BUDGETING

Reference – Mgmt Accounting –Reddy and Sharma

What is a Budget and Budgeting?

It is the monetary or quantitative expression of business plans and policies in the future period of time.

Budgeting is preparing budgets and other procedure for planning , coordination and control of business enterprise.

It involves a detailed study of business environment clearly grasping the management objectives , available resources and capacity of the enterprise.

Features of Budgeting :

1. Financial statement with or without monetary data

2. Prepared for a particular period and also prepared in advance

3. Detailed plan

4. Function : to attain a specific objective

Budgetary Control

Process of preparation of budgets for various activities and comparing the budgeted figures for arriving at deviations if any which are to be eliminated in future.

Budgetary control is the end result Estimates : Predetermination of future events either through guess work or

scientific procedures Forecast : Assessment of possible future events Budget : Planning of future events Objectives : 1. Planning2. Coordination3. Efficiency and economy 4. Increase in profitability5. Anticipation – future capital expenditure6. Control and Deviations

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

Preparation of Budgets

Determine the Key factor

Making forecasts

Evaluation of alternative combination of factors

Preparation of various financial budgets

Most important are : Cash and Master Budget

Preparation of Master Budget

Classification of Budget

Classification according to time

1. Long-term budgets

2. Short-term budgets

3. Current budgets

Classification based on functions

1. Functional/Subsidiary budgets

2. Master budget

Classification on the basis of flexibility

1. Fixed budget

2. Flexible budget

On the basis of Time and Function

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

FUNCTION

Functional Budget : Budgets that relate to various functions of the

concern - Purchase budget , Cash budget , Production budget etc

Master Budget : Summary of various functional budgets – it encompasses

activities of the whole organization.

On the basis of Flexibility

Fixed Budget : prepared for a given level of activity and remains same irrespective

of change in activity.

Flexible Budget : prepared for a various levels of activity – fixed , variable and semi-

variable.

Other important Budgets :

Sales Budget : shows quantity of finished products to be sold and the price at which

they are sold.

Production Budget : it is based on sales budget and it shows the budgeted quantity

of output to be produced during a specific period.

Material and Labour Budget

Overhead Budget – Production , Administration , Selling and Distribution and

R&D.

Cash Budgets

It estimates the amount of cash receipts and payments and the balance of

cash during a specific budget period

Objective : To provide for all cash requirements in time and avoid

accumulation of excess cash.

Methods of preparing Cash Budget :

1. Receipts and Payment Method

2. Balance Sheet Method

3. Adjusted P and L Account Method

Receipts and Payment Method

General receipts of cash :

1. Cash Sales

2. Cash received from debtors

3. Dividends General Payments of cash :

1. Cash purchases

2. Payment to creditors

3. Payment of wages, expenses, dividend , fixed assets, tax and bonus

Method :

1. Starts with Opening Balance of cash and all receipts are added.

2. From the total all payments are reduced.

3. Result is : Closing balance of cash for the period

Balance Sheet Method

This method is good for long term or annual forecasts.

Opening Balance of cash

Add : Decrease in asset items

Increase in liability items

Less : Decrease in liability items

Increase in asset items

Balance is cash at the end of the period

Adjusted P and L A/C

It is based on the analogy that, profit made during the period should increase the cash balance.

Net Profit Add : Depreciation

Provisions / reserves Accrued expenses

Capital receipts Issue of shares , debentures Reduction in stocks , debtors Less : Dividends Prepayments Increase in stock, debtors Decrease in liabilities

Balance being cash

Master Budgets

A comprehensive one, prepared for the entire organization All functional budgets are integrated. An overall plan for the guidance of the management P and L A/C + Balance Sheet Helps in coordinating activities of various functional departments.

Procedure

1. Preparation of sales budget – determines the scope of operations of a firm

2. Preparation of production budget – helps in estimating the material required , labour hours and machine hours necessary for production.

3. Cost of production budget – elements of cost of production – helps in estimating the cash requirements

4. Preparation of cash budget – estimates the cash required for payments and different sources of funds to be mobilized.

Cost of Production Budget

The production budget determines the number of units to be produced.

When these units are converted into monetary terms, it becomes a “cost of

production” budget.

The physical units are broken into elements i.e.. Material, quantity, labour

time etc.

Cost of production budget = Material cost + Labour Cost + Overheads

Zero Base budgeting

Concerned with all requisites of budgets

Evaluation of existing and newly proposed activities

Planning the resources , prioritization , redeployment.

Process

1. Specification of decision units

2. Development of decision packages

3. Prioritization of activities , projects , programmes

4. Approval and allotment of funds