Budget& budgetory control

Chapter –VII

Budgeting and Budgetary Control

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The Life of every man is a diary in which he means

to write one story, and writes another; and his

humblest hour is when he compares the volume as it

is with what he vowed to make it.

- J.M. Barrie

What is a Budget?

A planned expression of money”

for a defined activity.

Shows;

• Income & Expenditure

• Total estimated costs

• Defined period of time

What is a budget?

A Plan

A Limit

A Schedule

A Reality Check

An Allocation

A budget is anaid

to management

not a substitutefor management.

Budget – Definition

According to CIMA Official Terminology –

Budget is a financial and/or quantitative

statement, prepared and approved prior to a

defined period of time and the policy to be

pursued during that period for the purpose

of attaining a given objective.

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Cont’d..,

Budget = Quantitative expression of a plan

Budgets involve – Planning

&

Control

Forecasting

&

Planning

Control

&

Evaluation

Why set budgets?

Enables the business to measure success.

Can be used to keep control of costs.

May motivate staff by providing them withtargets / direction.

Enables management to focus on thoseareas failing to meet budgets.

Enables business to empower departments.

Encourages efficiency = lowers costs longterm.

Limitations of Budgets

May lack flexibility and not reflect changing conditions.

Managers may take short term decisions to keep within budget rather than the ‘right’long term decision

May be problems agreeing on the targets.

Budgets may constrain action; managers may not take certain steps because they exceed the budget.

Managers may resist attempts to set financial targets (do not want to be measured).

The process of setting and agreeing budgets may in itself be very time consuming.

Budget may be unrealistic and demotivate staff

Job insecurity if they do not meet targets

Effective budgets must beS.M.A.R.T.

Specific (inform departments) Measurable (A means of tracking progress) Achievable (possible to accomplish) Realistic (does it fit the business) Timed – have a set time scale (1 year)

TASK Write a smart objective for yourself. i.e

I (Mr. ’X’) want to loose 5kg of weight by Christmas

What is Budgeting?

Budgeting is the whole process of

designing, implementing and operating

budgets.

The main emphasis in this is short-term

budgeting process involving the prevision

of resources to support plans which are

being implemented.

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Participative Budgeting

Flow of budget data from lower management to top levels.

Invite each level of management to participate.This “bottom-to-top” approach is called

Participative Budgeting.

Budgetary Control

Budgetary control is the establishment of

budgets relating the responsibilities of

executives to the requirements of a policy,

and the continuous comparison of actual

with budgeted results, either to secure by

individual action the objective of that policy

or to provide a basis for its revision.

- CMA Official Terminology

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Budgetary Control

The use of budgets to control operations. Compare actual results with plannedobjectives.

The steps involved in a Budgetary Control system

Establish a plan or target of performance which coordinates all the activities of the business.

Record the actual performance

Compare the actual performance with that planned.

Calculate the differences, or variances, and analyze use reasons for them.

Act immediately, if necessary, to remedy the situation.

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Budgetary Control System

Advantages of Budgetary Control

Maximization of Profits

Effective coordination

Evaluation of Executive Performance ( on the basis of

goals set for each department)

Clear cut goals and targets

Economy in operations

Correction of Performance continuously

Introduction of Incentive schemes of remuneration

Shutting down of unprofitable products and

activities

Limitations of Budgetary Control

Prediction of uncertain future

Changes of conditions

Complacence

Difficulty in coordination

Conflict among different departments

Classification of Budgets

ACCORDING TO ACCORDING TO ACCORDING TO

TIME FUNCTION FLEXIBILITY

1. Long term budget 1. Sales budget 1. Fixed budget

2. Short term budget 2. Production budget 2. Flexible budget

3. Current budget 3. Purchase budget

4. Personnel budget

5. R & D budget

6. Capital Expenditure budget

7. Cash budget

8. Master budget

I- According to Time

Long term Budget : They are prepared by top

management to reflect the long-term planning for special

activities like capital expenditure, R&D etc ..,

Short term Budget : Budgets generally for a duration of

1 yr and expressed in monetary terms.

Current Budget: Duration – 1 month and are prepared

for current operations of the business

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II- According to Function

A functional Budget is one, which related to a

function of the business.

E.g. Sales Budget, Production Budget, Purchase

Budget, Cash Budget etc..,

There are many types of functional budget, of

which the following are important.

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A. Sales Budget

A sales budget is a detailed schedule showing the

expected sales for the budget period.

This budget is a forecast of quantities and values

of sales to be achieved in a budget period.

It will help to determine that how many units will

have to be produced.

Thus, the production budget is prepared after the

sales budget.

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Example:

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B-Production budget

Production budget involves planning the level of

production which in turn involves the answer to the

following questions:

a. What is to be produced?

b. When is it to be produced?

c. How is it to be produced?

d. Where is it to be produced?

The general formula used to determine the required production level is

as follows:

Required Production = Expected Sales + Expected Ending

Inventory – Beginning Inventory

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Case Study - I

ABC Company is preparing a quarterly production

budget for 20X3.

The company estimates to sell 10,000, 12,000,

14,000, and 11,000 of units in each respective

quarter.

Also, the company wants to maintain the

following ending inventory levels in each

subsequent quarter, respectively: 2,000, 3,000,

4,000, and 2,500 units.

At the beginning of 20X3, beginning inventory is

8,000 units. 25

Solution

ABC Company Production Budget (Units)

For the year ended 12/31/20X3

Quarter

YearI II III IV

Sales 10,000 12,000 14,000 11,000 47,000

Ending Inventory2,000 3,000 4,000 2,500 2,500

Total Needs 12,000 15,000 18,000 13,500 49,500

Less: Beginning

Inventory -8,000 -2,000 -3,000 -4,000 -8,000

Required

production 4,000 13,000 15,000 9,500 41,500

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As the budget shows, the company will need to produce 4,000, 13,000, 15,000, and 9,500

units during each of the four quarters to meet the sales and ending inventory demands.

– C - Purchase Budget:

– This budget provides information about the materials to be acquired from

the market during the budget period.

D- Personnel Budget:

This budget gives an estimate of the requirements of direct labour essential

to meet the production target.

This budget may be classified into –

a. Labour requirement budget

b. Labour recruitment budget

E- Research and Development Budget:

This budget provides an estimate of expenditure to be incurred on R & D

during the budget period.

A R&D budget is prepared taking into consideration the research projects

in hand and new R & D projects to be taken up.

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F - Capital Expenditure Budget:

This is an important budget providing for acquisition of assets

necessitated by the following factors:

a. Replacement of existing assets.

b. Purchase of additional assets to meet increased production

c. Installation of improved type of machinery to reduce costs.

G - Master Budget:

CIMA defines this budget as “ The summary budget incorporating its

component functional budget and which is finally approved, adopted

and employed”.

Thus master budget is a summary of all functional budgets in capsule

form available in one report.

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H- Cash budget

Cash budget is a financial budget prepared

to calculate the budgeted cash inflows and

outflows during a period.

It helps the managers to determine any

excessive idle cash or cash shortage that is

expected during the period.

It is also helpful to plan and control our

expenses payment.

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Case Study -II

February

March

April

May

June

Sales Rs. Purchase Rs. Wages Rs. Expenses Rs.

70,000

80,000

92,000

1,00,000

1,20,000

40,000

50,000

52,000

60,000

55,000

8,000

8,000

9,000

10,000

12,000

6,000

7,000

7,000

8,000

9,0000

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A company is expecting to have Rs. 25,000 cash in hand on 1st April 2003 and it requiresyou to prepare cash budget for the three months. April to june 2003. The followinginformation is supplied to you:

Other Information:1.Period of credit allowed by suppliers is two months;2.25% of sale is for cash and the period of credit allowed to customers for creditsale is one month;3.Delay in payment of wages and expenses one month:4.Income tax Rs. 25,000 is to be paid in June 2003.

Solution:

Cash Budget for three months ending June 2003

Opening Balance

Receipts:

Cash Sales (25%)

Debtor (75%)

Total

Payments:

Creditors (Purchases)

Wages

Expenses

Income Tax

Total

Closing Balance

April

25,000

23,000

60,000

83,000

40,000

8,000

7,000

-

55,000

53,000

May

53,000

25,000

69,000

94,000

50,000

9,000

7,000

-

66,000

81,000

June

81,000

30,000

75,000

1,05,000

52,000

10,000

8,000

25,000

95,000

91,000

Total

25,000

78,000

2,04,000

2,82,000

1,42,000

27,000

22,000

25,000

2,16,000

91,000

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Working notes

Cash sales 25%

(April)= 92000*25/100 = 23000

May =100000*25/100 = 25000

June = 120000*25/100 = 30000

Credit sales 75 (debtors%) for one month:

April (Consider March month) = 80000*75/100 = 60000

May = 92000*75/100 = 69000

June = 100000*75/100 = 75000

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III- According to Flexibility

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A. Fixed Budget:

This is defined as a budget which is

designed to remain unchanged irrespective

of the volume of output or turnover attained.

This budget will, therefore, be useful only

when the actual level of activity

corresponds to the budgeted level of

activity.

B- Flexible Budget

A flexible Budget is one which is assigned to change in

relation to the level of activity attained.

It has been developed with the objective of changing the

budget figure to correspond with the actual output

achieved.

Thus budget might prepared for various level of activity,

says 70%, 80%, 90%and 100% capacity utilization.

Flexible budgets are prepared in those companies where it

is extremely difficult to forecast output and sales.

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Case Study -III

Prepare a flexible Budget for production at 80% and 100%

activity on the basis of the following information

Production at 50% capacity : 5,000units

Raw Material : Rs. 80 per unit

Direct Labour : Rs. 50 per unit

Direct Expenses : Rs. 15 per unit

Factory Expenses : Rs. 50,000 (50% fixed)

Administrative Expenses : Rs. 60,000 (60% Fixed)

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Solution:-Flexible Budget

For the period…………………………….

Cost

80% Capacity 8000units 100% Capacity 10,000unit

Per unit

Rs.

Total

Rs.

Per unit

Rs.

Total

Rs.

Raw material

Direct Labour

Direct Expenses

Prime Cost

Factory expenses:

Fixed

Variable

Works cost

Administrative

Exp.

Fixed

Variable

Total Cost

80.00

50.00

15.00

640,000

400,000

120,000

80.00

50.00

15.00

800,000

500,000

150,000

145.00 1,160,000 145.00 1,450,000

5.00

3.125

40,000

25,000

5.00

2.50

50,000

25,000

153.125 1,225,000 152.50 1,525,000

7.20

3.00

57,600

24,000

7.20

2.40

72,000

24,000

163.325 1,306,600 162.10 1,621,000

Working notes

Factory exp:

Fixed cost= 50000*50/100 = 25000

Per unit = 25000/5000 units = 5

Variable cost for 8000 units = 25000/8000 = 3.125

Variable for 10,000 units = 25000/10000 = 2.5

Administrative Exp:

Fixed = 60000*60/100 = 36000

Per unit = 36000/5000 = 7.2

Variable for 8000 units = 60000*40/100=24000

24000/8000 = 3

Variable for 10,000 units = 24000/10000 = 2.437

Zero Base Budgeting

Zero base budgeting is one of the renowned managerial tool,

developed in the year 1962 in America by the Former President

Jimmy Carter.

The name suggests, it is commencing from the scratch, which never

incorporates the methodology of the other types of budgeting in

determining the estimates.

The Zero base budgeting considers the current year as a new year

for the preparation of the budget but the yester period is not

considered for consideration.

The future activities are forecasted through the zero base budgeting

in accordance with the future activities.

Benefits:

It acts as guide for the management to allocate the resources

more accurately depends upon the priority for an effective

implementation.

It enhances capability of the managers who prepares the

budget for future action.

It paves way for optimum utilization of resources available.

It is dome shaped only towards the achievement of

organizational goals.

By,Dr. Suresh VaddeM.Com, M.Com (FA), MBA, M.Phil, Ph.DDept. of Management, Samara University.