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Welcome

- Hi, I'm Jim Stice. I'm a professor of accounting at Brigham Young University. This is my brother, Kay. -

I'm also a professor of accounting at Brigham Young University. - In this course we discuss

budgeting with a focus on budgeting in businesses. - The word budget scares many people. They have

nightmares of forms and spreadsheets and oppression, but really budgeting just involves making a

numerical plan and writing it down. - Young growing companies don't have a long history of

organizational inertia to guide manager decisions. Such companies need to harness the power of

budgeting to identify and solve problems on paper before those problems actually arise in the real

world.

- In addition, these budget numbers provide informed benchmarks to use in evaluating subsequent

actual performance. - [Jim] This course demonstrates the construction of purchase budgets, production

budgets, hiring budgets, and overhead budgets. - This course also covers my favorite budget, the cash

budget. Now, before taking this budgeting course, you might consider taking our Accounting

Fundamentals course. Among other things, that course introduces you to the basics of all three major

types of accounting, managerial, financial, and income taxes.

- With that said, we've designed this budgeting course to be self-contained and we carefully explain

any terminology that we use. - In short, this is an introductory course with no prior accounting

knowledge necessary. - Running an organization without a budget is a very exciting exercise. - From

one day to the next, you have no idea what is coming. - Every morning you wake up to a whole new

collection of surprises. - That's one way to run an organization. A different way is to spend some

time carefully constructing a numerical plan.

How does budgeting affect people?

- We make our living talking about accounting. - We like our job, primarily because it's really the only

thing we know how to do. - But we have two other brothers and both of them have real jobs. - One of

them operates heavy equipment. Front-end loaders, bulldozers, and trackhoes. - The other one is a

quality control and safety manager at a manufacturing facility. - Years ago, this brother was involved

in the budgeting process at his manufacturing plant. - This plant is owned by a large company that

has plants and operations all over the world. - Historically, budget planners and company
headquarters had determined budget numbers for each one of the manufacturing plants and had then

sent those numbers down to the individual plant managers.

- This is a perfect example of top-down budgeting. - But one particular year our brother tells

uscompany headquarters decided to implement a bottom-up budgeting process. - Each plant

manager was told to organize an employee committee, and these employee committees would create

their own plant budgets after being given a sales forecast generated by company headquarters. -

Now our brother was on the employee committee for his plant. He says that the employee group took

this budgeting task seriously and given their collective experience created a budget for the

manufacturing plant for that year.

- They passed this budget along to the plant manager who forwarded it to company headquarters. -

And a few days later, the plant manager reconvened the employee budget committee. Company

headquarters had sent a message: "This budget isn't quite what we had in mind. "Please take another

look and get back to us "Next week with a revised budget." - Okay, so the employee budget

committee got together again, revisited their reasoning,reviewed their numbers, and

ultimately revised the budget. With some relief, because this budgeting process had now taken much

more time than they had anticipated, they gave their revised budget to the plant manager who again

shipped it off to company headquarters.

- And again, a few days later a message came back from company headquarters: "This still isn't what

we're looking for. "Please get back together and give it one more try." - Well, by now, the employee

budget committee was sick to the teeth of this bottom-up approach to budgeting. Our brother was

deputized to pass along this poignant message to company headquarters through the plant

manager: "Listen, just tell us what you want specifically "and we will change the budget "to match

what you're looking for." - So much for the bottom-up approach.

In the end, it was still a top-down budget. - And the whole exercise had created a bit more cynicism

and frankly a bit less employee loyalty. - Ultimately, budgets are not about numbers.A budget is about

people, and the budgeting process must carefully take into account the people who will be working

under that budget.


Budgeting for merchandising firms

- Brigham Boat Company is a manufacturing firm. How do operational budgets work for merchandising
firms, retail and wholesale, such as Wind River, a company that buys boats for resale from other

manufacturers rather than making the boats themselves. Or for a service firm, such as the Boulder

View Inn, a small motel. There are several similarities in the budgeting process for manufacturing

businesses, merchandising companies, and service companies. Basically the budgeting process

involves budgeting or forecasting revenues and the cash that will be generated by those revenues as

well as budgeting expenses and cash that will be paid for those expenses.

Managers are always interested in how much revenue and expense they will have during each

budgeted period and how much cash and other assets and liabilities they will have at the end of each

budgeted period. Because merchandising companies buy products rather than make them, their

budgeting process is less complicated than the budgeting done by manufacturing companies. For

example, if Brigham were a merchandising firm rather than a manufacturing firm, the company would

prepare a purchases budget rather than a production budget for the boats. However, the format of the

merchandise company's purchases budget would be similar to the format of the manufacturing

company's production budget.

By combining expected sales with desired ending inventory and subtracting the beginning inventory

expected to be on hand, the merchandise company will arrive at the number of boats to be

purchased rather than produced for the period. Now these labels manufacturing companyand

merchandising company may seem a bit strange, but let me convince you that you alreadyunderstand

the distinction between the two. A good example of a manufacturing company is General Motors,

General Motors assembles raw materials, employs skilled auto workers,maintains a large infrastructure

of production facilities, machinery, and supervisory staff and actually makes cars and trucks.

GM then sells those manufactured cars and trucks to automobile dealerships. General Motors makes

cars and trucks. It's a manufacturing company. In contrast, a merchandising companydoesn't make

anything. A good example is Walmart. The goods sold by Walmart are all made by other

companies, Procter & Gamble, PepsiCo, Kraft Foods, and Campbell's Soup. Walmart buys those

completed goods, puts them on the shelves, and sells them. Walmart doesn't make anything, Walmart

is a merchandising company.
The master budgeting process for a merchandising firm is much less complicated than that done for a

manufacturing firm. Merchandising companies replace four budgets, the production budget, the direct

materials budget, the direct labor budget, and the manufacturing overhead budget used

by manufacturing firms with a single budget, the purchases budget. The sales budget and the selling

and administrative expense budget are similar to those prepared for manufacturing firms, so we won't

discuss those budgets again. Instead, we'll focus on the purchases budget for Wind River, a retail

company that buys boats from manufacturers and then sells them to customers.

Again, this process is quite similar to what we've already done. We need to figure out how many

boats Wind River will sell during the period, how many they want on hand for the next period, and how

many they already have on hand at the start of this period. Let's assume that Wind River has four

boats in inventory at the start of 2015. Let's also assume that Wind Riverwould like to have on hand at

the end of a quarter inventory equal to 20% of next quarter's sales. Let's review why a company, either

a merchandising company or a manufacturing company, why they want ending inventory.

On the one side, what if we run out of finished goods? Well, we get lost sales, lost now and maybe lost

forever, and lost reputation because we don't have anything to sell. But on the other side, what if we

have too many finished goods? Well, there are excess resources tied up in inventory. If we have the

inventory too long, it could become obsolete and have to be sold at a loss. And where do we store

those extra boats? In balancing those factors, Wind River has decided to plan for an ending

inventory equal to 20% of the next quarter sales.

We will also assume that Wind River pays $8,000 for each boat it purchases, and it pays for its

boats 50% in the quarter of the purchase and 50% in the subsequent quarter. Now let's work through

the purchases budget for Wind River for the first quarter. First recall that Wind River pays

suppliers $8,000 for each 15 foot boat. Note that Wind River begins the year with four boats in

beginning inventory and has a policy to maintain 20% of next quarter's expected sales in ending

inventory. Expected sales in the first quarter, 20 boats.

And sales are expected to increase to 40 boats in the second quarter. so in the first quarter, Wind River

needs the 20 boats to sell in that first quarter plus another 8 boats in ending inventory equal to 20% of

the 40 boats expected to be sold in the second quarter. That's a total of 28 boats needed, 20 to sell

and 8 to put in ending inventory. Wind River already has 4 boats in beginning inventory, so the company

only needs to buy 24 boats, 28 needed less 4 already in beginning inventory during the first quarter.
Now looking ahead to the cash budget, the company plans to pay for 50% of its purchases in the quarter

when the purchase is made with the remaining purchases paid for in the following quarter. In the first

quarter, Wind River will pay for 50% of the boats it buys during that quarter. That's 24 boats times

$8,000 cost per boat times 50%, which comes out to be $96,000. Wind River must also plan to pay for

the remaining balance on the boats it's purchased in the preceding quarter. That was $48,000. So the

total amount of cash expected to be paid for boat purchases in the first quarter is $144,000, 48,000

remaining from the preceding quarter plus 96,000 which is half of the cost of the boats purchased during

the first quarter itself.

So what do we know at this point? We know how many boats we forecast selling each quarter, which

tells us how many boats we need to buy each quarter, which then helps us to compute how much we

expect to pay for those boats each quarter. All of these numbers are incredibly helpful as we plan for

the future and determine if and when we will have the cash available to properly execute our strategic

and operational plans.