BUDGET

A budget is a formal statement of estimated income and expenses based on future plans and
objectives. In other words, a budget is a document that management makes to estimate the
revenues and expenses for an upcoming period based on their goals for the business.
A budget is a quantitative plan of the operations of an organization or an individual; it identifies
the resources and the commitments required to fulfill the organisation’s or individual’s goals for
the budgeted period.
Features of a budget
- It is a plan in quantities
- The set objectives must be achieved within a particular time frame. This time frame is
termed the budget period.
- there must be definite resources set aside to achieve the set objectives
- It must have objectives, and a clearly expressed means of achieving the stated objectives.
Budgeting
Budgeting is the tactical implementation of a business plan. To achieve the goals in a
business’s strategic plan, we need some type of budget that finances the business plan and sets
measures and indicators of performance. We can then make changes along the way to ensure that
we arrive at the desired goals.
Budgeting is the process of preparing budgets.
The budgeting process for most large companies usually begins four to six months before the
start of the financial year, while some may take an entire fiscal year to complete. Most
organizations set budgets and undertake variance analysis on a monthly basis. Starting from the
initial planning stage, the company goes through a series of stages to finally implement the
budget. Common processes include communication within executive management, establishing
objectives and targets, developing a detailed budget, compilation and revision of budget model,
budget committee review, and approval.
Goals of the Budgeting Process
Budgeting is a critical process for any business in several ways.
1. Aids in the planning of actual operations: The process gets managers to consider how
conditions may change and what steps they need to take, while also allowing managers to
understand how to address problems when they arise.
2. Co-ordinates the activities of the organization: Budgeting encourages managers to build
relationships with the other parts of the operation and understand how the various departments
and teams interact with each other and how they all support the overall organization.
 3. Communicating plans to various managers: Communicating plans to managers is an
important social aspect of the process, which ensures that everyone gets a clear understanding of
how they support the organization. It encourages communication of individual goals, plans, and
initiatives, which all roll up together to support the growth of the business. It also ensures
appropriate individuals are made accountable for implementing the budget.
4. Motivates managers to strive to achieve the budget goals: Budgeting gets managers to focus
on participation in the budget process. It provides a challenge or target for individuals and
managers by linking their compensation and performance relative to the budget.
5. Control activities: Managers can compare actual spending with the budget to control financial
activities.
6. Evaluate the performance of managers: Budgeting provides a means of informing managers of
how well they are performing in meeting targets they have set

Budget manual
This contains the guidelines for the preparation of various budgets, and set out the responsibilities of
the persons engaged in the routine of and the form and records required for budgetary control. The
manual is referred to for clarification of procedure details and formats to be used.

Principal budget factor

The Principal budget factor is also known as limiting factor or key budget factor is a factory,
which at any time is an overriding planning limitation on the activities of the organization.
Examples including staffing limitations, scarcity of materials and other logistics, limited
financial resources, low sales demand, limited storage facilities etc.
Types of budget
1. Short-term budgets typically only cover a one-year span of time or less. The estimated
revenues and expenses are set at the beginning of the year and the actual numbers are
evaluated later in the period to see if they “met the budget.” They are detailed, containing
well-defined targets, which translate into work plans and performance measurements for
each unit in the business. Short term budgets are a means of implementing strategic plans.
2. Long-term budgets cover time periods of one-year or more and are usually are quite
general. Since it’s difficult enough to estimate production expenses and sales volumes in
the current period, it’s even more difficult for years into the future. Instead, long-term
budgets general tend to focus on large investments and broad company goals. The
planning process involves: identify objectives, search for alternative courses of action,
3. Fixed budget are prepared for one level of activity, which means the budget remains
unchanged no matter the level of activity actually attained. It is done majorly for the short
period of time. It is liable to revision if due to business conditions undergoing a basic
change or due to other reasons actual operations differ from those planned in the fixed
budget.
 4. Flexible budget is a budget which by recognizing the difference between fixed, semi-
variable and variable cost is designed to change in relation to the level of activity
attained. It represents the amount of expense that is reasonably necessary to achieve each
level of output specified.
5. Master budget summarizes all the budgets into a coordinate projected financial statement.
It embraces both operating decisions and financial decisions. The master budget
comprises of budgeted trading, profit and loss account, budgeted statement of affairs and
budgeted cash flow statement for the period.
6. Functional budget are the budgets developed for the operations of each function in the
organization. Functional budget is prepared for each function and they are subsidiary to
the master budget of the business.
Types of functional budget
Sales budget, production budget, purchase budget, cash budget, production cost budget,
capital expenditure budget, selling and distribution cost budget. Etc.

MASTER BUDGET
A master budget is composed of both operating and financial budget.
Operating budget is expressed in both units and Naira. When an operating budget relates to
revenues, the units presented are expected to be sold and the naira reflect selling prices, then
when an operating budget relates to cost, the input units presented are expected to be transformed
into output units or consumed and the naira reflect costs.
Monetary details from the operating budgets are aggregated to prepare financial budgets. Which
indicates the funds to be generated or consumed during the budget period. Financial budget
includes cash and capital budget as well as projected or pro forma financial statements.
The master budget is prepared for a specific period and is static based on a single level of output
demand expressed at that point in time.
The master budget is highly useful to top management, since all the meaningful information is
available in just one form
It also gives an overall estimated profit of the organization
It gives information about forecast financial position
It enables the company to estimate the profitability at the end of the year
It also results in improved communication within the organization
It gives the company a clear sense of direction and approach that can be used as an increasingly
important planning tool.
FUNCTIONAL BUDGET
Functional budgets are budgets developed for the operations of each function in the organization.
The budget for the function that has the binding or effective budget factor or limiting factor id
first developed bearing in mind the budget factor. Then all the other functional budget are
subsequently developed from the budget of the function with the binding constraint.

Illustration
Kemi Ltd manufactures two products A and B. The products use the same raw materials RM1
and RM2. But in different proportions:s
One bag of A uses 20kg of RM1 and 30kg of RM2
One bag of B uses 25kg of RM1 and 25kg of RM2
The following estimates are relevant for next year:
(i) Raw Materials RM1 RM2
- Cost per kilo #5,000 #4,000
- Opening stock (kg) 10,000 8,000
- Closing stock (kg) 2,000 1,000
- Provision for loss 500 300
(ii) Finished Products A B
- Sales (bags) 200,000 150,000
- Selling price per bag #30,000 #22,000
- Opening stock (bags) 40,000 25,000
- Closing stocks (bags) 10,000 5,000
(iii) Direct labour hours required
per unit of each product 8hrs 5hrs
Standard wage rate of direct labour is #5,000 per hour
You are required to prepare:
a. Sales budget
b. Production budget
c. Material Purchase Budget for next year
d. Direct labour Budget for next year
CASH BUDGET
Cash budget summarizes the cash flow effects of all the functional and policy related budgets by
coordinating them into one summarizes statement.
It represents the cash receipts and payment and the estimated, cash balance for each of the
budget period.
It is usually developed to cover monthly or quarterly control period.
Benefits of cash budgeting includes:
i. Expected cash deficits are identified in advance of and financing planned to avoid a
situation where commitments cannot be met due to lack of cash
ii. Helps to minimize cash committed to surplus balances by carefully planning how
surplus cash should be invested
iii. Synchronizing receipts and payments to ensure the carrying out of all operations as
scheduled.
iv. To ensure that significant cash is available when required
Preparation of cash budget
The information on which the cash budget is prepared comes from the following sources
i. The sales budget, with a receivable budget, indicating cash receipts;
ii. Materials budget, with a payable budget indicating cash expenditure;
iii. Total expenses budget and a secondary payable budget
iv. Total Labour or Payroll budget
v. Policy budget which reveal such items as tax, dividends, interest, and possibly
anticipated new sources of funds such as new share issued, debenture issues,
mortgage and so on
vi. Fixed asset or capital replacement and investment budget.
First ascertain all expected cash receipts or inflows.
Secondly, ascertain all expected payments or cash outflows.
Thirdly, ascertain the differences between the expected cash inflow and the expected cash
outflow. It will result to either surplus or deficit.
Finally, add the opening cash balance to the obtained surplus or deficit. The result of this
addition will be the expected closing cash balance.
Non cash expenses such as depreciation, provision for doubtful debts etc are not treated in
the cash budget. Also the timing of the various cash flows is extremely important.

ILLUSTRATION
Danni Ltd produces items for domestic use. The company experienced theft in the office thereby
losing all cash on hand in the process. On the date of the theft, the company had an overdraft
balance of #125 million with its bankers. The bank agreed on a short term loan of #500 million
granted to the company on 31st December, 2013 on the following terms:
 Facility - Short term loan
Duration - One year
Interest - 27.504% per annum simple interest
Repayment - Principal payment in 4 equal quarerly installments
- Interest payable monthly in arrears
(i) From the following additional information, prepare a cash budget for the company for the
six months ended 30th June 2014.
(a) Production in units:
2013 2014
Nov Dec Jan Feb March April May June
5,000 6,000 5,000 8,000 6,000 5,000 5,000 6,000ss
(b) Raw materials used for the production cost #10,000 per unit. Of this 25% is paid in
the same month as production and 75% in the month following production
(c) Direct labour costs of #1,000 per unit are payable in the same month as production
whilst variable expenses are #6,000 per unit, payable 50% in the same month as
production and the remainder in the following month.
Sales
2013 2014
Oct Nov Dec Jan Feb March April May June
200 600 600 768 720 640 500 500 560
All sales are on credit and debtors take an average credit period of two months.
Fixed overheads are #18 million per month, payable each month.
A new packaging equipment costing #84 million is to be paid for equally in March and
September 2014. It has a useful life of 5 years and a straight line depreciation policy. The
depreciation of this equipment has not been included in the fixed overheads above
Rent income of #6million per quarter is to be received at the end of each quarter.