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3. Components of the Budget

Business processes are highly complex and require considerable effort to coordinate. Managers frequently cite coordination as one of the greatest leadership challenges. The comprehensive or "master" budget is an essential part of the coordinating effort. Such budgets consist of many individual building blocks that are tied together in logical harmony, and reflect the financial plan for the entire organization. Careful articulation is essential.

The starting point for the master budget is an assessment of anticipated sales via the sales budget. The expected sales level drives both the production plans and the selling, general, and administrative budget. Production drives the need for materials and labor. Factory overhead may be applied based on labor, but it is ultimately driven by overall production. The upper portion of the following graphic is a simplified illustration of these budget building blocks. Notice that the background colors of each block reflect dependency on another budget (i.e., the production and SG&A budget blocks each have a purple background because they are derivatives of the purple sales budget).

The lower portion of the graphic illustrates that the planned business activities must be considered in terms of their cash flow and financial statement impacts. It is quite easy to plan production that can outstrip the resources of a company. In addition, a business should develop plans that have a successful outcome; the budgeted financial statements are key measures of that objective.

It would be very easy to expand the illustration to reflect additional interactions and budgets (e.g., the coordination of a long-term capital spending budget). However, the graphic would start to resemble the organization chart that was steam rolled earlier in this chapter. Little educational value would be derived by such a complex illustration. Instead, the point is to make it clear that comprehensive budgeting entails coordination and interconnection of various components. Next is a detailed illustration showing how these budget concepts are put into operation.

3.1. Sales Budget

The budgeting process usually begins with a sales budget. The sales budget reflects forecasted sales volume and is influenced by previous sales patterns, current and expected economic conditions, activities of competitors, and so forth. The sales budget is complimented by an analysis of the resulting expected cash collections. Sales often occur on account, so there can be a delay between the time of a sale and the actual conversion of the transaction to cash. For the budget to be useful, careful consideration must also be given to the timing and pattern of cash collections.

Mezan Shehadeh recently perfected a low-cost vinyl product that was very durable and could be used outdoors in conjunction with rear screen projection equipment. This product enables movie theaters to replace the usual lettered signs with actual videos to promote the "now showing" movies. Mezan's company, Shehadeh Movie Screens, is rapidly growing. The sales budget for 20X9 follows. Review the sales budget closely, noting the expected pattern of sales. The fall and winter seasons are typically the best for the release of new movies, and the anticipated pattern of screen sales aligns with this industry-wide business cycle. The screens are sold through a network of dealers/installers at a very low price point of $175 per unit.

The lower portion of the sales budget converts the expected sales to expected collections. Dealers are normally given credit terms of 30 days, and the result is that roughly two-thirds of sales are collected in the same quarter as the sale itself. The other third is collected in the following quarter. Shehadeh started 20X9 with $100,000 in receivables, and they are assumed to be collected in the first quarter of 20X9. Shehadeh's dealer network has been carefully screened and the company has very few problems with uncollectible accounts. Shehadeh will end the year with $140,000 in receivables, determined as one-third of the final quarter's expected sales ($420,000 X 1/3 = $140,000).

Mezan uses an electronic spreadsheet to compile the budget. This tool is extremely useful in budgeting applications. If care is used in constructing the embedded formulas, it becomes very easy to amend the budget to examine the impact of different assumptions about sales, sales price, etc. If you look closely at the very bottom of this illustration, you will note that a unique sheet is created for each budget building block; here, the Sales sheet is the active sheet:

Microsoft Excel - budget

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