The owner of Babycakes is Erin McKenna, who is planning to open a new bakery in Los Angeles after a successful run in New York. It will assist the company to grow and expand its market. Although the two markets are similar in many respects, the decision to open up a new bakery depends on the financial feasibility of the project. It implies that the planning phase requires the management to prepare a realistic budget for the new bakery, which will include estimations of the related revenue, costs, and expenses.
Importance of Realistic Budgets
It should be understood that planning without realistic budgeting is a weak strategy and can result in financial problems for the business. A realistic budget is crucial, as it helps the company in arranging the required resources and also addressing any issues that may arise during the course of the business. This form of a budget is similar to a storyboard that informs the allocation of various types of costs and expenses to different processes involved in the manufacturing business (McKinsey, 2018). Thus, Erin can use this budgeting technique to determine the level of business activity or revenue that the new bakery needs to generate to cover all costs and expenses and achieve profitability. Furthermore, it assists in determining the level of inventory required for managing daily operations and fulfilling sales orders. Thus, it can ensure that customers are satisfied to become regular buyers of its products.
Sales Budget for Babycakes Store in Los Angeles
Erin needs to create sales and production plans as parts of the budget to ensure that it meets the upcoming festivals’ requirements. The sales/income budget for the new bakery in Los Angeles is provided in Table 1 based on the expected sales per day excluding holiday sales.
Table 1. Sales Projections in the 4th Quarter.
|Sales Projections for the 4thQuarter|
|No. of Units||22,500||22,500||22,500||67,500|
The actual budget is provided in the Appendix, which shows that the new bakery will have a net income in the fourth quarter of 2016. It is based on the assumptions given in Table 2 including the number of units to be sold in October, November, and December, unit price, unit cost, and fixed costs.
Table 2. Assumptions for Sales and Costs.
|a||Days in a month||30|
|b||Units sale per day||750|
|c||Average selling price||$3.50|
|d||Holiday sales per day|
|e||Production cost per unit||$1.40|
Fixed costs include rent, utilities, marketing, and administrative salaries. Variables costs include the salaries of employees who are directly involved in the production process and the cost of materials. It is assumed that sales in these months will be higher than the standard number of units sold by the bakery in other months.
The budget indicates that the number of units sold in a month is calculated by adding the additional units to be sold in each festive month to the standard number of units sold. The total revenue is calculated by multiplying the number of units and the selling price. The production cost represents the variable cost of production. The fixed costs do not change in each of the three months (Drury, 2015).
Table 3 indicates the three products that the owner plans to introduce in the last quarter of 2016. It is assumed that each product will only be sold in the related festive month.
Table 3. Three Products.
Static and Flexible Budget Comparison
A static budget is appropriate for a business that has been operating for multiple periods. However, it is not suitable for Babycakes because it does not have previous financial records to compare (Mowen, Hansen, & Heitger, 2015). It does not change according to the level of business activity. Furthermore, it is not feasible to compare the financial information of two different business locations. On the other hand, a flexible budget considers different levels of activity for estimating the operating income. Table 4 shows the comparison of static and flexible budgets. It indicates that there is a favorable variation in the operating income at the actual low-level of activity despite an unfavorable variation based on the static budget. Therefore, flexible budgeting is more useful than static budgeting, and it is recommended for measuring the performance of a business.
Table 4. Budget Comparison.
|Static Budget vs. Flexible Budget|
|Static Budget||Actual||Variance||Flexible Budget||Variance|
|No. of Units||28,500||25,000||3,500||U||25,000||–|
|Total Production Cost||$39,900||$30,000||9,900||F||35,000||5,000||F|
|Fixed Expense (Rent)||$6,500||$5,000||1,500||F||$6,500||1,500||F|
Overspending by businesses can have a negative impact on their profitability in the long term (Cagan, 2018). In the case of Babycakes, overspending can be related to its inventory. It can lose the value of inventory due to the wastage or overproduction of its products. Erin can control this situation by carefully planning the daily sales of the new bakery and implementing waste management techniques to control overspending.
Cagan, M. (2018). Budgeting 101: From getting out of debt and tracking expenses to setting financial goals and building your savings, your essential guide to budgeting. New York, NY: Simon and Schuster.
Drury, C. (2015). Management and cost accounting. Andover, MA: Cengage Learning.
McKinsey, J. O. (2018). Budgetary control. New York, NY: Creative Media Partners.
Mowen, M. M., Hansen, D. R., & Heitger, D. L. (2015). Cornerstones of managerial accounting. Boston, MA: Cengage Learning.