Topic 5: Financial Planning and Budgets

Introduction
• Budget is defined as a plan expressed in quantitative terms on how to acquire and use the
resources of an entity during and over a certain future period of time.
• Budgeting Process involves a lot of planning taking into consideration the goals and objectives of
the company. The primary consideration why the budgeting process must take place is for
planning and control.

Importance of Budgeting in Organizations

1. Planning
2. Facilitating communication and coordination
3. Resource allocation in quantified terms
4. Controlling profit and operations
5. Valuating performance and providing incentives
* Planning – involves developing objectives and preparing various budgets to achieve those objectives
* Control Process – ensuring that objectives are met thus both oriented toward both the present and the
past

Types/Kinds of Budget Reports

1. Master Budget (Fixed or Static Budget) – the overall plan of the organization for a certain period
of time
2. Budgeted Financial Statements (Pro-forma Financial Statements) – it is composed of the pro-
forma balance sheet, income statement, and statement of cash flows
3. Capital Budget – the budget that summarizes the planned asset acquisition of the company
(specifically that of capital assets)
4. Financial Budget – the budget that summarizes the planned financing activity of the company
(either through debt or equity)
5. Rolling Budgets (Continuous, Progressive, Perpetual or Revolving Budget) – a budget that is
continuously updated by extending the time frame by another time period
6. Physical Budget – a budget that is pertaining to non-monetary measures such as direct labor
hours, units and etc.

Organizational Aspects of Budgeting: Budget Administration, Budget Officer, and Budget Manual
• In large companies or corporations, the controller is often assigned as the budget director or
budget officer tasked to collate information to prepare the master budget. The budget
officer/director is governed by the budget manual (which summarizes policies and procedures in
budget preparation). Budgets are approved by the board of directors but are subject to the initial
approval of the budget committee in most organization.
• In budget administration, it must be noted that budgets must be specific, measurable, attainable,
relevant, time bound, communicated, owned, and written. Furthermore, it should encourage goal
congruence and prevent sub-optimization. Furthermore, note that budgets must be viewed with
some element of risk or uncertainty.

Various Techniques in Budgeting

1. Zero-based Budgeting – this budgeting technique does not allow the prior year’s budget to be the
basis of the new budget. Each expense item must be substantiated again.
2. Incremental Budgeting – in contrast with zero-based budgeting, this budgeting technique allows
the use of the prior year’s budget in determining the new budget. Only a % increase or decrease
is necessary.
3. Project Budgeting – this is the budgeting technique used by condominiums that each project has
a separate budget report.
4. Flexible Budgeting (Variable Budget) – this is the budget that can be adjusted for certain levels of
activity.
5. Probabilities Budgeting – this is the budgeting technique that probabilities are used to determine
the appropriate budget.
6. Programs Budgeting – this is the budgeting technique that does not required details of
expenditures. It is normally expressed in lump sum amount.
7. Line Items Budgeting – in contrast with programs budgeting, it requires line items and details
expenditures.
 8. Life Cycle Budgeting – process of estimating total costs and revenues related to each product for
the complete life cycle of the product. A product’s life cycle is the time period covered between
the initial design and development of a product and the termination of its production, marketing,
distribution and customer support.

The Master Budget and Its Preparations

• The master budget shows the overall plan of the organization for a certain period of time. As
such, the master budget is composed of operational budget (which deals with the projected
income statement) and financial budget (which deal with projected balance sheet).
• In preparing master budget, it must be noted that the starting point is the preparation of sales
budget. The preparation of sales budget deals with various information which may come from
various sectors of the organization. The primary technique used in the preparation of the sales
budget is called sales forecasting, which is the process of determining the number of units the
company is expecting to sell for a certain period of time.

Emerging Concepts in Budgeting and the Behavioral Implication of the Budgeting Process
1. Activity Based Budgeting
2. Goal Congruence – alignment of employees’ and management attitudes and actions such that all
parties are acting as a unified whole toward achieving the objectives of the organizations.
3. Budgetary Slack – also known as budget padding/shaving to be able to manipulate budgets to
favor certain personalities or departments such as increasing cost projections or reducing targets
and quotas.
4. Participative Budgeting – Budgets are effective when those who are responsible for carrying out
plans and whose performance will be measured against the outcomes of those plans participate
in the process of budget development.
5. Authoritative Budgeting – top management imposes the budget on the organization.

Operational Budget
1. Sales Budget – it sows the expected sales of the company in units and in pesos. The primary
technique used is sales forecasting.
Time Period
Expected Sales in units XXX
Unit Selling Price XXX
Total Sales XXX

2. Production Volume Budget – it shows the expected number of units to be produced after
considering the beginning inventory and the expected ending inventory of the company.
Time Period
Expected Sales in units XXX
Add: Expected Eding Inventory XXX
Total Inventory Requirement for the period XXX
Less: Beginning Inventory on Hand XXX
Estimated Production in units XXX

3. Direct Materials Purchased Budget – it shows the expected number of direct materials (in units
and in pesos) to be purchased after considering the beginning inventory and the expected ending
inventory of the company.
Time Period
Expected Direct Materials usage in production
XXX
(Production X Raw Materials per unit produced)
Add: Expected Eding Inventory XXX
Total Raw Material Requirement for the period XXX
Less: Beginning Inventory on Hand XXX
Estimated Purchases (in units) XXX
Multiply: Purchase Cost XXX
Estimated Purchases (in pesos) XXX
4. Direct Materials Cost Budget – it shows the expected cost of direct materials used in production.
Time Period
Units to be produced (from production budget) XXX
Multiply: Number of Raw Materials per Unit Produced XXX
Total Expected Usage in Production XXX
Multiply: Unit Cost XXX
Estimated Direct Materials Cost XXX

5. Direct Labor Cost Budget - it shows the expected cost of direct labor cost incurred in production.
Time Period
Units to be produced (from production budget) XXX
Multiply: Number of Hours per Unit Produced XXX
Total Expected Usage in Production XXX
Multiply: Unit Cost XXX
Estimated Direct Labor Cost XXX

6. Overhead Budget – it shows the expected cost of variable and fixed manufacturing overhead
incurred in production.
Time Period
Units to be produced (from production budget) XXX
Multiply: Variable Manufacturing Overhead Cost Per Unit XXX
Total Expected Variable Manufacturing Overhead XXX
Estimated Fixed Manufacturing Overhead Cost XXX
Budgeted Manufacturing Overhead Cost XXX

Note that manufacturing overhead may also be an itemized budget enumerating indirect
materials, indirect labor and etc. It may also be a budget based on standard application rate you
learned in cost accounting. In today’s current practice, overhead budgets are already under the
principle of activity based costing which takes into account the cost hierarchy (unit level, batch
level, product level, and facility and general operations level.)

7. Budgeted Cost of Goods Manufactured and Cost of Goods Sold – the budgeted cost of goods
manufactured shows the total cost of goods expected to be manufactured while cost of goods
sold contains the total cost of goods expected to be sold. This budget is similar to that of cost
accounting. The only difference is that these reports are showing expected/budgeted amounts.
Cost of Goods Manufactured
Time Period
Direct Materials Used XXX
Direct Labor XXX
Manufacturing Overhead XXX
Total Manufacturing Cost XXX
Add: Work in Process, Beginning XXX
Total Cost Placed in Production XXX
Less: Work in Process, End XXX
Cost of Goods Manufactured XXX

Cost of Goods Sold

Time Period
Beginning Inventory XXX
Add: Cost of Goods Manufactured XXX
Cost of Goods Available for Sale XXX
Less: Ending Inventory XXX
Cost of Goods Sold XXX

8. Selling and Administrative Expense Budget – the selling and administrative budget shows the
amount of expenditure that will be directed to selling and administrative expenses.
 Time Period
Units to be Sold (From Sales Budget) XXX
Multiply: Variable Selling and Administrative Cost Per Unit XXX
Total Expected Variable Selling and Administrative Cost XXX
Estimated fixed Selling and Administrative Cost XXX
Budgeted Selling and Administrative Cost XXX

Similar to overhead budget, note that selling and administrative budget may also be an itemized
budget enumerating sales commission, selling personnel salaries and etc. It may also be a
budget based on standard application rate you learned in cost accounting. In today’s current
practice, selling and administrative expense budgets are already under the principle of activity
based costing which takes into account the cost hierarchy (unit level, batch level, product level,
and facility and general operations level.)

9. Budgeted Income Statement – the budgeted income statement shows the forecasted net income
of the company for a specific period of time. It is similar with the income statement in financial
accounting, however, this report shows budgeted amounts.
Time Period
Sales XXX
Less: Cost of Goods Sold XXX
Gross Margin XXX
Less: Selling and Administrative XXX
Net Income XXX

Financial Budget
1. Cash Receipts Budget and Cash Disbursement Budget – the cash receipts budget shows how
the company expect to receive cash from various sources (operations, dividends, and etc.) while
the cash disbursement shows how the company expects to disburse cash for various purposes
(payment of purchases, salaries and etc.)
Cash Receipts
Time Period
Cash Receipts XXX
From Operations XXX
From Other Sources XXX
Total Cash Receipts XXX

Cash Disbursement
Time Period
Cash Payments XXX
To Suppliers XXX
To Other Payees XXX
Total Cash Payments XXX

Cash Budget
Time Period
Cash Receipts XXX
Less: Cash Payments XXX
Cash Generated for the Period XXX
Add: Cash Beginning XXX
Total Cash on Hand XXX
Financing
Borrowing (if needed) XXX
Payment (if with excess cash) XXX
Interest (on borrowing) XXX
Cash Balance Ending XXX
2. Capital Expenditure Budget – the capital expenditure budget shows the planned investment in
long term assets of the company. This shall be discussed in capital budgeting. Just note that the
capital expenditure budget normally shows acquisition of property, plant, and equipment.

3. Budgeted Balance Sheet – the budgeted balance sheet is the same with financial accounting. It
shows the total resources and liabilities of the company.