Summary Accounting, finance and control

PROCESS:

− Articulation and timing of the process: who rules (chi governa) the process, the timing of the process can

change very much

− Plan updates: one choice could be I prepare budget and I don’t change it or another optionn is that after six

months I understand that the forecasts are not in line with the expectations at the beginning of the year and

I can update the budget, so this is a rolling budget;

− Planning guidance provided : this is a process that requires the involvement of different organizational units.

Different organizational managers have to make their estimates. We could provide them some guidelines for

the estimations or not.

Ex manufacturing organizations: Ex retail organizations

The articulation of the budget for retail organizations is very different because basically they don’t have production

activities. Production phases is replaced by the purchases budget. So the format of the budget changes depending on

the core activities of the company (this is not true for the FS).

Ex service organizations: in this case we don’t have production

activities but the core activities are

represented in

the service revenue budget and

labour budget.

So the green part of the scheme could

change a lot depending on the

business in which the company

operates.

We’ll use the master budget as a main referment framework for the preparation of the budget, because it is still the

most common process and in particular we’ll refer to the case of a manufacturing company.

9.1.1 OPERATING BUDGETS

The operating budgets focus on revenues and operating costs and the output of this budget is the preparation of a

prospective income statement till the EBIT (= revenues operating costs).

We’ll see the artculation by function, but we can also

use the articulation by nature.

To determine the operating income, the following budgets need to be prepared:

1) REVENUES BUDGET

It is usually the first budget that is prepared. Depending on the sale budget all the other budget are prepared, so

mistakes are a problem. The revenues budget gives an estimation of the level of sales in terms of quantities and

price. -> Sales and marketing manager discuss and then define the target.

Revenues budget in then articulated by: (depending on the business of the company)

− Product lines

− Geographical area

− Clients

− Selling channel

There is a strong linkage between the sale budget and the strategy, because the sale budget determines the

penetration, the market share, the level of revenues.

For preparing the sale budget we generally make an intensive use of marketing instruments (survey, forecasting

instrument…)

The level of revenues takes into account many different factors:

− Macroeconomic factors (local and national economies, industry’s economy, competition…)

− New product plans

− Number of units sold in prior periods

− Pricing policies

− Credit policies and collection policies

Real case of budget:

SECO case study:

2) PRODUCTION BUDGET

Once we have defined the sales budget, we have to determine the amount of products that the company has to

manufacture. This is the only budget that is expressed in physical terms, in unit (all the other budgets are expressed

in monetary terms.).

With this budget we have to make an estimation of the total finished goods to be produced considering two

information:

1. the level of sales that is derived from our revenues budget;

2. the level of inventories, because on the one hand there could be some units maintaned as an inventory in

the company’s warehouse, and on the other hand we need to consider if the company wants to increase or

decrease the level of inventories.

So the budgeted production is given by: I have to verify if the production capacity that is

available is enough for fulfilling the production

budget. In case of missing production capacity we

need to find a solution. A solution could be:

− outsourcing

− we could invest in new machines increasing the capacity

− we could reduce sales

− we could modify the inventory policy, this is a short-term strategy

− if possible, we can temporary increase our production capacity for instance postponing some maintenance

interventions, some extrordinary work …

these solutions have an impact on a different time horizon.

SECO case study: Through data we notice that our capacity analysis

will be focused on machine hours.

Now we have to compare the capacity in terms of machine

hours needed to produce 1050 units against the capacity that

is available. We don’t have enough capacity because the

maximum capacity is 3000 hours/year but 150 hours/year are

used for maintenance activities. So the available capacity is

2850 hours/year. The required capacity can be as 1050 unit *

3 hours= 3150 hours, so the capacity that is needed is not

enough compared to the available capacity.

In this case adjusting the budget means reducing sales. The capacity is difficult to be adjusted. The choice that we’ll

make here will have an influence on all the costs of the company and all its cash flows.

One of the key point of the budget is that this process is useful for aligning the financials with the operationals. So

the idea of the budgeting process is to ensure that the operations are coherent with the financial figures.

3) COST OF GOOD SOLD BUDGET

This budget comprises all the resources used in manufacturing a product (or delivering a service), it is composed by

many different document:

− Direct material usage budget

− Direct labour budget

− Manufacturing overhead budget

− Finished goods purchase budget

− Ending inventories budget

So our cost of good sold budget is the translation in monetary terms of the production plan, considering different

cost items.

• DIRECT MATERIALS USAGE BUDGET

In this budget we find different materials and components in terms of quantities and price.

Thhe amount of raw materials needed is determined based on the bill of materials.

SECO case study:

For producing one unit of product we need 6 kg/units of raw materials. What is our Direct Material Usage Budget?

We have to consider the number of units to be produced internally. According to the production budget we’ll

produce 950 units internally and purchase from suppliers (ousourcing) 100 units. Since we are computing the

amount of raw material that we’ll use, we have to refer to the internal production.

In this case we expect an increase in the level of inventories of raw materials of +5%. So, we have 1000 kg of raw

materials as inventories and we’ll have to buy 50kg during this year (because at the end we want an increase).

If we look at the price of raw materials that is in the company’s warehouse it is not the same value of the raw

materials that we’ll buy, because in this case the value is 1.00 €/kg instead of 2.00 €/kg

So, one question in preparing this budget is how the usage of raw materials should be evaluated, what price should

we use’ 1€ or 2€?

I have 1000 kg that have a value of 1 €/kg then I have to buy 5700 kg but I don’t know what what value should I

consider for these raw materials. What I know is that if I buy some raw materials during 2018, I will pay them

2.00€/kg. I could do two different things:

1. FIFO: of these 5700kg, I could value 1000 at 1.00€/kg and 4700 at 2€/kg and in the end I will have 1050 kg as

inventory that we’ll be valued at 2.00€/kg.

2. LIFO: I could decide that the units used during this period for producing my 950 units of final products are

bought during 2018 meaning that all of them are valued at 2.00€/kg. meaning that if I look at the inventories

I will have 1000 units valued at 1.00€/kg and 50 units will be valued at 2.00€/kg

In this case the company applies a Lifo logic, so we’ll use first the raw materials that have been bought more recently.

• DIRECT MATERIAL PURCHASE BUDGET

• DIRECT LABOUR BUDGET

This budget identifies the needed manufacturing labour hours. The direct labour is a variable cost.

SECO case study: We have a consumption of 2 hours/unit of direct labour and our

employees are paid on an hourly rate that is 8€/h.

The overall cost of direct manufacturing labour is 2 * 8 * 950.

• MANUFACTURING OVERHEAD BUDGET

It is necessary distinguishing between:

− Variable overhead: they fluctuate in proportion to the quantity produced

− Fixed overhead: they remain constant over a relevant range of output

SECO case study: The amount of variable overheads is 1,5€/machine hour.

Fixed overheads include equipment, depreciation, supervisor

and other costs.

SECO case study:

full product cost make units (lifo) full product cost make units (fifo)

10400= 1000kg*1€/kg + 4700*2; 1000+4700=5700=6kg/u*950u

• FINISHED GOODS PURCHASED BUDGET

SECO case study:

In coclusion Direct materials used = direct material usage

budget and it is fuction of the inventory policy

(lifo vs fifo)

Cost of goods purchased = finished goods

purchased budget

Endining finished goods inventory are the units

that we don’t sell since we want increase the level

of inventory

Now we are ready to prepare our IS in the very

first part: budgeted revenues- budgeted cost of

sales=gross margin (margine lordo industriale).

To have the EBIT we have to consider period costs.

4) BUDGET OF PERIOD COSTS

Period costs include 3 important categories of costs:

− Selling and marketing expenses (Marketing budget and division between fixed and variable costs)

− Administrative and general expenses

− Research and development expenses

There are different ways for calculating the budgeted period cost:

− Incremental approach: very simple, we move from acrual cost of the previous year (2022) and we estimate

the budget period cost (2023) proporrtionally.

− Zero based budget

They differ in terms of: cost, time, precision

INCREMENTAL APPROACH:

It is a very rough approach, we can use it if the period cost have a low impact on the ebit.

The budgeted period costs (PC) are calculated on the prvious year value. An high disadvantage is the

amplification of errors, if I made a

mistake in the estimation of one year

budget this mistake is repeated in the

following years and also amplified by α.

The main advantage of the method is

the low cost of implementation.

ZERO BASED BUDGET:

This is an approach much more precise but also much more expensive. The Budgeted Period Costs are redefined

starting from “zero”.

Each organisational unit has to :

− Define the minimum set of resources required for running the unit, necessary for the unit for surviving;

− Identifying “packages” of alternatives and assigning a budget to each project.