COURSE MAS 5: STRATEGIC BUSINESS ANALYSIS

DEVELOPER AND Principal Autho:

THEIR BACKGROUND Dr. Derick S. Figueroa, CPA, CTT.
Chairperson, Accountancy Department
Email address: [email protected]

Editor:
Dr. Henry D. Rufino, CPA.
Chairperson, Accounting Information System Department
Email address: [email protected]

COURSE This course is the culmination of Financial Management and Management Accounting and Services courses. The
DESCRIPTION course will start with the budgeting process: both operation and financial budgeting collectively known as the master
budget. The Cost-volume-profit analysis will then be reviewed and applied in-depth with business decision making
and strategy formulations. For the final term, the concept of capital structure and weighted average cost of capital will
be reviewed, and the concepts be applied in understanding leverages and business risks. Capital budgeting is the
last topic to be covered which will extensively tackle the different approaches and techniques. The final requirement
of this course is focused on the analysis of business strategies through business plan, a feasibility study, scenario
building or a consultancy service recommendation proposal.
COURSE OUTLINE 1. The Operational and Financial Budgeting Process: Master Budget
2. Cost-volume-profit analysis (an in-depth approach)
3. Capital Structure, Weighted Average Cost of Capital (WACC) and Leverages
4. Capital Budgeting Techniques

CHAPTER # 1
TITLE THE OPERATIONAL AND FINANCIAL BUDGETING PROCESS: MASTER BUDGET
RATIONALE This chapter focuses on the operational and financial budgeting and planning process of every organization. To
illustrate completely, a manufacturing business model will be used in the discussion. The topic at hand focuses on
how a company should prepare its operational budget from sales budget to budgeted income statement. After the
budgeted income statement is done, the budgeted cash together with the budgeted balance sheet and cash flow
statement shall be prepared.

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INSTRUCTION TO THE This module is designed to be comprehensive yet concise enough to include all relevant principles, rules and
USERS concepts. Students are expected to study the course on their own. Further readings as to items that are critical in
understanding the whole course shall be included here for student’s strong knowledge foundation.

The following YouTube videos are necessary to be viewed before starting this module. Please have time to view
them.

https://www.youtube.com/watch?v=mkWQVJzbyRs (Budgeting in General)

https://www.youtube.com/watch?v=2Wbr7cScyOA (The Master Budget)

https://www.youtube.com/watch?v=1O_PUoS4N4E (Computation/ Formula for Master Budget)

PRE-TEST
LEARNING At the end of this chapter, students are expected to explain and demonstrate mastery of the:
OBJECTIVES A. The components of a master budget: Operational and Financial
B. Preparation of operational budget and observe the sales budget effect to to budgeted income statement.
C. Preparation of the budgeted cash balance and balance sheet and cash flow statement.
CONTENT Cost Accounting and Strategic Cost Management courses had tackled the manufacturing costing process. The
PREPARATORY difference between job order costing and process costing has been discussed. Also, the Just in Time manufacturing
ACTIVITIES concept and materials planning is extensively discussed. The ideas and concepts learned in the said course is a
preparatory to conduct the operational planning process. Therefore, it is ideal to review such topics first before going
to this introductory topic of the course.

DEVELOPMENTAL ACTIVITIES

BUDGET- is a management plan, expressed in quantitative terms, used for both planning and control of operations for a given period of
time. The budget is a plan or standard at the start of the period; at the end of the period, it serves as a control device to hel p management
measure its performance against the plan so that future performance may be improved. The term budgeting is used to denote the
process of coming up with budgets.

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THE MASTER BUDGET
- is a comprehensive budget that consolidates the overall: plan of the organization within a budget period. It consists of all the individual budgets
for each of the segments of the organization aggregated or consolidated into one overall budget for the entire firm. (Other terms: pro forma
budget, planning budget, forecast budget, master profit plan)

OPERATING BUDGET FINANCIAL BUDGET

Sales budget Cash budget

Production budget Budgeted balance sheet
Direct materials budget Budgeted cash flow statement
Direct labor budget
Factory overhead budget
Inventory budget
Budgeted cost of goods sold
Budgeted operating expense SPECIAL PURPOSE BUDGETS
Budgeted operating income Advertising budget
Budgeted net income Research and development budget
Budgeted income statement

BUDGETING-RELATED TERMINOLOGIES

FIXED BUDGET- A budget prepared for a one level of activity within a certain period. (Other term: static budget)

FLEXIBLE BUDGET-A budget prepared, for different levels of activity within a certain period. (Other terms: variable budget, sliding scale budget)

CONTINUOUS BUDGET - A 12-month budget that rolls forward one month as the current month is completed (other term: perpetual budget)

ZERO-BASED BUDGETING - A method of budgeting in which managers are required to justify all costs as if the programs involved were being
proposed for the first time

IMPOSED BUDGETING - A process wherein budgets are prepared by top- management with little or no inputs from operating personnel

PARTICIPATORY BUDGETING - A process wherein budgets are developed through joint decisions by top management and operating personnel

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BUDGET COMMITTEE – a group of key management persons responsible for over-all policy matters relating to the budget program and for
coordinating the budget preparation.

BUDGET MANUAL – this describes how a budget is prepared and includes a planning calendar and distribution instructions for all budget
schedules.

THE OPERATIONAL PLANNING PROCESS (STEP BY STEP PROCEDURE)

1. Prepare for the sales budget. This can be done by estimating the projected sales for the next period. This should be done with utmost diligence,
so not to overstate or not to understate the estimation of sales. The sales amount is the starting point in operational budgeting. Therefore, this is
the most important budget to prepare. More so, all factors that affects the market and its environment must be listed down and assess their
probable impact in the sales.

2. After the sales figure has been reliably determined, it is now the time to known how much units must be produced to meet the sales unit
projected. Together with the sales figure, the desired ending inventory that company wants to maintain must be satisfied as well. The company
usually has beginning inventory that should be sold first before the new units produced must be out for sale. Therefore, the beginning and ending
finished goods inventories must be considered in the projection of the production budget.

3. After determining the units to be produced in the current period, the required purchase of raw materials will be the next to determined. Be it
noted that the raw materials inventory usually has beginning balance as well and the company has a desired ending inventory as well for materials.
These are to be considered in the raw materials purchases budget.

4. The required conversion costs are then determined, conversion costs include direct labor and factory overhead. Conversion costs usually
consists of variable costs and fixed costs. The behavior of costs therefore must be considered in projecting the total conversion costs.

5. The operating expenses budget is next to be prepared. The operating expenses are composed of variable and fixed expenses as well.
Remember that there are costs that directly varies with sales such as sales commission and delivery fees. While other are fixed such as
depreciation and salaries of office personnel.

6. After the sales, cost of production and cost of sales, operating expenses were determined the budgeted income statement can now be
prepared.

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 SAMPLE PROBLEMS

Illustrative Problem #1: Philadelphia Company has budgeted sales of 24,000 finished units for the forthcoming 6-month period. It takes 4 lbs. of
direct materials to make one finished unit. How many pounds of raw materials should be budgeted for purchase during the 6-month period,
given the following:
Finished Units Raw Materials (pounds)
Beginning inventory 2,000 4,000
Target ending inventory 4,000 8,000

Suggested Solution

Budgeted Sales 24,000 Total pounds of RW used in finished product 104,000

Desired Ending Inventory 4,000 Target ending inventory (RM) in pounds 8,000

Total units available for sale 28,000 Total pounds of raw materials available for use 112,000

Beginning Inventory (FG) 2,000 Beginning Inventory (RM) 4,000

Units to be produced 26,000 Raw Materials purchases (in pounds) 108,000

pounds per unit of finished product 4

Total pounds of RW used in finished
104,000
product

Illustrative Problem #2: Washington Company has the following 2020 budget data:
Beginning finished goods inventory 10,000 units
Sales 70,000 units
Ending finished goods inventory 12,000 units
Direct materials P 10 per unit
Direct labor P 20 per unit
Variable factory overhead P 5 per unit
Fixed factory overhead P 80,000

What are the 2020 total budgeted production costs?

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 Suggested Solution

Sales 70,000 units Goods Produced in the period 72,000 units

Ending Inventory 12,000 units Total Variable Cost per unit 35 pesos
Total Goods Available for Sale 82,000 units Total variable costs to produce 2,520,000 pesos
Beginning Inventory 10,000 units Total fixed costs 80,000 pesos
Goods Produced in the period 72,000 units Total budgeted production costs 2,600,000 pesos

Comprehensive Illustrative Problem: The following information was gathered by the Budget Committee Chairman of DERICK Corporation:

Derick Corporation produces and sells only one product. The selling price during the budget period is expected to be the prevailing price of
P25.00 per unit. The company expects to sell 112, 500 units of the product during the period. The desired finished goods inventory at the end of
the period is 5, 000 units, while the beginning inventory is 2, 500 units (cost of these units is the same as the current year’s production)

Direct labor is P40.00 per hour. Each product requires 15 minutes to complete. Factory overhead is applied to production on the basis of direct
labor hours. Variable factory overhead costs at the planned level of production are budgeted at P49, 450; fixed budgeted overhead is budgeted
at P149,500.

Each unit of product requires 1.5kgs. of raw materials. Only one kind of raw material is used and it is expected to cost P5.00 per kilo. The desired
ending inventory of raw materials is 2, 000 kgs while the beginning inventory is 500 kgs.

Variable selling and administrative costs will amount to P1.50 per unit of product sold. Total fixed selling and administrative costs are P53, 000
including depreciation expense of P3, 000.

Prepare for the following:

a. Budgeted production in units
b. Budgeted materials purchases in peso
c. Budgeted direct labor cost is
d. Budgeted costs of goods sold on absorption (normal) costing is
e. Budgeted net income is

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 Suggested Solution
A. D. All costs are based on units sold
Budgeted Sales in units 112,500 Budgeted Raw Materials Cost
843,750
Desired Ending Inventory 5,000 (112,500units *1.5 kgs *P5.00)
Total Units available for sale 117,500 Budgeted Direct Labor Costs
1,125,000
Beginning Inventory 2,500 (112,500units*0.25hrs*P40)
Budgeted Production in units 115,000 Budgeted Overhead Costs
194,625
112,500units*
{(49,450+149,500)/115,000}
B. Budgeted Costs of goods sold 2,163,375
Budgeted Production in units 115,000
Raw material requirement per unit 1.50 kg/unit
Total RM required in production 172,500 kg E.
Desired Ending Inventory 2,000 kg Budgeted Sales (112,500*P25) 2,812,500
Total MR available for use 174,500 kg Budgeted Cost of Goods sold 2,163,375
Beginning inventory 500 kg Budgeted Gross Profit 649,125
Raw Materials Purchases in units 174,000 kg Budgeted Operating Expenses
Purchase Price per kilo 5 pesos Variable (P1.50*112,500) 168,750
Budgeted RM Purchases in peso 870,000 Fixed 53,000
Budgeted Net Income 427,375
C.
Budgeted Production in units 115,000
Labor Hours per units 0.25 hrs
Total hours needed to produce 28,750
Labor rate per hour 40
Budgeted total direct labor costs 1,150,000

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 THE FINANCIAL BUDGET

The financial budget is typically composed of budgeted balance sheet and budgeted cash flow as a minimum.

The budgeted balance sheet uses the information from the operational budgets prepared. Additional information needed to prepare the
budgeted balance sheet includes the opening balances of the assets, liabilities and equity accounts as of the end of the previous period. The
financial assumptions shall also be used to establish the projected balances of various accounts of the balance sheet at the end of the projected
period covered.

The budgeted cash flow identifies three activities of the organization: operating, investing and financing activities. Operating activities focuses
on the movement of the working capital accounts: the current assets and current liabilities. Investing activities on the other hand relates to
movement of non-current asset accounts which usually involves fixed assets and various investments. While, financing activities focuses on
sources of capital which includes committing long term liabilities or involving equity instruments of the company.

The budgeted cash flows will be used to determine if the company will be needing additional cash to sustain operations and capital spending as
projected in the operational budget process. The capital spending on the other hand will be determined by the company’s board of directors or
those charged with governance and the management as established in the agreed organizational plans.

Cash flow can be presented either direct method or indirect method as far as operating activities is concern. However, for budgeting purposes,
the use of direct method is encouraged to properly trace the inflow and outflow of cash from operations.

Illustrative Problem #1: Online Selling Company, a merchandising firm, is preparing its master budget and has gathered the fo llowing data to
help budget cash disbursements:
Budgeted data:
Cost of goods sold 1,680,000 Desired decrease in inventories 80,000 Desired decrease in accounts payable 40,000

All of the accounts payable are for inventory purchases and all inventories are purchased on account. What are the estimated cash
disbursements for inventories for the budget period?

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 Suggested Answer
The company desired to decrease it inventories by 80,000, it means that the company shall purchase inventories lesser than it s projected cost
of sales. If the company desires to decrease its accounts payable by 40, 000, it means that aside from the amount of current purchases, the
company needs to pay its past obligations, which will require additional cash payment. Therefore, the solutions shall be:

Estimated cash disbursements = Cost of goods sold - Desired decrease in inventories + Desired decrease in accounts payable
Estimated cash disbursements = 1, 680, 000 - 80, 000 + 40, 000
Estimated cash disbursements = 1, 640, 000

Illustrative Problem #2: The following information is taken from LAZHOPEE Corporation’s accounting records for the year ended December
31, 2019. These data would be used as the basis for the next year’s cash budget.
A. Customer sales receipts for P 870,000
B. Purchased machinery and equipment for P 125,000 cash.
C. Settled income taxes of P 50,000
D. Sold investment securities for P 500,000.
E. Paid dividends of P 60,000.
F.Received rental income of P 85,000
G. Issued 500 shares of common stock (ordinary shares) for P 250,000.
H. Paid a sum of P 100,000 due to suppliers and payroll to employees.
I. Purchased real estate for P 550,000 cash that was borrowed from a bank.
J. Paid P50,000 due on the loan from a bank.

Required: Determine the following:

a. Net cash provided (used) by operating activities.
b. Net cash provided (used) in investing activities
c. Net cash provided (used) in financing activities.
d. Net cash increase or decrease.

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 Suggested Answers

A. Receipts from Sales P 870, 000 C. Payment of dividends P (60, 000)

Settlement of tax (50, 000) Proceeds from share issuance 250, 000
Rental Income 85, 000 Proceeds from bank loan 550, 000
Payment to suppliers and employees (100, 000) Payment of bank loan (50, 000)
Net cash provided by operating activities 805, 000 Net cash provided by financing activities 690, 000

B. Purchase of machinery & equipment P (125, 000) D. Net cash provided by operating activities P 805, 000
Proceeds from sale of investment 500, 000 Net cash used by investing activities (175, 000)
Purchase of real estate (550, 000) Net cash provided by operating activities 690, 000
Net cash used by investing activities 175, 000 Net increase in cash 1, 320, 000

CLOSURE As a take-home exercise, students are advised to answer this problem:

ACTIVITIES
Exercise #1: Maryland Company has been accumulating operating data in order to prepare an annual profit plan.
Details regarding Maryland’s sales for the first 6 months of the coming year are as follows:

Estimated Monthly Sales Type of Monthly Sales

January P 600,000 Cash sales 20%
February 650,000 Credit sales 80%
March 700,000
April 625,000
May 720,000
June 800,000

Collection Pattern for Credit Sales

Month of Sale- 30% One month following sale-40% Second month following sale-25% Uncollectible-5%

Maryland’s cost of goods sold averages 40% of the sales value. Maryland’s objective is to maintain a target inventory
equal to 30% of the next month’s-sales in units. Purchases of merchandise for resale are paid for in the month
following the sale. The variable operating expenses (other than cost of goods sold) for Maryland are 10% of sales
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 and are paid for in the month following the sale. The annual fixed operating expenses are presented below. All of
these are incurred uniformly throughout the year and paid monthly except for insurance and property taxes. Insurance
is paid quarterly in January, April, July and October. Property taxes are paid twice a year in April and October.
Advertising P 720,000
Depreciation 420,000
Insurance 180,000
Property taxes 240,000
Salaries 1,080,000

Identify the following:

a. The amount of cash collected in March for Maryland Company from the sales made during March will be
b. Maryland Company’s total cash receipts for the month of April will be
c. The purchase of merchandise that Maryland Company will need to make during February will be
d. The amount for cost of goods sold that will projected for the month of February will be
e. The total cash disbursements for operating expenses (excluding cost of goods sold) during April will be
SYNTHESIS / ✓ Operational budgeting starts with sales budget, therefore, it is proper to project sales as accurate as possible
GENERALIZATION for it will affect the whole planning and budgeting process.
✓ Manufacturing costs are then established in relation with sales. These includes materials, labor and overhead
costs.
✓ Operating expenses are then determined to be planned and budgeted as well.
✓ A budgeted income statement shall now be ready for preparation.
✓ A budgeted balance sheet and statement of cash flow are the final budgets to prepare. We can view here if a
company have sufficient cash to accomplish projected operation or may need to borrow funds to sustain
operations. Decision on financing then follows. The management will decide if they will resort to debt or equity
financing.
EVALUATION 1. Enumerate and explain the step-by-step procedure in the operational budgeting process.
2. How would the sales budget affect the components of an operational budget?
3. What are the factors to be considered in preparing the budgeted cash flow and budgeted balance sheet?
ASSIGNMENT / 1. Review the concepts in CVP analysis.
AGREEMENT 2. Review application of CVP in sensitivity analysis.
SUGGESTED Budgeting, Roque, 2007e
READINGS Operational and Financial Budgeting from Financial Management, Balatbat- Cabrera 2016e;
Working Capital Management from Managerial Finance, L. Gitman 2016e

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