Chapter 16

Forecasting Short-Term (Operating)

Financial Requirements
Budget is a plan which sets forth the projected expenditures for a certain activity and explains
where the required funds will come from. (i.e., production budget presents a detailed analysis
of the required investments in materials, labor, and plant necessary to support the forecasted
sales level.)
- A financial plan of the resources needed to carry out tasks and meet financial goals. It is also a
quantitative expression of the goals of the organizations wishes to achieve and the costs of
attaining these goals.
Budgetary Control - use of budget to control a firms activities.
Purposes of Budgets:
1. Defining broad objectives and goals and formulating strategies to achieve such objectives.
2. Coordinating the activities of the organization by integrating the plans of the various parts
thereby pulling every one in the same direction.
3. Allocating resources to those parts of the organization where they can be used most
effectively.
4. Communicating managements approved plans throughout the organization.
5. Uncovering and preparing for potential bottleneck in the operations before they occur.
6. Motivating managers to achieve the desired results and
7. Setting a standard or benchmark for evaluating actual performance.
Advantages of Budgets:
1. It forces planning and exposes situations in which plans of subcomponents are inadequate to
attain the total organizations objectives.
2. It allows a reiterative process to bring the goals of the organization and the subcomponents
into agreement.
3. It provides a means of communicating organization goals down through the organization
and sub-unit operational limitations up through the organization.
4. It provides basis for financial planning, sub-unit coordination, resource acquisition, inventory
policy, scheduling, and output distribution.
5. It provides a basis by which activity can be monitored, with actual results being compared to
the planned results.
Disadvantages of Budgets:
1. Budgets tend to oversimplify the real situation and fail to allow for variations in external
factors. They do not reflect qualitative variables.
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Technological Institute of the Philippines - Manila

2. It is difficult to prepare a detailed budget for an organization that has never existed or for a
new division, product, or department of an existing firm.
3. There may be lack of higher and lower management commitment because of lack of
understanding of the fundamentals of budget preparation and utilization.
Types of Budget:
1. The Operating Budget
2. The Financial Budget
3. The Capital Budget
A. Operating Budget
1. Budgeted Income Statement
a. Sales Budget
b. Production Budget (1) Materials Cost Budget, (2) Direct Labor Cost Budget, (3) Factory
Overhead Budget, (4) Inventory Levels
2. Cost of Sales Budget
3. Selling and Administrative Expenses Budget
4. Financial Expense Budget
B. Financial Budget
1. Budgeted Statement of Financial Position
2. Cash Budget
3. Budgeted Statement of Sources and Uses of Funds
C. Investment Budget
Steps in Developing a Master Budget
1. Establish basic goals and long-range plans for the company. These will serve as guidelines in
the preparation of budget estimates.
2. Prepare a sales forecast for the budget period.
3. Establish the cost of goods sold and operating expenses.
4. Determine the effect of budgeted operating results on assets, liabilities, and ownership
equity accounts. The cash budget is the largest part of this step, since changes in many asset
and liability accounts will depend upon the cash flow forecast.
5. Summarize the estimated data in the form of a projected income statement for the budget
period and the projected statement of financial position as of the end of the budget period.

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Technological Institute of the Philippines - Manila

Operating Budget:
A. Sales Budget foundation on which all other short-term budgets are built,
- triggers a chain reaction that leads to the development of many other budget
figures in an organization
- provides the revenue predictions from which cash receipts from customers can
be estimated and supplies the basic data for constructing budgets for production costs
and selling and administrative expenses.
*The sales forecast is made after consideration of the ff. factors: past volume sales, general
economic and industry condition, relationship of sales to economic indicators, relative product
profitability, market research studies and competition, pricing, advertising, and other promotion
policies, production capacity, quality of sales force, seasonal variations, and long term sales
trends for various products.
Formula for Desired Sales Revenue:
Sales Revenue = Desired Sold Units x Sales Price per Unit
B. Production Budget after the sales budget has been set, a decision can be made on the level of
production that will be needed for the period to support sales and the production budget can be set as
well.
-becomes a key factor in the determination of other budgets, including the direct materials budget,
the direct labor budget, and the manufacturing overhead budget which in turn are needed in
formulating a cash budget.
Formula for Desired Production (units):
Units to be sold
Plus: Desired Ending Finished Goods Inventory
Less: Desired Beginning Finished Goods Inventory
Units to be produced

xx
xx
(xx)
xx

B.1 Raw Materials Budget prepared after the determining the number of units to be produced
Formula for Raw Materials needed in Production
Raw Materials needed in Production = Units to be produced x no. of raw materials needed to produce
finished goods inventory

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Technological Institute of the Philippines - Manila

Formula for Purchases of Raw Materials:

Units required for production = materials required per unit production X desired production units

Units required for Production

Add: Ending Materials Inventory
Less: Beginning Materials Inventory
Units to be purchased
Multiply:Unit Cost
Total Cost of Materials Purchases

xx
xx
(xx)
xx
xx
xx

B.2 Direct Labor Budget computed on the budgeted production during the period.

Total Direct Labor Hours = Budgeted Quantity Production (units) X Direct Labor Hours/unit

Direct Labor Cost = Direct Labor rate/hour X Total Direct Labor Hours
B.3 Factory Overhead Budget Unlike direct materials and direct labor which are usually classified as
purely variable costs, factory overhead costs are composed of both variable and fixed costs elements.
Some overhead items may be projected on the basis of direct labor hours or on materials costs or on
machine hours.
Budgeted Variable Manufacturing Overhead = Desired Production X Variable MBudanufacturing
Unit Cost
Total Budgeted Manufacturing Overhead = Budgeted Variable MOH +Budgeted Fixed MOH

2. Cost of Sales Budget is computed using the figures for production, materials, labor, factory
overhead and the beginning and ending inventories of finished goods.
Budgeted Direct Materials
Plus: Budgeted Direct Labor
Plus: Budgeted Factory Overhead
Total Manufacturing Costs
Plus: Beginning WIP inventory
Less: Ending WIP inventory
Total Total Cost of Goods Manufactured
Plus: Expected Finished goods beginning inventory
Less: Management
Desired Finished
Financial
1 goods ending inventory
CostInstitute
of Sales of the Philippines - Manila
Technological

xx
xx
xx
xx
xx
(xx)
xx
xx
(xx)
xx

3. Selling and Administrative Expenses As with overhead costs, marketing and administrative
expenses are also made up of fixed and marketing variable components.
Total Selling and Administrative Expenses = Variable SAE + Fixed SAE

B. Financial Budget
1. Cash Budget is a vital part of the financial budget because with this, management can more or less
foresee possible cash shortage or overage which may have a great impact on the overall operations
during the budget period.
Expected Cash Balance, Beginning

xxx

Add: Budgeted Cash Receipts

xxx

Total Cash Available

xxx

Less: Budgeted Cash Disbursements

Expected Cash Balance, ending

(xxx)
xxx

Cash Receipts may come:

-Cash Sales
-Collection of Accounts Receivable
-Loan Proceeds
-Additional Investment of owners/stockholders
-Sale of companys assets other than finished goods or merchandise
-Donations
-Interest or dividends on investments
Cash Disbursements may come:
-Cash Purchases of materials or merchandise
-Other manufacturing Costs
-Payment of Accounts Payable
-Operating Expenses
-Payment of Loans
-Dividends or withdrawals by owners/partners
-Acquisition of assets other than materials or merchandise (fixed assets)
-Donations
-Interest on Loans

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Technological Institute of the Philippines - Manila

2. Budgeted Income Statement

3. Budgeted Statement of Financial Position is developed by beginning with the current statement of
financial position and adjusting it for the data contained in other budgets.

Financial Management 1
Technological Institute of the Philippines - Manila