IMA EDUCATIONAL CASE JOURNAL VOL. 2 , NO. 2 , ART. 3 JUNE 20091
BACkgROUND
Buns Bakery is a medium-sized regional bakery that
specializes in providing orders to grocery and convenience
stores. Because of the popularity of its brand, it has also
opened a small café for walk-in business.
In order to maintain its high quality standard, Buns
produces only three products: breakfast muffins, fresh bread,
and chocolate chip cookies. Although business has been
good in the past few years, a lucky contact with a large chain
has recently allowed it to expand its brand out of the local
region. Growth has been high since the new contract went
into effect.
Andy Griff, the chief executive officer (CEO) and
founder, has arranged a meeting with a venture capital
firm next week. Hopefully the meeting will result in the
sale of some of Buns’ stock and an opportunity to establish
a significant line of credit with the venture capital firm.
These extra funds, if Andy can secure them, should provide
sufficient money to meet Buns’ growth targets for the next
few years. The venture capital firm’s assessment team has
asked Andy to provide a quarterly master budget for the
coming year, complete with pro forma financial statements,
at the meeting. They have expressed special interest in
Buns’ earnings per share (EPS), cash flow from operations,
and profit margins, indicating that good numbers in these
areas will be essential for final approval.
In typical managerial style, Andy immediately assigned
the task of creating the budget to Nicole Quarterman, who
has just been hired as Buns’ controller. Since this project is
her first assignment, Nicole started by making appointments
with each of the divisional managers to gather information
for the budget and also to learn more about the company.
PART I: CREATINg ThE BUDgET
MEETINgS wITh DIvISIONAL MANAgERS
MEETINg wITh ThE SALES DEPARTMENT
Walking down the hallway towards the office of Jeff Barza,
the sales manager, Nicole read the results for last quarter.
Buns Bakery sold 45,000 one-dozen packages of muffins for
$5.50 each, 65,000 one-dozen packages of cookies for $4.75
each, and 85,000 loaves of bread for $5.25 each. When Nicole
got to Jeff’s office, he motioned her in to have a seat.
“Is it time for our meeting already?” he asked. “Where
does the day go?”
“Who knows? It seems like one minute I’m having
my morning muffin and the next I’m saying good-bye to
everyone,” Nicole said with a sigh. “There’s never time to
get everything done. And now I get to do the budget.” Jeff
started to laugh. “Thanks,” she muttered. “I knew I could
count on your support.”
“I’m sorry. I just have to laugh at the amount of time you
are going to put into something that isn’t really used anyway,
except for setting bonuses, of course.”
“Not really used? I don’t know how it’s been around here
in the past, but this year, at least, the budget will prove to be
a valuable tool.” Nicole waved away Jeff’s retort. “Anyway,
one way or another I have to create one and, as you know,
the process always starts with projected sales. Do you have a
copy of last quarter’s results?”
“Yes, right here somewhere,” Jeff said, shuffling papers
around on his desk. “Got it!” he exclaimed, waving it gently
as he pulled it from under a stack of other papers. “Now,
what do you want to know exactly?”
“Well, Andy thinks that since we have established a
strong following both locally and in our new markets, we
1
ISSN 1940-204X
Buns Bakery: Creating and Using a Master Budget
Jason C. Porter
University of Idaho
Teresa Stephenson
University of Wyoming
can raise our prices slightly next year without a sharp drop in
sales. He was thinking $6.00 for muffins, $5.25 for cookies,
and $5.75 for bread. What do you think?”
“I agree,” Jeff said eagerly. “I’ve been pushing that for
years. Of course, I think that sales will drop some in the first
quarter of next year. They always drop off a bit after the
holidays anyway, but with the increase in sales price . . . I’d
say a 20 percent drop from the fourth quarter results we have
here.” He looked up questioningly and raised an eyebrow.
Nicole frowned. “That sounds kind of high. Based on
what I saw in the dairy industry, I was thinking the drop
would only be about 10 percent.”
Jeff looked a little uncomfortable and shuffled around in
his chair. “Well, it’s a little different for a bakery. Our price is
a little more elastic than dairy products. Besides, 20 percent
is a more conservative estimate and in the past we wanted no
surprises.” He looked at her and challenged, “Are you going
to change that?”
“Yeah, but we’ll be using this master budget to create
a cash flow budget and pro forma financial statements to
show our new investor. We need to look good, not bad.”
Nicole frowned. She didn’t want to start making changes and
enemies in her first few months.
“I guess so. But, look—my bonus is tied to how well I
meet my estimates. If we estimate low results and then go
up . . .” Seeing the look on her face, he quickly changed
direction. “Besides, Nicole, we are raising the prices. A 10
percent drop is normal after Christmas, but couple that with
the increased prices, and 20 percent is reasonable.”
Nicole frowned, and then sighed. She didn’t quite accept
his reasoning, but it would be better to have him on her
side until she understood the company politics a bit better.
“Okay, Jeff. I’ll take your word for it. We’ll use 20 percent.
After all, you’re the expert.”
“You’ve got that right!” Jeff said, trying to hide his relief.
He was obviously really counting on that bonus. He looked
at a couple of sales reports and market projections on the
desk in front of him. “After that, I think sales will grow
steadily at about 5 percent a quarter with these new prices.
Fourth-quarter sales will be high because of the holidays—
let’s say 20 percent, instead of 5 percent, from the third to
the fourth quarter. The first quarter of the following year will
continue the 5 percent growth as though the holiday jump
didn’t occur. And I’m not messing with those estimates.
That’s really my best guess, given what I’ve seen in the
past.” He looked up. “Does that give you all you need?”
“Just a few more questions. Have you made any changes
to the credit policy? The information I have from last year
says that we make about 10 percent of our sales through our
café and that we don’t sell to those customers on credit.”
Jeff smiled. “Yep. But we do sell on credit to the business
customers. If we didn’t, they’d definitely go somewhere else.
So, we give our business customers a lot of leeway in paying
us. It makes it a little hard on us, but it keeps them loyal.
Anyway, we collect 30 percent of the credit sales within the
current quarter, 45 percent in the following quarter, and 25
percent in the quarter after that. The good news is that we
don’t have any bad debt. Our customers are mostly large
chains with strong sales and even better reputations. Since
they are large companies, they take their time paying small
companies like us, but we get the money from all of them in
the end.”
“Then I have only two more questions. What were total
sales during the third and fourth quarters of last year, and are
we still collecting any of that money?”
Jeff pulled up a file. “Total sales were $802,000 and
$1,002,500, respectively, and we are still collecting quite a bit
of that money based on our collection breakdown.”
“I think that does it, then. If I’ve forgotten something,
I’ll come back and bug you later. It’s more fun to interrupt
you several times anyway. And you owe me one now.”
MEETINg wITh ThE PRODUCTION DEPARTMENT
Nicole sighed as she headed to her meeting with Phil
Mainster, Buns’ head chef. She wasn’t sure about that large
drop Jeff wanted her to use, but as the new member of the
staff she wasn’t sure what she should do. Of course, she
didn’t have much time to think about it now anyway. She
had met Phil before, so she knew that it was going to be an
interesting meeting.
As she had suspected, she found Phil in the bakery
instead of his office. “Phil,” she called as she hurried towards
him, “did you forget our meeting?”
“Me, forget?” Phil asked in a surprised voice. “I never
forget anything!” Nicole had to chuckle at the large streak
of flour across his face. “You said you wanted to see our
production facility, and I’m ready to show it to you.”
Nicole shook her head. “No, Phil. I didn’t say I wanted
to see the production facility; I said I wanted to talk to you
about the budget for next year.”
“Oh, of course you did.” Phil’s round face had turned a
deeper shade of pink. “Then why don’t we go to my office
and talk?”
Nicole sighed. “That’s a great idea, Phil.”
As they sat down, Nicole asked her first question. “Okay,
Phil, I need to know how much inventory we keep on hand.”
“Well, we can’t keep much in the way of finished goods
on hand. My cookies and bread would dry out if we kept
IMA EDUCATIONAL CASE JOURNAL VOL. 2 , NO. 2 , ART. 3 JUNE 20092
them too long. I’d say that we normally keep only about two
days’ worth of inventory on hand to avoid shipping issues or
problems with the café.”
“Okay, and you make your estimates based on a 90-day
quarter?”
Phil nodded impatiently. “Please, Nicole, don’t ask
obvious questions.”
“I’m sorry. Let’s talk about your pantry. You take care of
purchasing too, don’t you?”
“Yessirree. We decided it would be easier for me to run
purchasing than to have a separate manager do it. After all, I
do everything else around here.”
“Well, we want it done right.”
Phil chuckled. “I’ll have to remember that one. Martha
will love it. Okay, let’s talk raw materials. Some days we have
to produce a lot to meet our orders, so I normally try to keep
15 percent of the next quarter’s raw materials on hand at all
times.”
“Is that what we’ve got on hand now for the coming
year?”
“Of course. Jeff and I had already talked about the
possibility of raising prices and his estimate of a 20 percent
drop in demand, so I’m ready to go.”
Nicole considered telling Phil that she was unsure the 20
percent drop would really materialize, but changed her mind.
There would be time to get the extra ingredients ordered if
sales only dropped 10 percent, and she didn’t want anyone
to think she had caved in to peer pressure. “Good. Can you
give me some estimates of how long it takes to make each
package of cookies, bread, and muffins?”
“Are you kidding? We don’t really move each item from
start to finish. We do them in large batches, so I have no idea
how long each final package takes.” Seeing Nicole’s frown, he
quickly went on. “But, I can tell you that one of my mixers
can mix together either 12 dozen cookies, 8 dozen muffins, or
4 loaves of bread in 15 minutes. The bakers then take another
half an hour to get the dough ready and bake it.”
“The batch sizes are the same for each product?”
“Yep. I try to keep things as standard as possible. The
packaging department is the slowest. They have to double
wrap the cookies and muffins—once to keep them fresh and
once in the fancy packages marketing came up with—so it
takes 15 minutes to package either two one-dozen packages
of cookies or two one-dozen packages of muffins. The bread
is a little faster. In 15 minutes we can package about eight
loaves of bread.”
“Do you happen to know what we are paying each group
of employees?”
Phil grabbed a piece of paper. “We pay the mixers $7.50 an
hour, the bakers $8.00 an hour, and the packers $6.50 an hour.”
“Perfect. Then I just have one more question.”
“Let me guess. You want a breakdown of ingredients for
each item we bake.”
“You must be psychic, Phil.”
“No, I just remember being bugged about this by the last
controller.” He handed Nicole a piece of paper with a table
on it. “Here they all are. Just make sure you don’t let it out
of the building! I don’t want my secret recipes to get out.”
“Don’t worry. I’ll be careful.” Nicole glanced down at the
price sheet. “Wow. I wish I could buy my groceries at these
prices.”
Phil chuckled. “So do I. You have to remember, though,
IMA EDUCATIONAL CASE JOURNAL VOL. 2 , NO. 2 , ART. 3 JUNE 20093
Exhibit 1
Summary of Ingredients
Cookies Muffins Bread
Ingredients lbs./dozen price/lb. total lbs./dozen price/lb. total lbs./dozen price/lb. total
Flour 0.5 $0.15 $0.08 0.5 $0.15 $0.08 3 $0.15 $0.45
Margarine 0.75 $0.25 $0.19 0.25 $0.25 $0.06
Sugar 1 $0.20 $0.20 0.5 $0.20 $0.10 0.25 $0.20 $0.05
Eggs (each) 2 $0.05 $0.10 2 $0.05 $0.10
Milk (per gallon) 0.10 $1.25 $0.13 0.25 $1.25 $0.31
Cocoa 0.25 $1.50 $0.38
Peanut Butter Chips 1 $0.75 $0.75
Mini Chocolate Chips 1 $0.75 $0.75
Shortening 0.25 $0.50 $0.13
Baking Packet* 1 $0.10 $0.10 1 $0.10 $0.10 1 $0.10 $0.10
$1.79 $1.31 $1.04
* The Baking Packet consists of ingredients too small to be purchased by the pound, so the bakery buys them in prepared packets.
that we buy in bulk, lots and lots of bulk. That lets us get
some great deals from our local vendors.”
“I guess that makes sense. Thanks for taking time to see me.”
“Just make sure you don’t leave without taking a cookie
or two.” Phil held out a plate loaded with perfect, if two-day
old, cookies. “If we don’t eat them, they go into the trash!”
“My pleasure!”
MEETINg wITh ThE ACCOUNTINg DEPARTMENT
Nicole hurried back to her own office. She had a staff
meeting in 15 minutes. She should be able to get most of the
information she still needed from Sarah, since she wrote the
checks. Even though Sarah only worked part-time, she’d been
with the bakery from the beginning and seemed to know
just about everything about the accounting system. Anything
Sarah didn’t know, Bob, their new summer intern, would have
found out for her by now. He was very good at digging up
information once he was pointed in the right direction.
“We thought you were going to stand us up,” Sarah said
as Nicole hurried into the office.
“Actually, we hoped you were,” Bob quipped. “We don’t
want to get stuck doing the budget, so we hoped that you
would forget to come.”
“Don’t worry,” Nicole said with a sigh. “Andy wants me
to take care of it personally. He seems to think it would be
good for me to get to know the company or something. So,
have you gathered all the information that I asked for?”
“Of course,” Sarah said. “Where do you want us to start?”
“Let’s start with our accounts payable.”
“That’s me,” Bob said. “Most of our vendors require that
we pay for everything within 30 days of making our purchase.
That means that 85 percent of our purchases are paid for
within the quarter they are made. And, before you ask, we
ordered $210,984 worth of inventory during the last quarter
last year, so we still owe 15 percent of that, or $31,648.”
“Thanks, Bob, but I actually knew that last part. After all,
it’s right there in the balance sheet.”
“Oh, yeah,” Bob said turning pink. “I forgot about that.”
Sarah laughed. “So, you calculated it by hand?”
“Well, yeah. I wanted to be prepared for the meeting today.”
“All right, you two,” said Nicole, jumping in before
Sarah could pick on the young man any more. “Let’s move
on to our overhead assumptions.”
“Sure,” Sarah said. “Last year we allocated variable
overhead at $1.50 for each direct labor hour. This year, I
think that we’re going to need to increase that to $2.00 to
cover increases in security fees, utility rates, and energy
prices. We also spend about $160,000 a quarter in fixed
overhead. Also, don’t forget that we usually use total direct
labor hours to calculate a predetermined overhead rate when
calculating the unit cost.”
“Unit cost?” asked Bob. “Oh, wait,” he said nodding, “I
remember. We have to include direct materials, direct labor,
and manufacturing overhead to get the cost of producing
each unit. Direct materials are calculated from the recipe and
direct labor cost from the employee information that Phil
gave you. But we need to multiply the number of hours it
takes to make each product by the predetermined overhead
rate so that we can figure a per-unit applied overhead
amount. Sorry to interrupt.”
“No problem.” Nicole nodded approvingly at the young
intern while finishing up her notes. “Just one last question,
Sarah. How much of that overhead is from depreciation?”
“Eight percent of the fixed amount.”
“Good. Bob, tell me about our sales costs.”
“Well, we don’t really have that much in variable sales
costs. We give a one percent commission to our sales staff.”
“Is that based on profit or sales price?” Sarah asked.
“Total sales price. Sorry, I forgot to mention that. The
commission is paid both for business sales and sales in the
café. Also, here’s the table of fixed selling and administrative
expenses.”
Exhibit 2
List of Selling and Administrative Expenses
S&A Expense Cost/quarterd
Advertising $ 40,000
Cleaning supplies 1,000
Janitorial service 6,000
Office staff salaries 25,000
Office supplies 3,000
Rent – Office 9,000
Sales salaries 35,000
Top management salaries 80,000
Utilities – Office 1,800
Total $200,800
Nicole took the paper. “Thanks. Okay, Sarah, tell me
about our debt.”
“Well, at the end of last year, we secured a $1,109,969
mortgage at 6 percent interest. Our payment each quarter is
$20,000. Since it’s a mortgage, the calculations are kind of
fun. Each payment requires us to pay a bunch of interest and
a little bit of principal. To break up the $20,000 into the two
parts, we have to multiply the current mortgage value by 6
percent and divide by 4. . .”
IMA EDUCATIONAL CASE JOURNAL VOL. 2 , NO. 2 , ART. 3 JUNE 20094
“Divide by 4?” asked Bob.
“Well, yeah, 6 percent is the annual rate. Since we make
quarterly payments, we divide the annual rate by 4.”
“Oh,” Bob said sheepishly. “I should have remembered that.”
“Yes, you should have,” Nicole said with a smile. She was
very pleased with how well Bob was progressing during his
summer with the firm. Hiring an intern had been one of her first
changes, and it seemed to be working out well. If the company
continued to grow, maybe he could be hired full-time once he
graduated in a couple of years. “Go ahead, Sarah.”
“Right. So, our first payment will be made at the end
of the upcoming quarter. We’ll end up paying $16,650 as
interest and $3,350 in principal. This means that the value
of the mortgage in the second quarter will be $1,106,619.
That’s the original $1,109,969 minus the $3,350, Bob.”
“Thanks, Sarah. I appreciate the help,” Bob retorted,
rolling his eyes.
“I appreciate it, too,” Nicole said. “If I remember right,
we have to pay the $20,000 each quarter. Our contract
prohibits us from paying any additional principal for the first
three years.”
Sarah nodded. “Yep. Kind of a bummer, but that was the
only way we could get that 6 percent interest rate.”
“Okay,” Nicole said. “The last thing is a recap of how we
handle income taxes. I think that has pretty much stayed the
same?”
“It sure has,” Bob responded, rifling through a tax folder.
“Our corporate tax rate is 30 percent and a portion of our
estimated taxes must be paid each quarter to avoid late fees.
Our policy is to pay 110 percent of the taxes that we owed
last year over the course of the current year. Since we paid
$15,000 last year, we will need to pay $16,500 this year.”
“And we’ll pay that equally over the four quarters?”
“Right. At the en
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