Frenchies: Creating and Using a Master Budget

BACKGROUND

Frenchies is a medium-sized regional bakery that specializes in providing orders to grocery and

convenience stores. Because of the popularity of its brand, it has also opened a small caf for walk-in

business.

In order to maintain its high quality standard, Frenchies produces only three products: breakfast

muffins, fresh bread, and chocolate chip cookies. Although business has been good in the past few

years, a lucky contact with a large chain has recently allowed it to expand its brand out of the local

region. Growth has been high since the new contract went into effect.

Andy Griff, the chief executive officer (CEO) and founder, has arranged a meeting with a venture

capital firm next week. Hopefully the meeting will result in the sale of some of Frenchies stock and an

opportunity to establish a significant line of credit with the venture capital firm. These extra funds, if

Andy can secure them, should provide sufficient money to meet Frenchies growth targets for the next

few years. The venture capital firm's assessment team has asked Andy to provide a quarterly master

budget for the year that just began, complete with pro forma financial statements, at the meeting. They

have expressed special interest in Frenchies earnings per share (EPS), cash flow from operations, and

profit margins, indicating that good numbers in these areas will be essential for final approval.

In typical managerial style, Andy immediately assigned the task of creating the budget to Nicole

Quarterman, who has just been hired as Frenchies controller. Since this project is her first assignment,

Nicole started by making appointments with each of the divisional managers to gather information for

the budget and also to learn more about the company.

PART I: CREATING THE BUDGET

MEETINGS WITH DIVISIONAL MANAGERS

MEETING WITH THE SALES DEPARTMENT

Walking down the hallway towards the office of Jeff Barza, the sales manager, Nicole read the results

for last quarter which ended on December 31, 2016. Frenchies sold 45,000 one-dozen packages of

muffins for $5.50 each, 65,000 one-dozen packages of cookies for $4.75 each, and 85,000 one-dozen

loaves of bread for $5.25 each. When Nicole got to Jeff's office, he motioned her in to have a seat.

"Is it time for our meeting already?" he asked. "Where does the day go?"

"Who knows? It seems like one minute I'm having my morning muffin and the next I'm saying goodbye

to everyone," Nicole said with a sigh. "There's never time to get everything done. And now I get to

do the budget." Jeff started to laugh. "Thanks," she muttered. "I knew I could count on your support."

"I'm sorry. I just have to laugh at the amount of time you are going to put into something that isn't

really used anyway, except for setting bonuses, of course."

"Not really used? I don't know how it's been around here in the past, but this year, at least, the

budget will prove to be a valuable tool." Nicole waved away Jeff's retort. "Anyway, one way or another I

have to create one and, as you know, the process always starts with projected sales. Do you have a

copy of last quarter's results?"

"Yes, right here somewhere," Jeff said, shuffling papers around on his desk. "Got it!" he exclaimed,

waving it gently as he pulled it from under a stack of other papers. "Now, what do you want to know

exactly?"

"Well, Andy thinks that since we have established a strong following both locally and in our new

markets, we can raise our prices slightly next year without a sharp drop in sales. He was thinking $6.00

for muffins, $5.25 for cookies, and $5.75 for bread. What do you think?"

"I agree," Jeff said eagerly. "I've been pushing that for years. Of course, I think that sales will drop some

in the first quarter of next year. They always drop off a bit after the holidays anyway, but with the increase

in sales price . . . I'd say a 20 percent drop from the fourth quarter results we have here." He looked up

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questioningly and raised an eyebrow.

Nicole frowned. "That sounds kind of high. Based on what I saw in the dairy industry; I was thinking the

drop would only be about 10 percent."

Jeff looked a little uncomfortable and shuffled around in his chair. "Well, it's a little different for a specialty

bakery. Our price is a little more elastic than dairy products. Besides, 20 percent is a more conservative

estimate and in the past we wanted no surprises." He looked at her and challenged, "Are you going to

change that?"

"Yeah, but we'll be using this master budget to make a cash flow budget and pro forma financial

statements to show our new investor. We need to look good, not bad." Nicole frowned. She didn't want to

start making changes and enemies in her first few months.

"I guess so. But, my bonus is tied to how well I meet my estimates. If we estimate low results and then

go up . . ." Seeing the look on her face, he quickly changed direction. "Besides, Nicole, we are raising the

prices. A 10 percent drop is normal after Christmas, but couple that with the increased prices, and 20

percent is reasonable."

Nicole frowned, and then sighed. She didn't quite accept his reasoning, but it would be better to have

him on her side until she understood the company politics a bit better. "Okay, Jeff. I'll take your word for it.

We'll use 20 percent. After all, you're the expert."

"You've got that right!" Jeff said, trying to hide his relief. He was obviously really counting on that bonus.

He looked at a couple of sales reports and market projections on the desk in front of him. "After that, I think

sales will grow steadily at about 5 percent a quarter with these new prices. Fourth-quarter sales will be

high because of the holidays let's say 20 percent, instead of 5 percent, from the third to the fourth quarter.

The first quarter of the following year will continue the 5 percent growth as though the holiday jump didn't

occur. And I'm not messing with those estimates. That's really my best guess, given what I've seen in the

past." He looked up. "Does that give you all you need?" "Just a few more questions. Have you made any

changes to the credit policy? The information I have from last year says that we make about 10 percent of

our sales through our caf and that we don't sell to those customers on credit."

Jeff smiled. "Yep, but we do sell on credit to the business customers. If we didn't, they'd definitely go

somewhere else. So, we give our business customers a lot of leeway in paying us. It makes it a little hard

on us, but it keeps them loyal. Anyway, we collect 30 percent of the credit sales within the current quarter,

45 percent in the following quarter, and 25 percent in the quarter after that. The good news is that we don't

have any bad debt. Our customers are mostly large chains with strong sales and even better reputations.

Since they are large companies, they take their time paying small companies like us, but we get the money

from all of them in the end."

"Then I have only two more questions. What were total sales during the third and fourth quarters of last

year, and are we still collecting any of that money?" Jeff pulled up a file. "Total sales were $802,000 and

$1,002,500, respectively, and we are still collecting quite a bit of that money based on our collection

breakdown."

"I think that does it, then. If I've forgotten something, I'll come back and bug you later. It's more fun to

interrupt you several times anyway. And you owe me one now."

MEETING WITH THE PRODUCTION DEPARTMENT

Nicole sighed as she headed to her meeting with Phil Mainster, Frenchies head chef. She wasn't sure

about that large drop Jeff wanted her to use, but as the new member of the staff she wasn't sure what she

should do. Of course, she didn't have much time to think about it now anyway. She had met Phil before,

so she knew that it was going to be an interesting meeting.

As she had suspected, she found Phil in the kitchen instead of his office. "Phil," she called as she hurried

towards him, "did you forget our meeting?"

"Me, forget?" Phil asked in a surprised voice. "I never forget anything!" Nicole had to chuckle at the large

streak of flour across his face. "You said you wanted to see our production facility, and I'm ready to show

it to you."

Nicole shook her head. "No, Phil. I didn't say I wanted to see the production facility; I said I wanted to

talk to you about the budget for next year."

"Oh, of course you did." Phil's round face had turned a deeper shade of pink. "Then why don't we go to

my office and talk?"

Nicole sighed. "That's a great idea, Phil."

As they sat down, Nicole asked her first question. "Okay, Phil, I need to know how much inventory we keep on hand."

"Well, we can't keep much in the way of finished goods on hand. My cookies and bread would dry out if we kept them too long. I'd say that we normally keep only about two days' worth of inventory on hand to avoid shipping issues or problems with the caf."

"Okay and you make your estimates based on a 90-day quarter?"

Phil nodded impatiently. "Please, Nicole, don't ask obvious questions."

"I'm sorry. Let's talk about your pantry. You take care of purchasing too, don't you?"

"Yessirree. We decided it would be easier for me to run purchasing than to have a separate manager do it. After all, I do everything else around here."

"Well, we want it done right."

Phil chuckled. "I'll have to remember that one. Martha will love it. Okay, let's talk raw materials. Some days we have to produce a lot to meet our orders, so I normally try to keep 15 percent of the next quarter's raw materials on hand at all times."

"Is that what we've got on hand now for the coming year?"

"Of course. Jeff and I had already talked about the possibility of raising prices and his estimate of a 20 percent drop in demand, so I'm ready to go."

Nicole considered telling Phil that she was unsure the 20 percent drop would really materialize, but changed her mind. There would be time to get the extra ingredients ordered if sales only dropped 10 percent, and she didn't want anyone to think she had caved in to peer pressure. "Good. Can you give me some estimates of how long it takes to make each package of cookies, bread, and muffins?"

"Are you kidding? We don't really move each item from start to finish. We do them in large batches, so I have no idea how long each final package takes." Seeing Nicole's frown, he quickly went on. "But, I can tell you that one of my mixers can mix together either 12 dozen cookies, 8 dozen muffins, or 4 dozen loaves of bread in 15 minutes. The bakers then take another half an hour to get the dough ready and bake it."

"The batch sizes are the same for each product?"

Question:

I need to work a sales budget and production budget.