Budgeting

7.3 Prepare Financial Budgets

Budgeted Balance Sheet

The cash budget shows how cash changes from the beginning of the year to the end of the year, and the ending cash balance is the amount shown on the budgeted balance sheet. The budgeted balance sheet is the estimated assets, liabilities, and equities that the company would have at the end of the year if their performance were to meet its expectations. Table 7.1 shows a list of the most common changes to the balance sheet and where the information is derived.

Common Changes in the Budgeted Balance Sheet

Information Source	Balance Sheet Change
Cash balance	ending cash balance from the cash budget
Accounts Receivable balance	uncollected receivables from the cash collections schedule
Inventory	ending balance in inventory as shown from calculations to create the income statement
Machinery & Equipment	ending balance in the capital asset budget
Accounts Payable	unpaid purchases from the cash payments schedule

Table7.1

Other balance sheet changes throughout the year are reflected in the income statement and statement of cash flows. For example, the beginning cash balance of Accounts Receivable plus the sales, less the cash collected results in the ending balance of Accounts Receivable. A similar formula is used to compute the ending balance in Accounts Payable. Other budgets and information such as the capital asset budget, depreciation, and financing loans are used as well.

To explain how to use a budgeted balance sheet, let's return to Big Bad Bikes. For simplicity, assume that they did not have accounts receivable or payable at the beginning of the year. They also incurred and paid back their financing during the year, so there is no ending debt. However, the cash budget shows cash inflows and outflows not related to sales or the purchase of materials. The company's capital assets increased by $8,500 from the copier purchase, and their common stock increased by $5,000 from the additional issue as shown in Figure 7.22.

BIG BAD BIKES Budgeted Balance Sheet December 31, 2019
	Jan. 1	Dec-31
Cash	$13,000	$36,443
Accounts Receivable	0	78,250
- Allowance for Doubtful Accounts		(22,000)
Inventory	0	42,629
Machinery and Equipment	15,000	23,500
Accumulated Depreciation	(2,000)	(22,000)
Total Assets	$26,000	$136,822
Accounts Payable	$0	$6,000
Line of Credit
Common Stock	15,000	20,000
Retained Earnings	11,000	110,822
Total Liability and Owner's Equity	$26,000	$136,822

Figure 7.22 Budgeted Balance Sheet for Big Bad Bikes.

Though there seem to be many budgets, they all fit together like a puzzle to create an overall picture of how a company expects the upcoming business year to look. Figure 7.15 detailed the components of the master budget, and can be used to summarize the budget process. All budgets begin with the sales budget. This budget estimates the number of units that need to be manufactured and precedes the production budget. The production budget (refer to Figure 7.6) provides the necessary information for the budgets needed to plan how many units will be produced. Knowing how many units need to be produced from the production budget, the direct materials budget, direct labor budget, and the manufacturing overhead budget are all prepared. The sales and administrative budget is a nonmanufacturing budget that relies on the sales estimates to pay commissions and other variable expenses. The sales and expenses estimated in all of these budgets are used to develop a budgeted income statement.

The estimated sales information is used to prepare the cash collections schedule, and the direct materials budget is used to prepare the cash payment schedule. The cash receipts and cash payments budget are combined with the direct labor budget, the manufacturing overhead budget, the sales and administrative budget, and the capital assets budget to develop the cash budget. Finally, all the information is used to flow to the budgeted balance sheet.

YOUR TURN

Creating a Master Budget

Molly Malone is starting her own company in which she will produce and sell Molly's Macaroons. Molly is trying to learn about the budget process as she puts her business plan together. Help Molly by explaining the optimal order for preparing the following budgets and schedules and why this is the optimal order.

budgeted balance sheet
budgeted income statement
capital asset budget
cash budget
cash collections schedule
cash payments schedule
direct materials budget
direct labor budget
master budget
manufacturing overhead
production budget
sales budget
selling and administrative budget

Solution

A master budget always begins with the sales budget must be prepared first as this determines the number of units that will need to be produced. The next step would be to create the production budget, which helps determine the number of units that will need to be produced each period to meet sales goals. Once Molly knows how many units she will need to produce, she will need to budget the costs associated with those units, which will require her to create the direct materials budget, the direct labor budget and the manufacturing overhead budget. But Molly will have costs other than manufacturing costs so she will need to create a selling and administrative expenses budget. Molly will need to determine what are her capital asset needs and budget for those. Now that Molly has all her revenues budgeted and her costs budgeted, she can determine her budgeted cash inflows and outflows by putting together the cash schedules that lead to the cash budget. Molly will then need to create a cash collections schedule and a cash payments schedule and that information, along with the cash inflow and outflow information from her other budgets, will allow her to create her cash budget. Once Molly has completed her cash budget she will be able to put together her budgeted income statement and budgeted balance sheet.