Accounting Principles for Hospitality and Tourism (HTB2004) Temasek Polytechnic

TOPIC 10: PLANNING & BUDGETING

Learning Objectives

At the end of the lecture, you should be able to:

1. Explain what a budget is and the purpose of budgeting.
2. Identify the different types of budgets.
3. Describe the budget preparation process.
4. Prepare an operating budget and a cash budget.
5. Perform variance analysis and communicate the findings clearly and
succinctly.

Reading:
Chapter 10, Hospitality Industry Managerial Accounting by Raymond S
Schmidgall
Chapter 9, Hospitality Management Accounting by Martin G. Jagels and
Michael M. Coltman

What is a budget?
A budget is a detailed _________ expressed in _________________ terms.

It is prepared and approved prior to the financial period and may show the
 estimated revenue
 estimated cost & expenses
 the capital to be employed

Main Purposes of Budgeting

1. Budgeting enables management to look forward, especially when strategic
planning is concerned. It forces management to examine _____________
before selecting a particular course of action.
 requires management to consider external and internal factors.
 provides management with an effective means of evaluating the
various possible alternatives.

2. Budgeting provides a standard of _________________.

 able to compare actual operating results to a formal plan (budget)
 significant variances can be investigated
 corrective action can then be taken
 budgets can be used for control purposes

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3. The budget process provides a channel of __________________ whereby

the operation’s objectives are communicated to the lowest managerial
levels.

4. When participative budgeting is practised, the budget process involves all

levels of management. It serves as a device for _______________ staff
through their involvement as they have real input in the process.

To summarize, three main functions of budgeting are:

Planning
Control
Execution

Budget Cycle
It is a process summarized as follows:

1. Establish attainable __________ or objectives.

2. __________ to achieve these goals or objectives.
3. Compare _____________ results with those planned and analyse the
differences ( ______________ ).
4. Take ________________ action.

Different Types of Budgets

As there can be many different types of plans in business and a budget is
basically a financial expression of that plan, there can also be many different
types of budgets.

eg. Types of Business Plans Types of Budgets

Sales plans ……………………..
Plans for better use of cash ……………………..
The entire hotel’s operation plan ……………………..

For the purpose of this module, we are interested in the cash and operating
budget.

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Budget Preparation Process

The major elements in the budget preparation process are as follows:

Financial / Business objectives

Financial/Business Objectives

 Establish business __________ or ________________ with board of

directors or owners.

 Important first step

 equivalent to having a business _________
 If the organization would like its business to remain as status quo, that
is a plan/goal by itself
 Some of the more common or underlying goals which an organization
may have are :
 long term profit maximization
 cost containment
 provide high quality service
 to be the market leader, etc.

 _______________ to achieve these goals or objectives.

 With these goals, the organization would have to establish

_________________ to achieve these goals and objectives
 These strategies would have to be expressed in _____________ terms
in order to prepare a budget

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Revenue Forecasts

 With the business goal(s) in mind and the necessary strategies needed to
achieve these goals, the organization would have to forecast (estimate) for
the revenue that it is expected to earn in the budget period.
 Usually done by the _________________ managers
 For most organizations, they build their revenue forecast based on historical
financial information provided by the accounting department -
_____________________________
eg. the room revenue is budgeted for an increase of 10% as the trend
for the past five years has been one of an increase by 10%
 If a revenue forecast is built from scratch, ie. with no historical information, we
would call this form of budgeting _________________________
eg. for a new hotel, the average room rate and the occupancy rate for
the budget would have to be estimated for the first year based on
the economic and market conditions.

Expenses Forecast

After we have forecast the revenue, we would have to forecast the necessary
expenses that have to be incurred in order to earn the budgeted revenue.

 Profit centre managers estimate their _____________ expenses in relation to

the projected revenues of their departments.
eg. If historically, the food cost of a restaurant has always been 35%
of food sales, then we can also budget at 35% of the budgeted
food sales revenue

 ___________________ managers also estimate their expenses for their

respective departments

 Expenses are usually projected on the basis of ________________ and

expected changes.

 Another method of estimating expenses is based on ________________

_____________
eg. Work standard requires room attendants to clean two rooms per
hour and the average hourly wage is $5. If 800 room sales are
budgeted for the month, then we can budget (800/2 x $5) $2,000 as
wages for the room attendants for the budgeted month

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 It is important to know the __________________ of the expenses (eg. fixed

or variable) in order to forecast the expenses accurately.

Net Income or Profit Forecasts

The final step of the budget formulation process is for the financial controller to
formulate the ____________ budget based on submissions from profit centres
and cost centres.

 The financial controller has to ________________ the various departments

revenue and expenses forecast into one hotel-wide budget income statement

 The forecast net income (or net profit) is a result of this process.

 If this budgeted net profit is acceptable to the board of directors and/or the
owners, then the budget formulation is _________________.

 If the budgeted net profit is not acceptable, then department heads are
required to rework their budgets to provide a budget acceptable to the
board/owners.

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Illustration A – Operating Budget

Grant Hotel is one of the many four-star hotel in Singapore. It has 200 rooms.
The owners and Board of Directors of Grant Hotel have decided that they would
like Grant Hotel to be the top hotel in town in Year 2007. The following
information is given for the Rooms Division and F&B Division.

Rooms Division
Currently, their occupancy is 70% and average room rate is $110. For
Year 2007, they would like the hotel to able to sustain the following:
Occupancy rate increased to 80%
Average room rate increased to $120
Expense forecast:
Labour - Fixed $ 800,000
Variable $ 5 per occupied room
Variable operating expense $10 per occupied room

F&B Division
Grant Hotel has only one outlet - Buffy’s Buffet. The budgeted food &
beverage revenue level for this outlet is set at $ 900,000.
 Food & Beverage cost: 52 % of sales
 Variable labour expense: 25% of sales
 Fixed labour cost: $ 60,000
 Other fixed operating expenses: $ 127,000

Required
Prepare the operating budget for the entire Grant Hotel for 2007. Assume the
Rooms Division and Buffy’s Buffet restaurant are the only operating departments
in the hotel.

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Answer to Illustration A
Grant Hotel
Operating Budget for the Financial Year ending 31 Dec 2007
Rooms Division F&B Division Total
Revenue ______ rms x$120 7,008,000 7,908,000
Less: Cost of Sales 52% x ______ 468,000
468,000
Gross Profit 432,000
Less: Expenses
Labour
- Variable 58,400 rms x $ __ 292,000 25% x ______ 225,000 517,000
- Fixed 860,000
Other Operatg Exp 58,400 rms x $ __ 584,000 ______ 711,000
_
Net Profit 5,332,000 5,352,000
20,000
Workings:-
No of occupied rooms in 2007 = ___% x ____ rooms x ____ days = 58,400

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Cash Budget

 Net Profit is not __________.

 Cash flow is not the same as profit flow due to items that were sold or
purchased on credit.
eg. A company may have earned $2,000 net profit but the cash balance
could be zero as most of it could be tied up in accounts receivable.

 As all organizations need cash to pay off its expenses, we will need a report
that tells us what is the __________________ of the organization and whether
it is going to have excesses or shortages of cash.
 Cash Budget is needed.

 A cash budget forecast the amount of cash _____________ at the end of the
period.

 A generic format of the cash budget should be:

Opening cash/bank balance

+
Cash Receipts
-
Cash Payments
=
Closing cash/bank balance

 Depending on the needs of the organization, cash budget can be prepared on

a monthly basis or yearly basis.

 Starting point in cash budgeting is the Profit & Loss statement showing the
budgeted revenues and expenditures.

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Illustration B - Cash Budget

Given the following budgeted P&L statements:

April May June

Revenue $ 30,000 $ 35,000 $ 40,000
Food Cost 12,000 14,000 16,000
Gross Profit 18,000 21,000 24,000
Payroll/Salaries expense $ 9,000 $ 10,500 $ 12,000
Supplies expense 1,500 1,750 2,000
Utilities 500 750 1,000
Rent 1,000 1,000 1,000
Net Profit $ 6,000 $ 7,000 $ 8,000

Information:
 60% of revenue is cash and 40% is charged and collected the following
month. March revenue was $28,000.
 Purchases of food is 25% cash and 75% bought on credit. The amount owing
is paid the month following purchase. March purchases was $11,000.
 Payroll, supplies, utilities and rent expenses are paid 100% cash.
 Bank Balance on April 1 is $10,200.

Required: Prepare cash budgets for the months of April, May and June.

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Answer to Illustration B

April May June

Opening Cash Balance (A) $ $ $
10,200 ______ 22,650

Add: Cash Receipts (B)

Cash Revenue 60% x Revenue $ $
21,000 24,000
Collection from Accounts 40% x last mth’s ______ 12,000 14,000
Receivable Revenue
Total ______ 33,000 38,000

Less : Cash Payments (C)

Current food purchases 25% x Food Cost $ 3,500 $ 4,000
3,000
Accounts Payable payment 75% x last mth’s 8,250 9,000 10,500
purchase
Payroll expense 9,000 10,500 12,000
Supplies expense 1,500 1,750 2,000
Utilities 500 750 1,000
Rent 1,000 1,000 1,000
Total $ $ $
23,250 26,500 30,500

Closing Cash/Bank Balance (A) + (B) – (C) $_ $ $

____ 22,650 30,150

Note that the breakdown between cash and charge revenue and expenses is
based on historic experience.
Analysis
 Use of ______________ Cash
 For the above situation, the company is enjoying a fairly healthy surplus of
cash. This surplus should not be left to accumulate in the bank as it would
earn very low returns (remember Management of Working Capital lectures).

 In this particular case, management might decide to take $20,000 or

$25,000 out of the bank and invest it in a high interest, short-term securities.
 ________________ Cash Budget
 Having anticipated a shortage of cash through cash budgeting, the company
can plan to cover it by means of a short-term bank loan or by owner loans.

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Budgetary Control
Budgetary control is a cost control method that enables actual results to be
compared with the budget, thereby enabling any necessary corrective action to
be taken.

The following steps are taken in the budgetary control process:

1. Determine variances
2. _____________ significant variances
3. Determine _____________
4. Take actions to _______________ problems

In order for budgets to be used effectively for control purposes,

- budget reports must be prepared __________________,
- for each level of ______________________;
- budget reports must be _____________ and ______________ in order to
be useful.

Variance Analysis

This is a useful technique for isolating the __________ of differences between

the budgeted and actual figures. The differences are broken down into:
 _______ and Quantity variance (when analysing revenue figures )
 _______ and Quantity variances (when analysing expense figures )

Variances are classified as favourable or unfavourable depending on its effect on

profits.

Situation Variance
Revenue Actual above budget
Actual below budget
Expenses Actual above budget
Actual below budget

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Illustration C – Variance Analysis (Revenue Item)

Banquet Revenue, Month of March

Budget Actual Difference

$ 50,000 $ 47,250 $ 2,750 (unfavourable)

Additional information:

Budget 5,000 guests x $ 10.00 average check = $ 50,000

Actual 4,500 guests x $ 10.50 average check = $ 47,250
Variance $ 2,750

Price Variance
Price Variance = Price Difference x Actual Quantity
= ($ - $ ) x guests
= $ 0.50 x 4,500 guests
= $ 2,250 ( ____________ )

Quantity Variance
Quantity Variance = Quantity Difference x Budgeted Price
= ( - ) guests x $
= 500 guests x $ 10
= $ 5,000 ( ______________ )

If we combine these results, our total variance is made up of

Price variance $ 2,250 ( favourable )

Quantity variance 5,000 ( unfavourable)
Total variance $ 2,750 ( __________ )

We now have information that tells us the main reasons for our difference
between budget and actual:

 A reduction in revenue of $ 5,000 due to fewer customer served

 But partly compensated for by $ 2,250 resulting from the average
banquet customer having a more expensive meal

This tells us that our banquet sales department is probably doing an

effective job in selling higher priced menus to banquet groups, but is
failing to bring in as many banquet or guests as anticipated.

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Illustration D – Variance Analysis (Expense Item)

Laundry Expense (laundry cost per room occupied), Month of March

Budget Actual Difference

$ 6,000 $ 6,510 $ 510 (unfavourable)

Additional information:

Budget 3,000 rooms sold at $ 2.00 per room = $ 6,000

Actual 3,100 rooms sold at $ 2.10 per room = 6,510
Variance $ 510

Cost Variance

Cost Variance = Cost Difference x Actual Quantity

= $ _____ x _____ rooms = $ 310
( ______________ )

Quantity Variance

Quantity Variance = Quantity Difference x Budgeted Cost

= ____ rooms x $ _____ = $ 200
( ______________ )

If we combine these results, our total variance is made up of

Cost variance $ 310 ( unfavourable )

Quantity variance 200 ( unfavourable)
Total variance $ 510 ( __________ )

This tells us that, although our total variance was $510, or 8.5% over budget
($510 divided by $6,000), only $310 is of concern to us. The remaining $200 is
inevitable because it is beyond our control.

If we sell more rooms, as we did, we would obviously have to pay the extra $200
for laundry. Even though this is considered unfavourable as a cost increase, we
would not worry about it since it would be more than offset by the extra revenue
obtained from selling the extra rooms.

Whether or not the other $310 overspending is serious would depend on the
cause.

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The cause could be a supplier cost increase that we may, or may not, be able to
do something about; or it could be that we actually sold more double rooms than
budgeted for ( which would mean more sheets to be laundered and therefore
cause our average laundry cost per room occupied to go up ). In the latter case,
the additional cost would be more than offset by the extra charge made for
double occupancy of a room.

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