In this Operating Budget section, we will discuss the following budgets:<\/p>\r\n\r\n
Formal sales forecasting techniques often involve the use of statistical tools. For example, to predict sales for the coming period, management may use economic indicators (or variables) such as the gross national product or gross national personal income, and other variables such as population growth, per capita income, new construction, and population migration.<\/p>\r\n
To use economic indicators to forecast sales, a relationship must exist between the indicators (called independent variables) and the sales that are being forecast (called the dependent variable). Then management can use statistical techniques to predict sales based on the economic indicators.<\/p>\r\n
Management often supplements formal techniques with informal sales forecasting techniques such as intuition or judgment. In some instances, management modifies sales projections using formal techniques based on other changes in the environment. Examples include the effect on sales of any changes in the expected level of advertising expenditures, the entry of new competitors, and\/or the addition or elimination of products or sales territories. In other instances, companies do not use any formal techniques. Instead, sales managers and salespersons estimate how much they can sell. Managers then add up the estimates to arrive at total estimated sales for the period.<\/p>\r\n
Usually, the sales manager is responsible for the sales budget and prepares it in units and then in dollars by multiplying the units by their selling price. The sales budget in units is the basis of the remaining budgets that support the operating budget.<\/p>\r\n
We will be illustrating the step-by-step preparation of a master budget for Leed Company, which manufactures low-priced running shoes.\u00a0 Most companies develop the sales budget in units and sales dollars because the remaining budgets will use both sales units and sales dollars.<\/p>\r\n
To illustrate this step, assume that Leed\u2019s management forecasts sales for the year at 100,000 units (each pair of shoes is one unit). Quarterly sales are expected to be 15,000, 40,000, 20,000, and 25,000 units, reflecting higher demand for shoes in the late spring and again around Christmas.\u00a0 The selling price for each pair of shoes forecasted at $40. Leed's sales budget would be prepared as by showing the sales unit for each quarter x budgeted sales price to get the sales in dollars.\u00a0 The totals for the year are added from each quarter.<\/p>\r\n\r\n
Leed Company\u00a0\u00a0\u00a0\u00a0\u00a0<\/strong><\/td>\r\n<\/tr>\r\n| Sales Budget\u00a0\u00a0\u00a0\u00a0\u00a0<\/strong><\/td>\r\n<\/tr>\r\n | <\/td>\r\n | Qtr 1<\/strong><\/td>\r\n | Qtr 2<\/strong><\/td>\r\n | Qtr 3<\/strong><\/td>\r\n | Qtr 4<\/strong><\/td>\r\n | YEAR<\/strong><\/td>\r\n<\/tr>\r\n | Sales in Units<\/td>\r\n | 15,000<\/td>\r\n | 40,000<\/td>\r\n | 20,000<\/td>\r\n | 25,000<\/td>\r\n | 100,000<\/td>\r\n<\/tr>\r\n | Budgeted price<\/td>\r\n | \u00a0 \u00a0 x $40<\/span><\/td>\r\n | \u00a0x $40<\/span><\/td>\r\n | x $40<\/span><\/td>\r\n | x $40<\/span><\/td>\r\n | <\/td>\r\n<\/tr>\r\n | Sales in Dollars<\/td>\r\n | $600,000<\/td>\r\n | $1,600,000<\/td>\r\n | $800,000<\/td>\r\n | $1,000,000<\/td>\r\n | $4,000,000<\/td>\r\n<\/tr>\r\n<\/tbody>\r\n<\/table>\r\n | Production budget<\/strong> The production budget<\/span><\/strong> considers the units in the sales budget and the company's inventory policy. Managers develop the production budget in units and then in dollars. Determining production volume is an important task. Companies should schedule production carefully to maintain certain minimum quantities of inventory while avoiding excessive inventory accumulation. The principal objective of the production budget is to coordinate the production and sale of goods in terms of time and quantity.<\/p>\r\n Companies using a just-in-time inventory system need to closely coordinate purchasing, sales, and production. In general, maintaining high inventory levels allows for more flexibility in coordinating purchases, sales, and production. However, businesses must compare the convenience of carrying inventory with the cost of carrying inventory; for example, they must consider storage costs and the opportunity cost of funds tied up in inventory.\u00a0 Watch this video for an example of how to create a production budget.<\/p>\r\nhttps:\/\/youtu.be\/YwIUeaFkOS8\r\n Firms often subdivide the production budget into budgets for materials, labor, and manufacturing overhead, which we will discuss in the manufacturing budgets. Usually materials, labor, and some elements of manufacturing overhead vary directly with production within a given relevant range of production. Fixed manufacturing overhead costs do not vary directly with production but are constant in total within a relevant range of production. To determine fixed manufacturing overhead costs accurately, management must determine the relevant range for the expected level of operations.<\/p>\r\n For our example company, Leed Company, we assume the company\u2019s policy is to maintain 40% of next quarters sales in ending inventory.\u00a0 Finished goods inventory on January 1 is 10,000 units (Note:\u00a0 You should be given this information but if you do not have the beginning inventory, you can assume the company followed the same ending inventory policy.\u00a0 This means, you can calculate beginning finished goods inventory as Quarter 1 sales x 40% since we can assume the company followed this policy and the ending inventory of 4th quarter last year is the beginning inventory of this year<\/em>).\u00a0 We anticipate the December 31 ending inventory to be 6,000 units. From these data, we can prepare the schedule of planned production using the Sales budget as our starting place.<\/p>\r\n\r\n Important things to note:<\/em><\/p>\r\n\r\n Cost of Goods Sold budget<\/strong> The cost of goods sold budget establishes the forecast for the inventory expense and is usually on of the largest expenses on an income statement.\u00a0 A cost of goods sold budget would not be necessary for a service company since they do not sell a product.\u00a0 Management must now prepare a schedule to forecast cost of goods sold, the next major amount in the planned operating budget. We need to understand the costs for making the product.\u00a0 Leed Company has the following costs:<\/p>\r\n\r\n The cost of goods sold budget would use the sales budget in units.\u00a0 We will take each of our variable costs (direct materials, direct labor and variable overhead) x budgeted sales units.\u00a0 The cost of goods sold budget would look like:<\/p>\r\n\r\n After managers forecast cost of goods sold, they prepare a separate budget for all selling and administrative expenses.<\/p>\r\n Selling and administrative expense budget\u00a0 <\/strong>The costs of selling a product are closely related to the sales forecast. Generally, the higher the forecast, the higher the selling expenses. Administrative expenses are likely to be less dependent on the sales forecast because many of the items are fixed costs (e.g. salaries of administrative personnel and depreciation of administrative buildings and office equipment). Managers must also estimate other expenses such as interest expense, income tax expense, and research and development expenses.<\/p>\r\nhttps:\/\/youtu.be\/kKlfC8iv-xY\r\n\r\nFor Leed Company, we need to know the following information:\r\n In this Operating Budget section, we will discuss the following budgets:<\/p>\n Sales budget<\/strong> The cornerstone of the budgeting process is the sales budget because the usefulness of the entire operating budget depends on it. The sales budget involves estimating or forecasting how much demand exists for a company’s goods and then determining if a realistic, attainable profit can be achieved based on this demand. Sales forecasting can involve either formal or informal techniques, or both.\u00a0 The video below illustrates a sales budget (watch the first 4 minutes of the video only for the sales budget).<\/p>\n |