Strategic Budget Analysis – Fabulous Beauty Salon (FBS)

Effective budgeting process is a critical tool to every business entity. Budgets, for instance, act as important planning and controlling tools, which managers use to assess the variance between actual and projected performance (Bamber, Braun & Harrison, 2008). This paper makes an analysis of the Beautifully Fabulous Beauty Salon (BFBS) budget for the quarter-year period ending 31st March 2011.

BFBS has put in place a comprehensive budgetary process that includes various constituents of a master budget. Typical components such as sales budget, cash budget, purchases and cost of goods sold budget (Bamber, Braun & Harrison, 2008, p. 542), are incorporated into BFBS budgeting process. The sales budget for BFBS for instance captures both cash and credit sales based on historical information that indicates 75 percent of each month’s sales to be on credit. Based on the estimated 11 percentage point increase in sales over the previous month’s sales throughout the first quarter of 2010, BFBS sales are $555,000, $616,050 and $ 683, 815.50 for the respective months of January, February and March in 2010 (Excel sheet). Such sales are generated in the ratio 3:1, credit to debit. With the credit sales being the significant revenue earner for the entity, the entity should institute sound collection procedures to avoid excessive bad debts.

The debts collection procedures for BFBS may be discerned from its cash receipts budget. Apart from its cash sales, BFBS cash receipts from credit sales are collected either within the same month (estimated 10 percent of all credit sales) or in the following month (the remaining 90 percent of credit sales made in the month). In every month the cash receipts for BFBS, according to their budget, thus includes 25 percent of sales of that month made via cash, 10 percent of sales of that month made via credit, and 90 percent of credit sales from the previous month. Accordingly, the total cash receipts for BFBS for the months January, February and March are estimated at $ 517,875, $574,841.25 and $638,073.79 respectively. From these receipts, the cash management practices of the entity could be discerned from its cash disbursements budget.

Cash disbursement budget for BFBS presents the forecasts for payments for inventory purchases and those for other expenses. To manage its cash reserves, the entity does not pay for all its supplies within that month; paying 40 percent during the month and 60 percent the following month. Accordingly, payments for inventory purchases in each month are a sum of 40 percent of that month’s purchases and 60 percent of the previous month’s purchases. Apart from the payments for inventory, the entity also makes other monthly payments for expenses such as sales and administrative salaries, and advertising and promotion; quarterly payments for interest on bonds and half-yearly payments for property taxes. Taking these cash payments into account, BFBS estimates that its total cash payments for operations for the Months of January, February and March will be $ 428,747, $ 524772.67 and $ 553,616.41 respectively. Accordingly, the net cash to be provided from the entity’s operations for the three months is estimated at $ 89,128 in January, $ 50,068.58 in February and $ 84,457.38 in March. Considering the operating activities only, BFBS cash management practices would then be considered to be sound since the cash receipts are higher than the cash payments for every month. Such a conclusion is however affected by other uses of cash such as cash expended or received from investing and financing activities. Investing activities include such activities as purchases of assets (expenditure) and sale of assets (receipts) (Bamber, Braun & Harrison, 2008). Financing activities include payment of dividends (expenditure) and capital injection (receipts) (Bamber, Braun & Harrison, 2008).

Incorporating the investing and financing activities of BFBS into its cash budget indicates that the entity could have a shortage of cash resources that it will need to source from external lenders or its shareholders. The entity would for instance need to purchase equipment worth $130,000 to support its activities. Although BFBS anticipates to make $ 16,600 from sale of its market securities (assumption that the book value of the securities as at December 31, 2009 is the selling price), such amount is not sufficient to meet the price of the equipment. Further, since the entity has a policy to maintain cash reserves to a minimum of $20,000, the shortage of cash available for purchase of the equipment is heightened. From the analysis (excel sheet), BFBS will need $103,400 to meet the cost of the equipment. Such amount is to be financed by angel investor at 5 percent annual interest. Accordingly, BFBS will incur a monthly interest charge of $ 430.83 (straight line basis) in addition to the principal repayment amount (not defined since repayment period is not provided). Other cash expenditure that will affect cash reserves for BFBS is the payment of declared dividend.

Budgets provide a critical planning and control tool to an entity. This paper discusses the master budget of BFBS. Various strengths are identified from BFBS budget. Firstly, the budget is informed both on historical data (e.g. credit and cash sales estimates) and expected changes in future (e.g. projected increase in sales spanning the first quarter of 2010). Such a consideration helps avoid high variances between the budgeted and actual figures; variances that may not be out of poor management but rather poor budgeting procedures. The weakness of the budget is that it overlooks any instance of bad debts, by posing that all debts not collected during the current month are to be fully realized in the following month. Even in cases where bad debts do not result, collecting as much as 90 percent of the credit sales in the month immediately following the month the sales were made may be an unrealistic target.  Despite this weakness, the budgetary process at BFBS provides a sound case on how to integrate various components into a master budget that highlights all operations – operating, investing and financing – that an entity undertakes.

References

Bamber, L. S., Braun, K.W. & Harrison, W.T. (2008). Managerial accounting, Prentice Hall, New Jersey.

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