Management Accounting A Road of Discovery Management Accounting

Management Accounting: A Road of Discovery

Management Accounting: A Road of Discovery James T. Mackey Michael F. Thomas Presentations by: Roderick S. Barclay Texas A&M University - Commerce James T. Mackey California State University - Sacramento © 2000 South-Western College Publishing

Chapter 4 How much cash can we take? Developing cash budgets from proformas

Key Learning Objectives • Explain why proforma income statements and CVP analysis have to be translated into a cash budget. • Discuss the usefulness of budgets when cash inflows are known. • Prepare a schedule for cash collections from sales. • Develop operating budgets (schedules for purchases, labor, overhead, and operating expenses). • Create a monthly cash budget. • Describe how cash budgeting can affect motivation and control. 7. [Appendix A] Comment on spreadsheet usefulness in budgeting.

Profit and Cashflows are not the Same Thing n n n Profit = Revenues less Expenses. Cashflow = Deposits into and withdrawals from our bank account. Revenue is an increase in our assets attributed to our sales activities. Expenses are reductions in assets to earn revenue — and include noncash and cash expenses. Matching means we match revenue and expenses in the same period to determine our profit — the amount by which revenue exceeds expenses. The timing of cashflows does not necessarily match the recognition of revenue.

Why Plan? Cash and Operational Budgets n n Limited resources — we need to allocate our resources to create the greatest value. Uncertainty — we need to assure we have enough cash to pay our bills when due. (This is why we prepare cash budgets. ) Communication — we need to understand what we can accomplish and communicate to our employees what we expect. Evaluation — we need to set performance expectations and measure productivity.

The Cash Management Process n n Estimate cash inflows. Plan expenditures (cash outflows). Limit spending to budget (Cash control). Compare budgeted to actual cashflows (evaluation).

Planning Motivates Control Through Evaluation Planning Control Evaluation Strategic plan to define Motivate daily decisions, Balanced scorecard to what we want to communication, and evaluate the success of accomplish and how we coordination through the strategic plan. 2 are going to do it. 1 knowing actual Variance reporting for performance will be Cash budget to identify operations and cash compared to plan and the timing of cash management. 3 used as a basis for receipts and payments rewards. necessary for the strategic plan to work. • Control means getting people to do what you want them to do. The plan allows managers to understand what is possible and communicate to others. The budget is a basis for control.

Brian’s College Dilemma — Send Cash, Hurry! n n n Brian’s cash budget with limited uncertainty. See Exhibit 4 -3, p. 101. Brian has a timing problem with his cash flow.

Brian’s Next Try at a Budget Cash-ins Pell grant State university grant Scholarships Student loans Total financial aid From Mom and Dad’s payroll Cash-outs Tuition Books School fees Miscellaneous Living expenses Ending Cash Balance September $1, 300 800 500 1, 700 $4, 300 740 (1, 200) (500) (100) (71) (1, 150) $2, 020 Note: See Exhibit 4 -4, p. 104, for the remainder of Brian’s Second Draft of his budget.

Budgeting in an Uncertain Business World — Solvency Management n n n Once we have taken care of the internal management issues, we must forecast the flow of cash needed to operate as planned. This will likely take several iterations. We must balance the outward flow of cash with the inward flow of cash. We must take into account the timing of the cash inflows and outflows.

The Cash-to-Cash Operating Cycle for Multree’s Standard Homes Cash-ins Month 1 Month 2 Make sale and collect a 40% down payment. n Cash-outs Buy all of the direct materials; pay 1/2 this month. n Pay for 1/3 of the direct labor and variable overhead. n Pay monthly fixed overhead. n Pay sales commissions. n Pay for ½ of direct materials. n. Pay for 1/3 of the direct labor and variable overhead. n Pay monthly fixed overhead. n

The Cash-to-Cash Operating Cycle for Multree’s Standard Homes (Continued) Cash-ins Month 3 Cash-outs Pay for 1/3 of the direct labor and variable overhead. n Pay monthly fixed overhead. n Month 4 n Deliver house and collect 50% of sales price. Month 5 n Collect the last 10% of the sales price. Pay monthly fixed overhead. n Pay shipping cost. n Pay monthly fixed overhead. n Note that each transaction creates a ripple effect of cashflow over many periods. An illustration is supplied as Exhibit 4 -7, p. 109.

Factors Influencing the Need for Budgeting & Planning é é Factors increasing the value of cash budgeting Scarce or expensive resources; money, materials, labor, etc. Long manufacturing or delivery times. High operating uncertainty; unreliable suppliers, unskilled or unmotivated workers, poorly maintained machinery, etc. Complexity and variety; many different types of products or services, customers, or activities. ê ê Factors decreasing the value of cash budgeting Abundance of resources; lots of money in the bank, many available workers, highly qualified workers, plenty of materials, etc. Short cash-to-cash operating cycle; e. g. a grocery store. Highly reliable operating environment. Little variety of products, customers, or activities.

Budgeting Cashflows From Sales n n n Timing Differences — cashflows lag sales. Trends and cycles — Sales vary from month to month. To help understand this process, we use the following several slides to illustrate and discuss the operations of Carrie’s Snowblowers. Month October November December January February March Sales $ 40, 000 100, 000 300, 000 100, 000 40, 000 2, 000 Unit Sales 200 500 1, 500 200 10

Carrie’s Snowblowers n n (Continued) 30% of all sales are for cash, 60% of receivables are collected in the month following the sale, 35% are collected two months after the purchase, and the rest become bad debts. There are no accounts receivable outstanding at the beginning of October. Calculate the budgeted cashflows from sales for December, January and February. Cash collections for = 30% of the month. current sales + 60% of previous month’s credit sales + 35% of two month’s previous credit sales Cash collections for = 30% x December = $300, 000 = $141, 800 $90, 000 + 60% x (70% x $100, 000) = $42, 000 + 35% x (70% x $40, 000 = $9, 800 Cash collections for = 30% x January = $100, 000 = $180, 500 $30, 000 + 60% x (70% x $300, 000) = $126, 000 +35% x (70% x $100, 000) = $24, 500 Cash collections for February = $127, 500

Carrie’s Snowblowers n (Continued) Budgeting for Cash Disbursements on Purchases. n n n Because of the uncertainty of sales forecasts, the company has a policy of having 120% of the following month’s forecast sales available at the beginning of each month. Prepare the purchasing schedule for Carrie company from October, November, and December. The beginning inventory in October is 200 units. When inventories are carried that may change from time to time, a Balance equation is a useful planning tool. The Balance equation simply states that for planning purposes: ‘The unit available’ must equal ‘the units required’.

Carrie’s Snowblowers (Continued) Units Available = Period Sales Purchases for the period + Beginning inventories = Period Sales Thus: Purchase during the current month = Sales for the current month + (120% x next - (120% x month’s sales current month’s sales Purchases for October = 600 units = 200 units + 1. 2 x 500 units - 200 units Purchases for November = 1, 700 units = 500 units + 1, 800 units - 600 units Purchases for December = 300 units Purchases for January = 140 units + Ending Inventory + Ending Inventories

Carrie’s Snowblowers n (Continued) Purchases Schedule n n n Month October November December January February March Unit Purchases 600 1, 700 300 140 No budgeted purchases

Carrie’s Snowblowers (Continued) Cost of goods is $100 per unit Inventories are bought on credit. 45% are paid in the month of purchase and 55% are paid in the month following purchase. Accounts receivable at the beginning of October were $15, 000. Payments on payables = 45% x current month’s purchases + 55% x last month’s October payments = $42, 000 =. 45 x 600 units x $100 + $15, 000 (given) November payments = $109, 500 =. 45 x 1, 700 units x $100 +. 55 x 600 units x $100 December payments = $107, 000 =. 45 x 300 units x $100 +. 55 x 1, 700 units x $100 January payments = $22, 800 February payments = $7, 700

Carrie’s Snowblowers (Continued) Expenses on the income statement for Selling, General and Administrative costs include noncash expenses for depreciation of $15, 000. Monthly selling costs include a variable shipping cost of $5 per unit. The fixed expenses for SG&A are $40, 000 a month. Payments for SG&A = $5 x sales units + total fixed expenses – noncash expenses = $5 x sales units + ($40, 000 – $15, 000) Payments in October = $5 x 200 units + $25, 000 = $26, 000 Payments in November = $5 x 500 units + $25, 000 = $27, 500 Payments in December = $5 x 1, 500 units + $25, 000 = $32, 500 Payments in January = $5 x 500 + $25, 000 = $27, 500 Payments in February =? = $26, 000 Payments in March =? = $25, 050

Carrie’s Snowblowers (Continued) Capital and Irregular Payments. In November, Carrie company buys new machinery for $20, 000 in cash and $5, 000 a month for the succeeding four months. Payments in October Payments in November = $20, 000 Payments in December = $ 5, 000 Payments in January = $ 5, 000 Payments in February = $ 5, 000 Payments in March = $ 5, 000 Due to operating uncertainties and forecasting errors in the past, Carrie Company has a policy of having at least $20, 000 in cash at the beginning of each month even if this means borrowing the money. Beginning cash + Cash receipts = Cash payments + Ending cash Cash available = Cash required

Carrie’s Snowblowers (Continued) Cash Budget for Carrie Company — 4 th Quarter October Beginning Cash Balance November December 4 th Quarter $40, 000 $20, 000 $ 40, 000 Sales and Receivables $12, 000 $46, 800 $141, 800 $200, 600 Total cash available $52, 000 $66, 800 $161, 800 $240, 600 $42, 000 $109, 500 $107, 000 $258, 500 26, 000 27, 500 32, 500 86, 000 20, 000 5, 000 25, 000 Cash collections: Less cash disbursements: Purchases SG&A Capital equipment Total cash requirements $68, 000 $157, 000 $144, 500 $369, 500 Excess (Deficit) (16, 000) (90, 200) 17, 300 (128, 900) Borrowings (Repayments) $36, 000 $110, 200 $ 2, 700 $148, 900 Ending Balance $20, 000 $ 20, 000

Carrie’s Snowblowers (Continued) Fourth Quarter Income Statement, Carrie Company Sales 2, 200 units x $200 $440, 000 Cost of Sales 2, 200 units x $100 220, 000 Gross margin 220, 000 Less: SG&A Cash and noncash Interest payable 1% per month on outstanding balance Net income 131, 000 3, 311 $ 85, 689 Why does the company have to borrow money when it is so profitable?

What Makes the Budgeting Process Successful? n Top management commitment. n n n Budgeting is part of overall good management. It operationalizes the strategic plan. It guides day-to-day operational control It is the basis for performance evaluation. Communication to employees about how the strategic plan is going to work. n n n Forces everyone to plan. Formalizes the planning process. Provides for financial resource allocations. (Continued)

What Makes the Budgeting Process Successful? (Continued) n Gain Employee commitment. n n n Coordination of value chain processes. n n n Employees participate in determining the budget. Employees are rewarded for good cash management Determine how change in the sales forecast affects purchasing and production processes. Effect on administrative support processes from changes in production schedules. Use the budget. n n Continuously update the budget for changing circumstances Budget only for programs that add value.

Comparing Participative and Authoritative Budgeting Goals Participative Authoritative Get needed information. If best source is employees. If best source is top management. Minimize time and effort Time and effort increase with more people involved. Less people involved speeds up the process. Communicate budget information throughout organization and coordinate operations. Accomplished by twoway information flows (back and forth between workers and managers). Plans understood because workers involved from the beginning of the process. Downward flow only passes top management information to workers. Because budget is imposed extra explanation and instruction may be needed for coordination.

Comparing Participative and Authoritative Budgeting Goals Participative Authoritative Budget commitment Through participation and negotiation. Communication fosters better understanding of strategic plan. Must come from already existing loyalty to organization. Limited understanding of how budget is linked to strategic plan. Motivation to do better than the budgets. Participation leads to higher motivation if individual performance is important within the corporate culture. The budget is not an important motivator if the corporate culture is characterized by workers’ pre-existing dedication to the organization. Driving out slack. Participation and peer pressure through information sharing. Continuous and zerobased budgets Don’t allow private lobbying. Continuous and zerobased budgets.