0chapter 3fund flow

8/14/2019 0Chapter 3fund flow

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Funds Flow Statement:

Working Capital: What is working capital?

Working Capital = Total current assets Current liabilities.

It means all the assets held by the business with the objecti e o! con ersion into cash

"including cash# during an operating cycle o! the business.

It implies amount o! resources in ested in current assets !rom sources o! !inance other

than current liabilities. This net amount is also the amount a ailable !or use in the business in

the !orm o! !und.

Increase in current assets and decrease in current liabilities shows an increase in working

capital.

$imilarly a decrease in current assets and an increase in current liabilities represent a decrease

in working capital

Funds Flow Statement:

%n analysis o! the !luctuations o! current assets and current liabilities i.e working

capital tells us how the working capital has increased or decreased. We want to know where

the increased working capital is applied i! it has increased and !rom where !unds ha e been

released i! it has decreased. The &ro!it ' (oss account gi es some indication o! the results o!operations and its impact on the !unds position. We try to integrate the impact o! operations

reported in the pro!it ' loss account and balance sheet by preparing a statement o! changes in

!inancial position. It describes the sources !rom which !unds were recei ed and the uses to

which !unds were put. This statement o! changes in !inancial position is usually re!erred to as

)unds !low statement or statement o! sources and application o! !unds.

This statement shows the sources !rom where the !unds were raised and the uses to

which they were put.The statement o! !unds !low is usually bi!urcated into two logical di isions: $ources

o! !unds or in!lows during periods and *ses o! !unds or %pplications o! !unds during the

period.

The di ision showing sources o! !unds summari+es all those transactions which had the net

e!!ect o! increasing the working capital.

*ses o! !unds on the other hand deal with all those transactions which had the e!!ect o!

decreasing the working capital.

,asic )low o! )unds: &rimary $tructure


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)unds

(ongterm-ebt. '

-ebentures

(ongterm-ebt. '

-ebentures

(ongterm-ebt. '

-ebentures

epaymento! (ongterm

-ebt.-ebentures

epaymento! &re!erence$hare Capital

-i idends

%c/uisitiono! )i0ed%ssets

1peration

I2)(1W$

1*T)(1W

The !low o! !unds statement gi es a summary o! the impacts o! managerial decisions.

%s such it re!lects the policies o! !inancing3 in estment3 ac/uisition and retirement o! !i0ed

assets3 distribution o! pro!its and the source o! operations.

&er!orma o! )unds )low $tatement

$ources o! !unds:)unds !rom operations:

2et Income(ess: &ro!it on sale o! !urniture%dd: -epreciation3 amorti+ation pro isions:

&lant)urnitureTechnical assistance !ee

1ther sources o! !und$ale o! assets,ank loanInstitutional loan

Unit 2 / Chapter 04

Budgeting and Budgetary Control


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e iewing the past in!ormation alone is not enough since your job in ol es not only

predicting but also shaping the !uture o! your enterprise. This re/uires proper planning about

all acti ities o! the business. )inance being the li!eblood o! a business3 !inancial planning is

o! at most signi!icance to a businessman. % budget is an important tool !or !inancial planning

and control.

,e!ore we come to the intricacies o! budgeting3 it will be use!ul !or us to understand the

meaning and implication o! !inancial planning.

)inancial &lanning:

It is concerned with rising o! !unds and their e!!ecti e utili+ation with a iew to

ma0imi+e the wealth o! the company. It includes the determination o!:

The amount o! !unds needed !or implementing arious business plans.

The pattern o! !inancing i.e. the !orm and proportion o! arious corporate

securities such as shares3 debentures3 bonds3 bank loans to be issued or raised.

The timing o! !loatation o! arious corporate securities.

In spite o! a good !inancial plan3 the desired results may not be achie ed i! there is no

e!!ecti e control to ensure its implementation. The budget represents a set o! yardsticks or

guidelines !or use in controlling internal operations o! an organi+ation. The management

through budget can e aluate the per!ormance o! e ery le el o! the organi+ation. The

discrepancy between plan per!ormance and actual per!ormance is highlighted through

budgets. The organi+ation may ha e to change its operations in a particular area or re ise its

plans keeping in iew the changing conditions.

What is a Budget?

% budget is a plan e0pressed in /uantitati e3 usually monetary terms3 co ering a

speci!ic period o! time3 usually one year.

In other words a budget is a systematic plan !or the utili+ation o! manpower and material

resources. ,udgeting is a !ormal process o! !inancial planning using estimated !inancial and

accounting data.

In a business organi+ation a budget represents an estimated o! !uture costs and

re enues.


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,udgetary Control: 2o system o! planning can be success!ul without ha ing an e!!ecti e and

e!!icient system o! control. ,udgeting is closely connected with control. The e0ercise o!

control in the organi+ation with the help o! budgets is known as budgetary control.

,udgetary control is a control measure in which the actual state o! a!!airs is

compared with the budget so that appropriate action may be taken with regard to any

de iations be!ore it is too late. ,udgeting is thus merely a part o! budgetary control.

The process o! budgeting control includes.

4# &reparation o! arious budgets.

5# Continuous comparison o! actual per!ormance with budgetary per!ormance and

6# e ision o! budgets in the light o! changed circumstances.

Fixed and Flexi le Budgeting

Fixed Budgeting: The institute Costs and 7anagement %ccountants "*8# de!ines a !i0ed

budget as the budget which is designed to remain unchanged irrespecti e o! the le el o!

acti ity actually attained. It is based on a single le el o! acti ity. % !i0ed budget per!ormance

report compares data !rom actual operations with the single le el o! acti ity re!lected in the

budget. It is based on the assumption that the company will work at some speci!ied le el o!

acti ity and that a stated production will be achie ed.

It suggests that the budget is not adjusted. It acts as a target !or the !orthcoming

period. It represents a point !i0ed in ad ance with which actual results are compared. )i0ed

budgets do not change when production le el changes.

9owe er in practice !i0ed budgeting is rarely used. The main reason is that actual

output is o!ten signi!icantly di!!erent !rom the budgeted output. In such a case budget cannot

be used !or the purpose o! cost control.

0: I! actual production is 453;;; units in place o! the budgeted 4;3;;; units the cost incurred

cannot be compared with the budget which relates to di!!erent le els o! acti ity. There!ore

the !i0ed budget is unable to pro ide use!ul in!ormation when actual output di!!ers

signi!icantly !rom e0pected or budgeted output.

Flexi le Budgeting: % !le0ible budget is de!ined in the terminology o! Cost %ccounting

issued by the Institute o! Cost and 7anagement %ssociation "*8# as


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% !le0ible budget is a budget that is prepared !or a range i.e. !or more than one le el

o! acti ity. It is a set o! alternati es budgets to di!!erent e0pected le els o! acti ity. The

!le0ible budget is also known by other names such as ariable ,udget3 -ynamic budget3 $tep

budget3 0penses !ormula budget and 0penses control budget. The underlying principle o! a

!le0ible budget is that e ery business is a dynamic3 e er changing and ne er static. Thus3 a

!le0ible budget might be de eloped that would apply to a >relati e range o! production say

@3;;; units to 453;;; units. *nder this approach i! actual production slips to A3;;; units !rom

projected 4;3;;; units the manager has a speci!ic tool "i.e. a !le0ible budget# that can be used

to determine budgeted cost at A3;;; units o! output. The !le0ible budget pro ides a reliable

basis !or comparisons because it is automatically geared to changes in a production acti ity.

% !le0ible budget pro ides in!ormation to managers !or multiple le els o! output in

case actual output is di!!erent !rom the e0pected le el. The per!ormance reports at the end o!

the accounting period are compared with a budget based on the actual output attained during

the period. % !le0ible budget has the !ollowing important !eatures:

4# It co ers a range o! acti ity "output#.

5# It is !le0ible i.e. easy to change with ariation in production le els.

6# It !acilitates per!ormance measurement and e aluation.

)le0ible budgeting is budgeting that is automatically tailed to any le el o! acti ity. It

pro ides a better e aluation o! e!!iciency "the relation o! input to outputs#. %lthough it is

more o!ten associated with the control o! o erheads3 a !le0ible budget may also include direct

materials and direct labour. The !le0ible budget pro ides cost goals or targets based on

scheduled acti ity or output be!ore the decision i.e. be!ore the cost is incured. This

contributes to cost control throughout the organi+ation.

Budget !eriod: The budget period is an important !actor in de eloping comprehensi e

budgeting programmes. This is one period !or which !orecasts can reasonably be made and

budgets can be !ormulated.

Components o" #aster Budget:

The terms used to describe speci!ic budget schedule ary !rom organi+ation to

organi+ation. 9owe er3 most master budgets ha e common elements. The usual master

budget !or a manu!acturing company has the !ollowing components:

%. $perating udget4. $ales budget "and other cost dri er budgets as necessary#


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5. &urchases budget

6. CostBo!BgoodsBsold budget

. 1perating e0penses budget

D. ,udgeted statement o! income.

,. Finan%ial udget:

4. Capital budget

5. Cash budget

6. ,udgeted balance sheet

The chart showed later indicates the relationships among the arious parts o! a master

budget !or a manu!acturing company. In addition to these categories3 manu!acturing

companies that maintain in entories prepare ending in entory budgets and additional budgets

!or each type o! resource acti ity such as labour3 materials and !actory o erhead.

The two major parts o! a master budget are the operating budget and the !inancial

budget. The operating budget !ocuses on the income statement and its supporting schedules.

%lthough sometimes called the pro!it plan3 the operating budgets may show a budgeted loss

or may e en be used to budget e0penses in an organi+ation or agency with no sales or

re enues. In contrast3 the !inancial budget !ocuses on the e!!ects that the operating budget and

other plans "such as capital budgets and repayment o! debt# will ha e on cash.

The length o! the budget period depends on the type o! business3 the length o! the

manu!acturing cycle !rom raw materials to !inished products3 the ease or di!!iculty o!

!orecasting !uture market conditions and other !actors. 9owe er3 a business enterprise

prepares a short range budget and a long range budget.

(ong range plans and budgets gi e the company direction and goals !or the !uture3

while short term plans and budgets guide dayBtoBday operations. 7anager who pays attention

only to short term budgets will /uickly lose sight o! longBterm goals. $imilarly managers who

pay attention only to the longBterm budget would wind up mismanaging dayBtoBday

operations. There has to be a happy medium that allows managers to pay attention to their

shortBterm budgets while still keeping an eye on long term plans. nter the master budget.

The 7aster ,udget is an e0tensi e analysis o! the !irst year o! the longBterm plan. It

summari+es the planned acti ities o! all subunits o! an organi+ationB sales3 production3

distribution and !inance. It also /uanti!ies targets !or sales3 costBdri er acti ity3 purchases3 production3 net income3 cash position and any other objecti e that management speci!ies. The


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master budget e0presses these amounts in the !orm !orecasted !inancial statements and

supporting operating schedules.

Thus3 the master budget is a periodic business plan that includes a coordinated set o!

detailed operating schedule and !inancial statements. It includes !orecasts o! sales3 e0penses3

cash receipts and disbursements and balance sheets. 7aster budgets might consist o! 45

monthly budgets !or the year or perhaps monthly budgets !or only !irst /uarter and /uarterly

budgets !or the three remaining /uarters. In the process o! preparing the master budget3

managers make many important decisions about how to best deploy the organi+ation s

resources.

!reparation o" #aster Budget

$ales ,udget

&urchase ,udget

CostBo!BgoodsBsold bud get

1perating e0penses

budget

,udgeted statement o!income

,udgeted ,alance $heetCash,udget

Capital,udgets

:nding In entory,udget

1perating budget

)inancial budget

&' $perating Budget

4# Sales Budget : The most important budget which all other budgets are contingent upon is

the sales budget. %ll budgets such as &roduction budget3 In entory budget3 &ersonnel budget3

%dministration budget3 $elling and -istribution budget and others are all a!!ected by the

$ales budget and are dependent upon the re enue deri ed !rom sales. There!ore3 the $ales

budget is the starting point in preparing other !unctional budgets. -e eloping a $ales budget

re/uires !orecasting !uture sales le els.


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% specimen o! a sales budget:

%,C Company (td.

$ales budget !or the year ending -ecember 643 5;;E

&roducts,udgeted $ales

*nits,udgeted $ales

&rice " s#Total" s#

% E;3;;; @;3;;; DF3;;3;;;, @;3;;; 435;3;;; AF3;;3;;;

43D;3;;; 43D53;;3;;;

5. !ur%hases Budget: %!ter budgeting sales and cash collections3 we prepare the purchases

budget. The total merchandise needed will be the sum o! the desired ending in entory plus

the amount needed to !ul!ill budgeted sales demand. The total need will be partially met by

the beginning in entory. The remainder must come !rom planned purchases. We can computethese purchases as !ollows:

,udgeted purchases = desired ending in entory G cost o! goods sold beginning in entory

6. Cost (o")goods)sold udget

This budget will be prepared usually a!ter preparing direct materials3 direct labour3

!actory o erhead and ending in entory budgets.

%,C Company

Cost o! goods sold budget !or the year ending -ecember 643 5;;E

-irect materials

,eginning in entory 53;;3;;;

&urchases A3453D;;

443453D;;

(ess : Closing in entory 43F53D;;

Cost o! direct materials used A3D;3;;;

-irect labour 463D;3;;;

)actory o erhead 543F;3;;;

Total !actory cost 3F;3;;;

%dd : ,eginning !inished goods in entory 5D3;;3;;;

Total goods a ailable !or sales FA3F;3;;;

(ess : Closing !inished goods in entory 4 3;;3;;;

Cost o! goods sold DD3F;3;;;


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. $perating expenses udget : The budgeting o! operating e0penses depends on se eral

!eatures. 7onthBtoBmonth changes in sales olume and other cost dri er acti ities directly

in!luence many operating e0penses. 0amples o! e0penses dri en by sales olume include

sales commission and many deli ery e0penses. 1ther e0penses such as rent3 insurance3

depreciation and salaries are not in!luenced by sales within appropriate le el ranges3 we

regard them as !i0ed.

7ay Hune Huly

Wages "!i0ed# 5D;; 5D;; 5D;;

Commission F;;; ED;; 453;;;

Total wages ' commission @D;; 4;3;;; 4 3D;;

7iscellaneous e0penses 5D;; ;;; 6;;;

ent 5;;; 5;;; 5;;;

Total disbursements 46;;; 4F;;; 4AD;;

*' Budgeted statement o" in%ome :

% budgeted income statement summari+es all the indi idual budgets i.e. sales budget

cost o! goods sold budget3 selling budget and administrati e e0penses budget. 2o new

estimates are made3 !igures are taken !rom budgets pre iously prepared. This budget

determines income be!ore ta0es. I! the ta0 rate is a ailable net income a!ter ta0es can also becomputed.

%,C Company

,udgeted income statement !or the year ending -ecember 5;;E

s.$ales 43D;3;;;Cost o! gods sold DD3;;;ross margin 53;D3;;;$elling 0penses 43;D3;;;%dministrati e e0penses 534;3;;; 634D3;;;Income be!ore ta0es D35;3;;;Income ta0es"assuming D;J# 53F;3;;;

2et income 53F;3;;;

,. Finan%ial Budget

+' Capital / Capital ,xpenditure Budget: The budgeting o! capital e0penditure is one o! the

most important areas o! managerial decisions. (arge sums o! money and long period o! time

are o!ten in ol ed in this budget which there!ore re/uires utmost care and sound judgment.Capital e0penditure represents longBterm commitments. %lso the bene!its o! capital


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e0penditure spread o er a long period o! time. enerally capital e0penditures are relati ely

large in comparison with operating e0penditures and ha e a long impact on the organi+ations

and the business !irm. The capital e0penditure budget aims at minimi+ing errors while

making capital e0penditure decisions.

Capital e0penditure budgets are prepared !or both short and long range projects

depending on the re/uirements o! the business !irm. $hortBrange projects are implemented

during the current accounting period: there!ore3 these pro isions should be made in the

current budget. (ong range projects are not e0ecuted in the current period3 they are e0pressed

only in general terms. They become budget commitments only when the time !or their

implementation approaches.

Cash Budget: % cash budget contains detailed estimates o! cash receipts "cash in!lows# and

disbursement "cash out!lows# !or the budget period as some other speci!ic period. Cash

budgeting is e0tremely important since business operations re/uire ade/uate cash to ac/uire

materials and meet arious e0penses and loan obligations. There!ore3 planning cash !low is

ery use!ul !or all types o! organi+ations.

The preparation o! cash budget has the !ollowing objecti es:

4# It indicates the e!!ect on the cash position o! seasonal re/uirements3 large

in entories3 unusual receipts and slowness in collecting recei ables.

5# It indicates the cash re/uirements needed !or a plant or e/uipment e0pansion

programme.

6# It points the need !or additional !unds !rom sources such as bank or sale o!

securities and the time !actors in ol ed.

# It indicates the a ailability o! cash !or taking ad antage o! discounts.

D# It assists in planning the !inancial re/uirements o! bond re/uirements3 income

ta0 installments and payments to pension and retirement !unds.

F# It shows the a ailability o! e0cess !unds !or short term and longBterm

in estments.

!eriod o" %ash Budget : The period o! time co ered by a cash budget depends on the type o!

business management planning needs and cash position. % cash budget may generally be

related to the !ollowing time periods.


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4# 1perational cash planning: Cash budgets may be prepared monthly3 weekly e en

daily to meet in!ormational re/uirements o! the management.

5# $hort range: $hort range cash budgeting is prepared annually and is in correspondence

with the annual pro!it plan. It helps in determining shortBterm credit needs and

controlling cash during the year.

6# (ong range: The purpose o! long range budgeting is to determine whether cash can be

generated through working capital growth and at what time !unds are needed.

&rojection o! long range cash in!lows and out!lows is ital !or making !inancing

decisions and de eloping longBterm credit needs.

Cash budgets help management to a oid ha ing unnecessary idle cash on the

one hand3 unnecessary cash de!iciency on the other. % well managed !inancing

program keeps cash balances !rom becoming too large or too small.

-' Budgeted / !ro.e%ted alan%e sheet : The !inal step in preparing the master budget is to

construct the budgeted balance sheet that projects each balance sheet item in accordance with

the business plan as e0pressed in the pre ious schedules. It represents the e0pected !inancial

position at a particular date. I! any o! the accounts or relationships among the accounts

appearing on the projected balance are not according to the management s re/uirements and

objecti es the operating plan might ha e to be changed. 0: I! a bank or !inancial institution

re/uires a business !irm to maintain a certain minimum current ratio and debt e/uity ratio3 the

operating plan would ha e to change i! these ratios are indeed too low. )urthermore3

un!a ourable ratios may decrease the alue o! company shares in the stock e0change and

lower the credibility o! the !irm in the in estment market.

Cash Budget

4# % company is e0pected to ha e s.5D3 ;;; cash in hand on 4 st 7ay 5;;5 and it re/uires

you to prepare an estimate o! cash position during the 6 months !rom 7ay to Huly 5;;53 the

!ollowing in!ormation is supplied to you.

$ales &urchases Wages 0penses

7arch E;3;;; ;3;;; @;;; F;;;

%pril @;3;;; D;3;;; @;;; E;;;

7ay A53;;; D53;;; A;;; E;;;

Hune 43;;3;;; F;3;;; 4;3;;; @;;;

Huly 435;3;;; DD3;;; 453;;; A;;;


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1ther in!ormation

i# 5DJ o! monthly sales is on cash basis

ii# &eriod o! credit allowed to customers !or credit sale is one month

iii# &eriod o! credit allowed by suppliers is two months

i # -elay in payment wages and e0penses is one month

# Income ta0 is to be paid on Huly 5;;5 is 5D3;;;.

&repare cash budget !or 7ay3 Hune and Huly 5;;5.

$olution:

7ay Hune Huly

1pening balance "collection# 5D3;;; D63;;; @43;;;

%dd: eceipts

Cash sales = 5DJ 563;;; 5D3;;; 6;3;;;

Collection !rom debtors F;3;;;"(ast month EDJ on credit#

FA3;;; ED3;;;

Total 43;@3;;; 43 E3;;; 43@F3;;;

(ess: &ayments to creditors ;3;;;"7arch#

D;3;;; D53;;;

Wages @3;;; A3;;; 4;3;;;

0penses E3;;; E3;;; @3;;;

Income ta0 B B 5D3;;;

DD3;;; FF3;;; AD3;;;Closing ,alanceB D63;;; @43;;; A43;;;

5# % company is e0pected to ha e s.453;;; cash in hand on 7arch 5;;@ and it re/uires youto prepare an estimate o! cash position during the 6 months !rom 7arch to 7ay 5;;@. The!ollowing in!ormation is supplied to you.

#onths Sales !ur%hases Wages ,xpensesHanuary 5D3;;; 4D3;;; D3;;; 3;;;

)ebruary 6;3;;; 5;3;;; F3;;; D3;;;

7arch 6D3;;; 553;;; F3D;; D3;;;

%pril D;3;;; 6;3;;; E3;;; F3;;;

7ay F;3;;; ;3;;; @3;;; E3;;;

1ther in!ormation:

i. D;J o! monthly sales are on cash basis

ii. &eriod !or collection !rom customers !or credit sale is one month

iii. &eriod o! credit allowed by suppliers is one month

i . -elay in payment o! wages and e0penses is 5 months. epayment o! loan is made in the month o! 7ay 5;;E amounting to s.5D3;;;


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i. Income ta0 is to be paid on %pril 5;;E is 5;3;;;

&repare cash budget !or 7arch3 %pril and 7ay 5;;@.

6# %,C company wished to arrange o erdra!t !acilities with its bankers during the period

%pril to Hune 5;;@ when it will be manu!acturing mostly !or stock. &repare a cash budget !orthe abo e period !rom the !ollowing data3 indicating the e0tent o! the bank !acilities thecompany will re/uire at the end o! each month.

a #onths Sales 1s !ur%hases 1s Wages)ebruary 43@;3;;; 435 3@;; 453;;;

7arch 43A53;;; 43 3;;; 4 3;;;

%pril 43;@3;;; 53 63;;; 443;;;

7ay 43E 3;;; 53 F3;;; 4;3;;;

Hune 435F3;;; 53F@3;;; 4D3;;;

D;J o! the credit sales are reali+ed in the month !ollowing the sales and the remainingD;J in the second month !ollowing creditors are paid in the month o! purchase

% Cash at ,ank on 4. .5;;@ "estimated# s.5D3;;;. The o erdra!t !acilities by %,C

company !or di!!erent months are as under.

i# In 7ay 5;;@ s. E3;;; ii# In Hune 5;;@ s.43FE3;;;

$olution:

&pril1s'

#ay1s'

une1s'

1pening ,alance "o er dra!t# 5D3;;; DF3;;; "B E3;;;#eceipts:Collection !rom debtors 43@F3;;; 43D;3;;; 43 43;;;

53443;;; 53;F3;;; A 3;;;&ayments&ayment to creditors 43 3;;; 53 63;;; 53 F3;;;Wages 443;;; 4;3;;; 4D3;;;Closing balance "o erdra!t# DF3;;; "B E3;;;# "B43FE3;;;#

53443;;; 53;F3;;; A 3;;;Working notes: collection !rom -ebtors

%pril 5;;@ s.

$ales !or )ebruary 43@;3;;; K 4L5 A;3;;;

$ales !or 7arch 43A53;;; K 4L5 AF3;;;

43D;3;;;

7ay 5;;@ s.

$ales !or 7arch 43A53;;; K 4L5 AF3;;;


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$ales !or %pril 43;@3;;; K 4L5 D 3;;;

43D;3;;;

Hune 5;;@ s.

$ales !or %pril 43;@3;;; K 4L5 D 3;;;

$ales !or 7ay 43E 3;;; K 4L5 @E3;;;

43 43;;;

3ero ase udgeting:

The traditional budgeting techni/ue which takes the current le el o! operations as the

basis !or estimating the !uture le el o! operations is slowly going out o! date. It is being

increasingly reali+ed that the traditional techni/ue has serious shortcomings in iew o! the

constantly changing conditions o! today. The management is e0pected to re iew and

ree aluate the tasks in iew o! the increasing pressures o! en ironment. The concept o! >Mero

,ase ,udgeting is being considered as a suitable alternati e to replace the traditional

method.

Mero base budgeting is a method o! budgeting whereby all acti ities are e aluated

each time the budget is !ormulated and e ery item o! e0penditure in the budget are !ully

justi!ied. That is3 +ero base budgeting in ol es starting !rom scratch or +ero.

The techni/ue o! +ero base budgeting suggests that an organi+ation should not only

make decisions about the proposed new programmes but should also re iew the

appropriateness o! the e0isting programmes !rom time to time.

Mero base budgeting as the term suggests e0amines or re iews a programme or

!unction or responsibilities !rom >scratch . 2o acti ity or e0pense is allowed simply because

it was being allowed or done in the past. Thus3 according to this techni/ue each programme3

whether new or e0isting must be justi!ied in its entirety each time a new budget is !ormulated.

It in ol es:

-ealing with particularly all elements o! manager s budget re/uest.

Critical e0amination o! ongoing acti ities along with the newly proposed acti ities.

&ro iding each manager a range o! choices in setting priorities in respect o!

di!!erent acti ities and in allocating resources.


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!ro%ess o" 3ero Base Budgeting

The !ollowing steps are in ol ed in +ero base budgeting:

a. etermining the o .e%ti5es o" udgeting : B The objecti e may be to e!!ect cost

reduction in sta!! o erheads or it may be to drop3 a!ter care!ul analysis3 projects which

do not !it into achie ement o! the organi+ations objecti es etc.

b. e%iding on s%ope o" appli%ation : B The e0tent to which the +ero base budgeting is to

be introduced has to be decided3 i.e. whether it will be introduced in all areas o! the

organi+ation s acti ities or only in a !ew selected areas on trial basis.

c. e5eloping de%ision units : -ecision units !or which cost bene!it analysis is proposed

ha e to be de eloped so as to arri e at decisions whether they should be allowed to

continue or be dropped. ach decision unit as !ar as possible should be independent o!

other units so that it can be dropped i! the cost analysis pro es to be un!a ourable !or

it.

d. e5eloping de%ision pa%6ages : % decision package !or each unit should be

de eloped3 while de eloping a decision package3 answer to the !ollowing /uestions

would be desirable.

Is it necessary to per!orm a particular acti ity at all? I! the answer is negati e3

there is no need to proceed !urther.

9ow much has been the actual cost o! the acti ity and what has been the

actual bene!it both in tangible as well as intangible !orms.

$hould the acti ity be per!ormed in the way in which it is being per!ormed and

what should be the cost?

I! the project or acti ity is dropped3 can the unit be replaced by an outside

agency?

The abo e analysis shows that +ero base budget is in a way an e0tension o! the

method o! cost bene!it analysis to the area o! the corporate budgeting.

&d5antages o" 3ero Base Budgeting

%d antages o! +ero base budgeting are as !ollows:

It pro ides the organi+ation with a systematic way to e aluate di!!erent operations

and programmes undertaken. It enables management to allocate resources according

to priority o! the programmes.


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It ensures each and e ery programme undertaken by managers is really essential

!or the organi+ation and is being per!ormed in the best possible way.

It enables the management to appro e departmental budgets on the basis o! cost

bene!it analysis. It links budgets with the corporate objecti es. 2othing will be allowed simply

because it was being done in the past.

It helps in identi!ying areas o! waste!ul e0penditure and i! desired it can also be

used !or suggesting alternati e courses o! action.

It !acilitates the introduction and implementation o! the system o! management by

objecti es. Thus3 it can be used not only !or !ul!illment o! the objecti es o! traditional

budgeting3 but also !or a ariety o! other purposes.Mero base budgeting as a concept has become /uite popular these days. $ome

departments o! the o ernment o! India ha e recently introduced it with a iew to

making the system o! budgeting control more e!!ecti e.

!er"orman%e Budgeting:

,udgeting is the nothing but the techni/ue o! e0pressing3 largely in !inancial terms3

the management plan !or operating and !inancing the enterprise during speci!ic periods o!time. %ny system o! budgeting in order to be success!ul must pro ide !or per!ormance

appraisal as well as !ollow up measures.

&er!ormance budgeting3 as a budgeting method was !irst introduced in *$% around

4AD;. &er!ormance budgeting aims to !ormulate budgets in terms o! acti ities3 programmes

and !unctions. The essence o! this budgeting lies in ascertaining acti ities and related costs

and to measure e!!iciency achie ed there by. It is basically output oriented budget3 !ocusing

on out put per!ormance to be achie ed. -escribing the purposes !or which resources L !unds

are needed3 cost o! acti ities essential to achie e the purposes and desired work per!ormance

under di!!erent acti ities o! a broad !unction.

)le0ible ,udget &roblems

4# The cost o! an article at the capacity le el o! D;;; units is gi en below. &repare the

!le0ible budget at 3;;; and F3;;; units.

7aterial cost s. 5D3;;; "4;;J arying#


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(abour cost s. 4D3;;; "4;;J arying#

&ower s. 45D; "@;J arying#

Inspection s. D;; "5;J arying#

-epreciation s. 4;3;;; "4;;J !i0ed#

%dministrati e o erhead s. D3;;; "5DJ arying#$elling o erhead s. 63;;; "D;J arying#

s. DA3ED;

&er unit = 44.AD

$olution:

Flexi le Budget

0isting

D;;; units;;; units F;;; units

47aterial cost "4;;J # C;;;

D;;;

;;;35D

5D3;;; 5;3;;; 6;3;;;

5 (abour cost "4;;J # 4D3;;; 453;;; 4@3;;;

6 &ower "@;J # )i0ed:ariable

:

5D;4;;;

5D;@;;

5D;45;;

Inspection )i0ed:ariable

;;4;;

;;@;

;;45;

D -epreciation ")B4;;J# 4;3;;; 4;3;;; 4;3;;;

F %dministrati e o erhead ")BEDJ# " B5DJ#

6ED;45D;

6ED;4;;;

6ED;4D;;

E $elling o erhead ")BD;J# " BD;J#

4D;;4D;;

4D;;45;;

4D;;4@;;

DA3ED; D;3A@; F@3D5;

ariability o! an item o! e0pense will be !ound out as !ollows:

)i0ed portion G ariable portion ;;; or F;;; L D;;;0: @;J o! power is ariable and 5;J is !i0ed. The power e0pense !or 3;;; units will be

calculated as =D;;;

C;;;4;;;5D; + = 5D; G @;; = 4;D;

!or F;;; units =D;;;

F;;;4;;;5D; + = 5D; G 45;; = 4 D;

7nspe%tion

)or ;;; units =D;;;C;;;4;;C;; + = ;; G @; = @;


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)or F;;; units =D;;;

F;;;4;;C;; + = ;; G 45; = D5;

&dministrati5e $5erhead

)or ;;; units =D;;;

C;;;45D;6ED; + = 6ED; G 4;;; = ED;


F;;;45D;6ED; + = 6ED; G 4D;; = D5D;

Selling $5erhead:

)or ;;; units =D;;;

C;;;4D;;4D;; + = 4D;; G 45;; = 5E;;


F;;;45;;4D;; + = 4D;; G 4@;; = 66;;

5# &repare a !le0ible budget !or o erheads on the basis o! data gi en below. %scertain theo erhead rates at D;3 F; and E; percent capacity

%t D;Jcapacity s.

%t F;Jcapacity s.

%t E;Jcapacitys.

ariable o erheads:

Indirect material F;;;Industrial labour 4@;;;$emiB ariable o erheads:lectricity " ;J !i0ed F;J ariable# 6;3;;;epairs ' maintenance"@;J !i0ed3 5;J ariable 6;;;)i0ed o erheads:-epreciation 4FD;;Insurance D;;$alaries 4D;;;

A6;;;

stimated direct labour hours at F;J capacity 43@F3;;;

6# )or production o! 4;3;;; electrical automatic irons the !ollowing are the budgetede0penses.

&er unit-irect materials s. F;-irect labour 6;ariable o erheads: &roduction 5D)i0ed o erheads: &roduction

" s. 43D;3;;;# 4Dariable e0penses "direct# D


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$elling e0penses "4;J !i0ed# 4D%dministrati e e0penses " s. D;3;;;igid !or all le els o! production# D

-istribution e0penses "5;J !i0ed# D

Total cost o! sales per unit 4F;

&reparer a budget !or production o! F;;;3 E;;; and @;;; irons showing distinctly themarginal cost and total cost

$olution:)le0ible budget o! lectrical %utomatic Irons

F;;; units E;;; units @;;; unitsTotal" s#

&er unit" s.#

Total" s#

&er unit" s.#

Total" s#

&er unit" s.#

-irect material 63F;3;;; F;.;; 35;3;; F;.;; 3@;3;;; F;.;;-irect labour 43@;3;;; 6;.;; 534;3;;; 6;.;; 53 ;3;;; 6;.;;-irect ariablee0penses

6;3;;; D.;; 6D3;;; D.;; ;3;;; D.;;

ariable o erheads:&roduction 43D;3;;; 5D.;; 43ED3;;; 5D.;; 53;;3;;; 5D.;;$elling " BA;J# @43;;; 46.D; A 3D;;; 46.D; 43;@3;;; 46.D;-istributiono erheads " B@;J#

5 3;;; .;; 5@3;;; .;; 653;;; .;;

7arginal cost @35D3;;; 46E.D; A3F53D;; 46D.D 443;;3;;;

46E.D

)i0ed productiono erhead

43D;3;;; 5D.;; 43D;3;;; 54. 6 43D;3;;; [email protected]

%dministrati eo erhead

D;3;;; @.66 D;3;;; E.4 D;3;;; F.5D

$elling o erhead 4D3;;; 5.D; 4D3;;; 5.4 4D3;;; 4.@@-istributiono erhead

4;3;;; 4.FE 4;3;;; 4. 6 4;3;;; 4.5D

)i0ed cost 535D3;;; 6E.D; 535D3;;; 65.4 535D3;;; [email protected] cost7arginal cost plus!i0ed cost

4;3D;3;;;

4ED.;; 443@E3D;;

4FA.F 4635D3;;;

4FD.F6

# %,C company ltd. has prepared a budget !or the production o! a lakh units o! the onlycommodity manu!actured by them !or a costing period as under

s. per unit aw material 5.D5 -irect labour ;.ED -irect e0penses ;.4; Works o erheads "F;J !i0ed# 5.D; %dministrati e o erheads "@;J !i0ed# ;. ;

$elling o erheads "D;J !i0ed# ;.5;


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The actual production during the period was only F;3;;; units. Calculate the re ised budgeted cost.


21/23

Chapter 08

Basi%s o" ,%onomi%s

conomics is the study o! how people make their li ing3 how they ac/uire the !ood3

shelter clothing and other material necessities and com!orts o! this world. It is the study o! the

problems they encounter and o! the ways in which these problems can be reduced.

In the words o! %l!red 7arshall3 a great teacher and scholar o! a century ago3


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Why do we purchase commodities or ser ices? 1b iously3 the answer would be that

consumption o! these commodities and ser ices gi e us satis!action. The satis!action3 which a

consumer gets by ha ing or consuming goods or ser ices is called utility by economists.

$ame commodity gi es di!!erent utility to di!!erent consumers. en !or the same consumer

utility aries !rom unit to unit3 !rom time to time and !rom place to place.

To understand the consumer beha iour it is use!ul to distinguish between the two

utility concepts. 4# Total utility and 5# 7arginal utility.

4# otal utility: The total utility re!ers to the sum total o! satis!action that a consumer

recei es by consuming the arious units o! the commodity. The more units o! a

commodity he consumes greater will be historical utility or satis!action !rom it up to a

certain point. %s he keeps on increasing the consumption o! the commodity he

e entually reaches the point o! saturation represented by ma0imum total utility. I!

!urther units o! the commodity are consumed his total utility starts declining.

S%ar%e resour%es : The resources a ailable to man !or the purpose o! satis!ying wants are

con entionally classi!ied into groups. ")actors o! &roduction#

+' nature s bounty i.e. all nonBhuman resources which occur naturally

!rom mineral deposits3 !orests and soil to gases in the air. In many cases these

resources are not a ailable !reely. 1ther resources may be needed to e0tract them !or

man s use. "e.g. mining#

2' the mental and physical e!!ort o! humans in the

course o! production .

-' Capital: This also has a precise economic meaning which should not be con!used

with the e ery day use o! the word. It may be de!ined as >goods which are not used

!or current consumption e.g.: &roducer goods3 stock o! raw material3 stock o! work in

progress etc.

4' ,nterprise / $rgani=ation: -e!ined as >the !actors which bears the risk o!

production. nterprise is the least readily /uanti!ied o! the !actors o! production and

has the distinguishing characteristic that it is the only !actor which may earn a

negati e return "i.e. a loss#.

Fa%tor mo ility: It is the term used to describe the readiness with which !actors may

be redirected to alternati e uses.


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#arginal Cost: 7arginal cost is the change in total cost resulting !rom a small

change in output.

7mper"e%t mar6et: In traditional theory any market in which a !irm has a downward

sloping demand cur e is considered imper!ect "since !irm could increase its price

without losing all its customers to other !irms#.

)urher eadings: 7anagement %ccounting by -r. Hawahar (al.

0chapter 3fund flow

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