Operational budgets are used by a retail company for planning and controlling its businessactivities. Data regarding the company’s monthly sales for the last 6 months of the year and itsprojected collection patterns are shown below. The cost of merchandise averages 40% of itsselling price. The company’s policy is to maintain an inventory equal to 25% of the next month’sforecasted sales. The inventory balance at cost is P80,000 as of June 3
The correct answer and explanation is :
To assist you thoroughly, let’s first structure the problem and then walk through the process of determining what’s needed. Since the full data (sales figures and collection patterns) wasn’t included in your message, I’ll walk you through the correct method assuming standard values and structure, and you can plug in your actual numbers accordingly.
Problem Summary:
- Company Type: Retail
- Budgeting Period: Last 6 months (July to December)
- Merchandise Cost: 40% of selling price
- Inventory Policy: Maintain ending inventory = 25% of next month’s forecasted sales (at cost)
- Beginning Inventory (July 1): P80,000 at cost
Step-by-Step Approach:
Assume monthly sales for July to December are:
| Month | Sales (P) |
|---|---|
| July | 100,000 |
| August | 120,000 |
| September | 140,000 |
| October | 160,000 |
| November | 180,000 |
| December | 200,000 |
1. Compute Cost of Goods Sold (COGS):
Since COGS = 40% of Sales:
| Month | Sales (P) | COGS (P) = 40% |
|---|---|---|
| July | 100,000 | 40,000 |
| August | 120,000 | 48,000 |
| September | 140,000 | 56,000 |
| October | 160,000 | 64,000 |
| November | 180,000 | 72,000 |
| December | 200,000 | 80,000 |
2. Compute Ending Inventory for Each Month:
Inventory = 25% of next month’s COGS
| Month | Next Month Sales | Next Month COGS | Ending Inventory (25%) |
|---|---|---|---|
| June | July (100,000) | 40,000 | 10,000 (Given: 80,000) |
| July | August | 48,000 | 12,000 |
| August | September | 56,000 | 14,000 |
| September | October | 64,000 | 16,000 |
| October | November | 72,000 | 18,000 |
| November | December | 80,000 | 20,000 |
| December | (assume next) | (estimate) | (optional) |
3. Compute Merchandise Purchases:
Formula:
Purchases = COGS + Ending Inventory – Beginning Inventory
Let’s calculate for July as an example:
- COGS = 40,000
- Ending Inventory (July) = 12,000
- Beginning Inventory (July) = 80,000
👉 Purchases = 40,000 + 12,000 – 80,000 = -28,000 → which suggests they’re overstocked and don’t need purchases this month.
For August:
- COGS = 48,000
- Ending Inventory = 14,000
- Beginning Inventory = 12,000
👉 Purchases = 48,000 + 14,000 – 12,000 = 50,000
You’d repeat this process monthly.
Explanation (300 words):
Operational budgets are essential tools that help retail businesses plan, control, and allocate resources effectively. One critical component of an operational budget in a retail setting is merchandise planning, which involves forecasting sales, estimating cost of goods sold (COGS), and planning inventory levels and purchases.
In this scenario, the company maintains a policy where inventory at the end of each month equals 25% of the next month’s forecasted cost of sales. This ensures there is enough stock on hand to meet demand while avoiding overstocking. Since the company’s merchandise cost is 40% of the selling price, the cost figures are derived by applying that percentage to the sales forecast.
To budget purchases accurately, companies use the formula:
Purchases = COGS + Ending Inventory – Beginning Inventory
This approach ensures that inventory aligns with projected sales while keeping the supply chain efficient. For instance, if July sales are projected at P100,000, the COGS would be P40,000. If August sales are higher, inventory requirements for July must increase accordingly to meet that demand. On the other hand, if beginning inventory is high, purchases may be reduced to optimize cash flow.
This budgeting approach enables better cash management, prevents inventory shortages, and aligns purchasing with sales expectations. It is a cornerstone of sound financial planning in retail operations, linking sales projections directly to procurement and inventory strategies.