Читать книгу The Art of Mathematics in Business - Dr Jae K Shim - Страница 9
Оглавление9. Establishing a Budgeting System for Profit Planning
Introduction
Business managers should adopt a budgeting procedure almost immediately after they start in business. Deviations from what has been budgeted enable business managers to anticipate potential serious financial problems early enough to take corrective action. A comprehensive (master) budget is a formal statement of management’s expectations regarding sales, expenses, volume, and other financial transactions of an organization for the coming period. Simply put, a budget is a set of pro forma (projected or planned) financial statements.
How is it computed?
The budget is classified broadly into two categories:
1.Operating budget, reflecting the results of operating decisions.
2.Financial budget, reflecting the financial decisions of the firm.
The operating budget consists of:
Sales budget
Production budget
Direct materials budget
Direct labor budget
Factory overhead budget
Selling and administrative expense budget
Pro forma income statement
The financial budget consists of:
Cash budget
Pro forma balance sheet
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 company uses a single material and one type of labor in the manufacture of the product.
It prepares a master budget on a quarterly basis.
Work in process inventories at the beginning and end of the year are negligible and are ignored.
The company uses a single cost driver—direct labor hours (DLH)---as the allocation base for assigning all factory overhead costs to the product.
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 |
| Total needs | $680,000 |
| Less: Beginning merchandise inventory | (80,000) |
| Required purchases (in units or in dollars) | $600,000 |
Note:
1.Cost of goods sold = beginning inventory + purchases − ending inventory.
Hence, purchases = cost of goods sold + ending inventory − beginning inventory
2.Gross profit (margin) = sales − cost of goods sold (or cost of sales). For example, percentagewise, 30% = 100% − 70%. For example, sales is $800,000, then the cost of goods sold is $800,000 × 70% = $560,000
The Direct Material Budget
When the level of production has been computed, a direct material budget should be constructed to show how much material will be required for production and how much material must be purchased to meet this production requirement.
The purchase will depend on both expected usage of materials and inventory levels. The formula for computation of the purchase is:
The direct material budget is usually accompanied by a computation of expected cash payments for materials.
Schedule 3
The Putnam Company – Direct Material Budget
| * | Given |
| ** | 25 percent of the next quarter’s units needed for production. For example, the 2nd quarter production needs are 3,640 lbs. Therefore, the desired ending inventory for the 1st quarter would be 25% × 3,640 lbs. = 910 lbs. Also note: 490 lbs = 25% × 1,960 = 490 lbs. |
| *** | Assume that the budgeted production needs in lbs. for the 1st quarter of 20C = 2,080 lbs. So, 25% × 2,080 lbs. = 520 lbs. |
| **** | The same as the prior quarter’s ending inventory. |
Schedule of Expected Cash Disbursements
| + | All of the $6,275 accounts payable balance (from the balance sheet, 20A) is assumed to be paid in the first quarter. |
| ++ | 50 percent of a quarter’s purchases are paid for in the quarter of purchase; the remaining 50% are paid for in the following quarter. |
The Direct Labor Budget
The production requirements as set forth in the production budget also provide the starting point for the preparation of the direct labor budget. To compute direct labor requirements, expected production volume for each period is multiplied by the number of direct labor hours required to produce a single unit. The direct labor hours to meet production requirements is then multiplied by the (standard) direct labor cost per hour to obtain budgeted total direct labor costs.
Schedule 4 4
The Putnam Company – Direct Labor Budget
*Both are given.
The Factory Overhead Budget
The factory overhead budget should provide a schedule of all manufacturing costs other than direct materials and direct labor. We must remember that depreciation does not entail a cash outlay and therefore must be deducted from the total factory overhead in computing cash disbursement for factory overhead.
To illustrate the factory overhead budget, we will assume that
Total factory overhead budgeted = $18,300 fixed (per quarter), plus $2 per hour of direct labor. This is one example of a cost-volume (or flexible budget) formula (y = a + bx), developed via the least-squares method with a high R2 .
Depreciation expenses are $4,000 each quarter.
Overhead costs involving cash outlays are paid for in the quarter incurred.
Schedule 5
The Putnam Company – Factory Overhead Budget
*Depreciation does not require a cash outlay.
The Ending Finished Goods Inventory Budget
The ending finished goods inventory budget provides us with the information required for the construction of budgeted financial statements. After completing Schedules 1-5, sufficient data will have been generated to compute the per-unit manufacturing cost of finished product. This computation is required for two reasons: (1) to help compute the cost of goods sold on the budgeted income statement; and (2) to give the dollar value of the ending finished goods inventory to appear on the budgeted balance sheet.
Schedule 6
The Putnam Company – Ending Finished Goods Inventory Budget
| ** | Predetermined factory overhead applied rate = Budgeted annual factory overhead/budgeted annual activity units = $ 134,200/30,500 DLH = $4.40 (see Chapter 3; Accumulation of Costs – Job Order Costing). |
The Selling and Administrative Expense Budget
The selling and administrative expense budget lists the operating expenses involved in selling the products and in managing the business. Just as in the case of the factory overhead budget, this budget can be developed using the coat-volume (flexible budget) formula in the form of y = a + bx.
If the number of expense items is very large, separate budgets may be needed for the selling and administrative functions.
Schedule 7
The Putnam Company – Selling & Administrative Expense Budget
| * | Assumed. It includes sales agents’ commissions, shipping, and supplies. |
| ** | Scheduled to be paid. |
| *** | Paid for in the quarter incurred. |
The Cash Budget
The cash budget is prepared for the purpose of cash planning and control. It presents the expected cash inflow and outflow for a designated time period. The cash budget helps management keep cash balances in reasonable relationship to its needs. It aids in avoiding unnecessary idle cash and possible cash shortages. The cash budget consists typically of four major sections:
1.The cash receipts section, which is cash collections from customers and other cash receipts such as royalty income and investment income.
2.The cash disbursements section, which comprises all cash payments made by purpose.
3.The cash surplus or deficit section, which simply shows the difference between the total cash available and the total cash needed including a minimum cash balance if required. If there is surplus cash, loans may be repaid or temporary investments made.
4.The financing section, which provides a detailed account of the borrowings, repayments , and interest payments expected during the budgeting period.
5.The investments section, which encompasses investment of excess cash and liquidation of investment of surplus cash.
Schedule 8
To illustrate, we will make the following assumptions:
Putnam Company has an open line of credit with its bank, which can be used as needed to bolster the cash position.
The company desires to maintain a $10,000 minimum cash balance at the end of each quarter. Therefore, borrowing must be sufficient to cover the cash shortfall and to provide for the minimum cash balance of $10,000
All borrowings and repayments must be in multiples of $1,000 amounts, and interest is 10 percent per annum.
Interest is computed and paid on the principal as the principal is repaid.
All borrowings take place at the beginning of a quarter, and all repayments are made at the end of a quarter.
No investment option is allowed in this example. The loan is self-liquidating in the sense that the borrowed money is used to obtain resources that are combined for sale, and the proceeds from sales are used to pay back the loan.
Note: To be useful for cash planning and control, the cash budget must be prepared on a monthly basis.
The Putnam Company – Cash Budget
| * | $19,000 (from the balance sheet 20A). |
| ** | The company desires to maintain a $ 10,000 minimum cash balance at the end of each quarter. Therefore, borrowing must be sufficient to cover the cash shortfall of $19,325 and to provide for the minimum cash balance of $10,000, for a total of $29,325. |
| *** | The interest payments relate only to the principal being repaid at the time it is repaid. For example, the interest in quarter 3 relates only to the interest due on the $30,000 principal being repaid from quarter 1 borrowing and on the $15,000 principal being repaid from quarter 2 borrowing. Total interest being paid is $3,000, shown as follows: |
| $30,000 × 10% × 3/4= $2,250 | |
| $15,000 × 10% × 2/4=750 | |
| + $35,000 × 10% × 3/4= $3,000 |
The Budgeted Income Statement
The budgeted income statement summarizes the various component projections of revenue and expenses for the budgeting period. However, for control purposes the budget can be divided into quarters or even months depending on the need.
Schedule 9
The Putnam Company – Budgeted Income Statement
| * | Cost of goods manufactured = total manufacturing cost + beginning work in process inventory – ending work in process inventory. Since there are no work in process inventories in this illustration, cost of goods manufactured = total manufacturing cost. Thus cost of goods manufactured = direct materials used + direct labor + factory overhead = $61,000 (12,200 ibs. @$5 per lbs.—Schedule 3) + $305,000 (Schedule 4) + $134,200 (Schedule 5) = $500,200 |
| ** | Estimated |
The Budgeted Balance Sheet
The budgeted balance sheet is developed by beginning with the balance sheet for the year just ended and adjusting it, using all the activities that are expected to take place during the budgeting period. Some of the reasons why the budgeted balance sheet must be prepared are:
It could disclose some unfavorable financial conditions that management might want to avoid.
It serves as a final check on the mathematical accuracy of all the other schedules.
It helps management perform a variety of ratio calculations.
It highlights future resources and obligations.
We can construct the budgeted balance sheet by using:
The December, 20A balance sheet (Schedule 10)
The cash budget (Schedule 8)
The budgeted income statement (Schedule 9).
Putnam’s budgeted balance sheet for December 31, 20B, is presented below. Supporting calculations of the individual statement accounts are also provided. To illustrate, we will use the following balance sheet for the year 20A.
Schedule 10
The Putnam Company – Balance Sheet
| December 31, 20A | ||
| Assets | ||
| Current assets: | ||
| Cash | $ 19,000 | |
| Accounts receivable | 100,000 | |
| Materials inventory (490 lbs.) | 2,450 | |
| Finished goods inventory (200 units) | 16,400 | |
| Total current assets | $137,850 | |
| Plant and equipment: | ||
| Land | 30,000 | |
| Buildings and equipment | 250,000 | |
| Accumulated depreciation | (74,000) | |
| Plant and equipment, net | 206,000 | |
| Total assets | $343,850 | |
| Liabilities and Stockholders’ Equity | ||
| Current liabilities | ||
| Accounts payable (raw materials) | $ 6,275 | |
| Income tax payable | 60,000 | |
| Total current liabilities | $66,275 | |
| Stockholders’ equity: | ||
| Common stock, no par | $200,000 | |
| Retained earnings | 77,575 | |
| Total stockholders’ equity | 277,575 | |
| Total liabilities and stockholders’ equity | $343,850 |
The Putnam Company – Balance Sheet
Supporting computations:
| a. | From Schedule 8 (cash budget). |
| b. | $100,000 (Accounts receivable, 12/31/20A) + $900,000 (Credit sales from Schedule 1) − $892,000(Collections from Schedule 1) = $108,000, or 60% of 4th quarter credit sales, from Schedule 1 ($180,000 × 60% = $108,000). |
| c. | Direct materials, ending inventory = 520 pounds × $ 5 = $2,600 (From Schedule 3) |
| d. | From Schedule 6 (ending finished goods inventory budget). |
| e. | From the 20A balance sheet and Schedule 8 (no change). |
| f. | $250,000 (Building and Equipment, 12/31/20A) + $42,000 (purchases from Schedule 8) = $292,000. |
| g. | $74,000 (Accumulated Depreciation, 12/31/20A) + $16,000 (depreciation expense from Schedule 5) = $90,000. |
| h. | Note that all accounts payable relate to material purchases. $6,275 (Accounts payable, 12/31/20A) + $61,150 (credit purchases from Schedule 3) − $60,950 (payments for purchases from Schedule 3) = $6,475, or 50% of 4th quarter purchase = 50% ($12,950) = $6,475. |
| i. | From Schedule 9. |
| j. | From the 20A balance sheet and Schedule 8 (no change). |
| k. | $77,575 (Retained earnings, 12/31/20A) + $64,375 (net income for the period, Schedule 9) − $20,000 (cash dividends from Schedule 8) = $121,950. |
How is it used and applied?
A budget is a tool for both planning and control. At the beginning of the period, the budget is a plan or standard; at the end of the period, it serves as a control device to help the business manager measure performance against the plan so that future performance may be improved.
The major objectives of a budgeted system are to:
1.Set acceptable targets for revenues and expenses.
2.Increase the likelihood that targets will be reached.
3.Provide time and opportunity to formulate and evaluate options should obstacles arise.
4.Evaluate a variety of “what-if” scenarios (especially with the aide of computer software) in an effort to find the best possible course of action.
It is important to realize that with the aide of computer technology, budgeting can be used as an effective device for evaluation of “what-if” scenarios. This way managers should be able to move toward finding the best course of action among various alternatives through simulation. If the manager does not like what he sees in analyzing the budgeted financial statements in terms of various financial ratios such as liquidity, activity (turnover), leverage, profit margin, and market value ratios, he can always alter the contemplated decision and planning set. A ratio is a relationship of one amount to another. It relates financial statement components to each other.
10. What Is The Cost Structure?
Introduction
The ratio of variable costs to fixed costs measures the relationship between costs that change with volume and costs that do not change within the short term.
How is it computed?
Examples of variable costs are direct materials and direct labor used in producing a product. Examples of fixed costs are rent, insurance and property taxes.
Example
A business reports total variable costs of $800,000 and total fixed costs of $8,000,000. The ratio is 0.10. This in unfavorable, because it is difficult to reduce the fixed costs in the short run when business falls off.
How is it used and applied?
When there is idle capacity, additional volume may be produced but total fixed costs remains constant. However, fixed cost per unit decreases because total fixed cost is spread over more units. Total variable cost increases as more units are produced, but the variable cost per unit remains the same. In a nonmanufacturing environment, service hours are substituted for units produced.
The cost structure of the business indicates what costs may be cut if needed, as in a recessionary environment (e.g., the early 1990’s). The owner can more readily control and adjust variable costs than fixed costs.
See Sec. 54, Cost-Volume-Profit Analysis; Sec. 55, Contribution Margin Analysis; and Sec. 107, Operating Leverage.
11. Using Budgeting to Control Cash
Introduction
The cash budget presents the amount and timing of the expected cash inflows and out flows for a specified time period. It is a tool for cash planning and control and should be detailed enough that you know how much is required to run your business. If you can estimate cash flows reliably, you will be able to keep cash balances near a target level using fewer transactions.
The cash budget should be prepared for the shortest time period for which reliable financial information can be obtained. In the case of many businesses, this may be one week. However, it is also possible to predict major cash receipts and cash payments for a specific day.
How is it prepared?
The cash budget usually consists of four major sections:
1.The receipts sections, which is the beginning cash balance, cash collections from customers, and other receipts
2.The disbursements sections, which comprises all cash payments that are expected for the budgeting period
3.The cash surplus or deficit section, which shows the difference between the cash receipts section and the cash disbursements section
4.The financing section, which provides a detailed account of the borrowings and repayments anticipated during the budgeting period
If further financing is needed, the cash budget projections allow adequate lead-time for the necessary arrangements to be made.
Cash budgets are often prepared monthly, but there are no general, it should be long enough to show the effects of your business policies, yet short enough so that estimates can be made with reasonable accuracy. Table 11.1 shows the major elements of a cash budget.
The basis for predicting cash receipts is sales, whether from cash sales or collections from customer balances. An incorrect sales estimate will result in erroneous cash estimates. The sales prediction also influences the projected cash outlays for manufacturing cost, since production is tied to sales. The projection of operating expenses may be tied to the supplier’s payment terms.
Table 11.1: Important Components of a Cash Budget
| Cash inflows | |
| Operating: | Cash sales, collections from customer on account |
| Non-operating: | Investment income (dividend income, interest income), rental income, sales of assets, amount received from debt incurrence, royalty income |
| Cash outflows | |
| Operating: | Salaries expense, rent expense, purchase of materials and supplies, payments to vendors utilities expense |
| Non-operating: | Purchases of fixed assets, repayments of loans, tax expense, purchases of stock and bonds in other companies |
Example
| FRED’S SPORTS CENTER | |
| Cash BudgetJanuary 20×8 | |
| Cash balance, Jan. 1 | $50,000 |
| Add: Cash receipts from customers | 150,000 |
| Cash available | $ 200,000 |
| Less: Cash payments | |
| For inventory | $ 40,000 |
| Rent | 10,000 |
| Insurance | 5,000 |
| Utilities | 3,000 |
| Purchase of equipment | 2,000 |
| Salaries | 12,000 |
| Taxes | 10,000 |
| Total cash payments Cash balance, Jan. 31 | $ 90,000$ 110,000 |
How is it used and applied?
The cash budget allows you to review future cash receipts and cash payments to identify possible patterns of cash flows. In this way, you can examine your collection and disbursement efforts to ascertain if you are maximizing your net cash flows. Further, the cash budget reveals when and how much to borrow and when you will be able to pay the money back. For instance, if your cash budget indicates that a large cash outlay will be needed to purchase assets such as store fixtures, you may have to borrow money and determine a debt repayment schedule. In order to obtain a credit line lenders usually required you to submit a cash budget, among with your financial statements.
Comparing estimated and actual cash figures allows you to study the reasons for any major discrepancies and to take any corrective action. Variance analysis gives you an idea of your cash position and provides insight in improving cash estimates in the next budgeting period. It also aids in the periodic revision of projections. This updating usually occurs at the beginning of each budget segment (e.g., the first day of a quarter, or the first day of a month). Budgets should be modified immediately for significant changes. Table 11.2 shows a format that may be used for variance analysis.
Variance analysis is important for a business, whether it be a retailer, wholesaler, manufacturer, or service concern. Evaluation of cash variances may be performed yearly, quarterly, monthly, or daily. If theft is suspected, variance analysis should be done frequently. After all, cash is the easiest asset to steal.
Table 11.2: Variance Analysis Report for Cash Budgeting
12. Forecasting Cash Collections
Introduction
A forecast of cash collections and potential bad debts is an essential part of cash budgeting. The critical step in making such a forecast is estimating the cash collection and bad debt percentages and applying them to sales or accounts receivable balances.
How is it computed?
The historical trend in cash collections relative to sales should be examined for the past three years. An example illustrates the technique.
Example 1
Assume that an analysis by Mr. Jones, the owner of a clothing store, of collection experience for August sales revealed the following collection data:
| Description | Percent of total credit sales | |
| Collected in | August | 2.3 |
| September | 80.2 | |
| October | 9.9 | |
| November | 5.1 | |
| December | 0.5 | |
| Cash discounts | 1.0 | |
| Bad debt losses | 1.0 | |
| Total | 100.0 |
If next year’s August sales are expected to fall into the same pattern, then the calculated percentage for August credit sales can be used to determine the probable monthly distribution of collections. The same analysis applied to each month of the year will give a reasonably reliable basis for collection forecasting. The worksheet (August column) for cash collections might look as follows:
The following example illustrates how cash collection rates are used to generate a forecast of the cash collection porting of the cash budget.
Example 2
The following data are given for Sharpe’s Clothing Store:
Past experience based on the aging of accounts receivable indicates that collections normally occur in the following pattern:
No collections are made in the month of sales.
80 percent of the sales are collected in the second following month.
19 percent of sales are collected in the second following month.
1 percent of sales are uncollectible.
The total cash receipts for November and December are computed as follows:
| November | December | |
| Cash receipts | ||
| Cash sales | $ 8,000 | $ 6,000 |
| Cash collections | ||
| September sales | ||
| $50,000 × 19% | 9,500 | |
| October sales | ||
| $48,000 × 80% | 38,400 | |
| $48,000 × 19% | 9,120 | |
| November sales | ||
| $62,000 × 80% | 49,600 | |
| Total cash receipts | $55,900 | $64,720 |
How is it used and applied?
The forecasting of cash collections is important in predicting whether sufficient cash will be available to meet expenditure needs. Further, the more quickly cash is received from customers, the less is the risk of noncollection. In addition, a return can be earned on the cash received early.
13. “What-if” Analysis
Introduction
Managers make decisions in the fact of uncertainty or risk. The environments in which they operate are subject to change without notice. It is therefore advisable to set up “what-if: scenarios and analyze them with the aid of computer software.
How is it computed?
Many “what-if” scenarios can be evaluated using the concepts of contribution margin as a tool for profit planning. Contribution margin is the difference between sales and the variable cost of a product or service; it is the amount of money available to cover fixed costs and generate profits.
Example 1
To illustrate a ‘what-if: analysis, consider the following data for the Allison Toy Store:
Let us suppose that, in an effort to stimulate sales, the owner is considering cutting the unit price by $5 and increasing the advertising budget by $1000. If these two steps be taken? To answer the question, you may construct a proposed income statement as follows:
The answer is yes, since these two steps will increase net income by $500.
Example 2
Delta Gamma Manufacturing wishes to prepare a 3-year projection on net income using the following information:
1.20×8 base-year amounts are as follows:
| Sales revenues | $4,500,000 |
| Cost of sales | 2,900,000 |
| Selling and administrative expenses | 800,000 |
| Net income before taxes | 800,000 |
2.Using the following “what-if: assumptions:
Sales revenues increase by 6 percent in 20×9, 7 percent in 20×10, and 8 percent in 20×11.
Cost of sales increases by 5 percent each year.
Selling and administrative expenses increase only 1 percent in 20×9 and will remain at the 20×9 level thereafter.
The income tax rate is 46 percent.
Figure 13.1 shows a spreadsheet for the pro forma income statement for the next 3 years. Using a spreadsheet program such as Excel allows managers to evaluate various “what-if” scenarios.
Figure 13.1: Delta Gamma Manufactures: three-year income projections (20×8-20×11)
Can a Computer Help?
Performing “what-if: analyses without the aid of a computer is almost impossible. “What-if” software includes:
1.Spreadsheet programs such as: Lotus 1-2-3, Microsoft’s Excel, and Quattro Pro.
2.Cash management and accounting software such as Quicken and Up Your Cash Flow.
3.Decision-support and budgeting software such as: Adaptive Planning, ®Risk, and BudgetMaestro.
How is it used and applied?
The cash budget would be incomplete if it were based on only one set of estimated cash inflows and cash outflows. These figures may well be expected cash flows or even most likely estimates, but we need to consider the possibility of errors or variability in cash flow estimates. Table 13.2 lists the principal known and uncertain cash flows.
The variability in cash flows can be handled by ‘what-if” analysis or by optimistic/ pessimistic forecasts. For example, what if your cash sales were, say, 10 percent higher, or lower, than originally expected? A cash budget prepared for a worst-case scenario might be quite useful. It may also allow you to plan better for difficult times.
Table 13.1: Certain and Uncertain Cash Flows
| Known cash flow | Uncertain cash flow |
| Interest receipts | Cash sales |
| Rent | Collections |
| Payroll | Payable payments |
| Tax Payments | |
| Interest Payments | |
| Loan repayments | |
| Purchase of long-term assets |
14. Budget Accuracy Ratios
Introduction
The accuracy of a budget may be evaluated by comparing budget figures to actual figures. The closer the actual amounts are to the estimates, the better is the budget process and the greater is the reliance that may be placed on future projections.
How is it computed?
Example
An owner budgeted profit for $800,000, but the business actually earned $1,000,000. The reasons for this favorable result might be one or more of the following:
Higher revenue and/or fewer expenses than predicted. The higher revenue might be due to excellent salesperson efforts. The lower expenses might have risen from a cost-reduction program.
The intentional underestimation of the budgeted profits, so that when actual sales exceed budgeted sales the manager looks good.
Poor planning due to the failure to properly take historical and current factors into account when making up the budget.
How is it used and applied?
There is no assurance that a plan designed to increase earnings will in fact do so. However, if actual profits exceeds budgeted profits, the owner has achieved the profit goal. This may arise because of greater revenue than expected, or better control over costs than anticipated.
By comparing actual to budgeted amounts, the owner can determine whether the business plans are sound. If not, improvements in the planning process are needed. Perhaps the planning is over-optimistic or unrealistic. On the other hand, the problem may lie with an inclination to overspend and/or waste. The expense deviation should be related to that of sales. Perhaps all that has happened is simply that expenses went up because sales revenue increased. In that case, the result is expected and no negative sign exists.
