Financial Budgets
Whereas our operating budgets looked at the number of units we needed to produce, our financial budgets look at the cash budget and our pro forma financial statements. Our cash budget is going to include various numbers, like what is our beginning cash balance? How much in cash do we expect to receive? How much in cash do we expect to disperse? How much in ending cash do we need?
For example, we figured out that we expect to spend $725,000 on direct materials and $3,500,000 on direct labor. Does that mean that we’re expecting to disperse cash of $4,225,000? Well, no, because of how accruals work. When we buy the materials, we buy them on credit, meaning we increase our accounts payable.
Therefore we don’t have to pay out that cash just yet. Meanwhile, we have our accounts payable balance from prior periods that we’re going to have to pay for in the current period. And then the same applies to our cash collections. We expect to sell $200 million worth of airplanes. Does that mean we expect to have cash receipts of $200 million?
Well, no, because when the companies buy the airplanes, we’re going to create accounts receivable. Therefore, we’re not going to receive the cash until a later period. Meanwhile, we have accounts receivable balances from prior periods that we’re going to collect the cash for in the current period.
The proforma statements are not based on real numbers, they are based on projections of what we think will happen. You can think of proforma as a projection. These proforma financial statements are going to include a proforma balance sheet, proforma income statement, and proforma cash flow statement.
Budgeting Practice Question
| Amount |
| Measured By | Pros | Cons |
|---|---|---|
| Number of Units Sold | 14,500 | - |
| Budgeted Beginning Finished Goods Inventory Units | 1,500 | - |
| Budgeted Ending Finished Goods Inventory Units | 3,000 | 1,500 Increase in finished goods (unsold products) |
| Budgeted Beginning Direct Materials Inventory Units | 2,000 | - |
| Budgeted Ending Direct Materials Inventory Units | 1,500 | (500) Direct materials used from prior period | Direct Manufacturing Material Cost Per Unit | $5 | % that Causes NPV to be $0 |
| What amount is the total direct materials purchasing budget? |
This question is asking us for the direct materials purchasing budget from the problem.
You may be wondering if we’re calculating the direct materials budget, then why are they giving us info on finished goods and units sold? Remember that we have to follow a certain order for creating budgets, which is sales budget, production budget, and then direct materials and direct labor budget. We have to start the problem by looking at the sales amount.
We’re planning to sell 14,500 units. Does that mean we need to produce 14,500 units? No. Once we finish making a product, it sits in the finished goods inventory until we sell it. Our beginning finished goods inventory is 1,500 and our ending finished goods inventory is 3,000. This means there is a 1,500-unit increase in unsold products that will sit in inventory.
We’re selling 14,500 units, yet we have an additional 1,500 units that will sit in finished goods. Therefore, we have to produce 14,500 units to sell, plus 1,500 units for our ending finished goods inventory. Our units to produce is therefore 16,000 units. Now we’ve gone through the sales amount and the production amount we can focus on the direct materials Amounts.
Do we need to purchase enough direct materials to make 16,000 units? No, we don’t. Our direct materials inventory account explains why we started the period with enough direct materials to make 2,000 units and we ended with enough direct materials to make 1,500 units. It ended with 500 units less than it started with.
This means that we used direct materials purchased in a prior period to make 500 units in the current period. We don’t have to buy materials for those 500 units. That means we take the 16,000 units we’re producing and subtract out 500 units. We only need to buy enough direct materials to produce 15,500 units. 15,500 units times $5 per unit = $77,500. Our direct materials budget is $77,500.
| Budget Order: | Units | Dollar | Amount |
|---|---|---|---|
| Sales | 14,500 | - | - |
| Production | 16,000 | - | - |
| Direct Materials | 15,500 | $ | 77,500 ($ X 15,500) |
| Direct Labor | - | - | - |
To understand the example better, we have added borders to the table.