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Chapter 9 How Are Operating Budgets Created?

Jerry Feltz is the president and owner of Jerry’s Ice Cream, a producer of high-quality ice cream sold to specialty grocery stores. Jerry is holding a meeting with the company’s managers to discuss plans for this coming year. Managers at the meeting are Tom Benson, the sales manager; Lynn Young, the production manager; and Michelle Hopkins, the treasurer and controller.

Jerry: It looks as if we are having another great year. Customers love our ice cream, and sales are up. It’s time to begin the budgeting process for next year. Tom, do you have any thoughts on what our sales will look like for next year?
Tom: I think we will continue to see significant sales growth. But it’s difficult to predict exactly how much growth. On the low end, I would expect about 10 percent; on the high end, perhaps 25 percent.
Lynn: Wow! I knew sales were going well, but I had no idea we were expecting to grow 10 percent to 25 percent next year. It will take some serious planning to produce enough ice cream to handle this growth.
Michelle: I agree. We need to make sure production has enough capacity to handle the growth, and cash flow planning will be critical to ensure we don’t run out of cash in the process of ramping up production.
Jerry: Tom, talk with our salespeople and industry contacts so we can get a solid estimate of quarterly sales for next year. If sales really are expected to grow as you say, we will face a huge challenge!
Tom: I’ll have something for you by the end of next week.
Michelle: I’ll start the budgeting process once we have the sales information from Tom.
Lynn: The sooner we start the budgeting process, the better, particularly if I have to hire more employees and find more production space.
Jerry: Let’s meet in two weeks to discuss the results of Tom’s research and to set up a plan to handle the growth. Thanks for your help!

Many companies encounter the same issue of growing sales that is facing Jerry’s Ice Cream. Those that plan for growth have a better chance of succeeding than those that sit idle and hope it all works out. Operating budgets are used to (1) plan operations and (2) control operations. We describe both of these objectives next and then devote the remainder of this chapter to the planning phase by creating an operating budget for Jerry’s Ice Cream. We cover the control phase in Chapter 10 "How Do Managers Evaluate Performance Using Cost Variance Analysis?".