Financing and Budgeting-chapter 5

8/16/2019 Financing and Budgeting-chapter 5

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FINANCING AND

BUDGETING

CHAPTER 5


2/86

KINDS OF CAPITALIn common usage the o!" #ca$%ta

%s the s%ng&e te!m use" to co'e! the&an"( )u%&"%ngs( mach%ne!*( too&s( an"mate!%a&s o+ a $!o"uct%'e ente!$!%se,Techn%ca&&*( he!eas &an" %s ca$%ta&( %t%s "%st%ngu%she" +!om the othe! meanso+ $!o"uct%on )ecause the* a!e!e$!o"uc%)&e an" &an" %s not,

Ra!e&* "oes the )us%nessman ma-eth%s "%st%nct%on,In the o!" ca$%ta&( he &um$s

togethe! a&& the e&ements he %&& nee"


3/86

He th%n-s o+ ca$%ta& most o+ten %nmone* te!ms,P!omot%ng a ne ente!$!%se %s 'e!*&a!ge&* a 0nanc%a& o$e!at%on,S%nce mone* an" c!e"%t a!e the ch%e+means +o! ac.u%!%ng the %nst!uments

o+ $!o"uct%on( the o!" ca$%ta& hasth%s 0nanc%a& as$ect,An" th%s %s the a* e sha&& use %t

he!e,A$$&%e" to %n"ust!%a& 0nanc%ng( ca$%ta&means the cash mone* an" c!e"%tnee"e" to sta!t an" to o$e!ate anente! !%se


4/86

These +o!ms o+ ca$%ta& a!e )estun"e!stoo" hen e e2am%ne the

ca$%ta& !e.u%!ements o+ ano!"%na!* %n"ust!%a& ente!$!%se,In th%s a*( too( the connect%on

%&& )e c&ea! )eteen mone*(ca$%ta& an" $!o"uct%'e ca$%ta&(the tang%)&e %nst!uments o+

$!o"uct%on,I+ an %n"ust!%a& ente!$!%se %s to )esta!te" +!om the g!oun" u$, so to

s$ea-( %t %&& nee" &an" an"


5/86

Assets o+ th%s -%n"( %nten"e" to )euse" o'e! an" o'e! aga%n %n$!o"uct%on +o! a &ong $e!%o" o+ t%me(a!e common&* ca&&e" fxed capital andthe mone* an" c!e"%t !e.u%!e" to $a*+o! such assets ta-e the same name,

An ente!$!%se a&so !e.u%!es +un"s toco'e! %ts o$e!at%ons3to ma%nta%n the$&ant( to $u!chase mate!%a&s an"

su$$&%es( to $a* sa&a!%es an" ages(to co'e! sto!age( t!ans$o!tat%on( an"sh%$$%ng se!'%ces( +o! a"'e!t%s%ng(an" to t%"e o'e! the ente!$!%se "u!%ngthe t%me &a )eteen the sa&e o+ %ts


6/86

SOURCES OF CAPITAL FUNDSTo 0nance mo"e!n %n"ust!*( &a!ge3sca&e sa'%ngs a!enecessa!*,B* &a!ge sca&e sa'%ngs e common&* mean mone*

sa'%ngs a!%s%ng %n a 'a!%et* o+ a*s th!oughout theeconom*, In"%'%"ua&s( !%ch an" $oo!( sa'e,The !%ch sa'e "%!ect&*( &a!ge&* )ecause the%! %ncomee2cee"s e'en the &a!ge s$en"%ng the* "o +o!themse&'es an" the%! +am%&%es,The* a&so sa'e %n"%!ect&* as hen the* $a* &%+e%nsu!ance $!em%ums( $u!chase annu%t%es( esta)&%sh+un"s( etc,F!om the ea&th* to the &oe! %ncome g!ou$( the!e

a!e g!a"at%ons %n the amount o+ "%!ect sa'%ngs &%-esa'%ngs )an- accounts( )u%&"%ng an" &oan sha!es(sa'%ngs )on"s4 an" much o+ the stea"* sa'%ngs %s"one th!ough such %n"%!ect means as &%+e %nsu!ance,The 'e!* $oo! cannot sa'e +o! themse&'es at a&& the%!

%ncome %s a&& use" u$ %n &%'%ng e2$enses( But thes en"%n o+ an %n"%'%"ua&s +!om the 'e! oo! to the


7/86

Go'e!nments ma-e u$ the th%!" &a!ge g!ou$ o+sa'e!s,The!e a!e a)out 66(666 go'e!nment un%ts %n theUn%te" States 3Fe"e!a&( state( an" &oca&, 7hen an*one

o+ these un%ts co&&ects mo!e %n ta2es than %s use" +o!o$e!at%ng e2$enses an" uses the )a&ance +o! $u)&%co!-s( the $a!t so use" !e$!esents go'e!nmentsa'%ngs,The sa'%ngs ta-e the +o!m o+ $u)&%c o!-s such as

h%gha*s( !%'e! an" ha!)o! const!uct%on(seage3"%s$osa& an" ate! s*stems( t!ans$o!tat%on+ac%&%t%es( $u)&%c )u%&"%ngs( an" the assets %n ag!o%ng &%st o+ go'e!nment ente!$!%ses,In a""%t%on( go'e!nment $u!chases man* )%&&%ons o+

"o&&a!s8 o!th o+ goo"s an" se!'%ces a $o!t%on o+h%ch 0n"s %ts a* %nto )us%ness ca$%ta& sa'%ngs +o!+utu!e %n'estment,So +a! as the st!eam o+ sa'%ngs an" %n'estments %sconce!ne"( go'e!nment sa'%ngs $e!+o!m 'e!* muchthe same +unct%on as "o )us%ness sa'%ngs,


8/86

THE 9ONE: 9ARKETThe 0nanc%a& !e.u%!ements o+ mo"e!n %n"ust!%a&ente!$!%se a!e so g!eat that a &a!ge neto!- %s

nee"e" to mo)%&%1e the mone* an" c!e"%t!esou!ces nee"e",The mone* ma!-et "oes th%s3 an" %s the!e+o!eone o+ the ch%e+ !ese!'o%!s o+ ca$%ta&,

7hat "o e mean )* the comme!c%a& mone*ma!-et;I+ a "e0n%t%on e!e attem$te"( %t m%ght !ea"someth%ng &%-e th%s<In %ts )!oa"est sense( the mone* ma!-et %s thetota& o+ %n"%'%"ua&s( 0!ms( %nst%tut%ons( an" the$!ocess )* h%ch mone* an" c!e"%t a!eco&&ecte"( accumu&ate"( an" a"m%n%ste!e" +o!the 0nanc%ng o+ econom%c act%'%t%es,

The ma!-et %s not a s%ng&e $&ace( o! channe&( o!


9/86

Long3Te!m Ca$%ta&Fo! &ong3te!m ca$%ta&( %n"ust!%a& )o!!oe!s ma* ta$se'e!a& channe&s,La!ge %n'estment )an-%ng houses se!'e &a!ge

%n"ust!%a& ente!$!%ses )* un"e!ta-%ng to un"e!!%tean" to ma!-et stoc- an" )on" %ssues,Insu!ance com$an%es ha'e &ate&* )ecome an%m$o!tant sou!ce +o! &ong3te!m ca$%ta& +un"s )*ta-%ng the secu!%t* %ssues o+ %n"ust!%a& ente!$!%ses=$a!t%cu&a!&* ut%&%t%es> )* "%!ect( $!%'ate $&acement,Inst%tut%ona& an" en"oment t!ust +un"s ma* a&sosu$$&* ca$%ta& )* "%!ect $&acement( )ut usua&&* the*"o the%! %n'est%ng )* $u!chas%ng secu!%t%es

"%st!%)ute" )* othe! agenc%es,In the $ast( comme!c%a& )an-s "ea&t ma%n&* %n sho!t3te!m &oans( )ut 0nanc%a& changes %n the &ast ?6 *ea!s3ha'e %n"uce" them to see- out&ets +o! the%! +un"s %n02e"3te!m %n'estments +o! as &ong as 6 to 5 *ea!s8

matu!%t*,Ra!e& "o ea&th %n"%'%"ua&s ma-e %n"e en"ent


10/86

Inte!me"%ate an" Sho!t3Te!m Loans7he!eas %nte!me"%ate an" sho!t3te!m

&oans !e$!esent "%/e!ent t*$es o+0nanc%ng( )oth a!e '%!tua&&* se!'%ce" )*the same t*$es o+ &en"%ng agenc%es,Sho!t3te!m &oans ma* !ange +!om @6 "a*s

u$ to ? *ea!s( an" %nte!me"%ate te!m&oans to 5 *ea!s( "e$en"%ng u$on thecha!acte! an" c%!cumstances o+ the &oan,Th%s %s the 0e&" occu$%e" )* the !egu&a!

comme!c%a& )an-s h%ch %n &oca&commun%t%es th!oughout the nat%on ha'et!a"%t%ona&&* se!'e" the cu!!ent c!e"%tnee"s o+ )us%ness ente!$!%ses,

Some changes ha'e )een ta-%ng $&ace %n


11/86

Fo! one th%ng( the 'e!* &a!ge %n"ust!%a& com$an%es%nc!eas%ng&* ten" to 0nance themse&'es %n matte!so+ %nte!me"%ate3 an" sho!t3te!m c!e"%t,On the othe! han", the nee" +o! )an- &%.u%"%t*( the

h%gh &en"%ng stan"a!"s, an" the !%s-%ness o+ sma&&)us%ness ten" to ma-e comme!c%a& )an-s!e&uctant to se!'e the c!e"%t nee"s o+ sma&&ente!$!%ses, un&ess Fe"e!a& &en"%ng agenc%es

$a!t%c%$ate %th the )an-s,To a cons%"e!a)&e e2tent a&so the )an-s ha'een&a!ge" the%! !o&e as a 0nanc%a& se!'%ce agenc* %nthe commun%t* %n han"&%ng the o o+ +un"s,Thus the* ha'e %nc!ease" the%! act%'%t%es %n

ma-%ng $e!sona&( automo)%&e( a$$&%ance( an"home3%m$!o'ement &oans to %n"%'%"ua&s an")us%ness,7he!e ga$s %n 0nanc%ng o$e!at%ons ha'e )een &e+to$en )* the comme!c%a& )an-s( 'a!%ous othe!&en"%ng agenc%es ha'e )ecome act%'e,


12/86

The chatte&3mo!tgage( 0nance( an"%n'estment com$an%es o$e!ate %n a

'a!%et* o+ +o!ms,The !ates the* cha!ge a!e &%-e&* to )eh%ghe!( the con"%t%ons $ut u$on the)o!!oe! mo!e )u!"ensome( an" the

!esu&tant cost o+ the &oan much h%ghe!than !egu&a! )an- c!e"%t,Comme!c%a& +acto!s( +!e.uent&*

!e+e!!e" to as the #m%""&emen o+c!e"%t(# ha'e come to occu$* an%m$o!tant $&ace %n %n"ust!%a& an")us%ness 0nance,

O!%g%na&&* the comme!c%a& +acto!


13/86

In t%me the +acto! came to "ea& e2tens%'e&* %n0nanc%ng o$e!at%ons th!ough the $u!chase o+accounts !ece%'a)&e( %nsta&&ment cont!acts($!om%sso!* notes( an" othe! comme!c%a& $a$e!)ase" on t!ansact%ons( %n'ento!%es( an"a!ehouse stoc-s,9an* o+ them s$ec%a&%1e %n a%"%ng st!ugg&%ng

ent!e$!eneu!s as e&& as esta)&%she" 0!msha!" $!esse" +o! o!-%ng ca$%ta&,In most cases the* o$e!ate %n a!eas he!e)an-s a!e !e&uctant to ente!( an" the* cha!ge

h%ghe! !ates +o! acce$t%ng the unusua& !%s-s,7%th the a%" o+ a +acto! a manu+actu!e! cantu!n o!"e!s %nto cash %thout a%t%ng ee-san" months +o! a !etu!n to )e !ea&%1e",

Th%s %s an %m$o!tant )ut cost&* an" somet%mesun!e&%a)&e se!'%ce to sma&& an" me"%um3s%1e"


14/86

T!a"e C!e"%tsNot ment%one" as *et( )ecause %t %s

not e2act&* a &en"%ng agenc*( %s thet!a"e c!e"%t,Th%s %s the ma%nsta* o+ %nte!me"%ate

an" sho!t3te!m 0nanc%ng($a!t%cu&a!&* +o! the sma&&ente!$!%se,It co'e!s not on&* commo"%t%es an"su$$&%es( )ut a&so mach%ne!*(02tu!es( e.u%$ment( an" othe!%tems o+ &onge! te!m 0nanc%ng,

The sma&& manu+actu!e! s%m$&*


15/86

A ne t%st on the t!a"e c!e"%t ma* eme!ge+!om the $!act%ce )* h%ch a &a!geco!$o!at%on somet%mes g%'es 0nanc%a& a%" tosome among %ts c&uste! o+ sma&&e! sate&&%tesu$$&%e!s,In a somehat s%m%&a! manne!( &a!ge )u*e!ssuch as ma%&3o!"e! houses an" "e$a!tmentsto!es somet%mes a%" those hose$!o"uct%on the* )u* ent%!e&* o! %nsu)stant%a& $a!t,A ne +o!m o+ 0nanc%ng !e&at%onsh%$ ma*g!o out o+ these $!act%ces( ust as +acto!0nanc%ng g!e out o+ me!chan"%s%ng+unct%ons o!%g%na&&* $e!+o!me" )* +acto!s +o!manu+actu!e!s,In )oom t%mes an" e'en %n t%mes o+ no!ma&


16/86

C!e"%t Inst!umentsC!e"%t %nst!uments a!e the &ega&

+o!ms th!ough h%ch &oans a!ema"e,The* "%/e! %th the t*$e o+ &oan(

the &ength o+ t%me %t %s to !un( theuse to h%ch the +un"s a!e to )e$ut( an" the t*$e o+ )o!!oe!,

The* "%/e! a&so )* the a* %nh%ch the* a/ect th%!" $a!t%es,On&* the mo!e gene!a& t*$es o+c!e"%t %nst!uments can )e touche"u on he!e )ecause each case %s


17/86

Long3te!m c!e"%t( %+ !e.u%!e" +o! e.u%t* o!02e" ca$%ta&( usua&&* ta-es the +o!m o+securities-stocks or bonds o the

borrowing company which ultimatelycome to )e he&" )* %n"%'%"ua&s( )an-s(%n'estment t!usts( an" othe! %n'esto!s,Comme!c%a& c!e"%t +o! othe! than 02e"ca$%ta& o+ $e!manent natu!e %s usua&&*!e$!esente" )* promissory notes, backedby collateral o various‘ -%n"s( an" a&most

a&a*s negot%a)&e, In some cases theco&&ate!a& ta-es the +o!m o+ mo!tgagesaga%nst the 0!ms !ea& estate( mach%ne!*(e.u%$ment( an" othe! chatte&s,

In othe! cases the co&&ate!a& ma*)e

Sh "% % & &


18/86

Sho!t3te!m c!e"%ts o! comme!c%a& &oans%nten"e" to 0nance s%ng&e t!ansact%ons o! ag!ou$ o+ t!ansact%ons that a!e to )ecom$&ete" %n sho!t t%me a!e o!"%na!%&*e'%"ence" )* promissory notes, drats, billso exchange or trade acceptances.These ma* o! ma* not )e su$$o!te" )* billso lading, warehouse receipts, o! chattelmortgage contracts as against materialsinvolved in transactions, and othe! c&a%msu$on $!o$e!t*,7hen accounts receivable are accepted ascollateral to a &oan( o! ta-en o'e! out!%ght )*a &en"%ng agenc*( the usua& +o!m %s to as signsuch accounts to the lender.I the frm markets its products direct to theconsume! an" ta-es installment notes or

PLANNING THE FINANCIAL STRUCTURE


19/86

PLANNING THE FINANCIAL STRUCTURE,Fe $eo$&e %&& "en* that ente!$!%ses ma*st%&& )e sta!te" on a shoest!%ng an" ma* )e

"e'e&o$e" %nto &a!ge3sca&e com$an%es,Th%s %s &ess $oss%)&e %n the o&"3&%ne%n"ust!%es he!e esta)&%she" 0!ms o/e!st!ong com$et%t%on than %t %s %n the nee!

%n"ust!%a& 0e&"s he!e "eman" an" su$$&*+o!ces a!e not +u&&* esta)&%she",The automot%'e( a%!$&ane( an" home3a$$&%ance %n"ust!%es a!e e2am$&es o+

esta)&%she" 0e&"s( h%&e $&ast%cs( &%ghtmeta&s( an" e&ect!on%cs a!e e2am$&es o+ thene 0e&"s,The $!o)&em o+ sta!t%ng a ne ente!$!%se %s

a&a*s much mo!e "%cu&t than that o+


20/86

F%nanc%ng the Non3co!$o!ate Ente!$!%seIn the case o+ the s%ng&e $!o$!%eto!sh%$ an"the $a!tne!sh%$ the %n%t%a& ca$%ta& comes +!om

the %n"%'%"ua&s "%!ect&* %nte!este" an"$oss%)&* th!ough the &oans an" %n'estmentsthat the%! +!%en"s a!e %&&%ng to ma-e %n the)us%ness,

In a""%t%on to cash( these %n"%'%"ua&s ma*cont!%)ute the actua& &an"( )u%&"%ngs(mach%ne!*( an" mate!%a&s nee"e" to ma-e u$the $!o"uct%'e ca$%ta& o+ the )us%ness,

7e sha&& see &ate! ho these ente!$!%ses canaugment the%! %n%t%a& ca$%ta& %th o!-%ngca$%ta& +!om 'a!%ous sou!ces( )ut at the sta!tthe* a!e &a!ge&* "e$en"ent u$on the%! on

!esou!ces,


21/86

Co!$o!ate Ca$%ta&%1at%onIt %s the co!$o!ate ente!$!%se that %smost conce!ne" %th the $!o)&ems o+

+o!ma& ca$%ta&%1at%on,At the t%me o+ %nco!$o!at%on the$!omote!s o! $!os$ect%'e manage!smust ma-e the $o&%c* "ec%s%on as to thetota& amount at h%ch the ente!$!%se %sto )e ca$%ta&%1e" an" hat +o!ms theca$%ta& st!uctu!e shou&" ta-e,

The ch%e+ +acto!s %n th%s "ec%s%on a!e thenatu!e an" s%1e o+ the )us%ness,F!om ca!e+u& ana&*s%s o+ the e&ements %nthese +acto!s( ana&*s%s o+ the $!o"uct(

ma!-et stu"%es( an" a gene!a& )us%ness


22/86

I+ !ea& estate( )u%&"%ngs( e.u%$ment(an" othe! tang%)&e $!o$e!t* a!econt!%)ute" )* the o!gan%1e!s( thecost o! 'a&ue o+ such assets %&& )e$a!t o+ the tota&,To th%s sum the!e %&& ha'e to )e

a""e" an amount suc%ent to co'e!necessa!* $!omot%on( eng%nee!%ng(an" "e'e&o$menta& e2$enses,It %s essent%a& to ha'e a +un" o+o!-%ng ca$%ta& suc%ent %n the)eg%nn%ng to ca!!* the 0!m th!oughthe $!o"uct%on c*c&e to the $o%nt hen

su)stant%a& an" susta%ne" !etu!ns

I + th %t &% t%


23/86

In some +e cases the ca$%ta&%1at%on ma*ta-e account o+ $atents( sec!et $!ocesses( t!a"ema!-s(

an" othe! %ntang%)&e %tems( )ut %n theunt!%e" ente!$!%se the!e %s &%tt&e )as%s +o!an*th%ng othe! than nom%na& 'a&ues onthese %tems,

Cu!!ent &ega& !e.u%!ements( state an"Fe"e!a&( %&& ha'e to )e cons%"e!e")ecause the* a/ect +!anch%se +ees(ta2at%on( secu!%t* sa&es,

An" othe! a/a%!s o+ the com$an*, In%t%a&ca$%ta&%1at%on m%ght a&so )e $&anne" %than e*e toa!" +utu!e e2$ans%on an"toa!" the $!o)&em o+ +utu!ema!-et%n o+ co! o!ate secu!%t%es( )ut


24/86

CLASSIFICATION OF STOCKTo com$&ete the )as%c0nanc%a& st!uctu!e( theautho!%1e" stoc- %&& ha'e to

)e c&ass%0e" to "e0ne the!e&at%ons o+ stoc-ho&"e!s tothe ente!$!%se( to 02 the

status o+ the co!$o!at%on%th c!e"%to!s an" the$u)&%c( an" to $!o'%"e the

CO99ON STOCK A&& th th % "


25/86

CO99ON STOCK A&& the autho!%1e"ca$%ta& stoc- o+ a com$an* ma* )e%ssue" %n a s%ng&e c&ass%0cat%on(common stock.o special rights or privileges a!eattache" to common stoc-,It )ea!s the +u&& !%s- o+ theente!$!%se( %ts successes an"+a%&u!es,

Common3stoc- ho&"e!s a!e %n &athe !ea& one!s o+ the ente!$!%se(an" the* a!e ent%t&e" to the net

assets o+ the )us%ness,


26/86

PREFERRED STOCK P!e+e!!e" stoc- %s thesecon" o+ the ma%n c&asses %nto h%chautho!%1e" ca$%ta& stoc- ma* )e "%'%"e",

The ch%e+ !eason +o! %t %s to o/e!%n"ucements to att!act %n'esto!s,The stoc- ma* )e $!e+e!!e" as to"%'%"en"s an" assets %t ma* )econ'e!t%)&e %nto common stoc- onatt!act%'e te!ms4 a s%n-%ng +un" ma* )eset u$ to gua!antee sa+et* o+ the

%n'estment4 %t ma* ha'e othe! !%ghts,On the othe! han"( %t ma* ha'e &%m%te" o!no 'ot%ng $oe! s%nce %ts othe! $!%'%&eges$!otect %t +!om the !%s-s h%ch common

sha!eho&"e!s assume,


27/86

No a!)%t!a!* !u&es can )e set +o! "%'%s%on )eteen(common an" $!e+e!!e" stoc-,Th%s %s a matte! o+ u"gment %n each case( %n anse!to such .uest%ons as<Ho an" )* hom %s the ente!$!%se to )e cont!o&&e";Ho much ca$%ta& %&& ha'e to )e sought +!omouts%"e!s;To hat e2tent %s %t %se to )u!"en the com$an* %th

o)&%gat%ons to $a* 02e" "%'%"en"s;7hat &ega& an" ta2 cons%"e!at%ons a!e %n'o&'e";Ho %&& the sa&e o+ secu!%t%es )e a/ecte" )*"%/e!ent c&asses o+ stoc-;7hat 0nanc%a& st!uctu!e %s most assu!%ng to

c!e"%to!s;7hat %s the most "es%!a)&e )as%s +o! the "%'%s%on o+ea!n%ngs an" o+ assets o+ the com$an* on "%sso&ut%on;These a!e a +e o+ the .uest%ons ente!%ng %nto the

"ec%s%on hen stoc- %s to )e set u$ %n c&asses,

B " I =C I " ) " >


28/86

Bon" Issues =Com$an* In"e)te"ness>7hen the ea!n%ngs !eco!" %s goo"(assets a!e su)stant%a&( an" $!os$ects o+

e2$ans%on +a'o!a)&e( a goo" metho" o+!a%s%ng nee"e" ca$%ta& %s to )o!!o %t on)on" %ssues,In essence( )on" %ssues a!e com$an*$!om%ses to !e$a* the &oan at state"$e!%o"s an" a!e )ac-e" )* a mo!tgageon $a!t o! a&& o+ the com$an*8s $!o$e!t*,

The* ta-e the +o!m o+ bonds debenturescertifcates, o! notes o issue basedupon a trust agreement or indenturewhich contains all the !%ghts an"

o)&%gat%ons )eteen the com$an*3

The essent%a& !e&at%onsh%$ )eteen the


29/86

The essent%a& !e&at%onsh%$ )eteen thecom$an* an" the )on"ho&"e!s %s that o+"e)to!3c!e"%to!,

7h%&e th%s means that )on"ho&"e!s ha'eno one!sh%$%nte!est %n the com$an*( %t a&so %m$&%esthat the%! !%ghts a!e su$e!%o! to those o+

the stoc-ho&"e!s unt%& the )on"s a!e!et%!e",A com$an* contem$&at%ng a )on" %ssueshou&" ma-e ca!e+u& stu"%es not on&* o+

the 'a!%et%es o+ )on"s h%ch ma* )e%ssue"( )ut o+ the %s"om o+ oat%ng a)on" %ssue at a&&,7he!eas )o!!o%ng +o! %n"ust!%a&e2 ans%on has man a"'anta es( %t a&so


30/86

7o!-%ng Ca$%ta&In the ne ente!$!%se( o!-%ng

ca$%ta& must come &a!ge&* th!oughthe %n%t%a& 0nanc%ng,A+te! the 0!m %s %n o$e!at%on( othe!sou!ces %&& )e o$en to %t,Ch%e+ o+ these sou!ces( o+ cou!se( %sthe cu!!ent o$e!at%ons o+ theente!$!%se,

These o$e!at%ons shou&" )esuc%ent to $!o"uce a&& the0nanc%ng !e.u%!e" to meet the

!out%ne cu!!ent nee"s o+ the


31/86

In common usage( working capital isthe total o current assets consistingo+ me!chan"%se an" mate!%a&s( cash(accounts !ece%'a)&e( an" othe! &%.u%"assets( &ess cu!!ent &%a)%&%t%es,P!o$e! !at%os shou&" )e sought

)eteen cu!!ent assets an" cu!!ent&%a)%&%t%es an" )eteen cu!!ent assetsan" ca$%ta& assets,7hat these !at%os shou&" )e "e$en"su$on the t*$e o+ ente!$!%se an" othe!+acto!s4 no 02e" !u&e can )e a$$&%e" toa&& conce!ns,

In gene!a&( o!-%ng ca$%ta& shou&" )e


32/86

A )u"get $&an %s the )est "e'%ce to"e'e&o$ an" cont!o& the o o+

o!-%ng ca$%ta&,It s%1es u$ the $!os$ects o+ the)us%ness %n a"'ance( $!o$o!t%onsthe 'a!%ous $a!ts o+ the ente!$!%se%n $!o$e! !e&at%on( sets the t%m%ngo+ %ncome3%n !e&at%on toe2$en"%tu!es( $!e$a!es +o!

cont%ngenc%es( an" -ee$s a !ese!'e%n !ea"%ness +o! une2$ecte"o$$o!tun%t%es,

A soun"&* o$e!ate" ente!$!%se %th


33/86

Rese!'es an" E2$ans%onSoun" 0nanc%a& a"m%n%st!at%on

!e.u%!es the sett%ng u$ o+!ese!'es +o! o!-%ngca$%ta&( to &%.u%"ate "e)ts( to

co'e! c!e"%t &osses( aga%nstcont%ngenc%es such as 0!e( the+t(an" une2$ecte" &%a)%&%t%es( +o!

"e$!ec%at%on an" o)so&escence( too/set $!%ce uctuat%ons on%n'ento!%es( +o! ta2es( to $!o'%"e

+o! %m$!o'ements an" e2$ans%on(


34/86

O!"%na!%&* a go%ng conce!n %&&accumu&ate some ca$%ta& +o! e2$ans%onth!ough o$e!at%ons,

7he!e the com$et%t%'e $!%ce st!uctu!ea&&os an" %n state3!egu&ate, ente!$!%ses&%-e ut%&%t%es( the un%t $!%ce o+ the $!o"ucto! se!'%ce ma* conta%n a +!act%ona& Sumto )e set as%"e %n the +o!m o+ !ese!'es +o!e2$ans%on o+ the )us%ness,C&ose&* ana&ogous to 0nanc%ng e2$ans%on

th!ough a s$ec%0c $a!t o+ the $!%ce a!ethe common metho"s o+ #$&o%ng )ac-the ea!n%ngs# an" "e$!ec%at%on !ese!'es,Ta2es( hoe'e!( ha'e )ecome so

)u!"ensome that the!e %s a !ea& $!o)&em

7hen g!eate! amounts o+ ca$%ta&


35/86

7hen g!eate! amounts o+ ca$%ta&a!e nee"e" +o! e2$ans%on( the0!m ma* see- e.u%t* ca$%ta&th!ough sa&es o+ stoc- toem$&o*ees( custome!s( somet%mesto c!e"%to!s( an" the gene!a&

$u)&%c,Stoc- !%ghts %ssue" to e2%st%ngsha!eho&"e!s o+ten !esu&t %n

%nc!ease" e.u%t* ca$%ta& +o! thecom$an*,In !ecent *ea!s sou!ces o+

e2$ans%on +un"s ma* )e +oun"( %n

O + th h% + th " + % "


36/86

One o+ the ch%e+ metho"s o+ e2$ans%on( use"e2tens%'e&* %n the &ast ha&+ centu!*( %s to com)%neto o! mo!e ente!$!%ses,So +a! as 0nanc%ng %s conce!ne"( com)%nat%on %s ametho" o+ !a%s%ng e.u%t* ca$%ta& an" o+ten o+st!engthen%ng the o!-%ng ca$%ta& o+ the su!'%'%ngente!$!%se,It shou&" not )e attem$te" &%ght&* o! %thout a

tho!ough stu"* o+ the man* $!o)&ems %n'o&'e",Is the 8$h*s%ca& $!o$e!t* o+ the conce!n to )eme!ge" %n goo" con"%t%on;Ho &ong has the com$an* )een %n )us%ness;

7hat a"'antages o! "%sa"'antages %&& )e%nhe!%te" +!om %ts $os%t%on %n the %n"ust!* an"t!a"e;7hat a!e %ts 0nanc%a& h%sto!* an" !eco!" o+ea!n%ngs;A!e the ea!n%ngs o+ the com)%nat%on &%-e&* to

Th " th t% t )


37/86

These an" man* othe! .uest%ons must )eanse!e" %th g!eat ca!e to )e ce!ta%n thatthe e%ght o+ a"'antage &%es %th the ne

com$an* o'e! the +o!me! se$a!ateconce!ns,A&though a caut%on s%gn shou&" a&a*s )e!a%se" hen a success+u&( go%ng conce!n

cons%"e!s a me!ge! %th anothe! conce!n %n"%cu&t%es( )us%ness h%sto!* a)oun"s %th

ust such com)%nat%ons,7he!e the com$an* %n "%cu&t%es has

$a!t%cu&a! ea-nesses( such as %nsuc%ento!-%ng ca$%ta&( $oo! management(%na"e.uate sa&es $e!sonne&( o! $oo!"%st!%)ut%on neto!-( )ut $ossesses a

"%st%nct%'e $!o"uct( esta)&%she" $&ace %n


38/86

In $a!t%cu&a!( ta23&oss ca!!* +o!a!"has come to $&a* a $!om%nent $a!t

%n man* !ecent me!ge!s, On theothe! han"( e2$ans%on gene!ate")* $!omote!s ho sa $!o0ts %nthe man%$u&at%on o+ com$an%es!athe!( than %n !unn%ng a soun"%n"ust!%a& ente!$!%se has &e" tog!eat a)uses %n the $ast an"

shou&" )e a'o%"e",At a&& e'ents( the &u!e o+ g!eat$!o0ts an" the "a11&e o+ em$%!e

)u%&"%ng th!ough e2$ans%on shou&"

The S$ec%a& P!o)&em o+ Sma&& Bus%ness


39/86

The S$ec%a& P!o)&em o+ Sma&& Bus%nessSma&& ente!$!%se %s an %m$o!tant e&ement%n the ent%!e econom*,

Nume!%ca&&* %t %s the &a!gest secto! o+ theeconom*( )ut %+ measu!e" )* em$&o*ment$!o'%"e" an" 'a&ue o+ $!o"ucts %n themanu+actu!%ng 0e&"( %t %s o'e!sha"oe"

)* me"%um3 an" &a!ge3sca&e ente!$!%ses,But these a!e not the on&* cons%"e!at%ons,Sma&& ente!$!%se $!o'%"es a sou!ce o+s$ec%a&%1e" $!o"ucts an" se!'%ces( a

sou!ce o+ su$$&%es an" $a!ts +o! &a!geente!$!%se( a ma!-et +o! goo"s an"se!'%ces( a hea&th* e&ement o+ com$et%t%on%n the econom*( a sou!ce o+ em$&o*ment+o! man e!sons( an" a 0e&" +o!

B + && % &% %t " %t &


40/86

Because o+ sma&& s%1e( &%m%te" ca$%ta&an" ea!n%ngs( &ac- o+ $e!sonne& +o!s$ec%a&%1e" management( an"%ntense com$et%t%on( the sma&&ente!$!%se has"%cu&t* %n gett%ng e.u%t* ca$%ta& at

the sta!t an" %n 0nanc%ng %tse&+ &ate!th!ough o$e!at%ons,Fo! h%s %n%t%a& ca$%ta& the sma&&

ente!$!%se! o+ten has to !e&* u$on h%son !esou!ces an" u$on the%&&%ngness o+ +!%en"s( !e&at%'es( an"

$otent%a& )us%ness assoc%ates to

Some commun%t* )an-s ma-e sho!t3te!m &oans


41/86

Some commun%t* )an-s ma-e sho!t te!m &oansto sma&& ente!$!%se( )ut the a%" %s &%m%te" an"!a!e&* co'e!s ca$%ta& e2$ans%on,The t!a"e c!e"%t %s an %m$o!tant ma%nsta* o+

sma&&3)us%ness 0nanc%ng( )ut %t %s cost&*(&%m%te" %n amount( an" not suc%ent&* !e&%a)&e,In man* cases +un"s ha'e to )e sought +!omcomme!c%a& +acto!s( mo!tgage an" 0nance

com$an%es( an" $e!sona& &oan agenc%es,Fo! each sat%s+acto!* !e&at%onsh%$ %th thesesou!ces( the!e a!e man* othe! sma&& )us%nessconce!ns h%ch ha'e ha" $a%n+u& e2$e!%ences

%th th%s t*$e o+ 0nanc%ng,9an* such &oans ca!!* h%""en #se!'%ce#cha!ges( autho!%1e &en"e!s to ho&" )ac- +un"s(t%e u$ a&& a'a%&a)&e co&&ate!a&( an" a&&o &en"e!s

to %nte!+e!e %n the management o+ theente! !%se,

But %n man* cases the sma&&


42/86

But %n man* cases the sma&&ente!$!%se! h%mse&+ %s $a!t&* at +au&t+o! h%s $&%ght,

Sma&& ente!$!%ses +!e.uent&* su/e!+!om )a" management( &ooseaccount%ng $!act%ces( too &%)e!a&

g!ant%ng o+ c!e"%t to the%! custome!s(e2cess%'e %th"!aa&s o+ cash )*one!s( an" $!ematu!e un%se

e2$ans%on,These con"%t%ons ma-e sma&&ente!$!%ses h%gh !%s-s( an" &en"e!sho sha!e %n those !%s-s see-

com ensat%on th!ou h h% h !ates an"


43/86

CAPITAL ALLOCATIONAssum%ng %n'estment ca$%ta& %s a'a%&a)&e(the!e %s a&most a&a*s a cho%ce o+ a*s to

%n'est %t,The to most %m$o!tant c!%te!%a o+o!th%ness a!e the !%s-s %n'o&'e" an" the$atte!n o+ cash o,An e'a&uat%on o+ !%s- !esu&ts +!om.uest%on%ng the &%-e&%hoo" o+ e2$ecte"!etu!ns, 9an* a$$!o$!%ate .uest%ons e!e

$ose" %n the $!e'%ous cha$te!,7hen %t %s $oss%)&e to measu!e$!o)a)%&%t%es o+ success +o! a&te!nat%'e%n'estments( the $!e+e!!e" so&ut%on

can )e o)ta%ne" .uant%tat%'e&*,

The t%me sca&e" $atte!n o+


44/86

The t%me3sca&e" $atte!n o+!ece%$ts an" "%s)u!sements

shou&" a&a*s )euant%tat%'e&* e'a&uate",The t%me 'a&ue o+ mone* %s

s*non*mous %th %nte!est,Inte!est( o! the cost o+

)o!!o%ng ca$%ta&( has )eenan acce$te" as$ect o+ ca$%ta&management +o! centu!%es,

In the &ast @6 *ea!s much Rece%'%ng a "o&&a! to"a* %s


45/86

Rece%'%ng a "o&&a! to"a* %s$!e+e!a)&e to !ece%'%ng %t a *ea!+!om no,

Pa!t o+ the !eason %s that %nat%onma* "et!act +!om the )u*%ng $oe!o+ the "e&a*e" "o&&a!( )ut the mo!e

ge!mane cons%"e!at%on %s that the"o&&a! !ece%'e" to"a* can )e $ut too!- %n the %nte!%m $e!%o",

It can ea!n %nte!est "u!%ng the *ea!%t o!-s )e+o!e the "e&a* "o&&a! %s!ece%'e",The amount %t ea!ns "%'%"e" )* the

amount %n'este" +o! the ea! %s the

The!e a!e se'e!a& a*s to ut%&%1e


46/86

The!e a!e se'e!a& a*s to ut%&%1e%nte!est !ates %n the e'a&uat%on o+$!o$ose" %n'estments3$a*out$e!%o"( $!esent o!th( e.u%'a&entannua& cost( ca$%ta&%1e" cost( !ateo+ !etu!n3)ut on&* !ate o+ !etu!n

%&& )e "esc!%)e" he!e,The !ate o+ !etu!n %s a $e!centage0gu!e( e.u%'a&ent to an %nte!est

!ate( h%ch %n"%cates the !etu!nea!ne" o'e! the &%+e o+ an%n'estment,

It %s ca&cu&ate" +!om the cash3o


47/86

h %)& h


48/86

Th!ee $oss%)&e cash3o$atte!ns a!e shon,

A&& th!ee !e$!esent !etu!nso'e! a $e!%o" o+ 6 *ea!s!ece%'e" +!om an %n%t%a&

%n'estment o+ (666 ma"e att%me O,

D%s!ega!"%ng ta2es( the th!ee$atte!ns a&& ha'e the samerate o !etu!n,

The o)'%ous conc&us%on to )e A+te! the !ate o+ !etu!n has )een com$ute"


49/86

A+te! the !ate o+ !etu!n has )een com$ute")* "%scount%ng the cash o o+ eacha&te!nat%'e( the 0na& ste$ %s to "ec%"e

h%ch( %+ an*( o+ the a&te!nat%'e%n'estments shou&" )e ma"e,An %n'estment $!om%s%ng a !ate o+ !etu!n&ess than cou&" )e ea!ne" +!om %n'est%ng %n

conse!'at%'e )on"s ou&" ha!"&* )eatt!act%'e,Each ente!$!%se has %ts on m%n%mumacce$ta)&e !ate o+ !etu!n( &a!ge! +o! h%gh3

!%s- en"ea'o!s an" &oe! +o! conse!'at%'eo$e!at%ons such as $u)&%c ut%&%t%es,P!o$osa&s +a%&%ng to meet the m%n%mum a!e"%sca!"e" un&ess the!e a!e 'e!* s%gn%0cant

%ntang%)&e )ene0ts %n'o&'e",

THE BUDGET


50/86

THE BUDGETIt %s the &ong3te!m !es$ons%)%&%t*

o+ management to so use%n'estment that%t %&& *%e&" the &a!gest $oss%)&e

$!o0t o! !etu!n( an" %t %s the+unct%on o+ )u"get%ng to $&anthat $!o0t $%ctu!e,

Pe!ha$s th%s $&ann%ng can )eun"e!stoo" )ette! %+ e 0!ste2am%ne the com$onents o+

$!o0t,


51/86

Sta!t%ng %th the u$$e! !%ght3han" come!


52/86

Sta!t%ng %th the u$$e! !%ght3han" come!o+ the cha!t e 0n" that o!-%ng ca$%ta& %sma"e u$ o+ %n'ento!%es( accounts

!ece%'a)&e( an" cash,These the $e!manent %n'estment %nassets such as &an"( )u%&"%ng( an"e.u%$ment com$!%se the tota& %n'estment

o+ the com$an*,7e "ete!m%ne ho ha!" th%s %n'estment %s)e%ng o!-e" )* com$a!%ng %t %th tota&sa&es +o! the "es%gnate" $e!%o" o+( &et ussa*( one *ea!,I+ sa&es e!e 66(666 an" %n'estment66(666 the tu!no'e! o+ %n'estment +o!

the *ea! ou&" )e +ou! o!( %n othe! o!"s(

The ne2t .uest%on( then( %s ho


53/86

The ne2t .uest%on( then( %s homuch "%" each tu!no'e! *%e&";The &oe! $a!t o+ the cha!t %n F%gu!e

53@ shos the metho" +o!ca&cu&at%ng ea!n%ngs %n te!ms o+ the$e!centage o+ the sa&es "o&&a!,

Note that the costs o+ sa&es a!e&%ste" %n the &oe! !%ght3han" come!,These com$!%se the cost o+ ma-%ng

the $!o"uct an" gett%ng %t to thecustome!s an" must )e "e"ucte"+!om tota& %ncome +!om sa&es to"ete!m%ne ea!n%ngs on sa&es,

I+ e 0n" that ea!n%n s on sa&es %s

PLANNINGTHROUGHTHEBUDGET The tas- %n


54/86

PLANNINGTHROUGHTHEBUDGET The tas- %n)u"get%ng %s to $&an $!o"uct%on %n acco!"ance%th sa&es est%mates &an" a m%n%mum cost,Recent t!en"s toa!" "ecent!a&%1at%on o+ autho!%t*an" !es$ons%)%&%t*( "%scusse" %n $!ece"%ngcha$te!s( a!e es$ec%a&&* a$$&%ca)&e %n )u"get$&ann%ng,Un"e! th%s s*stem on&* a !e&at%'e&* sma&& 0nance

sta/ %s ma%nta%ne" at hea".ua!te!s un"e! thesu$e!'%s%on o+ a cont!o&&e!,He ma* $e!sona&&* e2e!c%se the &ea"e!sh%$ %n)u"get $&ann%ng o! he ma* "e&egate th%s to a

)u"get "%!ecto!,Each o$e!at%ng "%'%s%on o! $&ant %s $!o'%"e" %th%ts on sta/s %n account%ng( %n"ust!%a&eng%nee!%ng( %n"ust!%a& !e&at%ons( an" %n some%nstances $!o"uct "e'e&o$ment( he!e the

com$an* %s o!gan%1e" on a $!o"uct )as%s,

Th%s %s %n cont!ast %th some cent!a&%1e"


55/86

Th%s %s %n cont!ast %th some cent!a&%1e"s%tuat%ons( a&though ce!ta%n&* not a&&(he!e the $!o0t )u"get %s $!e$a!e" %n

hea".ua!te!s an" the "%'%s%on manage! %shan"e" a $atte!n o+ o$e!at%on %th$!e"ete!m%ne" stan"a!"s aga%nst h%ch h%so$e!at%ons %&& )e e'a&uate",

In such a s%tuat%on he +ee&s &%tt&e conce!n+o! $!o0t,Un"e! the "ecent!a&%1e" s*stem he %scons%"e!e" an e2ecut%'e %n cha!ge o+ a un%t

o+ the %n'estment h%ch %s e2$ecte" to$!o"uce %ts sha!e o+ the !etu!n,Fu!the!mo!e( %t %s h%s !es$ons%)%&%t* tos$!ea" th%s conce!n +o! $!o0t th!oughout

h%s un%t to "e$a!tment hea"s( su$e!'%so!s(

Sa&es ma* o! ma* not )e "ecent!a&%1e" )*


56/86

Sa&es ma* o! ma* not )e "ecent!a&%1e" )*$&ants o! "%'%s%ons,I+ "ecent!a&%1e"( sa&es %&& o$e!ate as a

se$a!ate sta/ un%t o!-%ng %th the )u"get"%!ecto! an" the $&ant manage! %n theesta)&%shment o+ sa&es goa&s an" $!o"uct%on!e.u%!ements to se!'e those goa&s,

In sma&& an" me"%um3s%1e" com$an%es the o) o+ )u"get $&ann%ng o$e!ates %n much thesame a* that %t o$e!ates %n a "%'%s%on o+ a&a!ge! com$an* e2ce$t that %t ma* not ha'e

the )ene0t o+ e2tens%'e "ata gathe!%ng an"!esea!ch $!o'%"e" )* hea".ua!te!s o+ the&a!ge com$an*,On the othe! han"( manage!s o+ sma&&

com$an%es shou&" ha'e an a"'antage %n

CONTROL THROUGH THE BUDGET It shou&"


57/86

CONTROL THROUGH THE BUDGET It shou&")e un"e!stoo" that a )u"get %s a meanstoa!" an en" an" %s not an en" %th%n

%tse&+,Bu"gets a!e ma"e to )e use",The* esta)&%sh goa&s to h%ch each"e$a!tment an" each o!-e! %th%n a"e$a!tment must cont!%)ute h%s"es%gnate" sha!e %n te!ms o+ the un%0e"$&an,

Th%s &ea"s toa!" $!ec%s%on an"con0"ence,A "e$a!tment hea" -nos hat %s &a%" out+o! h%s "e$a!tment to accom$&%sh,

He -nos hat %s e2$ecte" o+ h%m,

Th h "% + t &


58/86

Th!ough !eco!"%ng o+ actua&!esu&ts aga%nst the est%mates

o+ the )u"get(!e$o!ts a!e const!ucte" that

!e'ea& the $o%nts o+ "%cu&t*an" "ange!3the$o%nts h%ch must )e

ana&*1e" an" %m$!o'e"u$on,9anagement o$e!at%ng on

# # COORDINATION THROUGH THE BUDGET


59/86

Bu"gets shou&" )e const!uct%'e a%"s to a&&"e$a!tments( %th%n an o!gan%1at%on %nach%e'%ng the%! common goa&s,

Un+o!tunate&*( hoe'e!( th%s $u!$ose %s+!e.uent&* m%sun"e!stoo",The ea!&* em$has%s g%'en to )u"gets ascont!o&s o+ e2$en"%tu!es esta)&%she" %n the

m%n"s o+ su)o!"%nates the att%tu"e that)u"gets e!e negat%'e cont!o&s on&*3"e'%cesto &%m%t e2$en"%tu!es,Th%s &e" to the #$a""%ng# o+ "e$a!tmenta&

)u"gets( the %"ea )e%ng +o! each "e$a!tmentto get as &a!ge an a&&otment o+ e2$en"%tu!es as$oss%)&e,7hen a&& )u"gets e!e assem)&e" an"

!e"uct%ons e!e "eeme" essent%a&( each

B " &


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Bu"gets( $!o$e!&*const!ucte" an" o$e!ate"(

ma* ha'e a const!uct%'e%nuence on the $e!sonne&

o+ an o!gan%1at%on,Bu"gets ma* se!'e as ameans +o! )!%ng%ng a)out an

un"e!stan"%ng o+ thecommon goa&s o+ a&& ho)e&ong to the o!gan%1at%on

T:PES OF BUDGETS


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T:PES OF BUDGETSThe!e a!e to $!%nc%$a& t*$es o+)u"gets< the static, or fxed, budgetand the variable, or !exible, budget."he static budget depends uponability to $!e"%ct %ncome( sa&es( o!

sh%$ments %th at &east a !easona)&e"eg!ee o+ accu!ac*,Us%ng th%s $!e"%ct%on as a )ase, 02e"

sums a!e a&&ocate" +o! e2$en"%tu!es%th a 02e" )u"get o+ $!o"uct%ono$e!at%ons +o! the $e!%o" %n .uest%on,The 'a!%a)&e )u"get !ecogn%1es the

# "he static budge$ Industry inherited


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#. "he static budge$ Industry inheritedthe static budget rom governmentaland %nst%tut%ona& o!gan%1at%ons,

Th%s t*$e o+ )u"get se!'e" a 'a&ua)&e$u!$ose %n the

$&ann%ng an" cont!o& o+ ce!ta%n 02e"t*$es o+ e2$en"%tu!es,The %n a"e.uac%es o+ such a )u"gethoe'e!( e!e soon +e&t hen %n"ust!*mo'e" %nto the $e!%o" o+ mass $!o"uct%on

he!e ma!g%ns o+ $!o0t $e! un%t o+$!o"uct%on e!e sma&& an" $&ann%ng an"cont!o& o'e! a&& o$e!at%ons )ecame mo!eessent%a&,

Th!ough stu"* %t as +oun" that costs $e!

?, "he variable budget "he


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?, "he variable budget "hevariable budget is constructed

in anticipation o variations %nsa&es,It $!o'%"es %n a"'ance +o!

o!"e!&* change %n the 'o&umeo+ $!o"uct%onan" %n e2$en"%tu!es,Th%s ta)u&at%on %s )ase" onthe !eco!"%ng o+ costs o+

$!e'%ous $e!%o"s o! on the


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F%gu!e 53 %s a s%m$&%0e" 'e!s%on


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F%gu!e 53 %s a s%m$&%0e" 'e!s%ono+ a t*$%ca& cost cu!'e %nten"e"

to sho the 'a!%at%on %n costs as'o&ume %nc!eases,Note that th!ee t*$es o+ cost a!e

%&&ust!ate"< 02e" o! stan" )*costs !e$!esent%ng those %temso+ o'e!hea" h%ch must )e met

e'en though the $&ant %s c&ose""on4 sem%302e" costs4 an"'a!%a)&e costs,

Actua&&*( hoe'e!( the sem% 02e" Fo! $u!$oses o+ s%m$&%c%t* an" c&a!%t*


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Fo! $u!$oses o+ s%m$&%c%t* an" c&a!%t*the !%se %n sem%302e" costs %s %n"%cate"at $o%nts he!e the !%se %s mo!e

$!onounce"( %,e,( at $o%nts he!e %t)ecomes necessa!* to esta)&%sha""%t%ona& sh%+ts %th the a""%t%on o+

+o!emen( see$e!s( e2t!a ma%ntenancec!es( etc,The same e/ect ou&" )e o)ta%ne" at$o%nts he!e a""%t%ona& )u%&"%ngs ha'e

to )e o$ene" +o! %nc!ease" 'o&ume o+$!o"uct%on,The g!eatest 'a!%at%on %n costs( hoe'e!(

%s %n those %tems h%ch a!e c&ass%0e" as

The!e a!e to %nte!$!etat%ons o+ the


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e e a e o e $ e a o s o ete!ms #02e"# an" 'a!%a)&e# costs,One %nte!$!etat%on cons%"e!s a 02e" cost

as one that %s constant %n tota& amount+o! a g%'en $e!%o"( h%&e a 'a!%a)&e cost%nc!eases o! "ec!eases %n $!o$o!t%on tothe 'o&ume o+ $!o"uct%on,

The secon" %nte!$!etat%on "e0nes a 02e"cost as one that %s constant %n amount $e!un%t o+ $!o"uct%on )ut 'a!%es %n tota&(h%&e a 'a!%a)&e cost changes %n amount$e! un%t )ut !ema%ns constant %n %ts tota&amount +o! a g%'en $e!%o",It %&& )e note" that these to

%nte!$!etat%ons a!e "%!ect&* o$$os%te %n

Sa&a!%es o+ mao! e2ecut%'es( ca$%ta&


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ta2es( "e$!ec%at%on( etc,( !ema%n 02e"!ega!"&ess o+ the 'o&ume o+ $!o"uct%on,

These a!e -non as 02e" costs,Othe! %tems( such as "%!ect &a)o! an""%!ect mate!%a&( 'a!* a&most %n$!o$o!t%on to the amount o+ $!o"uct%on

an" a!e te!me" 'a!%a)&e costs,9ost costs a!e su)ect to some'a!%at%on,

Cost o+ e&ect!%c%t* ma* )e cons%"e!e"!e&at%'e&*constant( )ut e'en that %&& 'a!* %the2t!eme changes %n 'o&ume o+

!o"uct%on h%ch ma !e u%!e chan es

Ho&"%ng to the $!%nc%$&e o+ 'a!%a)&e )u"gets(% t% % th + + ) " t% "


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'a!%at%ons %n the +o!m o+ )u"get%ng $!oce"u!ema* )e esta)&%she" to meet the $ecu&%a! nee"so+ a s$ec%0c ente!$!%se,

In gene!a&( e ma* sa* that s%m$&%c%t* %n)u"get%ng shou&" )e he&" as a $!%ma!* '%!tue,Deta%&e" c&e!%ca& o!- %n'o&'e" %n the$!e$a!at%on an" o$e!at%on o+ a )u"get shou&"

)e he&" to a m%n%mum,Th%s $!%nc%$&e not on&* &ea"s to the e&%m%nat%ono+ unnecessa!* costs %n )u"get%ng )ut %ngene!a& $!omotes ease %n the %nte!$!etat%on

an" cont!o& o+ the )u"get,In a sma&& com$an* he!e4 costs a!e eas%&*%"ent%0e" an" cont!o&&e" o! %n com$an%eshe!e the!e %s &%tt&e 'a!%at%on %n $!o"uct%on

'o&ume( a 'e!* s%m$&e t*$e o+ )u"get )ecomes

Ja!%a)&e )u"gets a!e o+ to $!%nc%$a&


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t*$es,One %s the step budget which %s !ea&&*

a se!%es o+ )u"gets set u$ at"%/e!ent &e'e&s o+ 'o&ume o+$!o"uct%on o! sa&es,

These ste$s a!e usua&&* esta)&%she"at $o%nts %n the 'a!%at%on %n 'o&umehe!e $!onounce" changes %n costs%&& occu!( such as a""%t%ona& sh%+ts()u%&"%ngs( an" su$e!'%so!* $e!sonne&,The )u"get +o! each ste$ !ecogn%1esa $o%nt o+ ma2%mum an" m%n%mum

!o"uct%on,

The secon" t*$e o+ 'a!%a)&e )u"get%" t% t + th i bl t


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$!o'%"es an est%mate o+ the variable rateo cost per unit o production or per

dollar shipments o sales.An* est%mate o+ the 'a!%a)&e rate o costmust recognize maximum and m%n%mum'o&umes,

As $!e'%ous&* state"( the !ate o+ cost o+mate!%a& ma*)ee2$ecte" to "ec!ease as 'o&ume%nc!eases( o%ng to a"'antages that

ma*)e atta%ne" th!ough $u!chas%ng %n&a!ge! &ots,G!eate! &a)o! ec%enc* hoe'e!( ma* )eo)ta%ne" +!om the !egu&a! +o!ce o+ (666

o!-e!s than ou&" )e !ea&%1e" e! un%t

PREPARING THE BUDGET


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PREPARING THE BUDGET9ent%on as ma"e ea!&%e! !ega!"%ng the(+unct%on o+ the )u"get "%!ecto!( most

+!e.uent&* the cont!o&&e! o! ass%stantcont!o&&e! se!'%ng %n th%s ca$ac%t*He se!'es, as a coo!"%nato! )eteen"%'%s%ons o! "e$a!tments %n )u"get$!e$a!at%on,Usua&&* the hea"s o+ these "%'%s%ons(togethe! %th se&ecte" sta/

!e$!esentat%'es( %&& se!'e as the )u"getcomm%ttee o+ the com$an*,Th%s comm%ttee !ece%'es an" a$$!o'es a&&+o!ecasts( "e$a!tmenta& o! "%'%s%on

)u"gets( an" $e!%o"%c !e$o!ts sho%ng

The )u"get oce! must see that a&&


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g"e$a!tment est%mates a!e $!e$a!e"%th suc%ent su$$o!t%ng "ata to

$!o'%"e an a"e.uate )as%s +o! e/ect%'econs%"e!at%on )* the comm%ttee,He has the !es$ons%)%&%t* +o! the

$!esentat%on o+ these )u"gets to thecomm%ttee an" +o! t!ansm%tt%ng )ac-to the "e$a!tments the!ecommen"at%ons o+ acce$tance o!

!e'%s%on,The )u"get oce! %s a&so !es$ons%)&e+o! the o!gan%1at%on o+ a s*stem o+

!egu&a! $e!%o"%c !e$o!ts !ega!"%ng the

The $!e$a!at%on o+ )u"get est%mates


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The $!e$a!at%on o+ )u"get est%mates%th%n each "e$a!tment shou&" a&so)e a comm%ttee $!o$os%t%on,Th%s %s %n a"he!ence to the same$!%nc%$&e o+ participation as a meanstoward cooperation participation in

the preparation o a )u"get se!'esto +am%&%a!%1e the $e!sonne& %th the$!o)&ems %n'o&'e",

7%th th%s -no&e"ge o+ the $!o)&emsan" the +ee&%ng o+ ha'%ng a $a!t %nsett%ng the goa&s an" &%m%tat%ons o+

the "e$a!tment( the $e!sonne& %&&

The hea" o+ the "e$a!tment ma* act


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$ *as cha%!man o+ the "e$a!tmentcomm%ttee )ut( %n the case o+ a &a!ge"e$a!tment( he shou&" "e&egate!es$ons%)%&%t* +o! the gathe!%ng o+"eta%&s +o! use )* h%s comm%ttee,

In othe! o!"s( he shou&" ha'e ano!gan%1at%on %th%n h%s on"e$a!tment +o! the $!e$a!at%on o+

the )u"get that +o&&os the samegene!a& $atte!n as the )u"geto!gan%1at%on +o! the ente!$!%se as aho&e,

A"e.uate Cost In+o!mat%on


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.A"e.uate cost %n+o!mat%on %s a $!%meessent%a& o+ )u"get%ng,

It const%tutes the +oun"at%on +o! thecon'e!s%on o+ +o!ecast an" )us%ness$o&%c* %nto $!o"uct%on,

Ou! +o!ecast te&&s us ho much e canse&& at a g%'en $!%ce &e'e&,Ou! cost %n+o!mat%on te&&s us ho much%t %&& cost to $!o"uce %t %n the( 'o&umes

s$ec%0e",Fu&& !ea&%1at%on o+ cost %n a"'ance o+)u"get $!e$a!at%on

ma* cause management to .uest%on the

Pe!ha$s the most %m$o!tant a"'antage to )ega%ne" th!ough the a'a%&a)%&%t* o+ accu!ate


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ga%ne" th!ough the a'a%&a)%&%t* o+ accu!atecost %n+o!mat%on %s that )u"get%ng can )e)ase" on +acts %nstea" o+ $e!sona& guesso!-,

The %n"%'%"ua& ho %s ca&&e" u$on to $!o'%"eest%mates %thout +acts on h%ch to )asethese est%mates %s %n the &ong !un +ac%ngt!ou)&e,

Th!ough su$e!%o! $e!sona& u"gment he ma*!ece%'e the$!a%se o+ management hen t%mes a!e goo"an" hen $!o"uct%on %s $!og!ess%ng t a

!e&at%'e&* e'en tem$o,I+ he %s %se he %&& $!o)a)&* a&&o !easona)&*sa+e ma!g%ns to $!otect h%mse&+ +!om the$oss%)&e e!!o!s o+ h%s

u"gment,

Those a!e the t%mes hen the %n"%'%"ua& ma* )e+ " t &% % t th % + + t


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+o!ce" to e&%m%nate those ma!g%ns o+ sa+et*,He $!om%ses to o$e!ate at &ess cost *et he "oesnot ha'e a "eta%&e" $&an a$$!o'e" )*

management as to ust ho those costs a!e to )e!e"uce",The chances a!e that the* %&& not )e !e"uce"an" he %&& )e c!%t%c%1e"( %+ not "%scha!ge"( +o!

$oo! management o+ h%s "e$a!tment,Ho much )ette! %t ou&" )e %+ he cou&" su$$&*+acts !ega!"%ng costs3+acts that cou&" )e%nte!$!ete" )* an* mem)e! o+ the managementg!ou$,The %n"%'%"ua& cou&" then !e&%e'e h%mse&+ o+!e&%ance on $e!sona& u"gment a&one an" $!esenth%s est%mates accom$an%e" )* s*stemat%ca&&*$!e$a!e" "ata,

Once the est%mates a!e acce$te" )* the )u"get

The Sa&es Bu"get


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gAs $!e'%ous&* ment%one"( theest%mates o+ +utu!e sa&es set the)oun"s o+ &%m%tat%ons +o! othe!)u"gets o+ the ente!$!%se,The!e a!e to $!%nc%$a& sou!ces o+

"ata +o! use %n the $!e$a!at%on o+sa&es est%mates<=I>$ast $e!+o!mance =sa&es o+

$!e'%ous $e!%o"s> an" =?> ma!-etana&*s%s,Both Sou!ces a!e gene!a&&* use" %n

ga%n%ng a

Sa&es$e!sons can $&a*a s%gn%0cant !o&e %n the$!e$a!at%on o+ the sa&es )u"gets,


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$!e$a!at%on o+ the sa&es )u"gets,The* a!e %n $e!sona& contact %th the custome!,The* a!e a)&e to o)ta%n 0!sthan" %n+o!mat%on

!ega!"%ng h%s ants, h%s att%tu"e toa!" +utu!e)us%ness con"%t%ons( h%s att%tu"e toa!" these!'%ces $!o'%"e" )* the ente!$!%se( h%s att%tu"etoa!" the $!og!am o+ a"'e!t%s%ng( etc,I+ sa&es$e!sons a!e t!a%ne" %n the %m$o!tance o+th%s %n+o!mat%on an" the metho"s )* h%ch %tshou&" )e $!o"uce"( the ente!$!%se can "e'e&o$%th%n %ts on o!gan%1at%on a 'a&ua)&e sou!ce o+ma!-et %n+o!mat%on,

9an* com$an%es ma-e the $!e$a!at%on o+ sa&esest%mates an" the %nt!o"uct%on o+ ne $!o"uctsto the ma!-et a coo$e!at%'e un"e!ta-%ng h%ch%nc&u"es $a!t%c%$at%on )* 'ote on the $a!t o+ each

sa&es$e!son,3

9anu+actu!%ng Bu"getsThe num)e! an" "%'%s%on o+ )u"gets +o! the


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The num)e! an" "%'%s%on o+ )u"gets +o! themanu+actu!%ng "%'%s%on o+ an ente!$!%se %&&(o+ cou!se( 'a!* %th the s%1e an" t*$e o+

ente!$!%se an" the $!o"ucts %t manu+actu!es,In gene!a&( %t ma* )e sa%" that s%2 )as%c)u"gets a!e nee"e"<=I> the $!o"uct%on )u"get h%ch out&%nes the

sche"u&e o+ $!o"uctun%ts to )e manu+actu!e"4=?> the mate!%a&s )u"get h%ch s$ec%0es the"%!ect mate!%a& nee"e" to $!o"uce the

num)e! o+ un%ts sche"u&e"4=@> The $&ant an" e.u%$ment )u"get that sets+o!th the !e.u%!ements o+ s$ace an"mach%ne!*4

=> the ma%ntenance )u"get4

The $!o"uct%on )u"get %s ta-en


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$ g"%!ect&* +!om the sa&es est%mates(e2ce$t that %t attem$ts %n so +a! as

$oss%)&e to s$!ea" the o!- e'en&*o'e! the $e!%o",Th%s )u"get +o!ms the )as%s +o! othe!

manu+actu!%ng )u"gets as &%ste"a)o'e,7%th the a%" o+ the mate!%a&s

s$ec%0cat%ons sheets +o! each$!o"uct( the mate!%a&s )u"get can )e$!e$a!e" )* months +o! the gu%"anceo+ the $u!chas%ng "e$a!tment,

The F%nanc%a& Bu"get


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The 0nanc%a& )u"get $!esents a summa!*o+ ant%c%$ate" !ece%$ts an"

"%s)u!sements +o! the )u"get $e!%o",Its $u!$ose %s to $&an +o! the a&&ocat%on o+o!-%ng ca$%ta& as !e$!esente" )* thecu!!ent assets o+ the ente!$!%se,Data +o! the 0nanc%a& )u"get a!e "e!%'e"+!om the )u"gets as $!e$a!e" )* the'a!%ous "%'%s%ons,

The 0nanc%a& )u"get must ant%c%$ate thecash !ece%$ts)* months o! at othe! "es%gnate" $o%ntso+ the $e!%o" an" ma-e a&&oance +o! the

!a%s%ng o+ a""%t%ona& +un"s( %+ nee"e"( to

E2$en"%tu!es ma*)e $&anne" %n


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$ * $cons%"e!at%on o+ to $!%ma!*+acto!s<=I>the a)so&ute necess%t%es o+ the

)u"gets o+ the 'a!%ous "%'%s%ons(%,e,( month&* !e.u%!ements o+mate!%a&s +o! $!o"uct%on($a*!o&&( etc,4 an"

=II>the3&%m%tat%ons o+ a'a%&a)&e

cash,It %s not cons%"e!e" goo" )us%ness

to ha'e &a!ge

amounts o+ cash & %n %"&e "u!%n Goo" )us%ness $o&%c* ou&" suggest

that attem$ts


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that attem$tsshou&" )e ma"e e%the! to s$!ea" the

a""e"e2$enses o+ these to months o'e!

a &onge!

$e!%o" o! to )o!!o a""%t%ona& +un"sth!oughsho!t3te!m notes,The!e a!e man* $!o)&ems a!%s%ng

out o+ attem$te"cont!o& o+ o!-%ng ca$%ta&( an"

the!e a!e &%-e%se

man oss%)&e so&ut%ons that ma )e

The!e a!e t%mes( o+ cou!se( hen the


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( (&%m%tat%ons o+ ca$%ta& ma* ma-e the$&ans as set +o!th %n the )u"gets o+'a!%ous "%'%s%ons $!oh%)%t%'e,Th%s %s es$ec%a&&* t!ue "u!%ng$e!%o"s o+ !a$%" e2$ans%on hen

a""%t%ona& $&ant an" e.u%$mentmust )e $!o'%"e" %n o!"e! to meetthe )u"gete" sche"u&e o+

$!o"uct%on,In such case the 0nanc%a& )u"getacts as a negat%'e cont!o& o'e! othe!

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Financing and Budgeting-chapter 5

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