Our Lady of the Pillar College - San Manuel, Inc.

DISTRICT 3, SAN MANUEL, ISABELA, PHILIPPINES

E-mail: nuestrasenioradelpilar@[Link]

Short-term Budgeting

Budget – a detailed plan that translates the company’s objectives into financial terms. It involves
identifying the resources and expenditures that will be required over a limited planning horizon,
which can be broken into shorter periods. It specifies how resources will be acquired and used
during a specified period of time.

Purposes of Budgeting
1. Planning – A budget forces the individuals who make up an organization to plan ahead.
2. Facilitating Communication and Coordination – For effectivity, each manager throughout an
organization must be aware of the plans made by other managers. The budgeting process pulls
together the plans of each manager in an organization.
3. Allocating Resources – Note that not all resources have unlimited capacities. For those with
limited capacities, budgets provide a means of allocating resources among competing uses.
4. Controlling Profit and Operations – A budget serves as a useful benchmark with which actual
results can be compared.
5. Evaluating Performance and Providing Incentives – Comparing actual results with budgeted
results will help managers evaluate the performance of individuals, departments, divisions or entire
companies. Budgets could also be used to provide incentives for people to perform well.

Based from the above discussion, budgeting encompasses the planning, control and
performance evaluation functions of management.

Benefits of Budgeting

1. Thinking ahead. It forces managers to look ahead and address potential problems.
2. Communication. It provides a mechanism for managers to share expectations and priorities for
the future. Because budgets span the entire organization, they require managers from different
functional areas to communicate and coordinate their activities.
3. Motivation and rewarding. It motivates employees to work hard to meet the company’s
objectives. It may also serve as a useful benchmark for evaluating and rewarding employee
performance.

Terminologies
1. Participative budgeting. Involves employees at all levels of the organization in the budgeting
process. It allows employees throughout the organization to have input into the budget-setting
process. This is a bottom-up approach. It is more likely to motivate people to work toward an
organization’s goals than a top-down approach.
2. Top-down approach. A budgeting approach which top management sets the budget and
imposes it on lower levels of the organization.
3. Budgetary slack. Making the budget look good by either understating expected sales or
overstating budgeted expenses.
4. Zero-based budgeting. The process of developing budget estimates by requiring all levels of
management to estimate sales, production, and the other operating data as though operations were
being initiated for the first time.
5. Continuous budgeting. A variant of fiscal-year budgeting whereby a twelve-month projection
in the future is maintained at all times. It is updated monthly or quarterly and where one month or
quarter is dropped, another is added.
6. Flexible budgeting. A budget that presents the plan for a range of activity so that the plan can
be adjusted for changes in activity levels.
7. Static budget. A budget that is established at the beginning of the period and not adjusted for
different levels of actual sales activity.
8. Incremental budgeting. Setting the budget allowances based on prior year expenditures.
9. Life-cycle budget. A budgeting tool or process in which estimates of revenues and expenses are
prepared for each product beginning with the product’s research and development phase and traced
through its customer support phase.
10. Kaizen budgeting. The budgeting process where the budget is based not on the existing
system, but on changes or improvements that is to be made. It assumes the continuous
improvement of products and processes.

Note: The ideal financial planning process would be a combination of top-down and bottom-up
planning.

Ways to minimize dysfunctional behaviors in budgeting

1. Use different budgets for planning rather than for performance evaluation.
2. Use a continuous, or rolling, budget approach. Management automatically adds another budget
when one budget period passes. This approach keeps managers in continuous planning mode and
always looking into the future.
3. Use a zero-based budgeting approach. Under this approach, the budget must be constructed from
scratch each period rather than starting with the last period’s actual results. This approach is time
consuming, but makes managers justify their budget each year.

Types of Budgets (Different types of budgets serve different purposes)

1. Master budget or profit plan – a comprehensive set of budgets covering all phases of an
organization’s operations for a specified period of time.
2. Budgeted financial statements – show how organization’s financial statements will appear at
a specified time if operations proceed according to plan.
3. Capital budget – plan for the acquisition of capital assets (e.g. buildings and equipment).
4. Financial budget – plan that shows how the organization will acquire its financial resources

Master budget – a comprehensive set of budgets that covers all phases of an organization’s
planned activities for a specified period of time. Within the master budget, individual budgets can
be classified as either operating budgets or financial budgets.
• Operating budgets – covers the organization’s planned operating activities for a
particular period including expected sales, production, raw materials purchases, direct
labor, manufacturing overhead and selling and administrative expenses. When all these are
combined, they form a budgeted income statement, which represents management’s
expectation of net operating income.
• Financial budgets – focus on the financial resources needed to support operations.

Preparation of Operating Budgets

• Sales Budget – This is the starting point for the master budget. Information based on a variety
of sources, including prior sales, industry trends, and planned marketing activities are typically
provided by the sales department. Budgeted sales revenue is calculated by multiplying the number
of units expected to be sold by the budgeted sales price.
• Production Budget – This budget shows the number of units that are to be produced during a
budget period. It is based on the sales budget and the amount of inventory managers want to have
on hand at the beginning and end of each period. In effect, it serves as the bridge between the sales
budget and the operational budgets that plan for spending on production. Budgeted unit sales +
Budgeted ending finished goods – Budgeted beginning finished goods = Budgeted production.
• Raw Materials Purchases Budget – This depends on budgeted production needs and on planned
levels of beginning and ending raw materials inventory. This budget would show us the number of
units and the cost of material to be purchased and used during a budget period. The formula is:
Raw materials needed for production + Budgeted ending raw materials inventory – Budgeted
beginning raw materials inventory = Budgeted raw materials purchases.

• Direct Labor Budget – In our Direct Labor budget, we compute for the cost for direct labor by
multiplying the amount of direct labor hours needed for the period by the direct labor rate. The
direct labor hours needed is computed by multiplying the amount of time needed for each unit by
the number of units needed to be produced.
• Manufacturing Overhead budget – This budget shows us the variable and fixed manufacturing
overhead incurred by the Company based on the budgeted production acquired in the production
budget. As regards the variable overhead, we just multiple the variable overhead rate per unit to
the budgeted production per period. As regards the fixed manufacturing overhead, we just allocate
the annual fixed overhead to the period.
• Budgeted cost of goods sold – this budget reflects all the costs incurred to make a physical
product, including direct materials, direct labor, and manufacturing overhead. In order to prepare
this budget, we need to determine the full manufacturing cost of each unit produced.
• Selling and Administrative Expense Budget – includes all costs related to selling the product and
managing the business. It is almost the same as the Overhead budget.
• Budgeted income statement – Combination of all the budgets prepared:
Budgeted sales revenue P xx
Budgeted CGS (xx)
Budgeted Gross profit P xx
Budgeted Operating expenses (xx)
Budgeted Operating income P xx

Financing budgets. After developing sales and operational budgets, a Company knows where its
money will be coming from and where it will go. We prepare financing budgets to project cash
flow and identify likely cash shortfalls and surpluses.
• Cash receipts budget – It provides information about the cash flows into the company based on
sales of its service or products (even from cash contributions and grants, in case of nonprofit
organizations). Most cash receipts come from customer sales. Remember, however, that sales
revenue is recognized when revenue is earned, not when cash is received. Make it a point to
account only for cash received, not revenue recognized. It is important to note and segregate what
amount of sales revenue may be obtained through cash sales and through credit sales. Cash sales
are obviously cash receipts during the period it was received. Credit sales, on the other hand would
depend on the credit terms. Collections from credit sales may be received during the period of sale
or maybe even after the period of sale. Make sure to account for both.
• Cash disbursement budget – This budget depends on the spending plans reflected in several
operational budgets (including RM purchases budget, direct labor budget, manufacturing overhead
budget and selling and administrative expenses budget). This budget shows the amount to be paid
to suppliers, employees and other parties. Most of the information for cash payments comes from
the operating budgets, including the raw materials purchases budget, the direct labor budget, the
manufacturing overhead budget, and the selling and administrative expense budget.
• Cash budget – This is a summary of the various cash inflows and outflows from operations. It
plays a critical role in planning the firm’s cash needs. By predicting its net cash position at frequent
points during the planning period, the firm can plan ahead. It can arrange sources of borrowing for
times when cash outflows exceed inflows, and it can plan to pay off borrowings and make
investments when cash flow reverses.

ILLUSTRATION. MARY ANN Co. The following is the sales forecast for the first three months
of the year:
January February March
Sales 100 units 300 units 150 units

In the year, sales price is expected to remain constant at P50 per unit. (In answering this problem,
assume continuity of the assumptions.)
1. Prepare a sales budget each month of the first quarter.

At the beginning of the year, there are 20 units in finished goods inventory and MARY ANN
maintains an ending finished goods inventory level equal to 10% of current sales.
2. Prepare a production budget each month of the first quarter.
Four kilograms of raw materials are required for each unit. A kilogram of this material costs P5.00.
Ending raw materials equal to 5% of current production are maintained. In December, 75 units
were produced.
3. Prepare a raw materials purchase budget each month of the first quarter.

A unit of finished good requires 2 direct labor hours at P3.00 per labor hour.
4. Prepare a direct labor budget each month of the first quarter.

A unit of finished good required 2 direct labor hours and variable overhead costs P5.00 per hour.
Fixed overhead is budgeted at P21 800 per annum.
5. Prepare a manufacturing overhead budget each month of the first quarter.
6. Prepare the budgeted cost of goods sold each month of the first quarter.

MARY ANN incurs sales commission equal to 1% of sales and fixed administrative expenses
incurred is estimated to be P100 per month.
7. Prepare a selling and administrative budget each month of the first quarter.
8. Prepare a budgeted income statement each month of the first quarter.

30% of the sales are made in cash, while 70% are on account. Of the sales on account, 25% are
paid in the month of sale, while 75%, in the month after sale. The beginning receivables balance
is P3 000.
9. Prepare a cash receipt budget each month of the first quarter.

Raw material purchases are made on account; 20% are paid in the month of purchase; 80% in the
month after purchase. Half of the direct labor costs are paid in the month of production; the
remaining amount, next month. Both variable and fixed manufacturing costs are presumed to be
paid as incurred. However, it includes an P816.67 monthly depreciation costs. At the beginning of
the month, Accounts payable balance is P2 000; wages payable, P400. Sales commissions are paid
upon collection of receivables. Fixed administrative expenses are presumed to be paid when
incurred.

10. Prepare a cash payment budget each month of the first quarter.

Beginning of the year cash balance is P3 000. A minimum of P2 000 should be maintained.
11. Prepare a cash budget

Problem 1. LARRY Corporation sells birdhouses. The company has prepared the following
forecast for the third quarter of 2023:
July 5,000
August 6,000
September 10,000

Inventory of finished goods in June 30, 2023 is budgeted at 1000 units. Management would like
the desired quantity of finished goods inventory at the end of each month to equal 20% of next
month’s budgeted sales. October’s projected sales are 12 000 units.

Each completed unit of finished product requires 3 square feet of raw materials at a cost of P15
per square foot. The company has determined that it needs 10% of next month’s raw material
needs on hand at the end of each month.
1. The cost of direct material that should be purchased in August is

Problem 2. JERRY Co. desires an ending inventory of P140 000. It expects sales of P800 000 and
has a beginning inventory of P130 000. Gross profit ratio is 35% of sales.
1. Determine the budgeted purchases.
Problem 3. VAN Inc. has projected sales to be P600 000 in January. P750 000 in February, and
P800 000 in March. VAN wants to have 50% of next month’s sales needs on hand at the end of
each month. VAN’s cost of sales to sales ratio is 60%.
1. Determine February purchases.

Problem 4. JM Company estimated sales of 40,000 units at P6 each. Budgeted cost of goods sold
per unit includes P1.20 of direct materials, six minutes of direct labor time at P15 per hour, and
unit overhead cost of P1.30. JM pays a sales commission of ten percent of sales revenue. Fixed
selling and administrative expenses are budgeted at P25,000. Prepare a statement of operating
income.
1. Budgeted variable marketing expense is?
2. Budgeted operating income is?
3. Recalculate budgeted operating income assuming fixed selling and administrative
expenses double and the selling price per unit increases 10%.

Problem 5. MITOSIS Holdings has P299 000 in accounts receivable on January 1, 2023.
Budgeted sales for January are P860 000. MITOSIS expects to sell 20% of its merchandise for
cash. Of the remaining sales, 75% are expected to be collected in the month of sale and the
remainder the following month.
1. What is the amount of cash collections from sales, in January?

Problem 6. CARDIO Trading expects its June sales to be P300 000, which is 25% higher than its
May sales. Purchases were P200 000 in May and are expected to be P240 000 in June. All sales
are on credit and are collected as follows: 80% in the month of the sale and 20% in the following
month. All payments in the month of sales are given 2% discount.

Sixty percent of purchases are paid in the month of purchase to take advantage of the purchase
term 1/10, n/40. The remaining amount is paid in the following month. The beginning cash balance
on June 1 is P20 000. Determine the following
1. Cash receipts for the month of June
2. Cash disbursements for the month of June
3. Ending cash balance on June 30
Problem 7. DER Corp will open a new store on January 1. Based on experience form its other
retail outlets, DER is making the following sales projections:
Cash Sales Credit Sales
January 600,000 400,000
February 300,000 500,000
March 400,000 600,000
April 400,000 800,000

DER Corp estimates that 70% of the credit sales will be collected in the month following the
month of the sale, with the balance collected in the second month following the sale.
1. Based on these data, the balance in accounts receivable on January 31 will be increased
by:

Problem 8. TRI STARR would like to prepare a summary cash budget for March. The following
data:
• The cash balance at March 1 is estimated to be P3 000
• March sales, all on account, are estimated to be P50 000. Sales are collected over a two month
period with 65% collected in the month of sale and the remainder in the subsequent month.
February sales on account were P60 000.
• Inventory purchases are expected to be P20 000 in March. The company pays for one-half of
inventory purchases in the month of purchase and the remainder in the subsequent month.
February’s purchases are P18 000.
• Cash disbursements for selling and administrative expenses are expected to be P4 000 in March.
• Depreciation expense for March is expected to be P5 000.
• Loan and interest payments for March are expected to be P25 000

1. What cash balance is expected by the end of March?

Problem 9. CRIZZLE Corporation’s budgeted income statement reflects the following amounts:

Sales Purchases Expenses

January P120,000 P78,000 P24,000
February 110,000 66,000 24,200
March 125,000 81,250 27,000
April 130,000 54,500 28,600

Sales are collected 50% in the month of sale, 30% in the month following sale, and 19% in the
second month following sale. One percent of sales is uncollectible and expensed at the end of the
year. CRIZZLE Pays for all purchases in the month following purchase and takes advantage of a
3% discount. The following balances are as of January 1:
Cash 88,000
Accounts receivable 58,000
Accounts payable 72,000

Of the AR balance, P35 000 will be collected in January and the remaining amount will be
collected in February. The monthly expense figures include P5 000 depreciation. The expenses
are paid in the month incurred.
1. Expected cash balance at the end of January
2. Budgeted cash receipts in February
3. Budgeted cash payments in February.