Chapter 6
Financial Forecasting and Budgeting
Steps in Projecting a Business Enterprise’s
Needs
1. Project sales
2. Project additional variable (such as
expenses)
3. Estimate the level of investment in current
plant and assets the business enterprise
will need to make to support the projected
sales
4. Calculate the business enterprise’s
financing needs
Percent-of-Sales Method – most widely used
method for projecting the business’s financing
needs
- Requires to estimate future expenses,
assets and liabilities as a percent of sales
for the period
- Construct forecasted statement of
financial position
- Major advantage: simple and inexpensive
to use
- Assumes that business is operating at full
capacity, does not have sufficient
productive capacity to absorb a projected
increase in sales
- Must be used with extreme caution if
excess capacity exists in certain asset
accounts
Budget – represents a business’s annual
financial plan
- Tool for both planning and control
- Beginning of period: plan or standard vs
end of period: control device by which
management measure its success in
achieving the goal outlined and plan to
improve future performance
- Two broad categories
1. Operating Budget – consist of:
Sales Budget
Production Budget
Direct Material Budget
Direct Labor Budget
Factory Overhead Budget
Selling and Administrative Budget
Pro Forma Income Statement
2. Financial Budget – consist of:
Cash Budget
Pro Forma Statement of Financial
Position
Comprehensive (Master) Budget – formal
statement of management’s expectation for
sales, expenses, volume and other financial
transaction
- Consist of:
1. Pro forma (projected/planned) Income
Statement
2. Pro forma Statement of Financial
Position
3. Cash Budget
Steps in Preparing the Budget
1. Prepare a sales forecast
2. Determine expected production volume
3. Estimate the manufacturing costs and
operating expenses
4. Determine the cash flow and other
financial statements
5. Formulate projected financial statements
Sales Forecast – gives the expected level of
sales
- Instrumental in planning and budgeting
functions
- Two Approaches
1. Qualitative Approach – includes:
Forecast based on judgement and
opinion (executive opinion and
Delphi technique)
Sales Force Pooling
Consumer Surveys
2. Quantitative Approach
Forecast based on Historical Data
 Naïve methods
 Moving averages
 Exponential smoothing
 Trend analysis
Associative (casual) Forecast
 Simple regression
 Multiple Regression
 Economic Modelling
Sales Budget – starting point in preparing
master budget
- Indicates the quantity in units of each
product the business enterprise expects to
sell
- Includes computation of expected cash
collections from credit sales (also used later
for cash budgeting)
Production Budget – developed by
determining the units expected to be
manufactured in order to meet budgeted sales
and inventory requirement
Expected Volume of Production =  avoid both unnecessarily idle cash and
determined by subtracting the estimated
inventory at the beginning of the period from the
sum of the units expected to be sold and the
desired inventory at the end of the period
= planned sales PLUS (desired ending
MINUS beginning inventory) inventory
Direct Material Budgeted – show how much
material will be required and how much must be
purchased to meet production requirements
- Usually accompanied by a computation
of expected cash payments for
materials
= Purchase in units = usage PLUS desired
ending inventory in units MINUS beginning
inventory units
Direct Labor Budget
* Direct Labor Requirement = expected
production volume for each period X direct labor
hours required to produce units
* Budgeted Direct Labor Cost = direct labor
requirement X direct labor hours
Factory Overhead Budget – provides a
schedule of all manufacturing cost other than
direct material and direct labor
- It is important to remember that depreciation
does not entail a cash outlay and therefor
must be deducted from the total factory
overhead when you compute cash
disbursement for factory overhead
Ending Inventory Budget – provides the
information required for the construction of
budgeted financial statement
- Helps compute Cost of Goods Sold on
budgeted income statement and the peso
value of the ending materials and finished
goods inventory that appears on budgeted
statement of financial position
Selling and Administrative Expense – list the
operating expenses incurred in selling the
products and in managing the business
* To complete budgeted income statement,
variable selling and administrative expenses
must be computed per unit
Cash Budget – helps managers anticipate:
 expected cash inflow and outflow for a
designated time period
 keep cash balances in reasonable
relationship to needs
possible cash shortage
- Four Major Sections:
1. Receipt Section – beginning cash
balance, cash collections from
customer, and other receipts
2. Disbursement section – cash
payments that are planned during the
budget period
3. Cash Surplus or Deficit Section –
differences between the cash receipt
section and the cash disbursements
section
4. Financing Portion – provides a
detailed account of the borrowings and
repayments expected during the
budgeting period
Budgeted Income Statement – summarizes
projections for the various components of
revenue and expenses for the budget period
- Budget can be divided into quarters to keep
tight control over its operation
Budgeted Statement of Financial Position –
developed by adjusting the statement of
financial for the year just ended
- Must be prepared because:
 Might disclose some unfavorable
financial conditions
 Serves as final check on the
mathematical accuracy of schedules
 Helps management perform a variety
of ratio calculations
 Highlights future resources and
obligations