factor to the 3 percent inflation rate (total increase equals 13 percent) and multiplies
one plus this growth factor (1.13) by the most recent office expenses in Year 3,
$2,650. Budgeted office expenses are then estimated at $2,995 (2,650 1.13 = 2,995).

− Legal and accounting expenses increased 6 percent each year. To compute legal and
accounting expenses for the budget, the company adds a 6 percent growth factor to
the 3 percent inflation rate (totaling 9 percent) and multiplies one plus this rate (1.09)
by legal and accounting expenses in Year 3, $3,800. Legal and accounting expense
are then budgeted for $4,142 (3,800 = 4,142).

Estimated office, legal and accounting expenses show an expected 3 percent inflation increase. As
these expenses are steadily rising, the highest and most recent figures are used to compute budget
figures.

Step 3: Calculate gross profit margin. Gross profit margin is the sum of net profit and total operating
expenses, computed by working the preliminary budget backwards. A&A Pool Supply Company's
gross profit margin is obtained by adding net profit of $65,000 to operating expenses of $95,119,
equaling $160,119.

Step 4: Estimate sales revenue. To target sales, the gross profit margin should be analyzed. Income
statements in Table 1 show that A&A Pool Supply Company has experienced a gross profit margin
equal to 30 percent of sales for three continuous years. Since a gross profit margin of $160,119 is
expected to equal 30 percent of net sales, then targeted net sales should equal $533,730 (160,119 .3
= 533,730).

Step 5: Adjust figures. If the preliminary figure for targeted net sales seems realistic, the budget is
complete. If generating the amount of targeted net sales will be a problem, the preliminary budget
must be reviewed and adjusted. A&A Pool Supply Company is uncomfortable with the preliminary
results; it does not believe it can realistically generate sales of more than $525,000. To derive a more
realistic budget, it decides to

− Delay installing additional telephone services to reduce telephone expenses by

$1,000. The new figure is $6,683.

− Carefully monitor expenses to reduce miscellaneous expenses by $1,000. The new

figure is $8,507.

− Choose a similar but less expensive employee benefit package with a higher
employee deductible for medical insurance to reduce benefits expenses by $1,200.
The new figure is $2,900.

After making the above adjustments to its budget (reflected in Table 3), the company's new gross
profit margin is $156,919 (65,000 + 91,919). To compute the targeted sales, the company divides the
gross profit margin by 30 percent for a targeted sales of $523,063. This figure is within the
company's limit of $525,000.

With careful planning and monitoring, A&A Pool Supply Company can achieve its targeted profit of
$65,000.

Budgeting as An Ongoing Process

The annual budget may have to be altered during the year to reflect changing circumstances. There
may be a sharp rise or drop in one or more variable expenses or in revenues. Often, annual budgets
are divided into smaller monthly or quarterly budgets. Monthly budgets are used to measure actual
results against budgeted goals.

The Master Budget

For companies with several departments or work functions, the annual budget should be expanded
into a master budget. A master budget consists of a group of separate but interconnected budgets. A
company with several departments will have separate sales, production, inventory, marketing and
personnel budgets for each department. These budgets will depend on and contribute to the
company's overall plans. For example, sales projections must take into account inventory levels.
Inventory planning must be coordinated with the production department. In order to add employees
during peak production periods, the production department must depend on the personnel
department.
______________________________________________________________________________
Table 3 -- A & A Pool Supply Company
Final Budget, Year 4

Amount ($) Percent of sales

Sales 523,063 100%

Cost of goods 366,144 70%
Gross profit margin 156,919 30%

Operating expenses:

Advertising 3,605 0.7%

Depreciation 4,000 0.8%
Insurance 2,900 0.6%
Legal and accounting expenses 4,142 0.8%
Office expenses 2,995 0.6%
Rent 24,000 4.6%
Repair & maintenance 437 0.1%
Salaries 34,650 6.6%
Telephone and utilities 6,683 1.3%
Miscellaneous 8,507 1.6%
Total operating expenses 91,919 17.6%

Net profit 65,000 12.4%

______________________________________________________________________________
Summary

A budget is an indispensable tool for converting plans into a successful reality. The budget helps
focus your thoughts on the direction in which you are headed. It indicates how much cash you have
to spend, your expenses and how much you need to earn. By planning on paper first, you minimize
the risks associated with your business endeavor. A good budget can build morale by helping you
organize, communicate and motivate employees to do their part in achieving the company's financial
goals.
______________________________________________________________________________

BASIC BUDGETS FOR PROFIT PLANNING -- Charles J. Woelful

Budgeting requires you to consider your basic objectives, policies, plans and resources.

− It requires you and your key employees to undertake a coordinated, comprehensive

and informed effort to achieve common objectives.

− It helps you to ensure that proper controls and evaluation procedures are established
throughout your company.

− It encourages and motivates everyone concerned to put forth a reasonable effort.

− It provides a plan so that all of you know where you are going, as well as why, how,
when and with whom.

In short, the budgeting process is a valuable tool in planning, income and expense.

You can prepare a budget to cover practically any time period. Usually, a one-year budget is
developed. In most cases, it is projected on a quarterly basis, with each quarter detailed in months
(sometimes weeks). It is also possible to prepare budgets for two, three and five years. Anything
beyond five years generally is impractical.

The following simplified examples give you an idea of the various interrelations developed in the
budgeting process. (These figures are relative to one given set of values. Of course, different
volumes of business would determine different costs and thus affect the realizable profits.) Using
these concepts as a framework, you and your staff can set up your own comprehensive profit-
planning budget.

A comprehensive budget picture begins with the sales budget. Other budgets are related directly or
indirectly to this budget. Table 4 is a sales forecast in units.
______________________________________________________________________________
 Table 4
Sales budget in units for the year ended December 31, 19__

1st 2nd 3rd 4th

Territory Total Quarter Quarter Quarter Quarter

East 26,000 5,000 6,000 7,000 8,000

West 11,000 2,000 2,500 3,000 3,500
Total 37,000 7,000 8,500 10,000 11,500
_________________________________________________________________

Assume you sell a single product with a sales price of $10. Your sales budget in terms of dollars
would look like Table 5.
_________________________________________________________________

Table 5
Sales budget in dollars for the year ended December 31,19__

1st 2nd 3rd 4th

Territory Total Quarter Quarter Quarter Quarter

East 260,000 50,000 60,000 70,000 80,000

West 110,000 20,000 25,000 30,000 35,000
Total 370,000 70,000 85,000 100,000 115,000
_________________________________________________________________

Say the estimated per unit cost of the project is $1.50 for direct material, $2.50 for direct labor and
$1.00 for manufacturing overhead. Table 6 reflects applying unit costs to
the sales budget in units.
_________________________________________________________________

Table 6
Cost of goods sold budget for the year ended December 31, 19__

1st 2nd 3rd 4th

Total Quarter Quarter Quarter Quarter
Direct
material 55,500 10,500 12,750 15,000 17,250

Direct
labor 92,500 17,500 21,250 25,000 28,750

Manufacturing
overhead 37,000 7,000 8,500 10,000 11,500

Total 185,000 35,000 42,500 50,000 57,500

_________________________________________________________________

Later, before a cash budget can be compiled, you must know the estimated cash requirements for
selling expenses. Therefore, you prepare a budget for selling expenses and another for cash
expenditures for selling expenses (total selling expenses less depreciation) as shown in Table 7 and
8.
_________________________________________________________________

Table 7
Selling expenses budget for the year ended December 31, 19__

1st 2nd 3rd 4th

Total Quarter Quarter Quarter Quarter
Commis-
sions 46,250 8,750 10,625 12,500 14,375
Rent 7,000 1,750 1,750 1,750 1,750
Advertising 9,250 1,750 2,125 2,500 2,875
Telephone 4,600 875 1,062 1,250 1,413
Depreciation
office 900 225 225 225 225
Other 22,000 4,150 5,088 6,025 6,737
Total 90,000 17,500 20,875 24,25 27,375
_________________________________________________________________
_________________________________________________________________

Table 8
Selling expenses budget cash requirements for the year ended
December 31, 19__

1st 2nd 3rd 4th

Total Quarter Quarter Quarter Quarter

Total
selling
expenses
less
deprec-
iation 90,000 17,500 20,875 24,250 27,375

Office
expense 900 225 225 225 225

Cash
require-
ments 89,100 17,275 20,650 24,025 27,150
_________________________________________________________________

Basic information for an estimate of administrative expenses for the coming year is easily compiled.
Again, from that budget you can estimate cash requirements for those expenses to be used
subsequently in preparing the cash budget (see Tables 9 and 10).
_________________________________________________________________

Table 9
Administrative expenses budget for the year ended
December 31, 19__

1st 2nd 3rd 4th

Total Quarter Quarter Quarter Quarter
Salaries 22,200 4,200 5,100 6,000 6,900
Insurance 1,850 350 425 500 575
Telephone 1,850 350 425 500 575
Supplies 3,700 700 850 1,000 1,150

Bad debt
expense 3,700 700 850 1,000 1,150

Other
expenses 3,700 700 850 1,000 1,150
Total 37,000 7,000 8,500 10,000 11,500
_________________________________________________________________
_________________________________________________________________

Table 10
Administrative expenses budget-cash requirements
for the year ended December 31, 19__

1st 2nd 3rd 4th

Total Quarter Quarter Quarter Quarter

Estimated
adminis-
trative
expenses 37,000 7,000 8,500 10,000 11,500

Less bad
debt
expenses 3,700 700 850 1,000 1,150

Cash
require-
ments 33,300 6,500 7,650 9,000 10,350
_________________________________________________________________

Now, from the information gathered so far, you can proceed to prepare the budget income statement.
Assume you plan to borrow $10,000 at the end of the first quarter. Although payable at maturity of
the note, the interest appears in the last three quarters of the year. The statement will resemble Table
11.
_________________________________________________________________

Table 11
Budgeted income statement for the year ended
December 31 19__

1st 2nd 3rd 4th

Total Quarter Quarter Quarter Quarter

Sales 370000 70000 85000 100000 115000

Cost of
goods sold 185000 35000 42500 50000 57500
Gross
margin 555000 105000 127500 150000 172500

Operating expenses

Selling 90000 17500 20875 24250 27375

Administr-
ative 37000 7000 8500 10000 11500

Total 127000 24500 29375 34250 38875

Net income from

Operations 58000 10500 13125 15750 18625

Interest
expense 450 150 150 150

Net income before

Income
taxes 57550 10500 12975 15600 18475

Federal
income
tax (25%
average) 14388 2625 3244 3900 4619

Net income 43162 7875 9731 11700 13856

_________________________________________________________________

Estimating that 90 percent of your account sales is collected in the quarter in which those sales were
made, 9 percent is collected in the quarter following the quarter in which the sales were made and 1
percent is uncollectible, your accounts receivable budget of collections will look like Table 12.
_________________________________________________________________

Table 12
Budget of collections of accounts receivable
for the year ended December 31, 19__

Total 1st 2nd 3rd 4th

(net) Quarter Quarter Quarter Quarter

4th Qtr.
sales
19-0 6,000 6,000

1st Qtr.
sales
19-1 69,300 63,000 6,300

2nd Qtr.
sales
19-1 84,150 76,500 7,650

3rd Qtr.
sales
19-1 99,000 90,000 9,000

4th Qtr.
sales
19-1 103,500 103,500

Total 361,950 69,000 82,800 97,650 112,500

_________________________________________________________________

Going back to the sales budget in units, prepare a production budget in units. Assume you have
2,000 units in the opening inventory and want to have on hand at the end of each quarter the
following quantities: first quarter, 3,000 units; second quarter, 3,500 units; third quarter, 4,000 units;
and fourth quarter, 4,500 units (see Table 13).
_________________________________________________________________

Table 13
Production budget in units for the year ended
December 31, 19__

1st 2nd 3rd 4th

Quarter Quarter Quarter Quarter

Sales
requirements 7,000 8,500 10,000 11,500

Plus ending
inventory
requirements 3,000 3,500 4,000 4,500

Total
requirements 10,000 12,000 14,000 16,000

Less
beginning
inventory 2,000 3,000 3,500 4,000

Production
requirements 8,000 9,000 10,500 12,000
_________________________________________________________________

Next, based on the production budget, prepare a budget to show the purchases needed during each of
the four quarters, expressed in dollars. Take the production and inventory figures and
multiply them by the cost of material (previously estimated at $1.50 per unit). You could prepare a
similar budget expressed in units (see Table 14).
_________________________________________________________________

Table 14
Budget of direct materials purchases
 for the year ended December 31, 19__

1st 2nd 3rd 4th

Quarter Quarter Quarter Quarter

Required for
production 12,000 13,500 15,750 18,000

Required for
ending inventory 4,500 5,250 6,000 6,750

Total 16,500 18,750 21,750 24,750

Less beginning
inventory 3,000 4,500 5,250 6,000

Required purchases 13,500 14,250 16,500 18,750

_________________________________________________________________

Suppose you pay 50 percent of your accounts in the quarter of the purchase and 50 percent in the
following quarter. Carryover payables from last year were $5,000. Since any discounts given to you
by your suppliers (net purchase discount) were figured into the $1.50 unit cost estimate, purchase
discounts do not appear in the payment budget. Thus your payment budget will come out like Table
15.
_________________________________________________________________

Table 15
Payment budget for the year ended December 31, 19__

1st 2nd 3rd 4th

Total Quarter Quarter Quarter Quarter

4th Qtr.
sales
19-0 $5,000 $5,000

1st Qtr.
sales
19-1 13,500 6,750 $6,750

2nd Qtr.
sales
19-1 14,250 7,125 $7,125

3rd Qtr.
sales
19-1 16,500 8,250 $8,250

4th Qtr.
sales
19-1 9,375 9,375
Payments
by
quarters $58,625 $11,750 $13,875 $15,375 $17,625
_________________________________________________________________

Taking the data for quantities produced from the production budget in units, calculate the direct
labor requirements on the basis of units to be produced. (The number and cost of labor hours
necessary to produce a given quantity can be set forth in supplemental schedules.) (See Table 16.)
_________________________________________________________________

Table 16
Direct labor budget cash requirements for the year ended
December 31, 19__

1st 2nd 3rd 4th

Total Quarter Quarter Quarter Quarter

Quantity 39,500 8,000 9,000 10,500 12,000

Direct
labor
cost 98,750 20,000 22,500 26,250 30,000
_________________________________________________________________

Now outline the items that make up your factory overhead, and prepare a budget as shown in Table
17.
_________________________________________________________________

Table 17
Manufacturing overhead budget-cash requirements
for the year ended December 31, 19__

1st 2nd 3rd 4th

Total Quarter Quarter Quarter Quarter

Production
units 39,500 8,000 9,000 10,500 12,000

Manufact-
uring
overhead
expenses $39,500 $8,000 $9,000 $10,500 $12,000

Less
deprec-
iation 2,800 700 700 700 700

Cash
require-
ments $36,700 $7,300 $8,300 $9,800 $11,300
_________________________________________________________________
Figure the cash payments for manufacturing overhead by subtracting depreciation, which requires no
cash outlay, from the totals above, and you will have the breakdown shown in Table 18.
_________________________________________________________________

Table 18
Manufacturing overhead budget for the year ended
December 31, 19__

1st 2nd 3rd 4th

Total Quarter Quarter Quarter Quarter

Heat and
power 10,000 1,000 2,500 3,000 3,500

Factory
supplies 5,300 1,000 1,500 1,800 1,000

Property
taxes 2,000 500 500 500 500

Deprec-
iation 2,800 700 700 700 700

Rent 8,000 2,000 2,000 2,000 2,000

Superint-
endent 11,400 2,800 1,800 2,500 4,300

Total 39,500 8,000 9,000 10,500 12,000

_________________________________________________________________

Now comes the all-important cash budget. Put it together by using the collection of accounts
receivable budget, selling expenses budget-cash requirements, administrative expenses budget cash
requirements, payment of purchases budget, direct labor budget cash requirements, and
manufacturing budget cash requirements. Take $15,000 as the beginning balance and assume that
dividends of $20,000 are to be paid in the fourth quarter (see Table 19).
_________________________________________________________________

Table 19
Cash budget for the year ended December 31 19__

1st 2nd 3rd 4th

Total Quarter Quarter Quarter Quarter

Beginning
cash
balance 15000 15000 16987 26812 40012

Cash
collect-
ions 361950 69000 82800 97650 112500
Total 376950 84000 99787 124462 152512

Cash
payments
purchases 58625 11750 13875 15375 17625

Direct
labor 98750 20000 22500 26250 30000

Manufact-
uring
overhead 36700 7300 8300 9800 11300

Selling
expense 89100 17275 20650 24025 27150

Adminis-
trative
expenses 33300 6300 7650 9000 10350

Federal
income
tax 14388 14388

Dividends 20000 20000

Interest
expenses 450 450

Loan
repayment 10000 10000

Total 361313 77013 72975 84450 126875

Cash
surplus 6987

Bank
loan
received 10000 10000

Ending
cash
balance 25637 16987 26812 40012 25637
_________________________________________________________________

Now you are ready to prepare a budget balance sheet. Take the account balances of last year and
combine them with the transactions reflected in the various budgets you have compiled. You will
come out with a sheet resembling Table 20.
_________________________________________________________________
 Table 20
Budgeted balance sheet December 31, 19__

19-- 19--

Current assets

Cash 10,000 25,637

Accounts receivable 11,500 6,666

Less allowance for

doubtful accounts (1,150) (666)

Inventory

Raw materials 6,750 3,000

Finished goods 22,500 10,000

Total current assets 49,600 44,637

Fixed assets

Land 50,000 50,000

Building 148,000 148,000

Less depreciation allowance (37,000) (33,000)

Total fixed assets 161,000 165,000

Total assets 210,600 209,637

Liabilities and shareholders' equity

Current liabilities
accounts payable 9,375 5,000

Shareholders' equity

Capital stock (10,000

shares; $10 par value) 100,000 100,000

Retained earnings 101,225 104,637

Total liabilities and

shareholders' equity 210,600 209,637
_________________________________________________________________

In order to make the most effective use of your budgets, you will want to establish reporting devices.
These will include periodic reports and reviews on both efforts and accomplishments. It is through
comparing actual performance with budgeted projections that you maintain control of operations.

Your company should be structured along functional lines, with well-identified areas of
responsibility and authority. Then, depending on the size of the company, the budget reports can be
prepared to correspond with the organizational structure.

Two typical budget reports are shown in Table 21 to demonstrate various forms these reports may
take.
_________________________________________________________________

Table 21
Report of actual and budgeted sales for the year ended
December 31, 19__

Variations from
budget (under)
----------------------
Actual sale Budgeted sales Quarterly Cumulative

1st $ $ $ $
quarter

2nd
quarter

3rd
quarter

4th
quarter
_________________________________________________________________
_________________________________________________________________

Table 21
Budgeted report on selling expenses for the year ended
December 31, 19__

+-------+--------+---------+--------+--------+----------+--------
|Budget | Actual |Variation| Budget | Actual |Variations|
| this | this | this | this | this | this |
|month | month | month | to date| to date| to date | Remarks
|-------|--------|---------|--------|--------|----------|--------
| | | | | | |
+-------+--------+------------------+--------+----------+--------
______________________________________________________________________________

APPENDIX: INFORMATION RESOURCES

U.S. Small Business Administration (SBA)

The SBA offers an extensive selection of information on most business management topics, from
how to start a business to exporting your products.

This information is listed in The Small Business Directory. For a free copy contact your nearest
SBA office.

SBA has offices throughout the country. Consult the U.S. Government section in your telephone
directory for the office nearest you. SBA offers a number of programs and services, including
training and educational programs, counseling services, financial programs and contract assistance.
Ask about

− Service Corps of Retired Executives (SCORE), a national organization sponsored

by SBA of over 13,000 volunteer business executives who provide free counseling,
workshops and seminars to prospective and existing small business people.

− Small Business Development Centers (SBDCs), sponsored by the SBA in

partnership with state and local governments, the educational community and the
private sector. They provide assistance, counseling and training to prospective and
existing business people.

− Small Business Institutes (SBIs), organized through SBA on more than 500 college
campuses nationwide. The institutes provide counseling by students and faculty to
small business clients.

For more information about SBA business development programs and services call the SBA Small
Business Answer Desk at 1-800-U-ASK-SBA (827-5722).

Other U.S. Government Resources

Many publications on business management and other related topics are available from the
Government Printing Office (GPO). GPO bookstores are located in 24 major cities and are listed in
the Yellow Pages under the bookstore heading. You can request a Subject Bibliography by writing
to Government Printing Office, Superintendent of Documents, Washington, DC 20402-9328.

Many federal agencies offer publications of interest to small businesses. There is a nominal fee for
some, but most are free. Below is a selected list of government agencies that provide publications
and other services targeted to small businesses. To get their publications, contact the regional offices
listed in the telephone directory or write to the addresses below:

Consumer Information Center (CIC)

P.O. Box 100
Pueblo, CO 81002
The CIC offers a consumer information catalog of federal publications.

Consumer Product Safety Commission (CPSC)

Publications Request
Washington, DC 20207
The CPSC offers guidelines for product safety requirements.

U.S. Department of Agriculture (USDA)

12th Street and Independence Avenue, SW
Washington, DC 20250
The USDA offers publications on selling to the USDA. Publications and programs on
entrepreneurship are also available through county extension offices nationwide.

U.S. Department of Commerce (DOC)

Office of Business Liaison
14th Street and Constitution Avenue, NW
Room 5898C
Washington, DC 20230
DOC's Business Assistance Center provides listings of business opportunities available in the federal
government. This service also will refer businesses to different programs and
services in the DOC and other federal agencies.

U.S. Department of Health and Human Services (HHS)

Public Health Service
Alcohol, Drug Abuse and Mental Health Administration
5600 Fishers Lane
Rockville, MD 20857
Drug Free Workplace Helpline: 1-800-843-4971.
Provides information on Employee Assistance Programs.
National Institute for Drug Abuse Hotline: 1-800-662-4357. Provides information on preventing
substance abuse in the workplace.
The National Clearinghouse for Alcohol and Drug Information: 1-800-729-6686 toll-free. Provides
pamphlets and resource materials on substance abuse.

U.S. Department of Labor (DOL)

Employment Standards Administration
200 Constitution Avenue, NW
Washington, DC 20210
The DOL offers publications on compliance with labor laws.

U.S. Department of Treasury

Internal Revenue Service (IRS)
P.O. Box 25866
Richmond, VA 23260
1-800-424-3676
The IRS offers information on tax requirements for small businesses.

U.S. Environmental Protection Agency (EPA)

Small Business Ombudsman
401 M Street, SW (A-149C)
Washington, DC 20460
1-800-368-5888 except DC and VA
703-557-1938 in DC and VA
The EPA offers more than 100 publications designed to help small businesses understand how they
can comply with EPA regulations.

U.S. Food and Drug Administration (FDA)

FDA Center for Food Safety and Applied Nutrition
200 Charles Street, SW
Washington, DC 20402
The FDA offers information on packaging and labeling requirements for food and food-related
products.

For More Information

A librarian can help you locate the specific information you need in reference books. Most libraries
have a variety of directories, indexes and encyclopedias that cover many business topics. They also
have other resources, such as

− Trade association information

Ask the librarian to show you a directory of trade associations. Associations provide
a valuable network of resources to their members through publications and services
such as newsletters, conferences and seminars.

− Books -- Many guidebooks, textbooks and manuals on small business are published
annually. To find the names of books not in your local library check Books In Print,
a directory of books currently available from publishers.

− Magazine and newspaper articles -- Business and professional magazines provide

information that is more current than that found in books and textbooks. There are a
number of indexes to help you find specific articles in periodicals.

In addition to books and magazines, many libraries offer free workshops, lend skill-building tapes
and have catalogues and brochures describing continuing education opportunities.