Business Planning

Levels of Business Planning

Strategic Planning:
Decisions regarding such long-range questions as which products to
make and sell, how to market the products, and how to finance the
Operational Budgeting resources necessary to achieve the organization's goals.

Capital Budgeting:
Planning for the acquisition of operational or long-term assets such
as property, plant and equipment.

Operational Budgeting:
Detailed plans of immediate goals for prospective sales, production,
expenses, cash flows and financial statement results.

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Personal Budgeting
Personal Budget (Cash Flow)
The Importance of Budgeting
.
Jan. Feb. Mar.
Budgeted Cash Inflows: Communication
Salary/Wage Income
Interest Income
Parental Subsidy
. Setting Goals and Objectives
Student Loan Proceeds
Budgeted Cash Outflows:
. Problem Resolution
Rent
Utilities . Coordination

.
Food
Entertainment Authorization
Tuition
Books
Insurance- Health . Performance Evaluation
Auto Payments
Auto Gas & Maint.
Insurance- Auto
. Motivation
Miscellaneous
Net Cash Flow

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Business Budgeting
Elements and Sequencing of an
Operating Budget
The Benefits of Budgeting for a Business
- Merchandising Business -
. Management Communication Sales
. Setting Goals and Objectives
Budget

. Problem Resolution
Inventory
Purchases
Selling &
Admin. Expense
. Coordination
Budget Budget

. Authorization Cash Flow Budget

. Performance Evaluation Pro-forma Pro-forma

. Motivation
Income
Statement
Balance
Sheet

Elements and Sequencing of an

Operating Budget
-Manufacturing Business-
Sales
Budget
Selling &
Production Admin. Expense
Budget Budget

Direct Direct Mfg.

Materials Labor Overhead
Budget Budget Budget

Cash Flow Budget

Pro-forma Pro-forma
Income Balance
Statement Sheet

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Operational Budgeting
Example: Given the information and assumptions provided below for SALES BUDGET
PowerPak, Inc., prepare the following budgets for the months noted
in 20X3: SEPT. OCT. NOV.
A. Sales Budget (Sept., Oct.,Nov.) Units to be sold 20,000 22,000 25,000
B. Production Budget (Sept., Oct.)
C. Direct Materials Budget (Sept.) Sales price/unit x 3.00 x 3.00 x 3.00
D. Direct Labor Budget (Sept.)
E. Cash Flow Budget (Sept.) Total Sales Revenue $60,000 $66,000 $75,000
PowerPak, Inc. makes and sells a food supplement drink that comes in a
one pint carton. One carton of PowerPak is made by mixing plain tap
water with a 6 oz. powder mix purchased directly from a manufacturer of
nutritional products based on a formula developed by PowerPak.

The product sells for $3.00 a carton and budgeted sales for the months of
September, October and November of 20X3 are 20,000, 22,000 and
25,000 units, respectively.

Management would like to keep a balance of finished inventory on hand The product costs are budgeted to include:
equal to 20% of the following month's anticipated sales volume to be
able to handle unexpected sales volume. Assume that there are 4,000
units of finished goods on hand at 8/31/X3. Given this information, the Variable Costs Per Unit-
Production Budget can be prepared. Direct Materials-
6 oz. Mix $.90 per unit
PRODUCTION BUDGET Carton $.20 per unit
Direct Labor $.10 per unit
SEPT. OCT. NOV.
Mfg. Overhead $.30 per unit
Units to be sold 20,000 22,000 25,000
Desired ending inventory * 4,400 5,000 Fixed Mfg. Overhead-
24,400 27,000 Per Month $7,000*

Beginning inventory (4,000) (4,400) * Amount includes $1,500 of equipment depreciation.

Units to be produced 20,400 22,600

* Calculated based on 20% of the subsequent month's budgeted sales.

MATERIALS USAGE BUDGET

SEPT. OCT.
Management likes to have on hand inventory of mix and cartons Units to be produced 20,400 22,600
equal to 30% of the following months budgeted materials usage.
Assume that there are 6,120 six oz. packets of mix and 6,120 cartons One 6oz. Mix and One
in materials inventory at 8/31/X3. Given this information, the Direct Carton per unit produced x 1 x 1
Materials Purchase and the Direct Labor Budget can be prepared. Mix and cartons to be used 20,400 22,600
MATERIALS PURCHASE BUDGET
MATERIALS USAGE BUDGET
SEPT. OCT.
Units of Mix & Cartons to be used 20,400 22,600
SEPT. OCT. Desired ending inventory* 6,780 ?
Units to be produced 20,400 22,600 27,180 ?
Beginning Inventory (6,120) (6,780)
One 6oz. Mix and One Mix and Cartons to purchase 21,060 ?
Carton per unit produced x 1 x 1
Price per Mix and Carton x 1.10 x 1.10
Mix and cartons to be used 20,400 22,600 Total Material purchases $23,166 ?
*Calculated based on 30% of subsequent month's budgeted usage.

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Operational Budgeting
DIRECT LABOR BUDGET Budgeted selling and administrative expenses amount to $ .40 per unit of
variable costs and $5,000 per month of fixed costs which include $700 of
SEPT. OCT. budgeted depreciation expense. Prepare the September Cash Flow Budget

.
Units to be produced 20,400 22,600 given the following additional assumptions:
Labor cost per unit x .10 x .10 All sales are made on account and experience shows that about 60%
Total Direct Labor $2,040 $2,260 of sales are collected in the month of sale with 40% in the following
month. No sales are anticipated to be uncollectible. The A/R
balance at 8/31/X3 amounts to $21,000.
. Direct materials are always purchased on account with 50% paid in
the month of purchase and the remainder paid in the following
month. The A/P balance at 8/31/X3 amounts to $10,500.
. Assume all direct labor, manufacturing overhead costs and selling
and administrative costs are paid in the month incurred.
. The cash balance at the beginning of the month is $6,000 and assume
that PowerPak operates in a world of no income taxes.

CASH FLOW BUDGET SEPT. Problem: Operational Budgeting

Beginning cash $6,000
Add collection of A/R:
Current month* ($60,000 x 60%) 36,000 Jordan Corp. sells cakes for $10 per unit. Budgeted sales volume in
Preceding month 21,000 # of units for the first 3 months of the year is noted below:
63,000
Deduct disbursements:
Direct materials- JAN. FEB. MAR.
Current month*($23,166 x 50%) 11,583 25,000 30,000 35,000
Preceding month 10,500
Direct labor 2,040 Jordan anticipates that 70% of sales will be made on account and accounts
Manufacturing Overhead-
Variable**(20,400 x $.30) 6,120 receivables are expected to be collected at the following rates:
Fixed (excluding depreciation of $1,500) 5,500
Selling & Administrative- 50% in the month of sale
Variable***(20,000 x $.40) 8,000
Fixed (excluding depreciation of $700) 4,300 35% in the first month following the month of sale
Cash balance/(deficiency) 14,957 10% in the second month following the month of sale
Cash capitalization required 0
Ending cash balance $14,957 5% uncollectible
* Collections of A/R are calculated at 60% in the ** Calculated at $.30 times the # of units 100%
month of sale and 40% in the subsequent month. budgeted for production.
Payments on purchases of direct materials, all on
*** Calculated at $.40 times the # of units Determine the amount of budgeted cash inflows for the month of
account, are calculated at 50% in the month of
purchase and 50% in the subsequent month budgeted for sale. March.

Solution: Operational Budgeting Problem: Various Budgets

March Cash Collections: Jordan Corp. has budgeted sales volume in units as follows:
Jan. Feb. Mar.
From January Sales: 25,000 30,000 35,000
25,000 x $10 x 70% x 10% = $17,500

From February Sales: Jordan wishes to maintain an inventory level of finished goods
30,000 x $10 x 70% x 35% = $73,500 equal to 30% of the following month's budgeted sales. Finished
goods inventory at the start of business on Jan. 1st amounts to
From March Sales: 7,000 units.
Cash Sales One unit of production requires 3 lbs. of flour which costs $2/lb.
35,000 x $10 x 30% = $105,000 Jordan plans to maintain a level of flour inventory (raw materials)
constant with the current inventory balance.
Credit Sales If Jordan plans to buy all raw materials on account paying 50% in
35,000 x $10 x 70% x 50% = $122,500 the month of purchase and 50% in the following month, how
much cash outflow for the purchase of flour should be budgeted
Total Cash Collections $318,500
for in February?

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Operational Budgeting
Problem: Various Budgets Solution: Various Budgets

Production Budget
Jan. Feb. Mar.
Budgeted Sales 25,000 30,000 35,000
Add: Desired Ending Inventory 9,000 10,500 ? February Cash Payment on Flour Purchases:
34,000 40,500 ?
Less: Beginning Inventory (7,000) (9,000) (10,500) Payments on January Purchases:
Units to be Produced 27,000 31,500 ? ($162,000 x .50%) $81,000
Materials Usage Budget Payments on February Purchases:
Jan. Feb. ($189,000 x .50%) $94,500
Units to be produced 27,000 31,500 $175,500
(x) 3 lbs. per unit x 3 x 3
lbs. to be used in production 81,000 94,500
Materials Purchases Budget
Jan. Feb.
Lbs. to be used in production 81,000 94,500
Add: Desired Ending Inventory
Less: Beginning Inventory
Budgeted Purchases 81,000 lbs. 94,500 lbs.
Cost per lb. x $2 x $2
Cost of Materials Purchases $ 162,000 $189,000

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Heavenly Molds Budgets
Elements and Sequencing of an Problem: Heavenly Molds Part 2-A

Operating Budget
Business Feasibility Study for
Sales HEAVENLY MOLDS, INC.
Budget As noted in the prior lesson, Heber Smith is seriously investigating
Selling & what he believes is a promising business opportunity. His idea is to
Production Admin. Expense manufacture and sell plastic jello molds in the form of famous LDS
Budget Budget religious symbols such as the Salt Lake Temple. Based on Heber's
personal research and preliminary marketing efforts, he believes that
Direct Direct Mfg. the following is a reasonable estimate of total sales volume at a price
Materials Labor Overhead of $2.50 per unit for the first quarter of operations beginning
Budget Budget Budget September 1, 20X1:
Sept. Oct. Nov.
Projected sales in # of units
2,000 3,000 4,000
Cash Flow Budget Heber currently plans to manufacture the jello molds rather than
contract out their production. The raw materials required for
Pro-forma Pro-forma production of a single jello mold, regardless of design, is 1 lb. of
Income Balance polypropylene which can be purchased from a local supplier for $.30
Statement Sheet per lb. Direct manufacturing labor costs are projected on a piece rate
basis at $.20 per unit produced.

Problem: Heavenly Molds Part 2-A Solution: Heavenly Molds Part 2-A

SALES BUDGET
ADDITIONAL BUDGETARY INFORMATION:
Following November, 20X1, Heber projects that sales volume SEPT. OCT. NOV. DEC. JAN.
will increase at a rate of 100 units per month. Inventory levels for Units to be sold 2,000 3,000 4,000 4,100 4,200
finished goods are to be budgeted at a level of 25% of the following Sales price/unit x 2.50 x 2.50 x 2.50 x 2.50 x 2.50
month's anticipated sales volume. Inventory levels for raw materials Total Sales Revenue $ 5,000 $7,500 $ 10,000 $10,250 $10,500
are budgeted at a level of 10% of the following month's budgeted
materials usage. PRODUCTION BUDGET
Required: (Given the above information round all calculations to the
SEPT. OCT. NOV. DEC.
nearest whole unit or dollar, as the case may be.)
Units to be sold 2,000 3,000 4,000 4,100
Given the information above, prepare the following budgets for
Heavenly Molds for the months of September through Add: Desired ending inventory* 750 1,000 1,025 1,050
November, 20X1: 2,750 4,000 5,025 5,150
A. Sales Budget (using $2.50 sales price per unit) Less: Beginning inventory ( 0) (750) (1,000) (1,025)
B. Production Budget Units to be produced 2,750 3,250 4,025 4,125
C. Materials Usage and Purchases Budget
D. Direct Labor Budget *Calculated based on 25% of the subsequent month's budgeted sales.

Problem: Heavenly Molds Part 2-A Solution: Heavenly Molds Part 2-A

MATERIALS USAGE BUDGET

DIRECT LABOR BUDGET
SEPT. OCT. NOV.
Units to be produced 2,750 3,250 4,025
Polypropylene per unit produced x 1 lb. x 1 lb. x 1 lb. SEPT. OCT. NOV.
Units to be produced 2,750 3,250 4,025
lbs. to be used 2,750 3,250 4,025
(X) Labor cost per unit x .20 x .20 x .20
MATERIALS PURCHASE BUDGET
SEPT. OCT. NOV. Total direct labor $ 550 $ 650 $ 805
lbs. to be used 2,750 3,250 4,025
Add: Desired ending inventory* 325 403 413
3,075 3,653 4,438
Less: Beginning inventory ( 0) (325) (403)
lbs. to purchase 3,075 3,328 4,035
Price per lb. x .30 x .30 x .30
Total purchases $ 923 $ 998 $ 1,211
*Calculated based on 10% of the subsequent month's budgeted usage.

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Heavenly Molds Budgets
Problem: Heavenly Molds Part 2-B Problem: Heavenly Molds Part 2-B

For simplicity's sake, all direct labor, manufacturing overhead and

Given the budgets prepared in the previous problem and the information selling and administrative costs are budgeted to be paid in the month
provided below, prepare a Cash Flow Budget for Heavenly Molds for incurred. Based on the work done in the prior lesson, the following
the months of September through November, 20X1. budgeted amounts are also available:
Variable Manufacturing Overhead Costs,
Additional Cash Flow Budgeting Information: For cash flow Includes $ .10/unit depreciation $.30/unit
budgeting purposes assume that all sales are expected to be made on Fixed Manufacturing Overhead Costs $3,830
Variable Selling and Administrative Costs $.10/unit
account with 30% budgeted for collection in the month of sale and
Fixed Selling and Administrative Costs $1,570
70% budgeted for collection in the subsequent month (no uncollectible
receivables are anticipated). All purchases of raw materials will be Hint: In the cash flow budget, variable costs of manufacturing
made on account with 25% budgeted for payment in the month of should be based on the # of units to be produced while the variable
selling and administrative costs would be based on the # of units
purchase with the remainder to be paid in the subsequent month.
budgeted for sale in any particular month. Remember that
depreciation expense included in the variable manufacturing
On September 1, 20X1, Heavenly Molds will have to make an initial overhead costs are non-cash costs and should be excluded from the
refundable deposit on the building and the injection molding machine cash flow budget.
leases of $3,000 and $2,000, respectively. In addition, the $20,000 cost Assume that any cash flow deficiency will be reflected as "Cash
of the original production molds will be due upon delivery at Capitalization Required" and Heber wishes the cash budget to
September 1, 20X1. reflect a minimum cash balance of $10,000 to insure adequate cash
capitalization throughout the period.

Solution: Heavenly Molds Part 2-B Problem: Heavenly Molds Part 2-C

CASH FLOW BUDGET Provided below are the pro-forma income statements for the first

( )
Run over the SEPT. OCT. NOV. three months of budgeted operations and the pro-forma balance
Beginning cash letters to see $ 0 $10,000 $10,000 sheet as of 11/30/X1, prepared from the previously provided
Add collection of A/R: the footnotes
Current month a. 1,500 2, 250 3,000 budgetary information. Included with these statements are certain
Preceding month a. 3,500 5,250 footnotes and calculations explaining the source of the amounts.
1,500 15,750 18,250
Deduct disbursements:
Review these statements to understand how the various elements
Direct materials were determined and then respond to questions which follow.
Current month b. 231 250 303
Preceding month b. 692 749 PRO-FORMA INCOME STATEMENTS
Direct labor 550 650 805
Manufacturing Overhead
Variable c. 550 650 805 SEPT. OCT. NOV.
Fixed 3,830 3,830 3,830 Sales Revenues $5,000) $7,500) $10,000)
Selling & Administrative a.
Variable d. 200 300 400 Less: Cost of Goods Sold (4,380) (6,098) (7,230)
Fixed 1,570 1,570 1,570 Gross Margin 620) 1,402) $2,770)
Deposit on
Machine lease 2,000 Less: Selling and Administration b. (1,770) (1,870) (1,970)
Building 3,000
Original mold cost 20,000 Net Income (Loss) ($1,150) ($468) $800)
Cash balance/(deficiency) (30,431) 7,808 9,788
Cash capitalization required 40,431 2,192 212 * a and b see next two pages
Ending cash balance $10,000 $10,000 $10,000

Problem: Heavenly Molds Part 2-C Problem: Heavenly Molds Part 2-C

a. Cost of Goods Sold calculation:

First, the average budgeted manufacturing cost per unit of b. Total selling and administrative costs are calculated based on
production is calculated for each month separately.
the # of units budgeted for sale.
SEPT. OCT. NOV.
Manufacturing costs: SEPT. OCT. NOV.
Variable @ $.80 per unit $2,200 $2,600 $3,220 Variable ($.10/unit) $ 200 $ 300 $ 400
Fixed 3,830 3,830 3,830 Fixed 1,570 1,570 1,570
Total Manufacturing cost $6,030 $6,430 $7,050
.
. Units Produced 2,750 3,250 4,025
$1,770 $1,870 $1,970
Per unit cost $2.19 $1.98 $1.75
Next, calculate Cost of Goods Sold: # units cost/
sold unit
Sept. 2,000 x $2.19 = $4,380
Oct. 750 x $2.19 = $1,643
2,250 x $1.98 = $4,455
3,000 $6,098
Nov. 1,000 x $1.98 = $1,980
3,000 x $1.75 = $5,250
4,000 $7,230

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Heavenly Molds Budgets
Problem: Heavenly Molds Part 2-C Problem: Heavenly Molds Part 2-C

PRO-FORMA BALANCE SHEET

November 30, 20X1 (A) As of November 30, 20X1, how much total capital does Heber plan to have
invested in the business? How was this amount determined?
ASSETS
Current Assets: (B) Why is the total amount of projected owner's equity at 11/30/X1, less than
Cash $10,000
the planned capital contributions? If the budget were extended an
Accounts Receivable ($10,000 x 70%) 7,000
Inventory: additional three months to 2/28/X2, would you expect owner's equity to
Raw Materials (413 lbs. x $.30) 124 increase or decrease and why? (Do not do the actual budget through
Finished Goods (1,025 x $1.75) 1,794 2/28/X2, simply identify the relevant trends.)
$ 1 8, 9 1 8
Mold Development costs: 20,000 (C) What is the primary cause of improved budgeted profitability from
Less: Accumulated Depreciation (1,003) September to November? Calculate cost of goods sold as a % of sales
$18,997 revenues in each month and generally explain the cause of the change.
Deposits: Machine Lease 2,000
Building Lease 3,000 (D) Based on your review, is the company using the Fifo or Lifo inventory cost
Total Assets $42,915 flow assumption? Show how "Accumulated Depreciation" amounting to
$1,003 was determined on the 11/30/X1 pro-forma balance sheet. Explain
LIABILITIES AND OWNER'S EQUITY how "Accounts Payable" of $908 was calculated on the same balance sheet.
Liabilities:
Accounts Payable $ 908 (E) Given the CVP analysis previously performed and the results of the
Owner's Equity:
Contributed Capital 42,835
budgetary process, what is your opinion of Heber's business opportunity
Retained Deficit (818) and why? How much investment capital do you think is actually at risk?
Total Liabilities and Owner's Equity $42,925 * What do you think is the most significant factor in determining Heavenly
* $10 difference with total assets due to rounding Molds' ultimate success?

Solution: Heavenly Molds Part 2-C Solution: Heavenly Molds Part 2-C

(A) As of November 30, 20X1, how much total capital does (B) Why is the total amount of projected owner's equity at
Heber plan to have invested in the business? How was 11/30/X1 less than the planned capital contributions? If the
this amount determined? budget were extended an additional three months to 2/28/X2
would you expect owner's equity to increase or decrease and
why? (Do not do the actual budget through 2/28/X2, simply
$42,835. This number is reflected on the balance sheet
identify the relevant trends.)
as "Contributed Capital." The amount comes from the
combined amount of "Cash Capitalization Required" Total owner's equity at 11/30/X1 is $818 less than the
from the cash flow budget for the first three months of contributed capital due to retained deficits or the
operations. cumulative losses from operations. Over the next three
months, owner's equity will increase due to a budgeted
trend of profitable operations and cash flows.

Solution: Heavenly Molds Part 2-C Solution: Heavenly Molds Part 2-C

(C) What is the primary cause of improved budgeted (D) Based on your review, is the company using the Fifo or Lifo
profitability from September to November? Calculate inventory cost flow assumption? Show how "Accumulated
cost of goods sold as a % of sales revenues in each Depreciation" amounting to $1,003 was determined on the
month and generally explain the cause of the change. 11/30/X1 pro-forma balance sheet. Explain how "Accounts
Payable" of $908 was calculated on the same balance sheet.
Improved profitability results from increased volume
and the resulting lower cost of goods sold per unit.
Cost of goods sold, as a % of sales revenues, declines Fifo.
as follows:
Accumulated Depreciation: $.10 x # of units produced
Sept. Oct. Nov. .10 x 10,025 = $1,003 rounded
87.6% 81.3% 72.3%
This reduction is due to the fixed manufacturing costs Accounts Payable: Raw material purchases in November
which are spread out over more units through amount to $1,211, of which 75% are budgeted for payment
increased volume, thus reducing the cost per unit of in the following month and are therefore payable as of
production and cost of goods sold per unit. 11/30/X1.

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Heavenly Molds Budgets
Solution: Heavenly Molds Part 2-C

,
(E) Given the CVP analysis previously performed and the
results of the budgetary process, what is your opinion of
Heber's business opportunity and why? How much
investment capital do you think is actually at risk? What
do you think is the most significant factor in determining
Heavenly Molds' ultimate success?
Answer to Part E - Listen to Walk Through for answer

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