Selling and Administrative Expense Budget
Companies must also plan for selling, general, and administrative costs. These costs also consist of variable and fixed components. The expected quarterly sales are multiplied by the variable cost per unit. Total variable expenses are added to the fixed items. Some fixed items (e.g., rent) may be the same each quarter. Other fixed costs can change over time. Below, Shehadeh is assuming a small advertising campaign in the first quarter, to be followed by an advertising blitz in the second quarter, and then a return to a more normal level during the final two quarters. The bottom line of the SG&A budget is the planned level of expenditures. Most of these items are funded at about the same time as they are incurred. Therefore, one may assume that the expense amount is met with a similar amount of cash outflow.
Each of the budgets/worksheets presented thus far are important in their own right. They will guide numerous operating decisions about raw materials acquisition, staffing, and so forth. But, at this point, it is very difficult to assess the success or failure of Shehadeh's plans! It is essential that all of these individual budgets be drawn together into a set of reports that provides for outcome assessments. This part of the budgeting process will result in the development of a cash budget and budgeted financial statements.
Cash is an essential resource. Without an adequate supply of cash to meet obligations as they come due, a business will quickly crash. Even the most successful businesses can get caught by cash crunches attributable to delays in collecting receivables, capital expenditures, and so on. These types of cash crises can usually be avoided with a little planning. The cash budget provides the necessary tool to anticipate cash receipts and disbursements, along with planned borrowings and repayments.
Shehadeh's cash budget follows. In reviewing this document, you will begin to see that the data in most rows are drawn from earlier budget components (the beginning of year cash is assumed to be $50,000). The cash received from customers is taken from the "Sales" sheet, the cash paid for materials is taken from the "Materials" sheet, and so on. The tax information is assumed; usually a tax accountant would perform some extensive analysis of the overall plan and provide this anticipated data. As mentioned earlier, it is also assumed that Shehadeh is planning to purchase new production equipment at the end of the second quarter, as shown on row 15 following.
Look carefully at the Cash budget, and you will notice that the company is on track to end the second quarter with a cash deficit of $85,584 (before financing activities). To offset this problem, Shehadeh must plan to reduce expenditures or obtain added funding. The cash plan reveals a planned borrowing of $150,000 during the second quarter.
Much of this borrowing will be repaid from the positive cash flow that is anticipated during the third and fourth quarters, but the company will still end the year with a $25,000 debt ($150,000 - $75,000 -$50,000). Interest on the borrowing is calculated at 8% per year, with the interest payment coinciding with the repayment of principal (i.e., $75,000 x 8% x 3/12 = $1,500; $50,000 x 8% x 6/12 = $2,000). Take note that accrued interest at the end of the year will relate to the unpaid debt of $25,000 ($25,000 x 8% x 9/12 = $1,500); this will be included in the subsequent income statement and balance sheet, but does not consume cash during 20X9.
Budgeted Income Statement and Balance Sheet
Shehadeh can also utilize the individual budget components to develop budgeted or "pro forma" financial statements. Almost every item in the budgeted income statement is drawn directly from another element of the master budget, as identified in the "notes" column.
The following budgeted balance sheet includes columns for 20x9 and 20x8. The 20x8 data are assumed. The 20x9 amounts are logically deduced by reference to the beginning balances and information found in the details of the master budget. The notes in column H are intended to help you trace the resulting 20x9 balance for each account. For example, ending accounts receivable of $140,000 would relate to the uncollected sales during the fourth quarter ($420,000 sales - $280,000 collected = $140,000), found on the "Sales" sheet.
External Use Documents
Caution - Caution - Caution! Projected financial statements are often requested by external financial statement users. Lenders, potential investors, and others have a keen interest in such information. While these documents are very common and heavily used for internal planning purposes, great care must be taken in allowing them to be viewed by persons outside of the entity.
The accountant who is involved with external use reports has a duty to utilize appropriate care in preparing them; there must be a reasonable basis for the underlying assumptions. In addition, professional standards dictate the reporting that must accompany such reports if they are to be released for external use. Those reporting standards become fairly complex, and the specifics will depend on the nature of external use. But, those reports will necessarily include language that makes it very clear that the participating accountant is not vouching for their achievability.
Managers must also be careful in external communications of forward looking information. USA securities laws can hold managers accountable if they fail to include appropriate cautionary language to accompany forward looking comments, and the comments are later shown to be faulty. In addition, other regulations (Reg FD) may require "full disclosure" to everyone when such information is made available to anyone. As a result, many managers are reticent to make any forward looking statements. It is no wonder that many budgetary documents are emblazoned "internal use only."
This chapter has made several references to the fact that budgets will be used for performance evaluations. Actual results will be compared to budgeted results. These comparisons will help identify strengths and weaknesses, areas for improvements, and potential staffing changes. But, the process for performance appraisal is far more complex than simply comparing budget to actual results - so much so that the next chapter is devoted exclusively to this subject.