Budgets

Using the flowchart for merchandising companies illustrated above, let's follow the steps in the budgeting process. Budgeting for merchandising is less complex than that for manufacturing companies, which will be illustrated later in the module.

Sales Budget

The budgeting process usually begins with a sales budget, which is a highly challenging activity. The sales budget reflects forecasted sales volume based on previous sales patterns, planned promotions, activities of competitors, current and expected economic conditions, etc. Overly optimistic sales budgets can result in excessive inventory which ties up cash and often leads to markdowns. In a service environment, a company will be overstaffed and labor costs will be high, negatively impacting net income. Highly conservative sales estimates can lead to inventory stockouts which negatively impacts customers and results in a loss of revenue; in a service environment it could result in overwhelming workloads for staff personnel. Both over and under estimating sales impacts the income statement. Developing anticipated sales projections requires "drilling down" to product categories or departments within retail units or specific types of service jobs. It can be further classified by cash or credit sales, store level, geographical regions, or salespersons.

Purchases Budget

Merchandising companies (wholesalers and retailers) purchase finished products from wholesalers and manufacturers. They do not typically produce products. Inventory relationships can be expressed mathematically as follows:

 

Beg. Inventory + Net Purchases = Cost of Goods Sold + End. Inventory

 

Translated: All inventory available to the company for sale to customers to generate sales revenue (BI + P) was either sold to customers (COGS) or remains in stock (EI). Inventory is reported on financial statements as an expense (COGS) on the income statement and a current asset on the balance sheet.

This basic relationship can be algebraically flipped to determine required purchases.

 

Budgeted Sales + Desired End. Inventory - Beg. Inventory = Required Purchases.

Translated: All inventory needed to meet sales forecasts and maintain a desired level of inventory in stock represents the total inventory needs of the company. Not all of it must be purchased or produced because there is inventory on the shelves/in the warehouse at the beginning of the period, thus subtracting the beginning inventory to determine the amount that needs to be purchased or produced during the current period.

Note the importance of estimated ending inventory and beginning inventory in the determination of purchasing needs. (Remember: ending inventory of one period = beginning inventory of the next period.)

SG&A Budget

Companies must also plan a selling, general and administrative expenses (SGA) budget. SG&A consists of variable and fixed components. Total variable expenses change based on volume of sales, while fixed expenses are a set amount for the budget period. Labor costs are normally tracked as a % of sales in a retail environment, reflecting that less employees are needed when sales levels are low, with increasing labor scheduling during heavy sales periods. Most fixed items will be the same each quarter (management salaries and depreciation), although some fixed costs, such as an advertising campaign, can fluctuate periodically.

 

Source: principlesofaccounting.com, Larry M. Walther, Copyright 2016.

 

Activity

Please complete the following activity.

 

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