Module 28 – Domain V: Finance & Materials

After reviewing Module 28 lecture, you should be able to:

  1. Describe types of budgets.
  2. Discuss methods of developing a budget.
  3. Discuss components of budget development
  4. Describe monitoring, evaluation, and control of financial status.

Budget Development/Resource Allocation

Types of budgets

  • Operating–
  • projects income and allocates funds needed to accomplish work
  • guides day to day operation
  • foundation of planning and control
  • includes revenue, costs/expenses (labor, direct material, overhead, other expenses)
  • Examples of operational budget line items include uniforms, utensils, glassware, plates, towels, cleaning supplies, food, and anything else used to maintain day-to-day operations.
  • Revenue–a part of operational budget?
  • estimated sales income; project the volume of good sold first, then set the price – as volume increases, the prices will decrease
  • revenue budget should be projected first during the budget process
  • Capital–
  • expenditures for expansion, repairs, improvements, major equipment etc
  • may include building or facility repairs or expansion
  • based on capital expenditures
  • these items can depreciate over time
  • Examples of capital budget line items include replacement of foodservice equipment and expansion of kitchen space to include a prep area.
  • Cash flow–
  • estimated flow of cash in and outduring a given period of time
  • Master–
  • includes operating, capital, revenue, and cash flow budgets
  • estimated profit is provided as well

The 4 steps of preparing a budget are:

1. Develop a sales budget with an estimate of revenue
2. Develop an expenditure budget
3. Develop a cash budget including sales and expenditures
4. Develop a capital budget

Methods

  • Incremental budget - budget based on last year's budget; specific amount is added to cover inflation
  • Performance budget - preference is given to those who exceed projections for generation of sales
  • Zero-based budget - made each year; funds allocated by justification of continuation of activities or beginning new activities

Components

  • Direct costs- costs which can be associated with a specific department, service, etc.
  • Indirect costs- costs which are not associated with a specific department (ie: overhead costs, taxes, etc.)
  • Capital Expenditures- major improvements, expansions, and purchases or replacements of equipment, buildings & land
  • Profitability ratios – measure the ability of an organization to generate profit in relation to sales or the investment of assets; profit or net income is the income remaining after all expenses have been deducted from income/revenue
  • Profit Margin on Sales (AKA Profit Margin) = Net Income / Sales
  • Revenue (sales)- total income from sales, services, etc.
  • Gross profit – profit after subtracting the cost of good sold from the sales/revenue (before expenses)
  • Cost of goods available for sale – beginning inventory plus purchases
  • Cost of goods sold – COGAS minus ending inventory
  • Net income – “Net income” is the phrase commonly used to refer to a company’s “profit.” It represents how much money the company has left over, if any, after it’s paid the costs of doing business — payroll, raw materials, taxes, interest on loans, depreciation rent, etc.
  • Gross profit minus labor, overhead and operating expenses (salaries, benefits)

Financial Status: monitoring, evaluation, and control

Monitoring

  • Financial Statements -aid in determination of financial condition and profitability; 4 principal documents are (1) Balance sheet, (2) income statement, (3) statement of cash flows, and (4) statement of retained earnings
  • Balance Sheet - provides statement of assets, liabilities and owners equity.
  • Asset – current (cash, accounts receivable, inventory, prepaid expenses), fixed (these will depreciate), and other
  • Liabilities – current (accounts payable – rent, payroll) accrued (these you will eventually have to pay), Unearned revenue, long-term debt, other
  • Equity – if assets are greater than liabilities, equity will be high; owners equity (business with 1 owner) or stockholders equity (business with more than 1 owner)
  • Income Statement - Revenue less expenses for the period arriving at net income (or loss if expenses exceed revenue & income).
  • Cost control formulas:
  • meals per labor hour = total # of meals served
    total # of labor hours
  • I.E. 4,600 meals for February, 1,150 labor hours were used.
    4,600/1,150 = 4 meals per labor hour. *If number of labor hours is not provided you may have to multiply the # of workers by each worker's hours worked to arrive at number of labor hours. 100 employees x 11.5 hours worked each = 1,150 labor hours.
  • cost per meal = total cost
    total # of meals prepared

Budget effectiveness

  • cost benefit studies–decisions making technique; evaluate whether different options would return better results financially or operationally
  • Cost Effectiveness: Cost vs. Results.
  • Often, the desired outcome is not measured in dollars
  • Cost effectiveness assists in determining a specific predetermined goal
  • *Cost effectiveness is popular in public programs.
  • Cost Effectiveness real world example. You are a dietitian forced to make budget cuts. You can keep one of two programs. A three day type 2 diabetes education class or individual type 2 diabetes counseling. To determine which program to cut you would conduct a cost effectiveness analysis. Which of the two groups have seen the least complications, better glucose control, and overall increased quality of life?
  • Cost Benefit Analysis: Effort, time, and expense vs. benefits.
  • Performance is measured in monetary terms
  • productivity studies - based on input versus output; evaluated quantitatively (meals/labor hr, minutes/meal, labor cost/meal served, etc)

Financial Statements & Costing

Key Terms (Memorize):
Balance Sheet: / Statement of Assets, Liabilities, and Equity.
Income Statement: / Statement of Revenue minus Expenses for a period of time (i.e. month or year) Total Sales minus Total Expenses for the period are recorded on the Income Statement.
Net Income: / Revenue - Expenses = Net Income (or profit) Net Income is a line item at the very bottom of the Income Statement.
Revenue: / Revenue: Amounts received from customers for goods sold or services rendered. e.g. Restaurant: Meals Sold Revenue. Dietitian Practice: Consultation Services Revenue. Book Store: Sale of Books Revenue.
Total Revenue: / Price * Quantity Sold = Total Revenue
Expenses: / The amounts incurred for producing revenues. Unlike assets, expenses do not benefit future time periods. Monthly electric bill, monthly water bill, monthly building rent, advertising expense, employee payroll, office supplies, etc.
Goods Available for Sale: / Beginning Inventory + Purchases = Goods Available for Sale Goods Available for Sale: Beginning inventory + purchases (net purchases, don't include purchases you made and later returned).
Cost of Goods Sold: / Beginning Inventory + Purchases - Ending Inventory = Cost of Goods Sold Cost of Goods Sold (COGS): the total cost of inventory that a company has used/sold during a period.
Gross Profit: / Gross Profit = Sales Revenue - Cost of Goods Sold Net sales minus cost of goods sold equals gross profit.
Prime Cost: / Raw Material + Labor (i.e. Food & Beverage + Labor = Prime Cost)
Fixed Cost: / Remain constant regardless of the level of production (i.e. the building insurance is $1,000 every month no matter how many meals are prepared)
Variable cost: / Costs that change with the level of production (i.e. labor and raw material cost will increase as production increases - double production and variable costs double)
LIFO: / Costing method, the Last In are the First Out for costing purposes. The last inventory purchased will be the first inventory costed on the financial statements.
FIFO: / Costing method, the First In are the First Out for costing purposes. The first inventory purchased will be the first inventory costed on the financial statements.
In general there are two main statements in accounting - the Balance Sheet and the Income Statement. Everything else is a spin off of these two main statements.
Let's take a look at an actual Balance Sheet :
ABC FOODSERVICE
Balance Sheet
February 31, 2000
ASSETS
Current assets:
Cash / $7,500
Accounts Receivable / 11,500
Inventory (meals for sale) / 22,750
Prepaid Insurance / 5,800
______
Total Current Assets / $47,550
Property Plant and Equipment:
Equipment / $156,000
Less Accumulated Depreciation / -27,500
______/ $128,500
______
Total Assets / $176,050
======
LIABILITIES & STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable (equipment loan) / $36,500
Salaries Payable / 14,500
______
Total current liabilities / $51,000
Stockholders Equity:
Capital Stock / $100,000
Retained Earnings / 25,050
______/ $125,050
______
Total liabilities & equity / $176,050
======
Take a look at the balance sheet again. What are the three main categories?
The three main categories of a Balance Sheet are ASSETS, LIABILITIES, & EQUITY.
All financial statements follow a standard convention regarding heading. At the very top of any financial statement you will find the entity's name. Below the entity's name is the title of the Financial Statement, followed by a date (or for a period if Income Statement). In this case ABC FOODSERVICE is the entity's name. The title of the statement = Balance Sheet
There is a fundamental equation for the Balance Sheet. Assets = Liabilities + Equity
In our example Total Assets = $176,050 (please look at this figure). Total Liabilities = $51,000 (again please look at the example). Total Equity = $125,050 (please look at the Balance Sheet and find this figure).
Now back to the Balance Sheet equation: Assets = Liabilities + Equity ... $176,050 = $51,000 + $125,050 *Notice Total Assets = $176,050 and Total liabilities & equity = $176,050 which says $176,050 = $176,050 (accountants really got creative when they named the Balance Sheet...NOT!)
If you were asked the question, "which statement utilizes the following equation: Assets = Liabilities + Equity?" - you could respond, "Balance Sheet!"
Notice that Inventory (food, beverages, items for sale) is on the Balance Sheet under the Assets section. An Asset is anything that has future benefit to the entity and is owned/controlled by the entity (entity being food service, business, hospital). Assets such as cash, receivables, and inventory can be used by ABC FoodService for future financial benefit. We will visit inventory in more detail a bit later.
There are two main categories of assets: Current Assets and Fixed Assets (Fixed Assets = long term assets such as Property, Plant and Equipment). Current Assets are those assets that can be quickly converted to cash. Fixed Assets are assets such as building and equipment that are not readily converted to cash; fixed Assets are FIXED (buildings and equipment are NOT easily moved). Please look at the assets section of the balance sheet to confirm this.
A few key points regarding Assets: Any amounts incurred/paid to prepare the asset for ordinary and regular business use are considered part of the asset's cost. Once the asset is "ready for service in a business setting" any amounts incurred to maintain it are expenses and not added to the cost of the asset. Here's an example problem:
stove purchased for $1500.00, delivery of stove $100.00, $225.00 for installation. What is the cost of this asset? Answer: $1825.00 ($1500.00 paid for the stove, $100.00 for delivery, and $225.00 for the installation). All of these amounts paid were necessary to get the stove in a "ready for service state," hence they are part of the asset's cost.
Once the stove is "ready for service in the business" amounts incurred to keep it running are expenses. An example of amounts that should be expensed rather than added to the cost of the stove: electrician later, after initial installation, comes out to rewire stove, or amounts paid for cleaning, painting, or moving the stove (after stove is "ready for business use") should be expenses for the period and not added to the cost of the asset (stove).
Since we just touched on the definition of an asset let's go over liability. A liability is basically the opposite of an asset. A liability is the probable future sacrifice of an asset.
At this point you need not be overly concerned with Equity, Shareholders Equity, etc. Just know that it is part of the Balance Sheet equation: Assets = Liabilities + Equity. When presented with the total Assets and Equity you could easily figure out the liabilities by using the Balance Sheet equation.
If you are still uncomfortable with the Balance Sheet take a break and revisit the lecture. Get a blank sheet of paper and copy the balance sheet in this example. Use your calculator to add up Total Assets, Total Liabilities & Equity. Confirm the Balance Sheet equation: Total Assets = Total Liabilities + Equity
Moving on to the second major financial statement, the Income Statement. The Income Statement is used to measure how well an entity (i.e. company, hospital, food service) is doing on a period to period basis (week to week, month to month, and year to year).
An Income Statement really boils down to revenue - expenses. It's not that bad if you consider it has two major sections, Revenue (Sales of products, goods, food, beverages, etc) and Expenses (inventory costs such as food & beverage costs, employee salaries, rent expenses, etc).
Wait a second how did, "inventory costs such as food & beverage costs," get moved from the Balance Sheet above to the Income Statement? These items were just on the Balance Sheet? Answer - when these items are sold they move from the balance sheet to the income statement. The Income Statement records the sale of the food & beverage as well as the cost of sale of the food and beverage.
The Income Statement is also referred to as the P & L (profit and loss) or Statement of Operations. Don't let this confuse you. It still means Revenue - Expenses = Income
Let's take a look at an actual Income Statement (remember Income Statement is a Statement of Revenue - Expenses for a period of time (i.e. month or year)
Total Sales minus Total Expenses for the period are recorded on the Income Statement.
Don't panic when presented a financial statement! Use the following approach: Start reading at the top. Systematically read everything from left to right moving down one line at a time:
ABC FOODSERVICE
Income Statement
For the Year Ended December 31, 2000
Revenue
Sales (meals) / $378,000
Other income / $0
Expenses
Cost of Goods Sold (meals) / $189,000
Marketing and administrative / 20,000
Rent / 30,000
Depreciation Expense / 15,600
Advertising and product promotion / 10,000
Research and development / 12,000
Wages / 44,400
Other expenses / 8,000
______/ 329,000
______
Net Income (or Net Loss if expenses exceed revenue/income) / $49,000
======
The Income Statement is pretty straight forward. As we can see it measures total revenue (sales) less total expenses for a period (week, month, or year in this case).
Please look at the Income Statement and notice Cost of Goods Sold (meals). You might ask, "well if the Income Statement simply reflects Revenue - Expenses what is all this "Costing" business about?"
Great Question! After the Revenue (Sales) section of the Income Statement comes the Expenses. It is necessary to determine how much expense (or cost) was encountered when selling all of the meals for the period (in this case year).
Let's break down Sales - Cost of Product/Goods Sold (fancy term for expenses directly attributed to sales) into a simple example.
ABC FoodService sells one meal to a customer for $6.00 This $6.00 would be reflected on the Income Statement below Revenue in the Sales (meals) column.
We know Revenue - Expenses = Net Income. Considering ABC FoodService's $6.00 sale does this mean they have Net Income of $6.00?
No! ABC FoodService only wishes Net Income was $6.00! We must take into account the COST of the meal sold.
To make the meal so it could be sold to the customer it cost us $3.00 ($1.50 for the food and $1.00 for the employee labor and .50 for the beverage).
In this example our Cost of Product/Goods Sold is $3.00 Do you know what our Net Income would be if these were the only items on our Income Statement? $3.00 ($6.00 sale - $3.00 Cost of Goods Sold = $3.00 Net Income)
Ok I think we've focused on that one example enough. Now consider the ABC FoodService Balance Sheet & Income Statement above.
Let's review some financial statement problems. Please read the question, look at the statement and work the problem on blank scratch paper WITHOUT looking at the answer). Scroll the screen to the point where only the Question appears (and the answer is hidden).
1Q. What is the total sales figure for ABC FoodService for the year ended December 31, 2000?
A. $378,000 - simple question, just look at the income statement.
2Q. If ABC FoodService had an equal amount of sales every month in 2000, how many meals did they sell each month if each meal sold for $6.00?
A. 5,250 - Meal Sales $378,000/$6.00 per meal = 63,000/12 months = 5,250
3Q. How many meals did ABC FoodService sell in 2000 if they sold each meal for $5.50?
A. 68,727 meals were sold in 2000. Look at the income statement, Sales Meals $378,000/$5.50 per sale = 68,727 meals sold for $5.50