HA355 : The Class : Financial Statement : Budgetary Control

Topic 2: Budgetary Control

A budget is part of a profit making business's annual business plan. The budget is a projection of the organization's income statement for the next fiscal year. It usually includes estimates of sales, expenses and net income. Other statistical information is frequently included as part of the budget. A budget, in addition to the income statement, will also include a cash flow projection and a capital expenditure budget.

Why do companies, such as restaurant companies, develop budgets?

Companies develop budgets because of the benefits:

1. It provides the organization with a goal.

2. It provides control over revenues and expenses during the budget year. Management compares their actual results with budgeted forecasts and then must account for any significant variances. Significantly large budget variances may indicate the presence of problems in the restaurant's operations.

3. It provides contingency plans for potential problems that may develop during the budget year.

4. It requires coordination throughout the organization. Each department, or unit, within the organization is responsible to prepare its part of the budget, which is then coordinated with the overall company budget.

5. Responsibility is assigned to Management in each organizational unit. They are responsible for the development of the budget and their department's subsequent performance against its budget.

6. Budgeting is an integral part of the planning process. Successful companies plan for their futures through the discipline of preparing an annual business plan, stipulating their financial and qualitative goals and strategies. The budget is an integral part of that plan.

Manage needs to collect the following types of information in order to prepare an accurate and useful budget:

1. The restaurant's actual operating and budget variance figures from the previous year.

2. The restaurant's goals

3. Sales statistics from the past

4. Any change in restaurant operating policies

5. Local and national economic conditions

6. Sales and expense trends

7. Statistics to back up budget numbers, such as menu prices, customer preference, portion size and food costs

8. Payroll statistics.

1. Estimate sales revenue and volume. The forecast of sales is the most important and difficult part of the income statement due to its volatility, and its pronounced effect on expenses and profits

2. Estimate expenses that are related of sales. Estimate other expenses based on planned activities.

3. Management consolidates the department and unit budgets into an overall comprehensive income statement budget.

4. The budgeted income statement is submitted to upper management for review, negotiation and revision.

5. After the review and final revisions, the final budget and plan is prepared and submitted to the appropriate departments within the organization.

Budget example

In this example we will examine a restaurant with a seasonal business pattern. We will be using an Excel spreadsheet program to develop a budget model. The first thing we need to do is develop the assumptions of our budget. We can also refer to these as control factors since they will drive the budget numbers. The following exhibit is from the income statement control factor sheet of the program:

The first thing that is estimated is food sales. Based on previous years and expectations about the coming year, food sales are estimated to start at $3,300 in January, build up to $20,460 in July and drop gradually to $2,640 in December. Beverage revenue is to be estimated at 33.48% of food revenue, which comes from past experience. Cost of sales is to be 40% of food sales and 30% beverage sales. Salaries and wages are based a percent which is related to the level of total sales:

For months with sales below the percent is set to 32%; as sales goes up the percent goes down with 28% from sales over $12,000. Interest expense is set at a per annum rate of 12% of long debt as reflected on the balance sheet (see below). Provision for state and federal income taxes are calculated at 18% of income before taxes. All other expense categories are estimated at a fixed dollar amount. With these assumptions we can prepare the income statement with all the numbers derived from the control factor sheet:

 

Budget-Income Statement	Jan.	Feb.	Mar.	Apr.	May	June	July	Aug.	Sept.	Oct.	Nov.	Dec.	Total
Sales
Food	3,300	4,950	6,600	8,250	9,900	13,200	20,460	20,460	13,860	6,600	3,300	2,640	113,520
Beverages	1,105	1,657	2,210	2,762	3,315	4,419	6,850	6,850	4,640	2,210	1,105	884	33,006
Total Sales	4,405	6,607	8,810	11,012	13,215	17,619	27,310	27,310	18,500	8,810	4,405	3,524	151,526
Cost of sales
Food	1,320	1,980	2,640	3,300	3,960	5,280	8,184	8,184	5,544	2,640	1,320	1,056	45,408
Beverages	331	497	663	829	994	1,326	2,055	2,055	1,392	663	331	265	11,402
Total cost of sales	1,651	2,477	3,303	4,129	4,954	6,606	10,239	10,239	6,936	3,303	1,651	1,321	55,810
Gross Profit	2,753	4,130	5,507	6,883	8,260	11,014	17,071	17,071	11,564	5,507	2,753	2,203	94,717
Controllable Expenses
Salaries and wages	1,410	1,982	2,643	3,304	3,700	4,933	7,647	7,647	5,180	2,643	1,410	1,128	43,628
Direct	246	396	529	661	793	1,057	1,693	1,693	1,110	529	264	211	9,092
Utilities	250	250	250	250	250	250	250	250	250	250	250	250	3,000
Marketing	100	100	100	100	100	100	100	100	100	100	100	100	1,200
Repairs & Maintainance	200	200	200	200	200	200	200	200	200	200	200	200	2,400
Administration	200	200	200	200	200	200	200	200	200	200	200	200	2,400
Total Controllable Exp.s	2,424	3,129	3,921	4,714	5,243	6,741	10,035	10,035	7,040	3,921	2,424	2,089	61,717
Operating Profit	330	1,001	1,585	2,169	3,017	4,273	7,036	7,036	4,524	1,585	330	114	32,999
Noncontrollable Expenses
Occupation expenses	500	500	500	500	500	500	500	500	500	500	500	500	6,000
Intrest expenses	150	149	149	148	147	146	146	145	144	143	143	142	1,752
Depreciation	360	360	450	450	450	450	450	450	450	450	450	450	5,220
Amortization	200	200	200	200	200	200	200	200	200	200	200	200	2,400
Total Noncontrollable Expenses	1,210	1,209	1,299	1,298	1,297	1,296	1,296	1,295	1,294	1,293	1,293	1,292	15,372
Income before income taxes	(880)	(208)	287	871	1,720	2,977	5,740	5,741	3,230	292	(963)	(1,178)	17,627
Provision for income taxes	158	37	(52)	(157)	(310)	(536)	(1,033)	(1,033)	(581)	(53)	173	212	(3,173)
Net income	(722)	(170)	235	714	1,410	2,441	4,707	4,707	2,649	239	(790)	(966)	14,454

The income statement is totally derived from the control factor sheet. If management wishes to change any of the control factors the changes will carry automatically to the income statement.

To complete the projection we need a cash flow statement. It is useful to project a balance sheet in which we can employ some double entry techniques. Tom complete the cash flow we will reference some information from the income statement and some information from the balance sheet To do this additional assumptions need to be made which we have labeled balance sheet control factors:

 

	Jan.	Feb.	Mar.	Apr.	May	June	July	Aug.	Sept.	Oct.	Nov.	Dec.
Input
Balance Sheet:
Inventory turnover:
Inventories-Food	0.50	0.50	0.50	0.50	0.50	0.50	0.50	0.50	0.50	0.50	0.50	0.50
Inventories-Beverages	1.00	1.00	1.00	1.00	1.00	1.00	1.00	1.00	1.00	1.00	1.00	1.00
Accounts payable tunrover
Total costs of sales	0.50	0.50	0.50	0.50	0.50	0.50	0.50	0.50	0.50	0.50	0.50	0.50
Accrued expenses
Salaries and wages	0.25	0.25	0.25	0.25	0.25	0.25	0.25	0.25	0.25	0.25	0.25	0.25
Long term debt-monthly payment	220.00	220.00	220.00	220.00	220.00	220.00	220.00	220.00	220.00	220.00	220.00	220.00
Capital expenditures-Properly and equipment	-	-	-	-	-	-	5,000.00	-	-	-	-	-

Inventory balances are based on turnover targets: twice a month for food and once a month for beverages. Accounts payable is based on 50% of cost of sales remaining unpaid at the end of the month. Accrued expenses are based on 25% of salaries and wages. Monthly payments of long term debt interest and principal is $220. A capital expenditure for property and equipment of $5,000 is planed for July.

Using information from the income statement and the balance sheet control factors we have the cash flow statement and balance sheet:

Table- cash flow statement & balance sheet.

The relationship of the tables is shown on the following diagram:

Spreadsheet Relationships

To experience how this spreadsheet model works down load the file and experiment with some assumptions changes in the income statement and balance sheet control factor sheet. For example, if you were to eliminate the $5,000 capital expenditure and use the funds to increase the July long term debt payment to $5,220 the following changes will automatically take place: (1) net income goes from $14,454 to $14,663; (2) year end cash changes from $4,603 to $4,585; and (3) long term debt drops from $14,112 to $8,857. You can experiment with other changes assumptions and see the resulting changes in the financial statements.

Are there any problems that can arise in the budget process?

There are some potential disadvantages in utilizing budgets that management needs to aware of:

1. Management time and money involved in preparing the budget
2. The inherent difficulties of forecasting future events
3. Unless all of the organizations within the corporation support the budget process, it can create disagreements within the company.

Objectives:

Upon completion of this topic:

You will understand the definition of a budget,
You will understand why companies develop budgets,
You will understand the basic steps in developing a budget,
You will understand how a budget spreadsheet model works,
You will understand some of the disadvantages of developing budgets.

To complete this Topic successfully, please complete the following activities in the order shown below:

TEXTBOOK READING : Read textbook, Chapter 23

ASSIGNMENT: Answer the Review Questions

ASSIGNMENT: Budget Problem

Go on to Topic 3: Cost-Volume-Profit Analysis
or
Go back to Module 1: Financial Statement and Analysis

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or call (520) 523-1001

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