Chapter 15 – Budgeting and Controlling Operations and Taxes
15-1
CHAPTER
Budgeting and Controlling
Operations and Taxes
CHAPTER CONTENTS
Learning Objectives 15.2
Chapter Overview 15.3
Brief Chapter Outline 15.3
15
Chapter 15 – Budgeting and Controlling Operations and Taxes
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LEARNING OBJECTIVES
After studying the material in this chapter, the student will be able to:
1. Explain how managers exercise control in a small business.
2. Tell what a budget is, explain the different types, and tell how they are prepared and used.
3. Discuss how information on actual performance can be obtained and used.
CHAPTER OVERVIEW
Chapter 15 emphasizes what this text has stressed throughout: the importance of controlling your
firm’s operations. Emphasis is placed upon the nature, objectives, and methods of control; the design and
use of budgets, the importance of budgetary control, and the role of taxes.
Chapter 15 – Budgeting and Controlling Operations and Taxes
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BRIEF CHAPTER OUTLINE
I. WHAT IS INVOLVED IN CONTROL?
A. The Role of Control
II. CHARACTERISTICS OF EFFECTIVE CONTROL SYSTEMS
III. USING BUDGETS TO COMMUNICATE STANDARDS
A. Types of Budget
IV. USING BUDGETARY CONTROL
A. Controlling Credit, Collections, and Accounts Receivable
B. Other Types of Budgetary Control
C. Using Audits to Control the Budget
V. OBTAINING AND USING PERFORMANCE INFORMATION FOR CONTROL
PURPOSES
A. Obtaining the Information
VI. EVALUATING THE FIRM’S FINANCIAL CONDITION
VII. SOME IMPORTANT RATIOS AND THEIR MEANINGS
A. Are Profits Satisfactory?
B. Are Assets Productive?
VIII. THE U.S. TAX SYSTEMS
A. Who Pays the Taxes?
B. How Taxes Affect Small Businesses
IX. TAXES IMPOSED ON THE BUSINESS
A. Taxes and Fees Paid to Operate the Business
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B. Excise and Intangible Property Taxes
X. EMPLOYMENT-RELATED TAXES
A. Income Tax Withholding
XI. PERSONAL TAXES PAID BY OWNERS
A. Taxes on Amounts Withdrawn from the Business
B. Taxes on Amounts Received from Sale of the Business
XII. RECORDKEEPING AND TAX REPORTING
A. Maintaining Tax Records
B. Reporting Your Taxes
XIII. CREDIT MANAGEMENT
A. Methods of Payment
CHAPTER OUTLINE AND TEACHING NOTES
CHAPTER OPENING PROFILE:
Allen Smith: eGo
This opening profile features eGo, a small company founded by Allen Smith, Andrew
Kallfelz, Jim Hamann, and Tad Borek. eGo manufactures battery-powered bicycles plug into
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CHAPTER OUTLINE AND TEACHING NOTES
I. WHAT IS INVOLVED IN CONTROL?
Learning Objective 1.
Explain how managers exercise control in a small
business.
A. Profit planning operations systems must be de-
signed:
B. The Role of Control
1. CONTROL is the process of assuring that or-
ganizational goals are achieved.
C. Steps in Control
1. Setting up standards of performance.
2. Measuring actual performance.
formity with planned performance.
D. Setting Performance Standards
1. PERFORMANCE STANDARDS set—in ad-
vance—acceptable levels to which employee
achievement should conform. These should
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CHAPTER OUTLINE AND TEACHING NOTES
b. Price paid or charged, as price per unit
for purchased goods.
3. Developing these standards comes through:
a. Intuition.
II. CHARACTERISTICS OF EFFECTIVE CON-
TROL SYSTEMS
A. Timely.
B. Cost-effective.
III. USING BUDGETS TO COMMUNICATE STANDARDS
Learning Objective 2.
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CHAPTER OUTLINE AND TEACHING NOTES
Tell what a budget is, explain the different types, and
tell how they are prepared and used.
A. Performance standards serve as building blocks
for the preparation of the budget.
1. A BUDGET is a detailed statement of finan-
cial results expected for a given future pe-
riod.
2. The budget is expressed in monetary terms,
but may also include other measurements,
B. Types of Budgets
1. A CAPITAL BUDGET plans expenditures for
obtaining, expanding, and replacing physical
facilities.
pay expenses and make other purchases.
C. Preparing the Operating Budget
1. The purpose of the operating budget is to
plan and control revenue and expenses to
obtain desired profit.
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CHAPTER OUTLINE AND TEACHING NOTES
purchasing, and personnel
4. A personnel budget is developed for the
number of people needed to produce the
product, any costs of training, and their pay
and benefits.
5. The sales budget must be prepared before
planning production and personnel budgets.
D. Preparing the Cash Flow Budget
1. A cash flow crisis comes as a major equip-
ment breakdown, seasonal fluctuations, cus-
3. Cash planning takes two forms:
a. Daily and weekly cash requirements for
4. Planning daily and weekly cash needs
a. Routine type of planning done on a daily
or weekly basis.
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CHAPTER OUTLINE AND TEACHING NOTES
5. Planning monthly cash needs, requires a
budget for each month of the year.
6. From Chapter 15, page 390: Robert Hackley
offers this advice on preparing for cash flow
crises:
a. Establish and maintain a good credit
E. Procedure for Planning Cash Needs
1. Chapter 15, Figure 15.1 is The Model Com-
pany worksheet, showing cash receipts, cash
IV. USING BUDGETARY CONTROL
A. BUDGETARY CONTROL is the system of budg-
ets used to control a company’s financial activi-
ties.
1. It includes frequent and close controls in the
areas where poor performance affects a
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B. Controlling Credit, Collections, and Accounts
Receivable
1. Extending credit increases the potential for
sales – and losses from bad debts.
2. The average retailer loses more from slow
accounts than from bad debts.
a. Checks should be made often enough
4. Control of bad-debt losses involves:
a. Investigating the customers’ ability and
illingness to pay.
C. Other Types of Budgetary Control
1. Any expense can increase gradually without
the change being recognized, as
2. These costs must be controlled.
D. Using Audits to Control the Budget
1. An AUDIT is a formalized examination and/or
review of a company’s financial records.
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a. In financial auditing, an outside certified
public accountant (CPA) examines the
V. OBTAINING AND USING PERFORMANCE INFOR-
MATION
Learning Objective 3.
Discuss how information on actual performance can be
obtained and used.
A. Information on actual performance comes through
feedback. FEEDBACK is the response a receiver
gives through further communication with the
sender of the message or some other person.
B. Obtaining the Information
1. Observation is most satisfying method, be-
cause you are at the scene of the action, and
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C. Comparing Actual Performance with Perfor-
mance Standards
1. An effective cost accounting system and
cost-sensitive controls are vital.
D. Determining Causes of Poor Performance
1. Poor performance can result from many fac-
tors, both internal and external, such as:
a. Having the wrong objectives.
b. Customers not buying the company’s
product.
VI. EVALUATING THE FIRM’S FINANCIAL CONDITION
Learning Objective 4.
Explain how ratios can be used to evaluate a firm’s fi-
nancial condition.
A. RATIOS are the relationships between two or
more variables.
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C. The value of these ratios can be used for evalua-
tion purposes:
VII. SOME IMPORTANT RATIOS AND THEIR MEANINGS
A. Are Profits Satisfactory?
1. RETURN ON EQUITY (ROE) is the percent-
age of net profit your equity earns, before
taxes. (Ratio 1 in Table 15.1.)
2. The ratio of net profit (income) to net sales
B. Are Assets Productive?
1. The ratio of net sales to fixed assets (Table
15.1 Ratio 3) provides information on your
company’s return on sales dollar. (Variables
exist.)
C. Can the Business Pay Its Debts?
1. The best known ratio is the current ratio Ta-
ble 15.1 Ratio5.), which is the ratio of current
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3. WORKING CAPITAL, the amount of current
assets less current liabilities.
4. Two other ratios show the company’s ability
D. How Good Are the Business’s Assets?
1. Accounts Receivable represent what you
should receive in cash from customers some-
2. Goods in inventories obsolete if not sold in a
reasonable period of time.
a. The turnover rate is expressed by the
3. The net sales to working capital (Ratio 11) is
an indicator of the support you receive from
your assets.
a. Accounts receivable and inventory
should increase in proportion with an
E. Is Your Equity in the Business Satisfactory?
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1. Assets are financed either by equity invest-
2. Any retained earnings, which are part of your
equity, can be used to increase assets or de-
crease liabilities.
a. You can maintain a high level of equity,
3. The ratios used to check the company’s
source-of-funds relationship are:
a. Long-term liabilities to working capital
(Ratio 12).
4. An extremely high value for any of these puts
your company in a risky situation.
F. Ratios Are Interrelated
1. Each individual ratio indicates only part of the
company’s position.
VIII. THE U.S. TAX SYSTEM
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CHAPTER OUTLINE AND TEACHING NOTES
Learning Objective 5.
Explain how the U.S. tax system operates.
A. The U.S. tax system includes all federal, state,
and local tax systems, each of which has at least
two parts:
B. Who Pays the Taxes?
1. INDIRECT TAXES are not paid by a person
or firm, but by someone else.
a. Because indirect taxes are part of the
C. How Taxes Affect Small Businesses
1. First, there is the direct taxation of business
income as an income tax on corporate prof-
its.
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3. Third, owners must pay personal taxes on
their salaries and other ownership-related in-
4. Fourth, taxes are levied on the transfer of
ownership of the business. To control the tax
bite on an inheritance, careful estate plan-
ning is needed. (See Chapter 2.)
5. Fifth, taxes also affect business decisions on
other levels as well. In Chapter 3, you
6. It is the responsibility of the business owner
D. Get Professional Help!
1. It is very important for someone in every
small firm to understand the tax system in or-
der to take advantage of the opportunities
E. Types of Taxes
1. Taxes imposed on the business itself.
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4. Estate taxes. (Discussed in Chapter 2.)
IX. TAXES IMPOSED ON THE BUSINESS
Learning Objective 6.
Name and describe the taxes imposed on the small
business itself.
A. Taxes and Fees Paid to Operate the Business
1. Some license fees, incorporation taxes, and
B. Excise and Intangible Property Taxes
1. An EXCISE TAX is an additional tax on cer-
tain items imposed by the federal govern-
ment.
a. Federal (And some states) add excise
taxes on automobiles and other moving vehi-
C. State and Local Sales and Use Taxes (See Ta-
ble 15.3, which has been updated in this
text.).
A USE TAX is a tax on the use, con-
sumption, or storage of goods within a taxing
jurisdiction.
a. This tax is often applied to automobiles
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a. These are the responsibility of the mer-
chant.
b. Separate municipalities may have addi-
tional sales taxes.
3. Caution: You will probably be held liable for
the full amount of the uncollected taxes even
if you do not collect these taxes from your
customers or clients.
D. Federal, State, and Local Income Taxes
1. From the very beginning of your business,
you should have a qualified accountant to
2. Three major decisions to make at the start
are:
a. The method of handling your income
E. How the Form of a Business Affects its Taxes
(See Chapter 3.)
1. The partnership or proprietorship form of
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2. U.S. tax laws permit some corporations to
seek S corporation status.
a. S corporation shareholders are taxed at
3. Another form of ownership with tax ad-
vantages is the limited-liability company
F. Treatment of Federal Corporate Income Taxes
1. Small businesses need to answer three
questions:
a. What tax rate applies to the business?
(1) The tax rate will depend on its in-
b. What is taxable income?
(1) For tax purposes, TAXABLE IN-
tors.
c. What expenses are deductible?