FINANCIAL MANAGEMENT 1

Marylin L. Asumbra

Aldon M. Francia
 Table of Contents

Module 1: Financial Statement Analysis – Part 1

Introduction 1
Learning Objectives 1
Lesson 1. Financial Statement 2
Lesson 2. General Approach to FS analysis 3
Lesson 3. FS Analysis 4
Assessment Task 5
Summary 13
References 13

Module 2: Financial Statement Analysis – Part 2

Introduction 14
Learning Objectives 14
Lesson 1. Definition of Financial ratios 15
Lesson 2. Limitations of Financial Ratios 15
Lesson 3. Basic Rules in Financial Ratios Computation 16
Lesson 4. Most Commonly Used Ratios 16
20
Assessment Task
24
Summary
24
References
Module 3: Financial Statement Analysis – Part 3
Introduction 25
Learning Objectives 25
Lesson 1. Nature of Financial Forecasting 26
Lesson 2. Projected FS Method 26
Assessment Task 28
Summary 36
References 36

Module 4: Planning and Budgeting

Introduction 37
Learning Objectives 37
Lesson 1. Budgeting 38
Lesson 2. Advantages and Limitations of budgeting 39
Assessment Task 42
Summary 49
References 49
Course Code: Fin 1

Course Description: This course provides the students an understanding of

the financial management methods used for analyzing the benefits of various
sources of finance. It includes the following topics, overview of financial
management; financial statement analysis, financial forecasting, planning and
budgeting; the mathematics of time value of money; management of cash and
marketable securities; receivables management; inventory management,
working capital policy and sources of short-term and medium-term financing;
capital expenditures and investments, long-term financial planning and treasury
management

Course Intended Learning Outcomes (CILO):

Upon completion of this module, the student should be able to
demonstrate the following course learning objectives:
1. Recognize the importance of financial management-related consulting
services of CPAs
2. Discuss the financial management-related consulting services of CPAs
3. Apply the different methods of financing decision to obtain the best and
optimal mix of financing alternatives
4. Calculate the appropriate risk-return trade-off relationship for the
maximization of the market value of these funds
5. Evaluate and justify the financing decisions in the procurement of funds,
allocation of these funds to company’s resources and the control these
resources.

Course Requirements:
 Assessment Tasks - 60%
 Major Exams - 40%
Periodic Grade 100%

PRELIM GRADE : 60% (Activity 1-4) + 40% (Prelim exam)

MIDTERM GRADE : 30% (Prelim Grade) + 70 % [60% (Activity 5-7)
+ 40% (Midterm exam)]
FINAL GRADE : 30% (Midterm Grade) + 70 % [60% (Activity 8-10)
+ 40% (Final exam)]
 MODULE 1
FINANCIAL STATEMENT ANALYSIS – PART 1

Introduction

The business is created for the purpose of maximizing the shareholder’s wealth. The
management must be able to track the overall performance of the business. This could be
done by preparing the different Financial Statements (FS). The said FS aid the decision
makers and the management in making decision for the business. Needless to say, these
financial statements speak for the business.

There are different ways in analyzing the financial statement of a business. The
introduction of the different financial statements, the use and computation of the common-size
financial statements as well as the inherent limitations are the topics included in this module.

Learning Outcomes

After completing the module, the student should be able to:

1. define the general approach to financial statement analysis;
2. list down the basic objectives of analyzing financial statements;

3. explain the basic objectives of financial statement analysis;

4. apply the horizontal techniques in financial statements analysis such as

comparative statements and trend percentages;

5. apply the guidelines in preparing and interpreting common size statements; and

6. calculate the major indicator differences (increase or decrease) in peso form that
helps to determine main factors influencing productivity and/or financial status.

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Lesson 1. Financial Statements (Cabrera & Cabrera, 2017)

The financial statement preparation is vital for decision making process. These
statements will give the decision makers an overall insight on the financial condition of the
business.

1. Four basic financial statements

a. Statement of Comprehensive Income (SCI)

This statement shows the result of the business’ operation -- whether it
gains profits or incurred a loss. In this statement, the revenues and expenses
are also reported.

b. Statement of Financial Position (SFP)

This statement shows the assets, liabilities and equity of the business as
of a specific period. In this statement, the total assets must be equal to the total
of total liabilities and total equity – known as accounting equation (Lee, 2013).
This statement shows information about the capitalization and liquidity of the
business.

c. Statement of Cash Flow

This statement shows the inflows and outflows of cash for a specific
period. In this statement, transactions that involve cash are being exposed. It is
important to know whether the business has sufficient cash to support its
operation thus, the statement of cash flow is created for this purpose.

d. Statement of Changes in Equity

This statement explains the movement of reserves that make up the
shareholder’s equity for a specific period. To be profitable a business must have
enough cash. It requires cash to pay for its bills, to pay bank loans, to pay taxes
and to purchase new properties. An analysis of the cash flow decides if there's
enough capital in a business to do just that.

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Lesson 2. General Approach to FS analysis (Cabrera et. al., 2017)

What is FS analysis?
The FS analysis is the method of examining the FS of a business for the
purpose of making decision. Outside parties use this to understand the overall
health of an organization, as well as to assess its business worth and financial
performance. Internal management use it as a financial management reporting tool.

a. Background study and evaluation of firm industry

Before starting to analyze the financial statements of a firm, you need
to do a background check and evaluate the industry that the business is in. This
will give you a better insight on how the business operates, its competition, etc.

b. Short-term solvency analysis

Solvency ratios calculate the ability of an enterprise to pay its long term
debt, as well as the interest added to it. Solvency ratios, as part of the financial
ratio study, help the company owner assess the long-term survival chances for
the organization. Solvency ratios are confused with liquidity ratios, at times. Both
evaluate the financial health of a company.

c. Capital structure and long-term solvency analysis

Analysis of capital structure is a constant evaluation of all the debt and
equity financing aspects of the organization. The objective of the analysis is to
evaluate which mix of equity and debt the enterprise should choose. This
combination varies significantly, based on the cost of debt and equity and the
risks a company is exposed to.

d. Operating efficiency and profitability analysis

Methods used in fundamental research are the performance ratios and
productivity ratios. Those ratios help investors make their investment decisions
and each reveals something else about a company. Profitability ratios show how
much income a business produces, while efficiency ratios measure how
effectively a company uses its capital to produce profit

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 e. Other Considerations

1. Quality of earnings
The quality of earnings of an organization is exposed by discarding any
irregularities, accounting tricks or one-time incidents that could distort the
actual results bottom-line figures. Once these are removed, the proceeds
derived from higher sales or lower costs can be clearly seen.

2. Asset quality and relative indebtedness

Assets must be evaluated in order to determine its market value as well as
the amount of debt that the company owed.

3. Transparent financial reporting

In order for the analysis to be useful, a transparent financial reporting
is needed. It means that the financial statements being presented must be
concise, clear and free from bias.

Lesson 3. FS Analysis (Cabrera et.al. 2017)

 Limitations of financial statement analysis

a. Information derived are only “indicators” of profitability and financial strength but
not absolute measures
b. Limitation inherent in accounting data due to some factors, like, failure to reflect
changes in purchasing power, etc.
c. Limitation of performance measures used
d. Management may influence the outcome of financial statements.

 Mode of financial statement analysis

a. Horizontal analysis- it involves the conversion of amounts showed in the financial
statements for two or more successive periods
b. Vertical analysis – involves conversion of amounts in the financial statements to
a common base

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 c. Gross profit variation analysis – involves analysis the adequacy or inadequacy
of gross profit which determine the final results of operations
d. Cash flow analysis- involves the analysis of the company’s cash disbursements
and receipts in terms of investing, operating, and financing activities.
e. Financial ratios- implies the existence of mathematical relationships between
accounts listed in the financial statements

Assessment Task 1

I. QUESTIONS
1. What is the objective of financial statement analysis?
2. What are some of the indications of satisfactory short-term solvency or working capital
position of a business firm?
3. What are some of the tests of a sound or healthy long-term financial position?
4. Give some indications of managerial efficiency in the use of company resources.
5. What are the most commonly used techniques in the analysis and interpretation of
financial statements?
6. What are the steps involved in using trend percentages in financial analysis?
7. Distinguish between horizontal and vertical analysis of financial statement data
8. What is the basic objective in looking at trends in financial ratios and other data?
9. Define trend percentages
10. Discuss the steps in analyzing financial statements using trend percentages.
11. In financial statement analysis, what is the basic objective of observing trends in data
and ratios? Suggest some other standards of comparison.
12. Distinguish between trend percentages and component percentages. Which
would be better suited for analyzing the change in sales over a term of several
years?
13. Nets sales of the Premiere General Store have been increasing at a reasonable
rate, but net income has been declining steadily as a percentage of these sales.
What appears to be the problem?

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 14. Under what circumstances would you consider a corporate net income of P1 million for
the year as being unreasonably low? Under what circumstances would you consider a
corporate profit of P1 million as being unreasonably high?

II. TRUE OR FALSE

1. Financial analysis is primarily a matter of making relevant mechanical computations.

2. Percentage changes usually are computed by use of the amounts for the latest
accounting period as a base.
3. The peso amount of change during an accounting period for an item appearing in
financial statements is less significant than the change measured as a percentage.
4. A business enterprise's earnings performance and its financial condition are the two
primary concerns of the financial analyst.
5. An increase in sales volume generally is accompanied by a proportionate increase in
net income.
6. On a common-size income statement, net income is given an equivalent of 100%.
7. The peso amount of a change during a period in a certain item appearing in financial
statements is probably less significant than the change measured as a percentage.
8. Percentage changes are usually computed by using the latest figure as a base.
9. It is possible that a decrease in gross profit rate may be offset by a decrease in
expenses, thus resulting in an increase in net income.
10. Industry standards tend to place the performance of a company in a more
meaningful perspective.

III. PROBLEMS

Problem 1 (Percentage Changes)

Selected information taken from financial statements of Little Company for two
successive years follows. You are to compute the percentage change from 2020 to 2019
whenever possible.
2020 2019
a. Accounts receivable............................... P126, 00 P150,000
b. Marketable securities............................. -0- 250,000
c. Retained earnings................................... 80,000 (80,000)

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 d. Notes receivable..................................... 120,000 -0-
e. Notes payables........................................ 860,000 800,000
f. Cash......................................................... 82,400 80,000
g. Sales.................................................. 990,000 900,000

Problem 2 ( computing and Interpreting Rates of Change)

Selected information from the financial statements of Yellow Harvest includes the following:
2020 2019
Net sales…………………………………… P2, 200,000 P2, 000,000
Total expenses…………………………….. 1, 998,000 1,800,000
Required:
a. Compute the percentage change in 2020 for the amounts of (1) net sales and (2) total
expenses
b. Using the information developed in a part a, express your opinion as to whether the
company’s net income for 2020:
1. Increased at a greater or lower percentage rate than did net sales.
2. Represented a larger or smaller percentage of net sales revenue than in 2019. For
each answer, explain your reasoning without making any computations or references
to peso amounts.

Problem 3 (Financial Statement Analysis using Comparative Statements or Increase-

Decrease Method)
The following data are available for XYZ Corporation for years 2020 and 2019.

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 XYZ Corporation
Statement of Financial Position
As of December 31
Change

2019 2020 Peso %

Assets
Cash and equivalents 14,000 16,000 2,000 ?
Receivables 28,800 55,000 26,800 93.06%
Inventories 54,000 85,600 ? ?
Prepayments and others 4,800 7,400 2,600 54.17%
Total Current Assets 101,600 164,000 ? 62.01%
Property, Plant &
Equipment-net of 30,200 73,400 43,200 143.05%
depreciation
Total Assets 131,800 238,000 ? ?
Liabilities and Equity
Notes payable to banks 10,000 54,000 44,000 440.00%
Accounts payable 31,600 55,400 23,800 ?
Accrued liabilities 4,200 6,800 2,600 61.90%
Income taxes payable 5,800 7,000 ? ?
Total Current 51,600 123,200 ? ?
liabilities
Share capital 44,600 44,600 0 0.00%
Retained earnings 35,600 70,200 34,600 ?
Total equity 80,200 114,800 34,600 43.14%
Total liabilities and 131,800 238,000 ? ?
equity

XYZ Corporation
Income Statement
Years ended December 31

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(P thousands)
Change

2019 2020 Peso %

Net sales 266,400 424,000 157,600 ?
Cost of goods sold 191,400 314,600 123,200 64.37%
Gross profit 75,000 109,400 ? ?
Selling, general and
administrative 35,500 58,400 ? 64.51%
expenses
Income before income 39,500 51,000 11,500 29.11%
Taxes
Income taxes 12,300 16,400 4,100 33.33%
Net income 27,200 34,600 ? ?

Required
1. Compute the missing changes in peso amounts and percentages in the above
statements
2. Evaluate the company’s short-term financial position, leverages, managerial efficiency
and Profitability using the increase-decrease method of analysis.

IV. MULTIPLE CHOICE

1. The data from comparative financial statements are useful

a. To analyze changes in gross and net earnings over a number accounting
periods
b. To analyze the sources of increase in assets
c. To indicate earnings trends and costs trends for the firm,
d. In accomplishing all of th above
e. In accomplishing (a) and (b) above

2. Index numbers are used in

a. trend analysis
b. ratio analysis

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 c. vertical analysis
d. common-size statements

3. "Trading on the equity" (financial leverage) is likely to be a good financial strategy for
shareholders of corporations with:
a. Rapidly growing amounts of net income
b. Steady but low amounts of net income,
c. Widely fluctuating net income over a short period of time
d. Steadily declining amounts of net income,

4. Select one with the CORRECT statement

a. An industry with a low turnover if operating assets would be expected to have
a lower rate operating percentage of sales than in industry with high operating
assets turnover
b. An increase in the rate of operating earnings as a percentage of sale may
accompany a decrease in operating earnings measured in absolute pesos
c. The ratio of net earnings to sales is one of best measures for comparing the
profitability of different companies without regard to the sources of assets
d. Net earnings as a percentage of sales measures the number of centavos of
net earnings on each unit of product sold

5. Comparing performance with industry norms is complicated by

a. The existence of diversified companies
b. the use of different accounting procedures by different companies
c. the fact that companies in the same industry will usually differ in some respect
d. all of the above

6. Which of the following would probably not be found in a company’s annual report?
a. The auditor's report
b. A five-or ten-year summary of operations

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 c. Interim financial statements
d. Analysis of the past year's operations

7.What is the first step in an analysis of financial statements?

a. Check the auditor's report
b. Check references containing financial information
c. Specify the objectives of the analysis
d. Do a common size analysis

8. What is a creditor's objective in performing an analysis of financial statements?

a. To decide whether the borrower has the ability to repay interest and principal
on borrowed funds
b. To determine the firm's capital structure
c. To determine the company's future earnings system
d. To decide whether the firm has operated profitably in the past

9. What is an investor's objective in financial statement analysis?

a. To determine if the firm is risky
b. To determine the stability of earnings
c. To determine changes necessary to improve future performance,
d. To determine whether an investment is warranted by estimating a company's
future earnings

10. Which of the following is not a tool or technique used by a financial statement
analyst?
a. Common size financial statements
b. Trend analysis
c. Random sampling analysis
d. Industry comparisons

11. In each of the past five years, the net sales of Beta Co. have increased at about half
the rate of inflation, but net income has increased at approximately twice the rate of
inflation. During this period, the company's total assets, liabilities and equity have

11
 remained almost unchanged; dividends are approximately equal to net
income.These relationships suggest (indicate all correct answers):
a. Management is successfully controlling costs and expenses
b. The company is selling more merchandise every year
c. The annual return on assets has been increasing
d. Financing activities are likely to result in a net use of cash

12. Holly Corporation's net income was P400.000 in 2018 and P160,000 in 2019. What
percentage increase in net income must Holly achieve in 2020 to offset the decline
in profits in 2019?
a. 60% c. 600%
b. 150% d. 67%

13. In financial statement analysis, the most difficult of the following items to predict is
whether:
a. The company's market share is increasing or declining
b. The company will be solvent in six months
c. Profits will increase in the coming year
d. The market price of share capital will rise or fall over the next months

Summary

Review of the financial statements gives an insight as to what is going to occur in the
future. Base from the current financial information, financial Statements users determine if the
situation is improving, deteriorating or staying constant. They gain insight into the direction in
which future results are likely to shift by comparing existing data which are similar from
previous period.

Other comparative standards involve businesses with other similar businesses,

comparison with standards and comparison with information from previous years. Through
comparing empirical data for one business with a certain objective criterion, the analyst aims

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to assess how the business's position in question is comparable with certain performance
expectations.

Financial ratios highlights movements, relationships, and patterns that are very hard
to discern, given that the unprocessed underlying data stand on its own. Financial data ratios
are also easier to comprehend through organizing the data into your point of view.

Reference

Cabrera, E.B., & Cabrera, G.A., (2017). Management Accounting: Concepts and
Applications. Manila, Philippines: Conanan Enterprises

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 MODULE 2
FINANCIAL STATEMENT ANALYSIS – PART 2

Introduction

The first module focuses on the part 1 of the financial statement analysis. This module
will focus on the computation of the financial ratios, its purpose and limitations, as well as the
illustration of the various types of ratios namely: activity ratios, profitability ratios, leverage
ratios, and liquidity ratios.

The financial ratios are important because it helps track the company’s overall liquidity,
profitability, efficiency and stability. With the available data from these ratios, the management
may be able to take advantage of the opportunities and overcome the possible threats.

Learning Outcomes

After completing the module, the student should be able to:

1. define financial ratios;
2. discuss the purpose and limitations of financial ratios;
3. implement the basic rules in computing financial ratios;
4. illustrate the different of activity ratios, profitability ratios, leverage ratios, and liquidity
ratios; and
5. calculate and interpret results of financial ratios.

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 Lesson 1. Definition of Financial ratios (Cabrera et. al., 2017)

 What are Financial Ratios?

Financial ratios are created by using numerical values taken from the financial

statements to obtain quantitative information about a business. The statistics found on a

financial statement – income statement, financial position statement, and cash flow

statement – are used to perform quantitative analysis and to assess a liquidity position,

value, growth, margins, profitability, debt, yield rate, etc.

 Purpose of Financial Ratios

By means of a ratio analysis, the user of the FS comes into control of measures that
provide overview into the profitability of the operational activities, the soundness of the
long-term and short-term financial condition of the company and the effectiveness with

which management has used the resources entrusted to it.

Lesson 2. Limitations of Financial Ratios (Cabrera et. al., 2017)

The most significant limitations on the use of the ratio analysis are the following:

1. Ratios must be used only as financial instruments, as weakness or power indicators

and not deemed good or bad per se.

2. Financial ratios are usually determined, without modification, directly from the the

FS of the business. There are a variety of shortcomings in traditional FS preparation

in compliance with the PFRS that administrators have to rely on if the figures are
relevant.

3. Ratios are a combination of several different estimates — some are for a span of

time, some for an instant time, and some for averages.

4. Ratios to be acceptable should be measured using certain criteria. Among these

the most popular are:

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 a. Own experience in the business (prior year)
b. Other firms in the same sector (Averages for business)

c. Management framework (Budget)

d. Rule of thumb

Lesson 3. Basic Rules in Financial Ratios Computation (Roque, 1990)

a. The numerator and denominator must be based on quantities as of the same date of the
balance sheet when determining a ratio The same applies to percentages that use only
the income statement amounts. Exception: growth ratio arithmetic.
b. If the sum of an income statement and a balance sheet sum are used together to measure
a ratio, the balance sheet amount will be calculated as an average of the value of the
income statement over the time period specified.
c. If the initial balance of a balance sheet account is not available and can not be calculated
from the data given, the ending balance is used as the average balance.
d. If transactions and/or purchases are made without making any distinction of whether
they're made on credit or in cash , assumptions shall be made according to the ratio being
calculated:
 Turnover ratios: They make purchases and sales on account.
 Cash flow ratios: purchases and sales are made in cash.
e. As a rule it is assumed that an operating year has 360 days, except as otherwise
stipulated.
 A year of 360 days is usually preferred, since this is compatible with a year of 12
months and a month of 30 days;
 Instead, a year can contain 365 calendar days, 300 working days or any number of
appropriate days.

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Lesson 4. Most Commonly Used Ratios (Cabrera et. al., 2017)
FINANCIAL RATIOS
Current Ratio
(Banker’s Ratio)
(Working Capital Ratio)
Quick Ratio
(Acid Test Ratio)
Working Capital Activity Ratios (Efficiency Ratios)
Turnover Income Statement Account
Average Balance Sheet
Account
Receivable Turnover
Average Age of Receivables
(Average Collection Period)
(Days’ Sales in Receivable)
Inventory Turnover
Average Age of Receivables
(Average Collection Period)
(Days’ Sales in Receivable)
Raw Materials Turnover
Work in Process Turnover
Finished Goods Turnover
Normal Operating Cycle
Trade Payable Turnover
Current Assets It is measure of adequacy of
Current Liabilities working capital. It is the primary
test of liquidity to meet current
obligations from current assets.
It measures the number of times
Quick Assets that the current liabilities could be
Current Liabilities paid with the available cash and
near-cash assets (i.e.,cash, current
receivables and marketable
securities).
Average age No. of days in a year
Turnover
Net Credit Sales It measures the number of times
Average Receivables receivables are recorded and
collected during the period
360 days It indicates the average number of
Receivables Turnover days during which the company
must wait before receivables are
collected
Cost of Goods Sold It measures the number of times
Ave. Merchandise that the inventory is replaced
Inventory during the period
360 days It indicates the average number of
Inventory Turnover days during which the company
must wait before the inventories
are sold
Cost of Materials Used
Average Raw Material Inventory
Cost of Goods Manufactured
Average Work in Process Inventory
Cost of Goods Sold
Average Finished Goods Inventory
Average Age of Inventory + Average Age of Receivables
Net Credit Purchases
Average Trade Payables
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 Average Age of Receivables
(Average Collection Period)
(Days’ Sales in Receivable)
Current Assets Turnover
* TEST OF SOLVENCY
Time Interest Earned
Debt-Equity Ratio
Debt Ratio
Equity Ratio
TEST OF PROFITABILITY
Return on Sales
Return on Assets
Return on Equity = Return on Sales x Assets Turnover x Equity Multiplier
Return on equity
Earnings Per Share Net Income – Preferred Dividends
Wtd. Ave. Common Shares
MARKET TEST
Price-Earnings (PE) ratio
Dividend Yield
Dividend Pay-out
OTHER MEANINGFUL RATIOS
Fixed Assets to Total
Equity
360 days It indicates the length of
Payables Turnover time during which
payables remain unpaid.
Cost of Sales + Operating It measures the movement
Expenses** and utilization of current
Average Current Assets assets to meet operating
requirements.
EBIT It determines the extent to which
Interest Expense operations cover interest expense.
Total Liabilities Proportion of assets provided by
Total Equity creditors compared to that
provided by owners
Total Liabilities Proportion of total assets provided
Total Assets by creditors
Total Equity Proportion of total assets provided
Total Assets by owners.
Income Determines the proportion of sales
Net Sales that went into company’s earnings
Income Efficiency with which assets are
Average Assets used to operate the business.
Income Measures the amount earned on
Average Equity the owners’ or stockholders’
investment
Efficiency with which assets are
used to operate the business.
Outstanding
Price Per Share It indicates the number of pesos
Earnings Per Share required to buy P 1 of earnings
Dividend Per Share Measures the rate of return in the
Price Per Share investor’s common stock
investments.
Dividend Per Share It indicates the proportion of
Earnings Per Share earnings distributed as dividends
Measures the proportion of
Fixed Assets owners’ equity to fixed assets.
Total Equity Indicative of over or under
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Fixed Assets to Total Fixed Assets (Net)
Assets Total Assets
Sales to Fixed Assets Net Sales
(Plant Turnover) Fixed Assets (Net)
Book Value Per Share- Common Shareholders’ Equity
Common Stock Common Shares Outstanding
Times Preferred Dividend Net Income After Taxes
Earned Preferred Dividends
Capital Intensity Ratio Total Assets
Net Sales
Times Fixed Charges Net Income before taxes & fixed
Earned charges
(fixed charges + sinking fund
payment)
investment by owners and
weakness in trading on the
equity*
Indicates possible over-expansion
of plant and equipment
Test roughly the efficiency of
management in keeping plant
properties employed.
Measures recoverable amount by
common stockholders in the event
of liquidation if assets are realized
at their book values
It indicates ability to provide
dividends to preferred
stockholders.
Measures efficiency of the firm to
generate sales through
employment of its resources
Measure ability to meet fixed
charges.

TEST OF OVER–ALL SHORT-TERM SOLVENCY OR SHORT-TERM FINANCIAL POSITION

Working Capital Net Sales Indicates adequacy of working
Turnover Average Working Capital capital to support operation (sales)
Defensive Interval Ratio Current Liabilities Measures coverage of current
Cash & Cash Equivalent liabilities
Payable Turnover Net Purchases Measures efficiency of the
Average Accounts Payable company in meeting the accounts
payable
Reflects extent of the utilization
Fixed Assets to Long- Fixed Assets of resources from long-term debt.
term Liabilities Long-term Liabilities Indicative of sources of additional
funds

RATIOS INDICATIVE OF INCOME POSITION

Rate of Return on Income Measures the profitability of
Average Current Asset Average Current Assets current assets invested.
Operating Profit Margin Operating Profit Measures profit generated after
Net Sales consideration of operating costs.
Cash Flow Margin Operating Cash Flow Measures the ability of the firm to
Net Sales translate sales to cash

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 Assessment Task 2

Problem 1 (Common-Size Income Statements)

Prepare common size income statements for Wise Company, a sole proprietorship, for the
two years shown below by converting the peso amounts into percentages. For each year,
sales will appear as 100% and other items will be expressed as a percentage of sales.
(Income taxes are not involved as the business is not incorporated.) Comment on whether the
changes from 2018 to 2019 are favorable or unfavorable.

2019 2018
Sales ₱ 500,000.00 ₱ 400,000.00
Cost of Goods Sold 330,000.00 268,000.00
Gross Profit ₱ 170,000.00 ₱ 132,000.00
Operating Expenses 140,000.00 116,000.00
Net Income ₱ 30,000.00 ₱ 16,000.00

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Problem 2 (Common-Size Income Statement)

A comparative income statement is given below for Rainbow Company

Rainbow Company
Comparative Income Statement
For the Years Ended June 30, 2019, and 2018

2019 2018
Sales ₱ 5,000,000.00 ₱ 4,000,000.00
Less: Cost of Goods Sold 3,160,000.00 2,400,000.00
Gross Margin ₱ 1,840,000.00 ₱ 1,600,000.00
Selling Expenses 900,000.00 700,000.00
Administrative Expenses 680,000.00 584,000.00
Total Expenses 1,580,000.00 1,284,000.00
Net Operating Income ₱ 260,000.00 ₱ 316,000.00
Interest Expense 70,000.00 40,000.00
Net Income Before Taxes ₱ 190,000.00 ₱ 276,000.00
The president is concerned that net income is down in 2019 even though sales have increased
during the year. The president is also concerned that administrative expenses have increased,
since the company made a concerted effort during 2019 to pare "fat" out of the organization.

Required:
1. Express each year's income statement in common-size percentages. Carry
computations to one decimal place.
2. Comment briefly on the changes between the two years.

21
Problem 3 (Financial Ratios)

Recent financial statements of Marina Company are given below:

Marina Company
Statement of Financial Position
June 30, 2020

Assets
Current Assets
Cash P 21,000.00
Accounts Receivables 160,000.00
Merchandise Inventory 300,000.00
Prepaid Expenses 9,000.00
Total Current Assets P 490,000.00
Property, Plant and Equipment 810,000.00
Total Assets P 1,300,000.00

Liabilities and Equity

Liabilities:
Current Liabilities P 200,000.00
Bonds Payable, 10% 300,000.00
Total Liabilities P 500,000.00
Equity:
Ordinary Shares, P5 par value P 100,000.00
Retained Earnings 700,000.00
Total Equity 800,000.00
Total Liabilities and Equity P 1,300,00.00

22
 Marina Company
Income Statement
For the month ended June 30, 2020

Sales P 2,100,000.00
Less: Cost of Goods Sold 1,260,000.00
Gross Margin P 840,000.00
Less: Operating Expenses 660,000.00
Net Operating Income P 180,000.00
Less: Interest Expenses 30,000.00
Net Income before Taxes P 150,000.00
Less: Income Taxes 45,000.00
Net Income P 105,000.00

Account balances at the beginning of the company’s fiscal year were: accounts receivable,
P140,000; and inventory, P260,000. All sales were on account.

Required:

Compute the following financial ratios: (3-points each)

1. Gross margin percentage – Mr. De Ramos
2. Current ratio – Mr. Juanillo
3. Acid-test (quick) ratio – Ms. Abadier
4. Accounts receivable turnover in days – Ms. Alvarez
5. Inventory turnover in days – Ms. Balasoto
6. Debt-to-equity ratio – Ms. De Guzman
7. Times interest earned – Ms. De Lima
8. Book value per share – Ms. Estares

23
 Problem 4 (Financial Ratio)

Refer to the financial statements for Marina Company in the previous problem. Assess at the
beginning of the year totaled P1,100,000, and the equity totaled P725,000.

Required:

Compute the following: (3 points each)

1. Return on total assets – Ms. Gailo
2. Return on ordinary shareholders’ equity – Ms. Galay

Summary

Module 2 discusses the significance of the different ratios that measure liquidity,
profitability and stability of a company. It also explains the limitations of using ratios to analyze
a company’s performance during the year as qualitative factors are not considered in the
computations. This module specifically shows the formulas used in computing for the
profitability, liquidity as well as the stability of the company under study. The interpretation of
the ratios will be very helpful in the analysis of performance of a company for a given date and
period for decision making purposes.

References

Cabrera, E.B., & Cabrera, G.A., (2017). Management Accounting: Concepts and
Applications. Manila, Philippines: Conanan Enterprises.

Roque, R.S., (1990). Management Advisory Services. Manila , Philippines: Roque Press, Inc.

24
 MODULE 3
FINANCIAL FORECASTING

Introduction

It is a need for a business to do forecasting. This forecast will help the management
to do their work effectively and efficiently towards the achievement of the business’ overall
goals. It is evident that a business must be able to foresee the events and things that might
happen in order to counter the bad ones.

The analysis of the available data can help the management to make strategic decision
and goals for the long-run. The management uses the historical data, especially the financial
data, to make this financial forecast.

Learning Outcomes

After completing the module, the student should be able to:

1. describe the financial forecasting;
2. execute and apply the guidelines in preparing forecasted FS;
3. evaluate the additional financing required; and
4. justify the financing feedback.

25
Lesson 1. Nature of Financial Forecasting (Cabrera, 2015)

 Nature of Financial Forecasting

The need for raising funds externally is one of the concerns for the firm in anticipating
events even before they occur. Therefore it is being done in the planning stage where the
management may be able to base their operating plans from the set of projected financial
statements.

Projected financial statement preparation begins with a revenue forecast for the next
five years or more. Then, the assets needed to achieve the revenue target are determined,
and a decision is taken about how to fund the assets required.

 Steps in financial forecasting

a. Determination of the amount of funds needed for a given period
b. Determine the amount of money the firm will generate internally on through
operations
c. Calculate the additional funds in extend financing required three the use of:
1. Projected on Pro-forms Financial Statement method
2. Formula method

Lesson 2. Projected FS Method (Cabrera, 2015)

a. Forecast the Statement of Comprehensive Income

 Prepare on sales forecast
 Prepare a production schedule
 Estimate selling and administrative expenses
 Consider financial expenses, if any
 Compute for the net profit

b. Forecast the statement of financial position

 Project the assets required to fund the projected sale
 Project resources which will be instantaneously obtained through the accounts
payable and retained earnings

26
 Project liability and shareholders' equity accounts, which will not rise instantaneously
with sales
 Determine additional funds needed.

Required Spontaneous Increase in

AFN = increase - increase - retained
in assets in Liabilities earnings

c. Raising the additional funds needed considering the optimal capital structure

d. Consider the financing feedback

Cost of financing charges on borrowed funds and the payment of dividend will
be considered in choosing the source of additional funds.

Formula Method
The AFN may be calculated as follows:

Additional Required Spontaneous Increase in

funds = increase - increase – retained
needed in assets in Liabilities earnings
where:
Required Changes Current Assets (present)
increase = in x sales (present)
in assets sales

Spontaneous Changes Current Assets (present)

increase = in x sales (present)
in liabilities sales

Increased Earnings dividend

in retained = after taxes x payment
earnings

27
 Assessment Task 3

I. QUESTIONS

1. What are the basic benefits and purposes of developing pro forma statements and a
cash budget?
2. Explain how the collections and purchases schedules are related to the borrowing
needs of the corporation.
3. Rapid corporate growth in sales and profits can cause financing problems. Elaborate
on this statement.
4. What conditions would help make a percent-of-sales forecast almost as accurate as
pro form a financial statements and cash budgets?

II. MULTIPLE CHOICE QUESTIONS

1. The percent-of-sales method of financial forecasting

a. is more detailed than a cash budget approach
b. requires more time than a cash budget approach
c. assumes that statement of financial position accounts maintain a constant
relationship to sales
d. provides a month-to-month breakdown of data

2. In the percent-of-sales method

a. as dividend payout ratio goes up, the required new funds also rise
b. as the dividends payout rise, required new funds decline
c. the dividends payout ratio does not affect new funds
d. None of the above

28
3. When using the percent-of-sales method in forecasting funds needed, which of the
following is not true?
a. As the dividends payout ratio decreases, the required new funds also decrease
b. Required new funds decrease as profits margins increase
c. Required new funds increase as accumulated depreciation increases
d. As the tax rate increases, the required new funds increase

4. BH Inc. determines that sales will rise from P300,000 to P500,000 next year.
Spontaneous assets are 70% of sales and spontaneous liabilities are 30% of sales.
BH has 10% profit margin and a
40% dividend payout ratio. What is the level of required new funds?
a. P50, 000
b. P20, 000
c. P 100,000
d. BH is in balance and no new funds are needed

5. A firm has targeted a 40% growth in sales this year. Last year’s cash as a percent of
sales was 15%, accounts receivable 30%, and inventory 35%. What percentage
growth in current assets is required to support the growth in sales under the percent-
of-sales forecasting method?
a. 32%
b. 26%
c. 18%
d. Not enough information to tell

6. A rapid rate of growth in sales and profits may require

a. higher dividend payments to shareholders
b. increased borrowing by the firm to support the sales increase
c. the firm to be less lenient with credit customers
d. sales forecasts to be made less frequently

29
7. Firms that successfully increase their rates of inventory will, among other things,
a. be able to reduce their borrowing needs
b. be able to reduce their dividend payments stockholders
c. find it more difficult to be given credit by their resource suppliers
d. have a greater need for high balances in their cash accounts

8. Which of the following statements is true?

a. An increase in sales and/or profits means there is also an increase in cash on
the statement of financial position
b. An increase in sales and profits generates the necessary cash required for
economic growth
c. Pro forma income statements follow a sales forecast and production plan
d. If inventory turnover is equal to 3, that means that the company keep a three-
month supply of inventory on hand

9. Which of the following statements is false?

a. The percent-of-sales method for financial forecasting assumes that statement
of financial position accounts maintain a constant relationship to sales
b. The percent-of-sales forecast is likely to be most accurate when used with
cyclical companies
c. Level production schedules usually have the advantage of reducing overall
production costs
d. The percent-of-sales method would be more accurate under a steady sales
assumption than cyclical sales

10. Which of the following statements is correct?

a. It is helpful to break down the income statement into smaller monthly periods
to enable evaluation of seasonal patterns of cash inflows and outflows
b. When sales volume varies from to month it is not advisable to use level
production
c. As the dividend payout ratio declines more external funds are required
d. Lower profit margin resulting from increased competition would mean a
lower need for external funds

30
11. Which of the following statements is incorrect?
a. A lower dividend payout ratio will decrease the firm’s need for borrowing
b. A higher growth rate in sales will require more external funds
c. sales projections and the ability to accurately predict the future have a large
impact on cash flow targets
d. The generations of sales and profits ensures that there will be adequate cash
on hand to meet financial obligations as they come due

12. A firm forecasted sales of P3, 000 in April, P4,500 in May and P6,500 in June. All
sales are on credit. 30% is collected the month of sales and the remainder the
following month. What will be the balance in accounts receivable at the end of
June?
a. P1,950
b. P6,500
c. P4,550
d. P5,100

13. In general, the larger the portion of a firm’s sales that are on credit, the
a. lower will be the firm’s need to borrow
b. higher will be the firm’s need to borrow
c. more rapidly credit sales will be paid off
d. more the firm can buy raw on credit

14. The need for an increase or decrease in short term borrowing can be predicted by
a. ratio analysis
b. trend analysis
c. a cash budget
d. an income statement.

31
15. The following is the statement of financial position for 2014 for marvellous Inc.
Marvelous Inc
Statement of Financial Position
2014
Assets Liabilities & Equity
Cash P150, 000 Accounts Payable P 900, 000
Accounts receivable 900, 000 Notes payable 300, 000
Inventory 600, 000 Accrued expenses 75, 000
Current assets 1,650,000 Current liabilities 1,275,000
Fixed assets 600,000 Ordinary shares 750,000
Retained earnings 225,000
Total assets P2,250, 000 Total liabilities & equity P2,250,000

Sales for 2014 were P3,000,000. Sales for 2015 have been projected to increase by 20%.
Marvelous Inc. is operating below capacity. The company has an 8% return on sales 70%
is paid out as dividends.

The amount of new funds required is

a. P48,600. c. P50,000
b. P46,800. d. P45,000

16. A company had sales last year of P10 million, with net income equal to 6% of sales.
This year the sales are expected to be P11.2 million. The accounts receivable balance
was P1.5 million at the end of last year. Using the percentage-of-sales method, the
accounts receivable balance at the end of this year is forecasted to be
a. P1.572 million.
b. P1.68 million
c. P2.172 million
d. P2.7 million

32
17. A company had P500,000 of sales for the year just ended and is projecting sales of
P600,000 for the coming year. For every P1 increase in sales, 38 centavos of additional
financing is required for the purchase of additional assets. The projected profit margin is
20%, and 60% of profits will be retained for reinvestment in the company. The amount of
additional external financing needed by the company in the coming year is
a. 0
b. P38, 000
c. P86, 000
d. P110, 000

18. Short-term interest rates are

a. Usually lower than long-term rates
b. Usually higher than long-term rates
c. Lower than long-term rates during periods of high inflation only
d. Not significantly related to long term rates

19. A downward-sloping yield curve depicting the team structure of interest rates implies that
a. Interest rates have declined over recent years
b. Interest rates have increased over recent years
c. Prevailing short-term interest rates are lower than prevailing long-term interest
rates
d. Prevailing short-term interest rates are higher than prevailing long-term interest
rates

33
III. PROBLEMS

Problem 1.
Odette Electronics has 90 operating plants in seven southwestern states. Sales for
last year were P100 million, and the statement of financial position at year-end is
similar in percentage of sales to that of previous years (and this will continue in the
future). All assets (including fixed assets) and current liabilities will vary directly with
sales.
_____________________________________________________________________________
Statement of Financial Position
(in P millions)
Assets Liabilities and Equity
Cash…………………………. P2 Accounts payable……………………... P15
Accounts receivable………… 20 Accrued wages………………………… 2
Inventory……………………. 23 Accrued taxes………………………….. 8
Current assets……………. P45 Current liabilities……………………… P25
Fixed assets…………………. 40 Notes payable………………………….. 10
Ordinary shares………………………... 15
Retained earnings……………………… 35
Total assets………………..... P85 Total liabilities and equity……………. P85
__________________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ _____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____ __________________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ _____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ __________

Odette’s has an after-tax profit margin of 7 percent and a dividend payout ratio of 40
percent.

If sales grow by 10 percent next year, determine how much of new funds are needed to
finance the growth.

34
 Problem 2
Tess’ Shop, Inc., a national clothing chain, had sales of P300 millions last year.
The business has a steady net profit margin of 8 percent and a dividend payout ratio of 25
percent. The statement of last year is shown below.
_______
__________________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ _____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____ __________________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ _____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ ____________ ________

Statement of Financial Position

End of Year
(P millions)
Assets Liabilities & Equity
Cash……………………..…. P20 Accounts payable………………… P70
Accounts receivable………... 25 Accrued expenses………………... 20
Inventory………………….... 75 Other payables…………………… 30
Plant and equipment………... 120 Ordinary shares………………….. 40
Retained earnings………………... 80
Total assets…………………P240 Total liabilities and equity………..P240

________________________________________________________________________________

The firm’s marketing staff has told the president that in the coming year there will be a large
increase in demand for overcoats and wool stacks. A sales increase of 15 percent is
forecasted for the company.

All statement of financial position items are expected to maintain the same percent-of-sales
relationships as last year, except for ordinary shares and retained earnings. No change is
scheduled in the number of ordinary shares outstanding, and retained earnings will change
as dictated by the profits and dividend policy of the firm. (Remember the net profit margin is
8 percent.)

a. Will external financing be required for the company during the coming year?
b. What would be the need for external financing if the net profit margin went up to 9.5
percent and the dividend payout ratio was increased to 50 percent? Explain.

35
Summary

Financial forecast estimates future revenue and expenditure for a company. They are
used to develop projections for income statement, balance sheets and other cash flow
forecasts.

The forecasted financial statement method begins with the projected sales, and then
the statement of comprehensive income should be ready to estimate the net loss or
net income generated by the company.

Based on the sales forecast, the amounts of assets necessary to support this sales
level are determined. Certain current assets as well as accruals and accounts payable will
increase spontaneously as the sales increases.

It is not sufficient only to find sources of finance; the timing of inflow of funds must also
be synchronized with the outflow of investment expenditures. Cost of production and other
expenditures. Therefore, it is necessary to prepare a cash flow table showing the inflow and
outflow finance.

Reference

Cabrera, E.B., (2015). Management Consultancy-Principles and Engagement. Manila

Philippines: Conanan Enterprises

36
 MODULE 4
PLANNING AND BUDGETING

Introduction

“By failing to prepare, you are preparing to fail.” – Benjamin Franklin.

It is true that the very foundation of the business’ success is through the effective
planning. In the planning stage, the management may be able to identify the events that need
to be prioritized. In this stage, the budgeting process is also included. The events that the
business will implement in the future needs fund thus, it is a must that the management must
incorporate the budget as early as possible.

In this module, the introduction of the different budgets namely: operating, capital and
financial budgets as well as the different terminologies are to be discussed.

Learning Outcomes

After completing the module, the student should be able to:

1. define budgeting and other related terminologies;
2. differentiate between operating budget, financial budget and capital budget; and
3. illustrate the master budget plan preparation for a manufacturing concern.

37
Lesson 1. Budgeting (Cabrera, E. and Cabrera, G., 2017)

 Budgeting Terminologies
a. Budget – a plan demonstrated in quantifiable form on the acquisition and use of an
entity's resources over a certain duration of time in the future.
b. Profit planning – in a broader perspective, it is a well thought-out operational plan which
involves setting of goal and objectives , as well as the methods in programs by which
such goals are to be achieved
c. Budgeting - tool of profit planning; act of preparing a budget
d. Budgeted Income Statement - refers to projection of revenues, expenses and
operating results for a specified period of time.
e. Cash Budget – a period by period cash statement at the beginning of the budgeting
process, predicted cash receipts categorized by source; anticipated cash
disbursements, classified by structure, liability and form; and the resulting cash
position at the end of the fiscal period.
f. Financial Budget - Reference is made to the spending plan of the financial resources
as represented in the budgetary statement of the financial position and the cash
budget.
g. Fixed budget -projection of costs at a specific and one level of output (normally at
normal capacity) over a certain period of time.
h. Flexible (variable) budget - Projection of costs at different stages of production over a
defined period of time.
i. Participative budget – a budget designed using staff at all organizational levels
j. Physical budget - budget expressed in material units, number of staff or number of
service units, rather than in pesos.
k. Planning budget (static budget) - another term for master budget.
l. Production budget - production plan of the resources required to meet current demand
for sales and guarantee a sufficient level of inventory.
m. Program budget - budget for the major projects that the company intends to pursue.
n. Operating budget - refers to business plans for the planning phase; involves the
budgeted revenue statement with all its supporting budgets.
o. Responsibility budget - budget of the responsibility center.

38
p. Rolling (continuous, progressive) budget - the budget that is formulated through the
year, that is to say, as one month passes, will be prepared for another month in the
future.
q. Sales budget - budget showing the amount of each good or service and the income
predicted to be sold.
r. Traditional budgeting - a budgeting system that focuses on the incremental progress
from the prior year, implying that the operations of the prior year are vital and it must
be continued.
s. Zero-based budgeting – a system for creating financial plans, starting with the
assumption that there is no action and justification for each program is needed.
t. Imposed budgeting – a process in which top management prepares the budget with
no or little insight from staff members.
u. Budget committee – a group of key managers accountable for all policy issues
pertaining to the budget program and for organizing the preparation of the budget.
v. Budget manual - this explains how the budget is being prepared and includes a
planning calendar and a distribution guidelines for all budget schedules.
w. Budget report - actual performance is compared to budgeted performance.
x. Life-cycle budget – approximate the incomes and expenditures of products over the
entire lifespan, starting with research and development, proceeding thru the phase of
introduction and growth, and then to the point of harvesting or decline.
y. Activity-based budgeting – applies to the budgeting of activity-based costing principles.
z. Kaizen budgeting - it assumes constant improvement of products or processes, usually
through many simple innovations instead of significant changes.

39
Lesson 2. Advantages and Limitations of budgeting (Bagayao, 2019)

Uses / Advantages of Budgeting Limitations of Budgeting

 Forces managers to plan ahead  Considerate time and cost are required.
 Provides a way of communicating  Budgets are merely assumptions that
management action plans across the require a judgment and may be altered or
organization. modified if required.
 It guides actions towards the attainment of  An effective budgetary system needs the
organizational objectives. collaboration of all members of an
organisation.
 Coordinates the operations of the entire  Budgets sometimes restrict flexibility in
entity by incorporating existing parts of the the decision-making process.
plan.
 It provides an efficient and effective way to  The budget program is simply a
allocate resources to the segment. reference, not a replacement for strong
management.
 It defines objectives that serve as
standards for the assessment of future
performance.
3. The Master Budget (Bagayao, 2019)
This consists of all individual budgets for each section of the organization assessed
in the consolidated form of a single overall budget for the whole company.

MASTER BUDGET

OPERATING BUDGET FINANCIAL BUDGET CAPITAL INVESTMENT BUDGET

Sales budget Cash budget Capital expenditure budget
Production budget Budgeted balance sheet Working capital budget
Budgeted Cost Good Sold Budgeted cash flow statement
Budgeted quantity expenses
Budgeted net income
Budgeted income statement

40
Operating Budget – contains the projected revenues, cost and expenses, as well as the
forecasted net Income figure for a certain budget period.

Financial budget – usually composed of the budgeted balance sheet, cash budget and
budgeted cash-flow statement
a. Cash budget – shows the expected cash balance at the start of the budget period, the
projected receipts and disbursement of cash during the period, and the expected ending
cash balance.
b. Budgeted balance sheet – Shows the projected balance of all the assets liability and
capital accounts at the end of the budget period
c. Budgeted Statement of Changes in Owner’s Equity provided from the information in the
budgeted income statements and the changes between the projected balance sheet at
the start of the budgetary period and the budgeted balance sheet at the end of same
duration.

Capital expenditure budget – Contains planned acquisition of major items like plant and
equipment

4. Step in Developing a Master Budget

a. Establish basic objectives and long-term corporate plans.

b. Prepare your sales forecast
c. Estimate the cost of sales of goods and operational costs
d. Evaluate the effort of the budgeted operating revenues in the assets,
liabilities and the equity accounts analysis
e. Prepare the projected statement of revenue and the projected balance sheet

41
 Assessment Task 4

I. QUESTIONS

1. “As a practical matter, planning and control mean exactly the same thing.” Do you
agree? Explain.
2. Budgets are half-used if they serve only as a planning device? Explain.
3. What are the two major features of a budgetary program? Which feature is more
important? why?
4. Explain briefly how a budget can be used in costing products.
5. Why must sales and production be coordinated?
6. How can a labor hour budget be translated into a labor cost budget?

7. How are long-range plans for the acquisition of plant assets included in current
budgets?
8. What is the budget period? Is a budget prepared for a month, for a year, or for
some other interval of time? Explain.
9. What is rolling, continuous, or progressive budget?
10. Explain how a comparison of actual results with a budget can be applied in the
control of operations.
11. Can a comparison of actual results with a budget lead to better future budget?
Explain.
12. What is a self-imposed budget? What are the major advantages of self-imposed
budgets? What cautions must be exercised in their use?
13. “The principal purpose of the cash budget is to see how much cash the company
will have in the bank at the end of the year.” Do you agree? Explain.
14. How does zero-based budgeting differ from traditional budgeting?
15. What is a budget? What is budgetary control?
16. Discuss some of the major benefits to be gained from budgeting.
17. What is master budget? Briefly describe its contents.

42
 18. Describe the flow of budget? Data in an organization. Who are the participants in
the budgeting process, and how do they participate?
19. How can budgeting assist a company in planning its workforce staffing levels?

II. MATCHING TYPE.

Match the definitions enumerated on the right column with the terms on the left
column.
1. Sales forecast A. A quantitative benchmark for measuring
company achievement.
2. Management by exception B. A budget reflecting long-range decisions
of the company.
3. Responsibility accounting C. The most important input for budget
preparation. All estimates of activity
depend upon this information.
4. Statement of financial position D. An integrated plan of action for the firm
as a whole, expressed in financial term.
5. Performance budget E. A system that relates costs to
organizational structure.
6. Objective F. An integrated statement of resource
levels and their sources.
7. Capital expenditures budget G. A set of statements providing broad
direction for the firm.
8. Profit plan I. The practice of focusing attention on
those activities where the actual
performance differs significantly from
planned performance.
9. Master budget J. A budget prepared after the fact,
showing what cost should have been at
the actual level of activity.
10. Goals K. An operating budget for a specific
future period of time

43
III. EXERCISES
Exercise 1 (Schedule of expected Cash Collection)
Peak sales for Mideast Products, Inc., occur in August. The company's sales
budget for the third quarter showing these peak sales is given below:
July August September Total
Budgeted sales ................ P600,000 P900,000 P2,000,000 P2,000.000

From past experience, the company has learned that 20% of a month’s sales are
collected in the month of sale, that another 70% is collected in the month following
sale, and that the remaining 10% is collected in the second month following sale.
Bad debts are negligible and can be ignored. May sales totaled P430,000 and
June sales totaled P540,000.

Required:
1. Prepare a schedule of expected cash collections from sales, by month
and in total, for the third quarter.
2. Assume that the company will prepare a budgeted statement of financial
position as of September 30. Compute the accounts receivable as of that
date.

Exercise 2 (Production Budget)

Rock Telecom has budgeted the sales of its innovative mobile phone over the next
four months as follows:
Sales in Units
July..................................... 30,000
August …........................... 45,000
September.......................... 60,000
October.............................. 50,000

The company is now in the process of preparing a production budget for the third

44
 quarter. Past experience has shown that end-of-month inventories of finished goods
must equal 10% of the next month's sales. The inventory at the end of June was
3,000 units.

Required:
Prepare a production budget for the third quarter showing the number of units
to be produced each month and for the quarter in total.

Exercise 3 (Materials Purchase Budget)

Mini Products, Inc., has developed a very powerful electronic calculator. Each
calculator requires three small "chips" that cost P2 per chip and are purchased
from an overseas supplier. Mini Products has prepared a production budget for the
calculator by quarters for Year 2 and for the first quarter of Year 3, as shown below.

Year 2 Year 3
First Second Third Fourth First
Budgeted production
in calculators ........ 60,000 90,000 150,000 100,000 80,000

The chip used in production of the calculator is sometimes hard to get, so it is

necessary to carry large inventories as a precaution against stockouts. For this
reason, the inventory of chips at the end of the quarter must be equal to 20% of
the following quarter's production needs. Some 36,000 chips will be on hand to
start the first quarter of Year 2.

Required:
Prepare a materials purchases budget for chips, by quarter and in total, for
Year 2. At the bottom of your budget, show the peso amount of purchases for
each quarter and for the year in total.

45
Exercise 4 (Direct Labor Budget)
The Production Department of the Laguna Plant of JC Corporation has submitted
the following forecast of units to be produced at the plant for each quarter of the
upcoming fiscal year. The plant produces high-end outdoor barbeque grills.

1st quarter 2 quarter 3rd quarter 4 quarter

Units to be produced..... 5,000 4,400 4,500 4,900

Each unit requires 0.40 direct labor-hours and direct labor-hour workers paid P11
per hour.
Required:
1. Construct the company's direct labor budget for the upcoming fiscal year,
assuming that the direct labor work force is adjusted each quarter to
match the number of hours required to produce the forecasted number of
units produced.
2. Construct the company's direct labor budget for the upcoming fiscal year,
assuming that the direct labor work force is not adjusted each quarter.
Instead, assume that the company's direct labor work force consists of \
permanent employees who are guaranteed to be paid for at least 1,800
hours of work each quarter. If the number of required direct labor-hours is
less than this number, the workers are paid for 1,800 hours anyway. Any
hours worked in excess of 1,800 hours in a quarter are paid at the rate of
1.5 times the normal hourly rate for direct labor.

Exercise 5 (Manufacturing Overhead Budget)

The direct labor budget of Kiko Corporation for the upcoming fiscal year
contains the following details concerning budgeted direct labor-hours.

1st quarter 2nd quarter 3rd quarter 4th quarter

Budgeted direct labor
hour........... 5,000 4,800 5,200 5,400

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 The company's variable manufacturing overhead rate is P1.75 per direct labor-
hour and the company's fixed manufacturing overhead is P35,000 per quarter.
The only noncash item included in the fixed manufacturing overhead is
depreciation, which is P15,000 per quarter.

Required:
1. Construct the company’s manufacturing overhead budget for the
upcoming fiscal Year.
2. Compute the company’s manufacturing overhead rate (including both
variable and fixed manufacturing overhead) for the upcoming fiscal year.
Round off to the nearest whole centavos.

Exercise 6 (Selling and Administrative Budget)

The budgeted unit sales of Helene Company for the upcoming fiscal year are
provided below:
1st quarter 2nd quarter 3rd quarter 4th quarter
Budgeted unit sales..... 12,000 14,000 11,000 10,000

The company's variable selling and administrative expenses per unit are P2.75.
Fixed selling and administrative expenses include advertising expenses of
P12,000 per quarter, executive salaries of P40,000 per quarter, and depreciation
of P16,000 per quarter. In addition, the company will make insurance payments
of P6,000 in the 2nd Quarter and P6,000 in the 4th Quarter. Finally, property
taxes of P6,000 will be paid in the 3rd Quarter.

Required:
Prepare the company's selling and administrative expense budget for the
upcoming fiscal year.

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Exercise 7 (Cash Budget Analysis)
A cash budget, by quarters, is given below for a retail company. (000 omitted).
The company requires a minimum cash balance of P5,000 to start each quarter.

Quarter
___________ _________ __ _________ ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ _______ ______ ______ ______ ______ ______ ______ ______ _

Cash balance, beginning………….. P 9
Add collections from customers…..
Total cash available……………….
Less disbursements:
Purchase of inventory…………
Operating expenses…………...
Equipment purchases…………
Dividends……………………..
Total disbursement………………..
Excess (deficiency) of cash available
Or disbursements………………. (3)
1 2 3 4 Year
P? P? P? P?
? ? 125 ? 391
85 ? ? ? ?
40 58 ? 32 ?
? 42 54 ? 180
10 8 8 ? 36
2 2 2 2 ?
? 110 ? ? ?
? 30 ? ?

Financing:
Borrowings……………………. ? 20 - - ?
Repayments (including interest)*.. - - (?) (7) (?)
Total financing……………………. ? ? (?) (?) ?
Cash balance, ending…………….... P? P? P? P? P?

*Interest will total P4, 000 for the year.

Required:
Fill in the missing amounts in the table above.

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Summary

Budgeting is planning how to use the assets of the firm during the budgeting process.
Budgeting requires periodic planning; improves communication, coordination
and cooperation; pushes the quantitative measurement of plans and propositions; creates a
basis for performance assessment and directs the company's activities towards the
accomplishment of the goals objective.

The implementation of the budgetary program does not stop with the creation of the
master budget plan. Once the master budget plan has been prepared, follow-ups are
necessary to compare actual results with planned in budgeted figures. This is accomplished
through the budget performance reports, which highlight deviation in variances that may serve
as guides for making the necessary corrective actions.

References

Bagayao, I.Y.S. (2019). Financial Management, Volume 2. Philippines: Lajara Publishing

House.

Cabrera, E.B., & Cabrera, G.A., (2017). Management Accounting: Concepts and
Applications. Manila, Philippines: Conanan Enterprises.

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