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. Planning 2. Coordination 3. Efficiency and economy 4. Increase in profitability 5. Anticipation – future capital expenditure 6. 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