Use the flexible budget template to complete this problem

The Antigua Blood bank, a private charity partly supported by government grants is located on the Caribbean island of Antigua. The blood bank has just finished its operations for September which was a particularly busy month due to a powerful hurricane that hit neighboring islands causing many injuries. The hurricane largely bypassed Antigua but residents of Antigua willingly donated their blood to help people on other islands. As a consequence, the blood bank collected and processed over 15% more blood than had been originally planned for the month.

	Planned Budget
Liters of blood collected	820
Administrative supplies (VC)	2,050
Equipment depreciation (FC)	6,600
Lab tests (VC)	7,790
Medical supplies (VC)	10,660
Refreshments for donors (VC)	5,740
Rent (FC)	4,000
Staff salaries (FC)	15,000
Utilities (FC)	810

1. Use the budget template and format the information into a contribution margin income statement. Include columns for totals and per unit costs. NOTE: the government will reimburse Antigua Blood Bank so that it covers all of its costs and breaks even. Determine how much the government needs to reimburse the blood bank in total and per liter of blood and enter that information as revenue.

A report prepared by a government official comparing actual costs to budgeted costs appears below. The report lists all costs in alphabetical order. Continued support from the government depends on the blood banks ability to demonstrate control over its costs.

	Actual
Liters of blood collected	950
Administrative supplies (VC)	2,300
Equipment depreciation (FC)	6,800
Lab tests (VC)	7,900
Medical supplies (VC)	12,500
Refreshments for donors (VC)	6,700
Rent (FC)	4,000
Staff salaries (FC)	15,000
Utilities (FC)	880

1. Enter the actual results into the appropriate columns of the budget template and calculate the overall variances. Indicate whether each variance is favorable (F) or unfavorable (U).
2. How well is the blood bank controlling its costs?

1. In the appropriate columns, create a flexible budget for the blood bank so that they can better evaluate actual performance. (Hint: you will need to find the variable cost per unit to complete the flexible budget)
2. In the appropriate columns, determine the volume variances for the month. Indicate whether each variance is favorable (F) or unfavorable (U)
3. In the appropriate columns, determine the spending variances for the month. Indicate whether each variance is favorable (F) or unfavorable (U)
4. Reevaluate how well the blood bank is controlling its costs.
5. Which of the variances in the report your prepared should be investigated? Explain why.

Chapter 8: Budgeting and Variance Analysis By the end of this chapter students will be able to 1. Explain the role of various types of budgets in the planning process 2. Create a planning budget 3. Translate an annual operating budget to a monthly cash budget 4. Create a flexible budget that adjusts a planning budget for changes in volume 5. Calculate volume and spending variances 6. Explain how variances are used in the budgeting process Introduction to Budgeting The main purposes of managerial are accounting planning, control and decision making. Budgeting and budgets have an essential role in fulfilling those purposes. Budgeting is the process of constructing and using a financial plan to guide and control business activity during a given period of time. Perhaps you have created a budget for yourself. The role of personal budgets, like business budgets, is to ensure that you have enough funding to cover your monthly expenses and to have enough left over to put away and save for longer term items like a car or a house. In looking at your own budget, your salary is your source of funding. Your salary will determine how much money you have available each month to cover monthly expenses including rent, clothing, utilities, and entertainment. Comparing your salary to your monthly expenses will determine how much money will be left at the end of each month to put aside and save for a car or a down payment for a house. Rather than seeing how much is left each month many financial planners suggest putting money aside each month towards the larger purchases before determining how much money you have available to cover monthly expenses. Either way, a budget helps ensure that the money coming in matches the needs for money going out. Many individuals do not bother with a formal budget, but companies would be lost without them. In addition to using budgets to develop a financial plan that matches money in with money out, budgets also serve to coordinate the work of the people in a business who are responsible for generating sales with the work of people who are responsible for controlling expenses. Budgets also provide a benchmark for measuring actual performance. With so many people making day to day decisions, you can imagine how important it is to coordinate efforts and keep track of results. Budget Basics There are two types of budgets: capital budgets and operating budgets. Capital budgets reflect decisions related to the purchase and maintenance of long term assets. We will return to capital budgets in the finance section of this book. Operating Budgets reflect decisions about revenues and expenses. The financial plan, or operating budget, that is created through the budgeting process includes the company's plan for generating revenue as well as their planned expenditures on salaries, supplies, inventory, and other expenses that will be incurred in generating the revenue. Creating operating budgets and using operating budgets to control operations will be the focus of this chapter. Operating budgets are typically created yearly and include a plan for expected revenues and expenses for the coming fiscal year. To be useful as a planning and control tool, the planning side of budgeting process should be complete before the start of the fiscal year while the control side of the budgeting process continues during the fiscal year. On a month by month basis, actual results are compared to the budget to determine how well the organization is following the financial plan. Month by month monitoring helps identify the need for corrective action if either revenues or expenses are different than what was originally planned. Operating budgets can be generated through a top-down or bottom up process. In a top-down process, the budgetary decisions are made by top management. For example, it may be that the vice presidents of an organization collect cost and revenue data and determine revenue targets as well as budgeted costs. It is then up to department managers to work within the budget that they are given. In a bottom up or participatory process, line managers collect cost data that is relevant for their department. They create a budget that they then send to top management. Top management combines the budgets from the various divisions to create a budget for the entire organization. Budgets are often sent back to the line managers for revisions before a final budget is agreed upon. A participatory process is usually more effective as managers who are charged with controlling costs had a say in determining those costs. Operating Budget Formats The most straightforward way to present budget information is using a one-step budget format. This format creates a budget that if formatted like a projected income statement. Sales forecasts are at the top and cost forecasts are presented below based on using the type of cost formulas we developed in Chapter 5 to forecast individual cost items. One Step Budget Master Budget Sales Forcast Cost forecasts using cost formula Net income projection based on sales less total costs Sales Forcast Production Budget Inventory purchases Direct materials budget Direct Labor Budget Manufacturing Overhead Bduget Selling and Administration Budget Cash Budget Budgeted Financial Statements A more complex type of budget is a master budget. A master budget includes a number of schedules to convert sales into production, purchasing and payment plans. It would start with a sales forecast followed by a schedule for the production of finished goods along with a schedule outlining the purchasing and warehousing of raw materials. There would be a schedule for the direct labor needed to convert raw materials into finished goods along with a manufacturing overhead schedule. There would be a schedule for selling and administrative expenditures and a schedule that outlines the receipt and payment of cash. The last two components of a master budget are a projected income statement and balance sheet. We will develop and use a one-step budget along with a cash budget in this chapter. DEVELOPING A BUDGET Format We will use the contribution margin income statement format that we developed in chapter 5 and used in Chapter 7 to create a one step budget. In this type of income statement revenues are listed at the top followed by variable costs and then fixed costs. While not all organizations will use this framework for preparing and presenting their budget data, this format is useful as it will help us see the impact of changes in volume on revenue, costs, and profit. Forecasting Sales The first step in developing a budget is to forecast sales because, as we learned in Chapter 7, the level of sales will determine the expected level of costs. Forecasting sales is by and large a marketing function. Marketers conduct extensive research to determine overall market demand for their good or service. Internally, they also investigate actual demand trends by comparing sales for their goods and services over the past few years. This will help them see whether demand appears to be growing, stable, or shrinking. Provided that the trends continue, evaluating actual demand will give marketers an initial estimate of future sales. Additionally they consider the impact of price point and changes in expenditures on potential sales volume (think back to the th types of CVP analysis we conducted in Chapter 7). Externally they investigate economic trends related to each good or service they are trying to sell. They identify competitors in order to estimate both the size of the total market for their good or service and their potential share of the total market demand. This information is then used to adjust their initial estimates. In addition to determining the level of sales, marketers will also try and determine when the sales will occur. For some companies and some products, sales will be spread evenly throughout the year, but for some products sales volume will differ by month or by season. You will learn more about forecasting sales in marketing course. In terms of understanding the financial aspects of a business, we will take sales levels as given and develop a budget based on forecasted sales. Estimating Costs In Chapter 5, we discussed the idea that there are different costs for different purposes. In that discussion we found that classifying costs by their behavior is essential when using costs for planning and control purposes. To classify costs by behavior, we determine whether costs are variable, fixed, or mixed. We further, decompose mixed costs into their fixed and variable components. Once cost formulas are determined for all costs, a budget can be constructed showing expected costs given an expected level of revenue. Let's see how this works. Peddlers' Pedicabs operates 30 pedicabs in Savannah, GA. Pedicabs provide an alternative to walking, driving private cars and parking, taking the bus or taking a taxi. It is a popular mode of transportation and because it reduces traffic congestion and parking problems, it is wholeheartedly supported by the city of Savannah. The pedicabs operate within the 2 square mile historic district of Savannah. Customers can hail cabs or call for pickup. As part of their annual budgeting process, the company has collected the following revenue and cost information. In terms of revenue, drivers rent the pedicabs from the company for four hour shifts at a rate of $25 per shift. Most drivers are college students who work around their class schedules. They work for tips and generally earn $100 to $150 during each four hour shift. Pedicabs are available for rent 16 hours per day from 8am to midnight. In a typical month, cabs are rented for about 60% of the available shifts. Downtime is used for maintenance and for other revenue opportunities. There are relatively few variable costs. No gasoline is required, but each cab has a battery for lights which must be recharged after each shift. It costs $.20 per shift to charge the battery. The company covers the cost of insuring the cab and the drive at a cost of $5 per shift. Every pedicab is serviced after each shift at a cost of $4.50. Monthly expenses include rent at $12,030, maintenance at $1,800, depreciation of $1,500 and telephone and internet at $170. Dispatcher are paid $18 per hour and someone is on duty during normal operating hours. The manager's salary is $75,000 per year. Combining the information above yields the following annual budget in a contribution margin income statement format. The budget could be presented in a traditional income statement format as well, but this format will be more useful when we compare actual to budgeted results. Peddlers' Pedicab Fiscal Year Budget Shifts per year: 26,280 Revenue Variable costs Insurance Servicing Electricity Total Variable Costs Contribution Margin Fixed Costs Rent Dispatcher Wages Manager Salary Maintenance Depreciation Telephone Total Fixed Costs Net Operating Income $ Total 657,000 131,400 118,260 5,256 254,916 402,084 $ $ $ Per Shift 25.00 $ 5.00 4.50 0.20 9.70 15.30 144,360 105,120 75,000 21,600 18,000 2,040 366,120 35,964 So, let's figure out how these numbers were determined. Each part of the final budget is supported by its own set of calculations. We will start with revenue. Revenue for Peddlers comes from the rental fee paid by the drivers. Drivers pay $25 to rent a pedicab for a 4 hour shift. To determine total revenue, we need to determine how many shifts the company anticipates it will rent the pedicabs. The calculation is shown in the exhibit below. The company owns 30 cabs. There are a maximum of 4- 4 hour shifts available during the 16 hours that the company is open every day. This results in 120 shifts available each day. The company operates 365 days per year which results in 43,800 shifts being available each year. The company estimates that only 60% of the available shifts will be used. 60% of 43,800 shifts is 26,280 shifts. When we multiply the number of shifts by the revenue of $25 per shift we arrive at projected revenue of $657,000 for the year. Take a minute to trace the number of shifts and the total revenue back to the budget in the previous exhibit. $ $ 30 4 120 365 43,800 60% 26,280 25 657,000 Peddlers Pedicab Revenue Projections cabs 4 hour shifts per day number of shifts available per day days per year shifts available per year portion of shifts rented shifts rented per year revenue per shift total revenue Now let's move onto the expenses. The variable costs include insurance at $5 per shift, servicing at $4.50 per shift, and electricity at $.20 per shift. We can determine the total cost for each of these variable costs by multiplying each of the per shift values by 26,280 shifts, which is the number of shifts anticipated during the fiscal year. The results of the multiplication are shown in the following table. Peddlers Pedicab Variable cost projections $ $ 26,280 5.00 131,400 shifts rented per year insurance cost per shift total annual insurance cost $ $ 26,280 4.50 118,260 shifts rented per year serivicing cost per shift total annual servicing cost $ $ 26,280 0.20 5,256 $ 254,916 shifts rented per year electricity cost per shift total annual electricity cost total annual variable cost The budgeted insurance cost for the year is $131,400, the budgeted servicing costs are $118,260, and the budgeted electricity costs are $5,256 for total variable costs of $254,916. Take a minute to trace these costs back to the budget. The fixed costs include rent, the manager's salary, the dispatchers wages, maintenance, depreciation, and telephone and internet. Most of these values are provided on a monthly basis. To determine the annual cost, simply multiply by 12. Peddlers Pedicab budgeted fixed costs cost per month months per year budgeted annual costs rent 12,030 12 $ 144,360 $ maintenance 1,800 12 $ 21,600 $ depreciation 1,500 12 $ 18,000 $ telephone $ 170 12 $ 2,040 The manager's salary of $75,000 is already given on an annual basis so no adjustment is needed. The final cost, the dispatchers' wages, is based on hours worked. There is a dispatcher on duty 16 hours a day 365 days a year. At $18 per hour, the budgeted dispatcher wages for the year are $105,120. Take a few minutes to trace the fixed costs back to the original budget. Peddlers Pedicab budgeted dispatcher wages dispatcher wages 16 365 5,840 $ 18 $ 105,120 hours per day days per year hours per year wage per hour total budgeted dispatcher wages As we have seen, the final annual budget displayed above is created by aggregating the information generated about revenues, variable costs, and fixed costs. In a small business like Peddlers' Pedicab, the manager would most likely collect all of the revenue and cost data, determine the budget for each component, and put the information together in an annual budget. The can be done in one step using the contribution margin income statement as shown in the fiscal year budget exhibit or can be done by creating a set of schedules (budgeted revenue, budgeted variable costs, budgeted fixed costs) and then aggregating the schedules into a fiscal year budget. Because of the wonders of math, the decision about process is an individual choice. Some people prefer working through individual steps and then aggregating the information, while other people prefer to do the budget in one step. In a larger organization the task of collecting and aggregating the information will include input from many people and many departments. In the case of a larger transportation company, marketing would most likely determine the sales budget, the garage manager would determine a budget for service and maintenance, the operation manager would determine the budget for insurance, electricity, and dispatcher wages, the general manager would determine the budget for rent, and depreciation, and the board of directors or the owner of the business would determine the budget for the general manager's salary. In this case, each manager would create a schedule for his or her part of the entire budget and an accountant within the firm would pull the information together to create the final budget. APPLY WHAT YOU HAVE LEARNED: Create a fiscal year budget. Time to Go is a manufacturer and e-retailer of digital watches. The company set the sales price of their watches at $34. The cost of creating the watch is $12.50 per watch. It costs $5.00 per watch for shipping and handling. $1.00 of utilities are used in creating, assembling and packing each watch. The administrative costs are $18,750 per month, selling expenses are $5,000 per month plus $2.00 per watch, insurance is $1,500 per month, and depreciation of non-manufacturing property and equipment is $3,000 per month. The company has budgeted sales of 35,000 watches. Create a budget for the fiscal year. You may create separate budgets for sales, fixed costs, and variable costs and aggregate the results to create a budget or you may use the one step method from above. Cash Budgeting One component of a master budget is a cash budget. It is created after creating an annual budget. Even without a complete multi-step master budget, it is a good idea to create a monthly cash budget. A cash budget provides a detailed plan of when during the year cash receipts and cash expenditures will occur. So while one goal of a planning budget is to ensure that revenues exceed expenses, the goal of a cash budget is to ensure that the level and timing of cash receipts is adequate to cover the level and timing of cash expenditures. In addition to using the cash budget to ensure that there is enough cash on hand throughout the year to meet the needs for cash, a monthly cash budget can also be used for completing the type of year to date analysis that was discussed earlier in the chapter. The general layout for a cash budget is provided on the following page. A basic cash budget has at least 5 sections: sales, cash collections, cash disbursements, excess or deficiency of cash, and financing. The sales section As we have seen, the basis of every budget is the level of sales. Sales may be distributed evenly across the year or they may follow a more seasonal pattern. For example, Hood or Garelick Farms will probably sell the same number of gallons of milk each month, but Parker Brothers will probably have seasonal variation in the number of games it sells with higher sales around holiday time in December. Developing the sales section of the cash budget is very straightforward. Total annual sales, which have already been determined in the planning budget, are divided over each month. Template for Monthly Cash Budget Sales Distribution of sales Sales quantity Revenue per sale Total sales dollars Cash collections In month of sale From previous month From 2 months prior Total cash collections Cash disbursements cost items listed individually Total cash disbursements Excess (deficiency) of cash Beginning balance of cash Cash before financing Financing Borrowing (at beginning) Repayment (at end) Interest Total financing End balance of cash Total Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec A sales budget for Peddlers Pedicab is shown below. The first row of the sales section lists the distribution of sales. In this example revenue is equally distributed across the year so that one twelfth (8.33%) of annual revenue is earned each month. The second row displays the number of shifts which is arrived at by multiplying the total number of shifts for the year by the percentage of shifts provided each month. The third row lists the revenue per shift and the fourth row shows total revenue dollars for each month which equals the number of shifts times the revenue per shift. You can clearly see monthly sales revenue ($54,750) is the same every month when sales are level throughout the year (2,190 shifts per month). Peddlers' Pedicabs Cash Budget Level sales Distribution of sales Sales quantity Revenue per sale Total sales dollars Total Jan Feb Mar Apr May Jun 100.00% 8.33% 8.33% 8.33% 8.33% 8.33% 8.33% 26,280 2,190 2,190 2,190 2,190 2,190 2,190 $ 25 $ 25 $ 25 $ 25 $ 25 $ 25 $ 25 $ 657,000 $ 54,750 $ 54,750 $ 54,750 $ 54,750 $ 54,750 $ 54,750 Distribution of sales Sales quantity Revenue per sale Total sales dollars Jul Aug Sep Oct Nov Dec 8.33% 8.33% 8.33% 8.33% 8.33% 8.33% 2,190 2,190 2,190 2,190 2,190 2,190 $ 25 $ 25 $ 25 $ 25 $ 25 $ 25 $ 54,750 $ 54,750 $ 54,750 $ 54,750 $ 54,750 $ 54,750 Assume for a moment, that there is seasonal variation in sales instead of level sales. To determine monthly sales, companies will need to estimate the percentage of annual sales they expect to earn each month and substitute the relevant percentages into the first row of the cash budget. The sales budget for Peddlers Pedicab that is shown below is based on seasonal variation. Take a look at the distribution of sales row in the budget. Past experience has shown that demand for the pedicabs varies across the year and is lowest in December, January, July, and August when it is either too cold and wet or too hot and buggy. As in the previous cash budget, monthly rentals are calculated by multiplying the total annual rentals times the monthly distributions. Because demand the number of pedicab rentals varies by month (from 4% of the total in both December and January to 12% of the total monthly in March through May), the monthly revenue also varies (from $26,280 in a slow month to $78,840 in a peak month). Peddlers' Pedicab Cash Budget Seasonal Sales Total 100.00% 26,280 $ 25 $ 657,000 Jan 4% 1,051 $ 25 $ 26,280 Feb 10% 2,628 $ 25 $ 65,700 Mar 12% 3,154 $ 25 $ 78,840 Apr 12% 3,154 $ 25 $ 78,840 May 12% 3,154 $ 25 $ 78,840 Jun 10% 2,628 $ 25 $ 65,700 Jul 5% 1,314 $ 25 $ 32,850 Distribution of sales Sales quantity Revenue per sale Total sales dollars Aug 5% 1,314 $ 25 $ 32,850 Sep 6% 1,577 $ 25 $ 39,420 Oct 10% 2,628 $ 25 $ 65,700 Nov 10% 2,628 $ 25 $ 65,700 Dec 4% 1,051 $ 25 $ 26,280 The collections section The next section of the budget maps the revenue that was earned into cash collections. Notice, for conciseness only half of the year is displayed in the following exhibits. If all revenue is collected in cash at the time of the sale, the monthly sales revenue will equal the cash collections, but this will not always be the case since many companies allow customers to buy on credit and pay either a month or two months after the sale. Knowing the sales terms and the pattern of collection is therefore essential to determine the timing of cash collections. In the exhibit below, cash is collected in the same month as the revenue was earned. Peddlers' Pedicabs Cash Budget Level Sales with Cash Collection in the Same Month Distribution of sales Sales quantity Revenue per sale Total sales dollars $ $ Total Jan Feb Mar Apr May Jun 100.00% 8.33% 8.33% 8.33% 8.33% 8.33% 8.33% 26,280 2,190 2,190 2,190 2,190 2,190 2,190 25 $ 25 $ 25 $ 25 $ 25 $ 25 $ 25 657,000 $ 54,750 $ 54,750 $ 54,750 $ 54,750 $ 54,750 $ 54,750 Collections in the same month Other collections Total collections Jan $ 54,750 Feb $ 54,750 Mar $ 54,750 Apr $ 54,750 May $ 54,750 Jun $ 54,750 $ 54,750 $ 54,750 $ 54,750 $ 54,750 $ 54,750 $ 54,750 In the cash budget displayed below, half of the cash is collected in the same month as the sale, 30% is collected a month after the sale, 15% is collected two months after the revenue was earned, and 5% of the revenue was never collected. This is a real risk with credit sales. No matter how hard companies work to evaluate the creditworthiness of their customers, there will always be some customers who do not pay. To determine cash collections for each month, we multiply the relevant level of sales times the portion that is collected each month. We'll focus on the revenue and collection values for March. March revenue equals $78,840. Half of revenue is collected as cash in the same month that the revenue was earned. As a result, in March Peddlers will collect $39,420 in cash from the revenue earned in March. The remaining March revenue will be collected in subsequent months. In April$23,652 will be collected (30% of $78,840) and in May $11,826 will be collected (15% of $78,840). As for March collections, Peddlers will collect $19,710 of February's revenue (30% of $65,700) and $3,942 of January's revenue (15% of $26,280 in addition to collecting $39,420 of March's revenue (50% of $78,840). Notice when there are seasonal sales, some of which are on credit, there will be a difference between revenue earned and cash collected. Before moving on, verify the when April's revenue will be collected as well as the source of collections for May. Peddlers' Pedicabs Cash Budget Seasonal Sales with Credit Terms Total Distribution of sales Jan 100% Sales quantity Feb 4% 26,280 Mar 10% 1,051 Apr 12% 2,628 May 12% 3,154 Jun 12% 3,154 3,154 Revenue per sale $ 25 $ 25 $ 25 $ 25 $ 25 $ 25 Total sales dollars $ 657,000 $ 26,280 $ 65,700 $ 78,840 $ 78,840 $ 78,840 Cash collections from operating activity 15% 30% 50% 30% 10% 2,628 $ 25 $ 65,700 15% in month of sale 50% 13,140 32,850 39,420 39,420 39,420 32,850 from previous month 30% 7,884 7,884 19,710 23,652 23,652 23,652 from 2 months prior 15% Total cash collections 9,855 3,942 3,942 9,855 11,826 11,826 30,879 44,676 63,072 72,927 74,898 68,328 The disbursements section The next section of the cash budget maps disbursements of cash used in operations. As with revenue, the budget provides projections of expenses. The issue here revolves around the pattern of payment. Some expenses might be paid for month by month while others might be paid quarterly or annually. Some payments might be equal each payments, while others will vary with sales depending on whether a given cost is fixed or variable. The disbursement section for the first half of the year follows below. The disbursement section starts with the heading, \"Cash Disbursements\" and continues with a listing of all expenses. The order used here follows the order of expenses in the planning budget. This consistency helps link the documents together. The second column has a listing of the total amount budgeted for the year. This information is placed here to see where the dollar values come from, but may be omitted. It should be noted that cash disbursements may not be equal to the budgeted amounts. The following columns are laid out for each month of the year. Again, only the first half of the year is presented in this exhibit. The complete budget is presented on page ___.. Notice that the quantity of sales is copied here from the sales section as the information is needed to map payment for certain expenses to the appropriate period. Cash Disbursements Total Jan 100% Sales quantity 4% Feb 10% Mar 12% Apr 12% May 12% Jun 10% 26,280 1,051 2,628 3,154 3,154 3,154 2,628 Insurance 131,400 5,256 13,140 15,768 15,768 15,768 13,140 Servicing 118,260 4,730 11,826 14,191 14,191 14,191 11,826 5,256 200 210 526 631 631 631 Cash disbursements Electricity Rent 144,360 Dispatcher Wages 105,120 8,760 8,760 8,760 8,760 8,760 8,760 Manager Salary 75,000 6,250 6,250 6,250 6,250 6,250 6,250 Maintenance 21,600 1,800 1,800 1,800 1,800 1,800 1,800 2,040 510 16,810 16,810 Telephone Total cash disbursements 24,060 17,320 24,060 24,060 510 16,810 16,810 17,320 We will use the Peddlers Pedicabs planning budget as the basis for the monthly cash budget. Information about the timing of cash payments is needed to map the total annual budgeted amounts to monthly cash disbursements. That information is provided below. As you read through the information be sure to take a few minutes to connect the information to how it is displayed in the cash budget. Peddlers' Pedicabs makes cash payments as follows: Insurance is paid each month based on the number of shifts. Cash Disbursement for insurance = number of shifts per month x $5 per shift So: Used and paid for in January 1,051 x $5 = $ 5,256 Used and paid for in February 2,628 x $5 = $13,140 Used and paid for n March 3,154 x $5 = $15,768 Used and paid for in April 3,154 x $5 = $15,768 Used and paid for in May 3,154 x $5 = $15,768 Used and paid for in June 2,628 x $5 = $13,140 Servicing is paid for month by month. It is a variable expense that changes with changes in the number of shifts worked. Cash disbursement for servicing = shifts per month x $4.50 per shift So: Used and paid for in January Used and paid for in February Used and paid for n March Used and paid for in April Used and paid for in May Used and paid for in June 1,051 x $4.50 = $ 4,730 2,628 x $4.50 = $11,826 3,154 x $4.50 = $14,191 3,154 x $4.50 = $14,191 3,154 x $4.50 = $14,191 2,628 x $4.50 = $11,826 Electricity is a variable expense that changes with changes in the number of shifts worked. We can determine the monthly cash disbursement by multiplying the rate of $0.20 per shift times the number of shifts worked. Electricity is paid for in the month after it is used. The outstanding bill for December (to be paid in January) was $200. Cash disbursement for electricity = number of shifts per month x $0.20 per shift Used in December and paid for in January $200 (given) Used in January and paid for in February 1,051 x $0.20 = $210 Used in February and paid for in March 2,628 x $0.20 = $526 Used in March and paid for in April 3,154 x $0.20 = $631 Used in April and paid for in May 3,154 x $0.20 = $631 Used in May and paid for in June 3,154 x $0.20 = $631 Used in June and paid for in July 2,628 x $0.20 = $526 As noted, electricity is used in one month and paid for in the following month. The $200 paid in January covers electricity used in December. So: Two months of rent are paid at a time. Rent is paid for every other month starting in February. Cash disbursement for rent = annual budgeted amount / 6 payment per year So: = $144,360 annual budgeted rent / 6 bi-monthly payment = $24,060 bi-monthly cash disbursement Rent is paid every other month in February, April, May, July, September, November Dispatcher wages are paid monthly at the end of each month. Wages are based on an hourly rate. Since the hours worked every month are roughly the same, we can determine the dollar value for each disbursement by dividing the total annual budgeted amount for wages by 12 month. Cash disbursement for dispatcher wages = annual budgeted amount / 12 months So: = $105,120 annual budgeted dispatcher wages / 12 months = $8,760 monthly cash disbursement for dispatcher wages. Notice that $8,760 is listed as a cash disbursement for dispatcher wages in every month The manager's salary is paid monthly So: Cash disbursement for manager's salary = annual budgeted amount / 12 months = $75,000 annual budgeted manager's salary / 12 months = $6,250 monthly cash disbursement for dispatcher wages. Notice that $6,250 is listed as a cash disbursement for manager's salary each month Maintenance is primarily the mechanics salary and is paid for monthly as work is done Cash disbursement for maintenance = annual budgeted amount / 12 months = $21,600 annual budgeted maintenance cost / 12 months = $1,800 monthly cash disbursement for maintenance. Notice that $1,800 is listed as a cash disbursement for maintenance in every month So: Telephone is a flat fee of $170 per month and is prepaid quarterly with payments made in January, April, July, and October. Cash disbursement for maintenance = monthly cost x 3 month Cash disbursement for maintenance = annual budgeted amount / 4 quarters So = $170 per month x 3 months = $510 per quarter = $2,040 per year / 4 quarters per year = $510 per quarter. Disbursements are recorded in January and April in the above exhibit and in January, April, July, and October in the annual cash budget that follows. After listing the monthly cash disbursements for each cost item, the values are added together to get total cash disbursements. This value is the amount of cash the company needs to have on hand in each month to cover their planned cash payments. The excess of cash section The first part of this section is used to determine if the company has enough cash each month to cover each month's cash payments. It starts with calculating the excess or deficiency of cash each month by subtracting planned disbursements from planned collections. If collections exceed disbursements, there is an excess of cash for the period, but if disbursements exceed collections there is a deficiency of cash. In the reconciliation bellow, we see that cash collections exceed disbursements in every month but February. In January cash collections were Peddlers' Pedicabs Excess or Deficiency of Cash Jan Total cash collections $ 30,879 LESS: Total cash disbursements 27,506 EQUALS: Excess (deficiency) of cash 3,373 PLUS: Beginning balance of cash 25,000 EQUALS: Cash before financing 28,373 Feb Mar $ 44,676 $ 63,072 66,046 47,295 (21,370) 15,777 28,373 10,002 7,002 25,780 Apr $ 72,927 71,970 957 22,720 23,677 May $ 74,898 47,400 27,498 23,677 51,175 Jun $ 68,328 66,467 1,861 51,175 53,036 $3,373 more than payments, in March $15,777 more, in April $957 more, in May $27,498 more, and in June $1,861 more. In February, cash disbursements were $21,270 more than cash collections, hence the negative value. The variability is related to the seasonality of shift rentals along with the timing differences in cash collections and cash disbursements. Rent payments also an impact on the level of cash the company has available at the end of every month. The smallest cash surpluses existed in April ($957) and June ($1,861) when rent payments were made. The deficit in February (-$21,270) was also a rent payment month.. The second part of this section is to factor in the available cash on hand from the prior period. The beginning balance of cash each period is added to the excess or deficiency of cash to determine the cash available before financing. Peddlers' Pedicabs started the year with $25,000 in their checking account. That amount is added to the excess of $3,373 to determine the amount of cash the company will have on hand at the end of the month. At the end of January Peddlers' cash budget shows $28,373 on hand. Companies usually set a target dollar value for their cash account. Peddlers has decided that they would like to have at least $10,000 in their cash account at all times. This serves as a cushion in case collections are delayed or an unanticipated need for cash arises. If the value of cash before financing is below that level, the company may arrange short term financing. Since, according to the cash budget Peddlers will have more than $10,000 in its cash account at the end of January, it will not need to borrow any money during January, so the cash balance displayed will roll over and become the beginning balance for February. This is true of January, May, and June. In February, there is only $7,000 available which is less than the $10,000 minimum value that Peddlers has set for its cash account. As a result, Peddlers will need to borrow money. The timing of the borrowing and repayment are outlined in the next section. The Financing Section As you can see below, the financing section builds off of the previous section of the monthly cash budget as the need for financing depends on the excess or deficiency of cash from the current period along with the amount of cash carried forward from the prior period. The financing section has rows to record borrowing, repayments, and the payment of interest. Peddlers' Pedicab Financing Section Excess (deficiency) of cash Beginning balance of cash Cash before financing Financing Borrowing (at beginning) Repayment (at end) Interest Total financing End balance of cash Jan 3,373 25,000 28,373 Feb (21,370) 28,373 7,002 Mar 15,777 10,002 25,780 Apr 957 22,720 23,677 May 27,498 23,677 51,175 Jun 1,861 51,175 53,036 (3,000) (60) (3,060) 22,720 23,677 51,175 53,036 3,000 28,373 3,000 10,002 If cash before financing exceeds the company's minimum cash needs, there is no need to borrow. If the value of cash before financing is shy of the minimum value, the company will borrow enough money to maintain their desired minimum balance. This is the case in February. The minimum desired balance for the cash account is $10,000, but the company only has $7,000. As a result, Peddlers will arrange to borrow $3,000 at the beginning of March to ensure that they have an adequate cash balance. The bank has agreed to charge them 2% interest per month. This is listed in the \"borrowing\" row for February. The net impact of borrowing is summed to arrive at the total financing cash flows. Again, for February this involves borrowing $3,000. This value is added to the cash before financing to arrive at the budgeted end balance of cash of $10,002. This value is carried over and becomes the beginning balance for the next month. In January, the cash before financing and the end balance of cash are the same, so they both equal the beginning balance of cash for February. In months when there is borrowing or repayment, the cash before financing and the end balance of cash will not be the same, and the end balance of cash should be used in determining the beginning balance for the subsequent month. Once a company has borrowed money, they must also develop a plan for repayment. Short term borrowing is usually repaid as soon as possible. For Peddlers, it turns out that they can repay the $3,000 in March without dropping below their minimum desired cash balance of $10,000.$3,000 is listed in the repayment row as a negative number to signify a cash outflow. In addition to paying the principle, Peddlers will also pay interest on the money they borrowed. Since the mney was borrowed at the beginning of February and will be repaid at the end of March, the interest will equal $60 ($3,000 x 2% per month x 2 months). This is listed in the interest row as a negative number to signify cash outflow. In total, Peddlers will pay out $3,060 in March to repay principle and pay interest. This will reduce their cash before financing from $25,780 to an end balance of $22,720. Even though there are other months during the year with cash deficits from operations, February is the only month in which Peddlers needs to borrow funds to maintain their desired minimum cash balance. In other months, Peddlers has made use of cash acquired in a previous period to cover the operating cash shortfall. This is a typical pattern for seasonal business or business where the collection of cash does not match the pattern of cash disbursements. Think of schools which primarily collect tuition in August and December, yet need to make disbursements every month. They have a strong need for a comprehensive monthly cash budget. Using a budget they can create a plan to insure that they have the cash they need throughout their fiscal year. Complete Monthly Cash Budget The exhibit on the following page pulls together all of the parts of a cash budget. It extends the previous work and displays the monthly cash budget for the entire year. The first six months of the sales section matches the exhibit on pages 19 showing seasonal demand. The collections section matches first six months of the collection section on page 20 which allowed for credit sales. The first six months of the disbursements section matches the exhibits on pages 21 through 23. The Excess (Deficiency) of Cash and the Financing sections of the budget extend the exhibits on pages 23 and 24 to show the entire year. So what are the takeaways from the cash budget. Given the level and pattern of sales, collections, and disbursements, Peddlers' Pedicabs generally has adequate cash coming in from operating activity to cover their operating cash disbursements. In February they will need to borrow $3,000 short term, but they will be able to repay the borrowing in the March. The balance in their cash account ranges from $28.373 in January to $70,668 in July. This is primarily due to the seasonality of demand for their service which reflects high demand in the spring months and a slight lag in collecting cash from the drivers. If they wanted to minimize the fluctuation in the cash balance and reduce the need for borrowing, they could think about the changing the timing of their larger disbursements. For example, perhaps they could pay paying more of their rent in the summer to match their cash collections. APPLY WHAT YOU HAVE LEARNED: Create a monthly cash budget based on the original planning budget. Time to Go is a manufacturer and e-retailer of digital watches. The company set the sales price of their watches at $34. The cost of creating the watch is $12.50 per watch. It costs $5.00 per watch for shipping and handling. $1.00 of utilities are used in creating, assembling and packing each watch. The administrative costs are $18,750 per month, selling expenses are $5,000 per month plus $2.00 per watch, insurance is $1,500 per month, and depreciation of non-manufacturing property and equipment is $3,000 per month. The company has budgeted sales of 35,000 watches. Collections and expenditures are timed as follows. Sales: 12% of sales occur in November, 18% in December, and the rest of sales are spread equally across the remaining months of the year. 60% of sales are collected in the month of the sale. 40% is collected in the following month. In January, Time to Go will collect $51,000 from sales in the previous December. Cost of goods sold is paid for in the month of the sale based on monthly sales Shipping is paid for in the month of the sale Utilities are paid for in the month after they are used. In January Time to Go will pay $3,750 owed from use of utilities in December. Selling costs include commissions which are paid in the month of the sale Administration: these costs are primarily salary and are paid for monthly Advertising: half is paid in January and the other half is paid in July. Insurance: the annual insurance policy is paid for in January Create a month cash budget. At the end of the prior year, Time to Go had $10,000 in their cash account. Their minimum cash balance is $10,000. Be sure to include any required borrowing and repayment needed to maintain a minimum cash balance of $10,000. Peddlers' Pedicabs Monthly Cash Budget Month Sales Distribution of sales Sales quantity Revenue per sale Total sales dollars Cash collections In month of sale From previous month From 2 months prior Total cash collections Jan Mar Apr May Jun Jul Aug Sep Oct Nov Dec 4% 10% 12% 12% 12% 10% 5% 5% 6% 10% 10% 4% 1,051 2,628 3,154 3,154 3,154 2,628 1,314 1,314 1,577 2,628 2,628 1,051 $ 25 $ 25 $ 25 $ 25 $ 25 $ 25 $ 25 $ 25 $ 25 $ 25 $ 25 $ 25 $ 26,280 $ 65,700 $ 78,840 $ 78,840 $ 78,840 $ 65,700 $ 32,850 $ 32,850 $ 39,420 $ 65,700 $ 65,700 $ 26,280 13,140 7,884 9,855 30,879 32,850 7,884 3,942 44,676 39,420 19,710 3,942 63,072 39,420 23,652 9,855 72,927 39,420 23,652 11,826 74,898 32,850 23,652 11,826 68,328 16,425 19,710 11,826 47,961 16,425 9,855 9,855 36,135 19,710 9,855 4,928 34,493 32,850 11,826 4,928 49,604 32,850 19,710 5,913 58,473 13,140 19,710 9,855 42,705 5,256 4,730 200 13,140 11,826 210 24,060 8,760 6,250 1,800 15,768 14,191 526 15,768 14,191 631 6,570 5,913 526 8,760 6,250 1,800 5,256 4,730 526 24,060 8,760 6,250 1,800 47,295 47,400 66,467 53,616 32,052 13,140 11,826 315 24,060 8,760 6,250 1,800 510 66,661 13,140 11,826 526 8,760 6,250 1,800 510 30,329 6,570 5,913 263 24,060 8,760 6,250 1,800 7,884 7,096 263 8,760 6,250 1,800 13,140 11,826 631 24,060 8,760 6,250 1,800 66,046 15,768 14,191 631 24,060 8,760 6,250 1,800 510 71,970 42,302 51,382 (21,370) 28,373 7,002 15,777 10,002 25,780 957 22,720 23,677 27,498 23,677 51,175 1,861 51,175 53,036 17,632 53,036 70,668 (17,481) 70,668 53,188 2,440 53,188 55,628 (17,058) 55,628 38,570 16,171 38,570 54,741 (8,677) 54,741 46,064 (3,000) (60) (3,060) $ 22,720 $ 23,677 $ 51,175 $ 53,036 $ 70,668 Cash disbursements Insurance Servicing Electricity Rent Dispatcher Wages Manager Salary Maintenance Telephone Total cash disbursements 8,760 6,250 1,800 510 27,506 Excess (deficiency) of cash Beginning balance of cash Cash before financing 3,373 25,000 28,373 Financing Borrowing (at beginning) Repayment (at end) Interest Total financing End balance of cash Feb 8,760 6,250 1,800 8,760 6,250 1,800 3,000 $ 28,373 3,000 $ 10,002 $ 53,188 $ 55,628 $ 38,570 $ 54,741 $ 46,064 Control Regardless of the exact process that is followed, the end result of the budgeting process is the creation of a financial plan that outlines planned revenue and planned expenses. Along with a financial plan is the allocation of responsibility for carrying out the plan. People throughout the organization will be held accountable for adhering to the plan. Marketing managers would most likely be held accountable for generating the budgeted level of sales, while production managers would be responsible for creating the appropriate quantity of goods at the budgeted cost. Once the budget is created and agreed upon by upper management as well as departmental heads, it is often presented to the board of directors of a for-profit business or the board of trustees of a nonprofit organization. These bodies sometimes, but not always, have the right and responsibility to approve the budget. Once approved, the budgetary process shifts from its role in planning, allocating resources, and assigning responsibility to its role as a control mechanism. As a control mechanism, it is used as a benchmark to periodically monitor and gauge performance. Management will investigate whether revenue and expenses are in line with the budgeted projections. This is done by comparing actual spending with the budget. Two types of comparisons are typically done: year to date comparisons and fiscal year comparisons. Year to date comparisons might be done monthly or quarterly. They provide insight into how the organization is doing as the year goes along and provide information to monitor performance along with the opportunity to make mid-year corrections. If in completing year to date comparisons, an organization finds that it is spending more than planned, it can take steps to curb future spending. If sales are lagging behind projections, it can provide incentives to sales staff to try and boost sales. If sales exceed projections, it might need to adjust production schedules and purchases of materials. When companies conduct year to date comparisons, they will compare actual spending to either monthly or quarterly budgets. Alternately, they could consider year to date spending as a percent of projected annual costs. If sales and spending vary by season It would be beneficial to lay out monthly or quarterly budgets (think of snow blowers, lawnmowers, life preservers, or any other product where sales are higher in some seasons than in others). If sales and spending are consistent across the fiscal year it would be appropriate to consider year to date spending as a percent of annual costs. For example, if the year is half over, an organization would anticipate that their actual expenditures would be near half of the annual budgeted amount, hence it would indicate a problem if actual spending was at 75% of the budgeted projections. The fiscal year comparisons provide a summary look at how performance compared to projections. It provides benchmark information for planning the following fiscal year. Keep in mind that while end of the fiscal year performance analysis is useful, waiting until the end of the fiscal year to compare actual spending to projections robs the organization of the opportunity to make mid-stream corrections. Whether completing year to date comparisons or fiscal year comparisons between actual results and budgeted projections, using budgets for control purposes is more than just looking at the numbers. It includes trying to understand the factors that caused actual results to differ from planned results. This requires managers to investigate possible explanations and to understand what factors are within the control of the organization or its managers and what factors are outside its control. We will turn to this next. Peddlers' Pedicab Variance Report shifts Revenue Variable costs Insurance Servicing Electricity Total Variable Costs Contribution Margin Fixed Costs Rent Dispatcher Wages Manager Salary Maintenance Depreciation Telephone Total Fixed Costs Net Operating Income Planning Budget 26,280 $ 657,000 Actual Results 24,090 $ 626,340 131,400 118,260 5,256 254,916 402,084 $ 134,904 120,450 3,614 258,968 367,373 144,360 105,120 75,000 21,600 18,000 2,040 366,120 35,964 145,000 100,000 75,000 22,000 18,000 2,200 362,200 5,173 Variance Analysis The actual operating results for Peddlers' Pedicab are presented above. The annual budget numbers were developed earlier in the chapter. The actual results were gathered at the end of the fiscal year. Net operating income, the last number in each column, reveals that actual income at $5,173 was considerably less than projected income of $35,964. This is an unhappy result. The owners of Peddlers' Pedicab want to understand why this happened. We will develop variance analysis tools to help them understand. Variance analysis involves the investigation and explanation of the difference between budgeted projections and actual results. The first step in variance analysis is to determine the overall variance or difference between budgeted values and actual results. To do this we simply subtract actual results less budgeted projections. These results are presented in the overall variance column in the exhibit below. Let's look at a few examples. Actual revenue of $626,340 was $30,660 less than budgeted revenue of $657,000. The brackets in the exhibit below indicate that actual revenue was less than planned revenue. Actual insurance costs of $134,904 less budgeted projections of $131,400 indicate a difference of $3,504. Because the number is positive, this indicates that insurance expenditures were higher than budgeted. Peddlers' Pedicab Variance Report Planning Budget 26,280 shifts Revenue Variable costs Insurance Servicing Electricity Total Variable Costs Contribution Margin Fixed Costs Rent Dispatcher Wages Manager Salary Maintenance Depreciation Telephone Total Fixed Costs Net Operating Income $ 657,000 Actual Results Total Variances 24,090 $ 626,340 131,400 118,260 5,256 254,916 402,084 $ 145,000 100,000 75,000 22,000 18,000 2,200 362,200 5,173 (30,660) $ 3,504 2,190 (1,643) 4,052 (34,711) 640 (5,120) 400 160 (3,920) (30,791) 134,904 120,450 3,614 258,968 367,373 144,360 105,120 75,000 21,600 18,000 2,040 366,120 35,964 $ Let's go down the rest of the list. Along with insurance, servicing, rent, maintenance, and telephone costs were higher than budgeted ($2,190, $640, $400, and $160 respectively). These were offset by lower than budgeted expenditures for electricity ($1,643) and dispatchers' wages ($5,120). A good starting point in understanding what these numbers mean requires dividing the overall variance into a volume variance and a spending variance. Volume variances explain the difference between budgeted projections and actual results that is due to a change the volume of sales. Spending variances explain the difference between budgeted projections and actual results that is due to spending an amount for resources that was different from what was planned. Volume variances are determined by first creating a flexible budget. Flexible Budgets To create a flexible budget we recast the planning budget to what it would have been based on the actual volume of sales. Think of it this way. If the people creating the budget were clairvoyant, there would be no need for a flexible budget because they would have known ahead of time exactly what the level of sales would be. They would have then used the exact number of actual future sales in constructing the original planning budget. Since very few of us are actually clairvoyant, budgets are based on best estimates of actual future sales. As a result, the level of sales that is budgeted is rarely if even exactly equal to the actual level of sales. If you look at Peddlers' Pedicab's budget, you will see that Peddlers based their budget on renting their pedicabs to drivers for 26,280 shifts, but that the actual results indicate that they only rented cabs for 24,090 shifts. Because revenue and variable costs are related to total sales volume, some of the variance between the budget projections and actual results can simply be explained by the change in volume between what was planned and what actually occurred. Since the actual number of shifts was less than the planned number of shifts, we should anticipate lower revenue and lower variable costs. Reconfiguring the planning budget based on the actual number of shifts helps us separate out the portion of the differences between the planning budget and the actual results that is due to a change in volume. To create a flexible budget, the initial cost information and the initial cost formulas are \"flexed\" to adjust the initial planning budget to accommodate the change in volume. To do this all of the variable revenue and cost information is multiplied by the actual number of shifts in order to get the total revenue and total variable costs. Since 24,090 shifts were used during the year, rather than the 26,280 shifts that were originally budgeted, per unit revenue and per unit costs will be multiplied by 24,090 to get total revenue along with the totals for each of the variable costs. So revenue is equal to 24,090 shifts times $25 per shift, insurance is equal to 24,090 shifts times $5 per shirt, servicing is equal to 24,090 times $4.50 per shift, electricity equals 24,090 shifts times 20 per shift. The flexible budget shows what revenue, costs, and profit should have been if the budget was based on 24,090 shifts. This \"flexed\" budget is shown below. The bottom line, had the original budget be based on 24,090 shifts, the net income would have been budgeted at $2,457 which is actually less than the actual results. Peddlers' Pedicab planning and flexible budgets Revenue Variable costs Insurance Servicing Electricity Total Variable Costs Contribution Margin Fixed Costs Rent Dispatcher Wages Manager Salary Maintenance Depreciation Telephone Total Fixed Costs Net Operating Income Original Planning Budget 26,280 $ 657,000 $ 131,400 118,260 5,256 254,916 402,084 $ $ 144,360 105,120 75,000 21,600 18,000 2,040 366,120 35,964 $ Flexible Budget 24,090 25.00 $ 602,250 5.00 4.50 0.20 9.70 15.30 120,450 108,405 4,818 233,673 368,577 $ 144,360 105,120 75,000 21,600 18,000 2,040 366,120 2,457 APPLY WHAT YOU HAVE LEARNED: Create a flexible budget based on actual sales of 35,500 watches. Time to Go is a manufacturer and e-retailer of digital watches. You created a planning budget for them using the information provided below. The company originally budgeted sales of 35,000 watches, but actual sales were 35,500. Create a flexible budget based on actual sales Original planning budget data: Time to Go set the sales price of their watches at $34. The cost of creating the watch is $12.50 per watch. It costs $5.00 per watch for shipping and handling. $1.00 of utilities is used in creating, assembling and packing each watch. The administrative costs are $18,750 per month, selling expenses are $5,000 per month plus $2.00 per watch, insurance is $1,500 per month, and depreciation of non-manufacturing property and equipment is $3,000 per month. VARIANCE ANALYSIS Volume Variances Once the budget is \"flexed\" to reflect what is would have been if the planners had anticipated the exact level of actual sales, volume variances can be calculated. Volume variances capture the portion of the overall variance that is due to a change in the level of sales. To calculate volume variances simply subtract the original planning budget values from the flexible budget values. The volume variances are shown in the exhibit below. Take a look at the exhibit. The first thing you should notice is that all of the volume variances are negative. This is because the actual quantity of shifts is less than the quantity of shifts planned for in the original budget. Since there were fewer shifts, it should make sense that total revenue and total variable costs should be less than originally planned. You should also notice the value of the variances in addition to the direction. Pedicabs were rented for 2,190 fewer shifts than planned. This resulted in a revenue variance or difference of $54,750 (2,190 shifts x $25 per shift). Based on lower sales, all of the variable expenses should have been less than the original planning budget. Total insurance should have been $19,950 (2190 shifts x $5 per shift) less than planned, total servicing should have been $9,855 (2190 shifts x $4.50 per shift) less, and electricity should have been $438 ( 2190 shifts x $0.20 per shift) less. There are no volume variances associated with fixed costs since they do not vary with quantity sold. Take a minute to make sure you understand how the volume variances were calculated. Peddlers' Pedicab planning and flexible budgets Quantity Revenue Variable costs Insurance Servicing Electricity Total Variable Costs Contribution Margin Fixed Costs Rent Dispatcher Wages Manager Salary Maintenance Depreciation Telephone Total Fixed Costs Net Operating Income Planning Budget 26,280 $ 657,000 131,400 118,260 5,256 254,916 402,084 144,360 105,120 75,000 21,600 18,000 2,040 $ 366,120 $ 35,964 $ 25.00 Flexible Budget 24,090 $ 602,250 $ 5.00 4.50 0.20 9.70 15.30 120,450 108,405 4,818 233,673 368,577 144,360 105,120 75,000 21,600 18,000 2,040 366,120 $ 2,457 Volume Actual Variance Results (2,190) 24,090 $ (54,750) $ 626,340 $ (10,950) 134,904 (9,855) 120,450 (438) 3,614 (21,243) 258,968 (33,507) 367,373 145,000 100,000 75,000 22,000 18,000 2,200 362,200 $ (33,507) 5,173 Total Variances (2,190) $ (30,660) $ 3,504 2,190 (1,643) 4,052 (34,711) 640 (5,120) 400 160 (3,920) (30,791) The central question in regards to volume variance is what caused the change in sales. As a manager you would like to understand whether the change in sales is due to company actions that could be adjusted or whether the change in sales is due to factors outside of the company's control. Some possible explanations of the drop shifts for Peddlers' Pedicab are poor recruitment of pedicab drivers, poor marketing of pedicab service, or the entrant of new competition. These are issues that the company should investigate and address. Other explanations include poor weather, a decrease in the number of college students renting pedicabs, or problems in the general economy. Perhaps the budget year in question was rainier, snowier, hotter, or colder than usual. Change in the weather could impact the likelihood of drivers renting cabs or of customers hiring pedicabs. Perhaps fewer college students came to Savannah during the budget year or students opted to take additional classes to maximize the value received from their tuition. Either of these would reduce the number shifts utilized by college students. Perhaps the economy was stagnant and people did not travel to Savannah. This would reduce the demand for pedicabs and drivers would find it not worthwhile to rent the cabs. The company does not have any control of these issues and would need to adjust their budget to control spending in light of the unanticipated decrease in revenue. Spending Variances The second component of the overall variance is spending variances. Spending variances occur when the actual results differ from the flexible budget projections. Spending variance can be attributed to change in the price of a resource or to changes in the amount of a resource used. Peddlers' Pedicab Complete Variance Analysis Revenue Variable costs Insurance Servicing Electricity Total Variable Costs Contribution Margin Fixed Costs Rent Dispatcher Wages Manager Salary Maintenance Depreciation Telephone Total Fixed Costs Net Operating Income Planning Budget 26,280 $ 657,000 Flexible Budget 24,090 $ 602,250 131,400 118,260 5,256 254,916 402,084 120,450 108,405 4,818 233,673 368,577 144,360 105,120 75,000 21,600 18,000 2,040 366,120 35,964 144,360 105,120 75,000 21,600 18,000 2,040 366,120 2,457 $ $ $ Volume Actual Variance Results (2,190) 24,090 $ (54,750) $ 626,340 $ (10,950) 134,904 (9,855) 120,450 (438) 3,614 (21,243) 258,968 (33,507) 367,373 145,000 100,000 75,000 22,000 18,000 2,200 362,200 $ (33,507) 5,173 Spending Variance $ 24,090 $ Overall Variance $ (30,660) 14,454 12,045 (1,205) 25,295 (1,205) 640 (5,120) 400 160 (3,920) 2,716 $ 3,504 2,190 (1,643) 4,052 (34,711) 640 (5,120) 400 160 (3,920) (30,791) For example, changes in insurance costs for Peddlers could be caused by insuring more cabs or paying more to insure each cab. To calculate spending variances we subtract actual results less the budget projections after \"flexing\" the budget to reflect the actual level of sales. So, in the exhibit below, we subtract actual results less the flexible budget projections. When considering the variable components of the budget, we find that revenue is actually $24,090 higher than it should have been given that cabs were rented for 24,090 shifts. Likewise, insurance and servicing were also higher than budgeted ($14,454 and $12,045 respectively). On the other hand, electricity costs were $1,205 lower than planned when compared to the flexible budget. Since the spending variance values indicate spending an amount that is different from what should have been spent at the actual level of activity, it must be that t