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The financial budget consists of:
The major steps in preparing the budget are:
1. Prepare a sales forecast.
2. Determine expected production volume.
3. Estimate manufacturing costs and operating expenses.
4. Determine cash flow and other financial effects.
5. Formulate projected financial statements.
Figure 9.1 shows a simplified diagram of the various parts of the comprehensive (master) budget, the master plan of the company.
Illustration
To illustrate how all these budgets are put together, we will focus on a manufacturing company called the Putnam Company, which produces and markets a single product. We will make the following assumptions:
The Sales Budget
The sales budget is the starting point in preparing the master budget, since estimated sales volume influences nearly all other items appearing throughout the master budget. The sales budget should show total sales in quantity and value. The expected total sales can be break-even or target income sales or projected sales. It may be analyzed further by product, by territory, by customer and, of course, by seasonal pattern of expected sales.
Generally, the sales budget includes a computation of expected cash collections from credit sales, which will be used later for cash budgeting.
Figure 9.1: A Master (Comprehensive) Budget
Schedule 1
The Putnam Company – Sales Budget
| + | All of the $100,000 accounts receivable balance is assumed to be collectible in the first quarter. |
| ++ | 40 percent of a quarter’s sales are collected in the quarter of sale. |
| +++ | 60 percent of a quarter’s sales are collected in the quarter following. |
Monthly Cash Collections from Customers
Frequently, there are time lags between monthly sales made on account and their related monthly cash collections. For example, in any month, credit sales are collected as follows: 15% in month of sale, 60% in the following month, 24% in the month after, and the remaining 1 percent are uncollectible.
The budgeted cash receipts for June and July are computed as follows:
For June:
| From April sales | $320 × .24 | $ 76.80 |
| From May sales | 200 × .60 | 120.00 |
| From June sales | 300 × .15 | 45.00 |
| Total budgeted collections in June | $241.80 |
For July:
| From May sales | $200 × .24 | $ 48 |
| From June sales | 300 × .60 | 180 |
| From July sales | 280 × .15 | 42 |
| Total budgeted collections in July | $270 |
The Production Budget
After sales are budgeted, the production budget can be determined. The production budget is a statement of the output by product and is generally expressed in units. It should take into account the sales budget, plant capacity, whether stocks are to be increased or decreased and outside purchases. The number of units expected to be manufactured to meet budgeted sales and inventory requirements is set forth in the production budget.
The production budget is illustrated as follows:
Schedule 2
The Putnam Company – Production Budget
| * | 10 percent of the next quarter’s sales. (For example, 180 = 10% × 1,800). |
| ** | Given. |
| *** | The same as the previous quarter’s ending inventory. |
Inventory Purchases – Merchandising Firm
Putnam Company is a manufacturing firm, so it prepares a production budget, as shown in Schedule 2. If it were a merchandising (retailing or wholesaling) firm, then instead of a production budget, it would develop a merchandise purchase budget showing the amount of goods to be purchased from its suppliers during the period. The merchandise purchases budget is in the same basic format as the production budget, except that it shows goods to be purchased rather than goods to be produced, as shown below:
| Budgeted cost of goods sold (in units or dollars) | $560,000 |
| Add: Desired ending merchandise inventory | 120,000 |
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