Budgeting

CA BUSINESS SCHOOL POSTGRADUATE DIPLOMA IN BUSINESS AND FINANCE

SEMESTER 1 : FINANCIAL PLANNING AND CONTROL

M B G Wimalarathna (ACA, ACMA, ACIM, SAT, ACPM)(MBA–PIM/USJ)

Introduction

A budget is a formal plan of actions (operating) expressed in monetary terms for a given future period of time. What you are going to do tomorrow? How you can quantified them?

The term budget appears to have been derived from the French word bougette which means a “little bag” or a container of documents and accounts.

Simply, a budget is a quantitative expression and presentation of entity’s future plans. The word quantitative essentially refers both financial and non-financial data/information.

Most of the entities tend to prepare a corporate budget for next 12 months which usually refers forthcoming financial year. But in order to reap more benefits and have more control, you better compile the budget by considering shorter period of time as much as possible.

You also must taken into consider the phenomena; risk of uncertainty. “More the time laps, hire the risk” (in general)

Importance of Compiling a Budget

A budget is a mere document for most of the organization which just prepares and documented as part of the job of the finance manager. I must re-iterate that the compilation of budget can theoretically be a duty of the finance manager but it should be a contribution of all the people within the company.

An entity must essentially link its (annual) budget with corporate strategic plan (business plan) in order to reap the real benefits.

Understand the importance of working towards achieving vision and mission of the organization. In simple term, if you are not, you do not have a future. CSP is a common tool which essentially communicates such level of importance among all the people within the company and the budget is the vehicle through which an organization compiled its CSP. Now, established the relationship/link and understand the importance of budget.

At minimum, an entity prepares a budgeted financial statements based on the current (audited) financial information. Most of the other budgets are directly linked with routine operations including marketing activities.

Use of Budget

As discussed in above, it revealed that most of the organizations prepare their budget simply for the sake of preparation as part of annual documentation. I believe that this is a quite big mistake they do. Annual budget is a very vital document which will be useful in many ways and even effective budget can turnaround your company. How your budget assist you in routine decision making?

Identify cash shortage mode of finance.(best) Identify cash excess mode of investment. (best) Utilization of capacity (properly) at maximum level. Enhance performance/activity of divisions/employees. Planning raw materials & other service requirements. Planning and effective utilization of labor force. Efficient/effective usage of all scares resources. Provide inputs to the long term plans/CSP/Vision & Mission. Control mechanism/tool.

Process of Compiling a Budget

Compilation of budget involves series of steps in which one essentially link to the other.

Consideration of past Performance

Assessment of expected trading & operation results

Initial budget preparation

Adjustment – (1) Line Managers

Sub Budget

Final Budget Monitoring Actual Vs

Budgeted Adjustment – (2) As per “F” above

Audited Financial Statements • Macro economic factors

• Production capacity • Expected Market(s)

* based on experience

* based on actual * during budget period * formal

(B)

(A)

(C)

(D)

(E)

(F)

(G)

Diversities of Budgets

Different types of budgets will be prepared by the entity and diversities of them including formats solely depend on the nature of the entity’s operational activities. Sales/Revenue Expenses Purchase/Production Sales Fee Functional Sectional R/m Services Manufacturing Budgeted Income Statement. Budgeted Balance Sheet. Cash Budget. Capital Budget. Apart from the above (common) budgets, some entities tend to prepare a program budget based on the availability and involvement of programs.

Master Budget

A Master Budget is a summary of entire budgets (discussed in above) prepared within the entity for a particular period. Generally, Master Budget divided in to two (02) parts. Operational Budget Sales (quantity and monetary) Operational expenditures Financial Budget Income Statement Balance Sheet Cash Capital Budget Variance: Difference between actual and forecasted (budgeted) figures/data/results. Why it is important? Budget Variance Favorable Unfavorable (need holistic analysis)

Cash Budget

A cash budget is the most common & popular budgetary statement prepare by entities which depicts future cash inflows and outflows coupled with the end results of net cash balance. Cash budget is essentially helps in decision making as follows. Determined cash receipts & payments time. Identify cash shortage Sources of Finance. Identify cash surplus Sources of Investment. Identify suitable time to make long term investments and purchase

of NCA. Determined how to use borrowed funds. Provide framework for “what if” analysis. Note: Cash Budget is generally prepare on a monthly basis and it should be treated as an effective control tool of an entity. (need care)

Use of Cash Budget

You must get maximum use of cash budget rather than mere prepares it. Amidst many use, cash budget essentially assist to improve the cash position of an entity as follows;

Enhance cash revenue (new market/new product/expansion)

Expedite/enhance collection from debtors (many ways)

Reduce unnecessary cash investment in stocks/inventory (many)

Sale of idle assets (still can have an impact over entity’s image)

Seek low cost sources of finance (debt as opposed to equity)

Control operational & maintenance expenditures (not cut)

Defer capital expenditures (will have an impact in the long run)

Maximum utilization of creditors’ support (ethically)

Behavioural Aspects of Budgeting Behavioral aspects refers human behaviors with respect to the preparation/presentation of budget and evaluation of the results of such budgets. Authoritarian Management styles Participative Some insights:

Over state expenditures - under state revenue

Reserve for margin of error (snow balling effect)

Manipulate information to show efficiency/performance

Unnecessary use of budget funds (program budget)