Budgeting

Budgeting for Planning and Control

Budget• Budget is a quantitative expressions of

plans that identify an organization’s objectives and the actions needed to achieve them.

• Budgets can be used to compare actual outcomes with planned outcomes.

• A budget might be a forecast, a means of allocating resources, a standard or a target.

Budget

• A budget is a 'quantitative expression of a plan for a defined period of time.’

• It may include – planned sales volumes and revenues; – resource quantities, – costs and expenses; – assets, liabilities and cash flows

Control• It is the process of setting standards,

receiving feedback on actual performance, and taking corrective action.

• Control is best achieved by comparison of the actual results with the original plan.

Control• Appropriate action can then be taken

to correct any deviations from the plan.

• The comparison of actual results with a budgetary plan, and the taking of action to correct deviations, is known as feedback control.

Budgets may help in …• Authorising expenditure• Communicating objectives and plans• Controlling operations• Co-ordinating activities• Evaluating performance• Planning and rewarding performance

The purposes of budgeting• They act as authorities to spend, that is,

they give authority to budget managers to incur expenditure in their part of the organisation;

• They act as comparators for current performance, by providing a yardstick against which current activities can be monitored. – These two roles are combined in a system of

budgetary planning and control.

The purposes of budgeting• A method of planning the use of resources

• A vehicle for forecasting

• A means of controlling the activities of various groups within the firm

• A means of motivating individuals to achieve performance levels agreed and set.

• A means of communicating the wishes and aspirations of senior management

• A means of resolving conflicts of interest between groups with the organisation

Essentials of Budget• It is prepared for a definite future period.

• It is a statement prepared prior to a defined period of time.

• The Budget is monetary and/or quantitative statement of policy.

• The Budget is a predetermined statement and its purpose is to attain a given objective.

• A budget, therefore, be taken as a document which is closely related to both the managerial as well as accounting functions of an organization.

Preparation of Budgets

Planning

• The act or process of making a plan or plans.

• Establishment of objectives, and the formulation, evaluation and selection of the policies, strategies, tactics and action required to achieve them.

Types of plans

• Strategic Planning• Budgetary Planning• Operational Planning

Strategic Planning – It is concerned with preparing long-

term action plans to attain the organisation’s objectives.

– It is also known as corporate planning or long-range planning.

Budgetary Planning– It is concerned with preparing the short-

to medium-term plans of the organisation.

– It will be carried out within the framework of the strategic plan.

– An organisation’s annual budget could be seen as an interim step towards achieving the long-term or strategic plan.

Operational Planning – It refers to the short-term or day-to-day

planning process.

– It is concerned with planning the utilisation of resources and will be carried out within the framework set by the budgetary plan.

– Each stage in the operational planning process can be seen as an interim step towards achieving the budget for the period.

– Operational planning is also known as tactical planning.

Budget Period• Period for which a budget is

prepared and used, which may then be subdivided into control periods. (may be 13 or 14 control periods)

Budget Manual• It is a collection of instructions

governing the responsibilities of periods and the procedures, forms and records relating to the preparation and use of budgetary data.

• It is likely to contain the objectives of the budgetary process, the organisational structure, principal budget outlines,

administrative details and procedural mattes.

The Responsibility for Preparing Budgets• Sales manager should draft the sales budget and

selling overhead cost centre budgets.

• Purchase manager should draft the material purchase budget.

• Production manager should draft the direct production cost budgets.

• Various cost centre managers should prepare the individual production, administration and distribution cost centre budgets for their own cost centre.

• The cost accountant will analyse the budgeted overheads to determine the overhead absorption orates for the next budget period.

Budget Committee• The budget committee is assisted by

a budget officer who is usually an accountant.

• Every part of the organisation should be represented on the committee.

• The coordination and administration of budgets is usually the responsibility of a budget committee.

Functions of Budget Committee

• Coordination (issues of the budget manual)

• Issuing of timetables• Allocation of responsibilities• Communication of final budgets to

appropriate managers• Comparison (actual with standards)

• Continuous assessment

Steps in the preparation of a budget

• The first task in the budgetary process is to identify the principal budget factor.

• This is also known as the key budget factor or limiting budget factor.

• The principal budget factor is the factor which limits the activities of an organisation.– For example, if sales volume is the principal budget factor,

then the sales budget must be prepared first, based on the available sales forecasts. All other budgets should then be

linked to this. Contd …

• In the second step the budget team needs to concentrate on the order of budget preparation.

• Assuming that the principal budget factor has been identified as being sales, the stages involved in the preparation of a budget can be summarised as follows…

Steps in the preparation of a budget

Contd …

Steps in the Preparation of a Budget– The sales budget is prepared in units of

product and sales value. This budget decides the planned increase or decrease in finished goods inventory levels.

– With the information from the sales and inventory budgets, the production budget can be prepared. The production budget will be stated in terms of units.

– This leads on logically to budgeting the resources for production. This involves preparing a materials usage budget, machine usage budget and a labour budget.

• During the preparation of the sales and production budgets, the managers of the cost centres of the organisation will prepare their draft budgets for the department overhead costs.

• Such overheads will include maintenance, stores, administration, selling and research and development.

• From the above information a budgeted income statement can be produced.

Steps in the Preparation of a Budget

• In addition several other budgets must be prepared in order to arrive at the budgeted statement of financial position.

• These are the capital expenditure budget (for non-current assets), the working capital budget (for budgeted increases or decreases in the level of receivables and accounts payable as well as inventories), and a cash budget.

Steps in the Preparation of a Budget

Why Budgets Cause Problems?• These are time consuming and expensive

• Budgets provide poor value to users

• Budgets fail to focus on shareholder value

• These are too rigid and prevent fast response

• Budgets protect rather than reduce costs

Why Budgets Cause Problems• Budgets stifle product and strategy

innovation

• Budgets focus on sales targets rather than customer satisfaction

• Budgets are divorced from strategy

• Budgets reinforce a dependency culture

• Budgets lead to unethical behavior

Role of Budgets• To aid the planning of the

organisation in a systematic and logical manner that adheres to the long term strategy

• It determines direction• It forecasts outcomes • It allocates resources • It promotes forward thinking

Role of Budgets• It turns strategic objectives into

practical reality • It establishes priorities. • It sets targets in numerical terms • It provides direction and co-

ordination • It communicates objectives,

opportunities and plans various managers

Role of Budgets• It assign responsibilities• It allocates resources • It delegates without loss of control• It provides motivation for

managers to achieve goals • It is motivating staff• It improves efficiency

• To establish targets and standards which employees are motivated to achieve

• To evaluate performance against the budget

• To provide a framework for evaluating the performance of managers in meeting individual and department targets

Role of Budgets

• To control activities by measuring progress against the original plan, making adjustments where necessary

• To control income and expenditure• To facilitates management by

exception• To take remedial action when there is

deviation from the plan

Role of Budgets

Types of Budgets

On the basis of Time• Long-Term Budgets– These are prepared for a longer period varies

between five to ten years.

• Short-Term Budgets– These budgets are usually prepared for a period of

one year.

• Current Budgets– Current budget is a budget which is established for

use over a short period of time and related to current conditions

According to Function• Functional or Subsidiary Budgets

– Sales Budget

– Purchase Budget

– Production Budget

– Selling and Distribution Cost Budget

– Labour Cost Budget

– Cash Budget

– Capital Expenditure Budget

• Master Budgets– Master Budget as the summary budget

incorporating its functional budgets, which is finally approved, adopted and employed.

On the basis of Capacity• Fixed Budget– A fixed budget is designed to remain

unchanged irrespective of the level of activity actually attained.

• Flexible Budget– A flexible budget is a budget which is

designed to change in accordance with the various level of activity actually attained.

Functional Budgets

Sales Budget• A sales budget is a detailed schedule

showing the expected sales for the budget period; typically, it is expressed in both dollars and units of production.

• An accurate sales budget is the key to the entire budgeting in some way.

Production Budget• The product budget is built up from

plant utilisation budget, which shows the extent of utilisation of plant and machinery. – It shows the extent of utilisation of each

machine,

– If the capacity is insufficient, extra-shift working may be required or new machinery may be purchased or a portion of output may have to be manufactured by outsideplants,

– If the capacity is idle, the sales department can be alerted to find out ways and means to get additional sales volume.

Labour and Manpower Budget• This budget will show the number of

each grade of workmen required to produce the target output which has been approved by the budget committee.

• It will also indicate anticipated labour cost for the budget period, and the period of training that would be required for the additional workmen, if required to be recruited.

Purchases/Materials Budget

• It will take into account the projected

inventories at the commencement of the

budget period and the inventory norms

fixed by the management and determine

the quantities and value of materials

that are needed to be purchased.

Cash Budget• A cash budget is a statement in which estimated

future cash receipts and payments are tabulated in such a way as to show the forecast cash balance of a business at defined intervals.

• A cash budget is a 'detailed budget of estimated cash inflows and outflows incorporating both revenue and capital items'.

• A cash budget can give forewarning of potential problems that could arise so that managers can be prepared for the situation or take action to avoid it.

Master budget• The master budget is a summary of all the

functional budgets.

• It usually comprises the budgeted income statement, budgeted balance sheet and budgeted cashflow statement.

• The master budget provides a consolidation of all the subsidiary budgets and normally consists of a budgeted income statement, budgeted statement of financial position, and a cash budget.

Budget variances • Control involves comparing a

flexible budget (based on the actual activity level) with actual results.

• The differences between the flexible budget figures and the actual results are budget variances.

Approaches to Budgeting

Incremental Budgeting– The traditional approach to budgeting is

to base next year's budget on the current year's results plus an extra amount for estimated growth or inflation next year.

– This approach is known as incremental budgeting since it is concerned mainly with the increments in costs and revenues which will occur in the coming period.

Rolling Budgets

• A rolling budget is a budget which is continuously updated by adding a further accounting period (a month or quarter) when the earlier accounting period has expired.

Participative budgeting

• It is ‘a budgeting system in which all budget holders are given the opportunity to participate in setting their own budgets'.

Zero-based budgeting• It involves preparing a budget for each

cost centre from a zero base. • Every item of expenditure has then to

be justified in its entirety in order to be included in the next year's budget.