Chapter Seven

Planning for Profit andCost Control

Three Levels of Planning

1.1. Strategic planningStrategic planning involves making long-term involves making long-term decisions such as defining the scope of the decisions such as defining the scope of the business, determining which products to business, determining which products to develop or discounting, and identifying the develop or discounting, and identifying the most profitable markets.most profitable markets.

2.2. Capital budgetingCapital budgeting focuses on intermediate focuses on intermediate range planning and involves decisions as range planning and involves decisions as whether to buy or lease equipment, whether to whether to buy or lease equipment, whether to stimulate sales, or whether to increase stimulate sales, or whether to increase company assets.company assets.

3.3. Master budgetMaster budget describes short-term objectives describes short-term objectives in specific sales targets, production goals, and in specific sales targets, production goals, and financing plans.financing plans.

1.1. Strategic planningStrategic planning involves making long-term involves making long-term decisions such as defining the scope of the decisions such as defining the scope of the business, determining which products to business, determining which products to develop or discounting, and identifying the develop or discounting, and identifying the most profitable markets.most profitable markets.

2.2. Capital budgetingCapital budgeting focuses on intermediate focuses on intermediate range planning and involves decisions as range planning and involves decisions as whether to buy or lease equipment, whether to whether to buy or lease equipment, whether to stimulate sales, or whether to increase stimulate sales, or whether to increase company assets.company assets.

3.3. Master budgetMaster budget describes short-term objectives describes short-term objectives in specific sales targets, production goals, and in specific sales targets, production goals, and financing plans.financing plans.

Advantages of Budgeting

BudgetingBudgetingBudgetingBudgeting

PromotesPromotesPlanningPlanningPromotesPromotesPlanningPlanning

PromotesPromotesCoordinationCoordination

PromotesPromotesCoordinationCoordination

EnhancesEnhancesPerformance Performance MeasuremenMeasuremen

tt

EnhancesEnhancesPerformance Performance MeasuremenMeasuremen

tt

EnhancesEnhancesCorrective Corrective

ActionsActions

EnhancesEnhancesCorrective Corrective

ActionsActions

Budgeting and Human Behavior

Upper management must be sensitive to the impact of the budgeting process on employees.

Budgets are Budgets are constraining. constraining.

They limit They limit individual individual

freedom in favor freedom in favor of an established of an established

plan.plan.

Budgets are Budgets are constraining. constraining.

They limit They limit individual individual

freedom in favor freedom in favor of an established of an established

plan.plan.

Many people find Many people find evaluation based evaluation based

on budget on budget expectations expectations

stressful. Think of stressful. Think of students and students and

exams.exams.

Many people find Many people find evaluation based evaluation based

on budget on budget expectations expectations

stressful. Think of stressful. Think of students and students and

exams.exams.Upper management must demonstrate Upper management must demonstrate

that budgets are sincere efforts to that budgets are sincere efforts to express realistic goals employees are express realistic goals employees are

expected to meet.expected to meet.

Upper management must demonstrate Upper management must demonstrate that budgets are sincere efforts to that budgets are sincere efforts to

express realistic goals employees are express realistic goals employees are expected to meet.expected to meet.

Cashpaymentsfor S & A

Cashpayments

for inventory

Inventorypurchases

budget

IncomeStatement

S & Aexpensebudget

BalanceSheet

Cashreceipts

Salesbudget

Cashbudget

Statement ofCash Flows

Cash Receiptsand Payments

Schedules

OperatingBudgets

Pro formaFinancial

StatementsStartStart

Sales Budget

Detailed schedule prepared by the marketing department showing expected

sales for the coming periods and expected collections on those sales. It is critical to

the success of the entire budgeting process.

Inventory Purchases Budget

The total amount of inventory needed for each month is equal to the amount of the cost of budgeted sales plus the desired

ending inventory.

Selling and Administrative Expense Budget

The details of the Selling and Administrative (S&A) Budget are shown on the next two screens. It is important to note that sales

commissions (based on 2% of sales) are paid in the month following the sale, while supplies

expense, based on 1% of sales) are paid in the month of the sale. The utility expense is paid in the month following the usage of the

electricity, gas, and water.

The details of the Selling and Administrative (S&A) Budget are shown on the next two screens. It is important to note that sales

commissions (based on 2% of sales) are paid in the month following the sale, while supplies

expense, based on 1% of sales) are paid in the month of the sale. The utility expense is paid in the month following the usage of the

electricity, gas, and water.

Check Yourself

Astor Company expects to incur the following Astor Company expects to incur the following operating expenses during September: Salary operating expenses during September: Salary Expense, $25,000; Utility Expense, $1,200; Expense, $25,000; Utility Expense, $1,200; Depreciation Expense, $5,400; and Selling Expense, Depreciation Expense, $5,400; and Selling Expense, $14,000. It pays operating expenses in cash in the $14,000. It pays operating expenses in cash in the month in which it incurs them. Based on this month in which it incurs them. Based on this information, the total amount of cash outflow information, the total amount of cash outflow reported in the Operating Activities section of the pro reported in the Operating Activities section of the pro format Statement of Cash Flows would be:format Statement of Cash Flows would be:

a.a. $45,600.$45,600.

b.b. $31,600.$31,600.

c.c. $40,200.$40,200.

d.d. $44,400$44,400

Depreciation Expense is a non-cashDepreciation Expense is a non-cashcharge to income and will not appearcharge to income and will not appear

on the Statement of Cash Flows.on the Statement of Cash Flows.

Depreciation Expense is a non-cashDepreciation Expense is a non-cashcharge to income and will not appearcharge to income and will not appear

on the Statement of Cash Flows.on the Statement of Cash Flows.

Pro Forma Income Statement

The pro forma income statement gives management an estimate of the expected

profitability of HH. If the project appears to be unprofitable, management can make the

decision to abandon it. Although managers remain responsible for data analysis and

decision making, computer technology offers powerful tools to asset in those tasks.

Pro Forma Statement of Cash Flows

Almost all the information for the Pro Forma Statement of Cash Flows can be

found on the Cash Budget.

End of Chapter Seven