Chapter: Budgeting

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 Budgeting
A Budget is a future plans express in numerical and
quantitative terms for a defined period of time. For
example, forecasts of sales, expenses, profit, cash flows,
Capital expenditure, and financial position (Balance sheet),
etc.
The budget of a company is often compiled annually, but not
necessarily.
Budget is used for two distinct purposes planning & control.
Planning involves developing goals & preparing various
sectional budgets to achieve the goals.
Control involves the steps, which are to be taken necessarily
to achieve the goals. Good planning without effective
control is a waste of time.
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Advantages of Budgeting
Following are the benefits of Budgeting:
1. Budgets communicate management’s plan
throughout the organization.
2. Budgets force managers to think about plan for
future.
3. The budgeting process provides a means of
allocating resources to those parts of the
organization where they can be used most
effectively.
4. The budgeting process can uncover potential
bottlenecks before they occur. 3
5. Budgets coordinate the activities of the
entire organization by integrating the
plans of its various parts.
6. Budgets define goals and objectives
that can serve as benchmarks for
evaluating subsequent performance.
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 It represents a comprehensive plan for
Master Budget:

achieving a firm’s profit goals.

The master budget consists of two major
categories:
1. Operating budget.
2. Financial budget.

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 1.Operating budget
Operating budget is the budget for income statement elements, such
as revenues and expenses. It shows a detailed plan regarding
revenues & expenses required to achieve a firm’s profit goals.
It contains the following components:
(i).Sales budget.
(ii).Production budget.
(iii).Direct raw materials purchase budget.
(iv).Direct labor budget.
(v).Manufacturing overhead budget.
(vi).Cost of goods sold budget.
(vii).Selling expense budget.
(viii).Administration expense budget.
(ix). Financial charges budget
(x).Income statement budget.
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 2. Financial Budget

Financial budget is the budget for balance sheet elements. In

other words, financial budget deals with financial position,
cash flow statement, & capital expenditure needed for
achieving the operating budget.
It shows the cash flows, financial position & capital
expenditure needed for achieving the operating budget.
It contains the following components:
(i)Cash Budget
(ii).Capital expenditure Budget
(iii).Balance sheet budget.

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1. Operating budget:
(i). Sales budget:
Sales budget shows sales forecast (product wise)
in terms of units & rupees. Normally it is made
month wise & including year’s total.
Sales budget is the beginning point for operating
budgeting.
►Formula:
Sales units x sales price = Sales value

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(ii).Production Budget:
Production budget shows number of units to
be produced to meet sales & desired ending
inventory requirements of finished goods.
It is prepared after finalization of Sales
budget.
►Formula:
Sales units + Desired ending finished goods
inventory – Beginning Inventory of finished
goods inventory
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(iii).Direct materials purchase budget:
It specifies the direct materials that must be
purchased to meet the production & desired
ending inventory of raw materials.
It is prepared after the finalization of production
budget. It is prepared in terms of units (KG,
units, etc) and as well as in rupees.
►Formula:
Production budget units X Raw material usage
Qty/unit + desired ending Inventory of Raw
material – Beginning Inventory of Raw material
= KGS/ units x unit price
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(iv).Direct Labor Budget:
The direct labor budget shows the direct
labor hours and labor costs required to
satisfy/meet the production budget.
It is prepared after finalization of
production budget.
► Formula:
Production budget units X Standard direct
labor hours/unit X Standard direct labor
rate per hour
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(v).Manufacturing overhead budget:
It shows item wise details of production costs except
direct materials & direct labor.
Further each item of manufacturing overhead budget
should also be separated into variable & fixed costs.
Variable overhead depends on per hour or unit,
where as fixed overhead will be estimated on lump
sump basis. Thus for preparing manufacturing
overhead budget, we need next year’s production
activity & group wise variable rates.

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(vi).Cost of goods sold Budget:

It contains direct materials consumption,

direct labor, and factory overhead plus
the adjustments of work in process and
finished goods inventories.

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(vii).Selling expense Budget:
It shows “item wise details of necessary Selling expenses
needed to generate the budgeted sales volume for the year.
Selling expenses may also be distinguished in terms of fixed &
variable expenses.
Examples of selling expenses are salaries and wages,
advertising expenses, sales men commissions, travelling, etc.
(viii).Administrative expenses Budget:
It shows the “item wise details relating to general administration”.
Normally general administration expenses are fixed in nature.
Examples of administrative expenses are salaries and wages, audit
expenses, legal expenses, bad debts expenses, depreciation of
office building, etc.

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(ix). Financial charges Budget
It shows interest expenses and other bank
charges against short term and long term loans
 (x).Income statement Budget:
All above operating Budgets are finally
summarized & consolidated to show the net
income in a standard format of income
statement.

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2. Financial budget.
(i)Cash Budget:
It shows the cash receipts from cash sales, credit sales(A/C
receivables) & others, such as interest income, dividend
income, loans and cash disbursement to creditors, employees,
payment for acquisition of fixed assets, payment to banks
against financial charges and as well as principal, etc. and
cash balances at beginning of the month/year & ending
month/year end.
Normally a separate indication is made in budget to show for
cash receipts from A/C receivables (sales) from each month &
cash disbursement to creditors (purchases) from each month.
The cash budget may be composed of the following sections:

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 ABC Company
Cash Budget
For the year ending December 31, 2020
Particulars ----- ► Months ◄ - Total
Cash inflows:
Cash sales

Collections from accounts receivable

Collections on loan

Other income collections

Total cash inflows {A}

 
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Cash outflows:
-- ► Months ◄ - Total
Payments on purchase of raw materials
Payments on wages and salaries
Payments on rent
Payments on interest on debt
Repayment on loan
Payments on taxes
Other payments
Total cash outflows {B}
Net Cash inflows/ (Outflows) {A-B}
Add: Beginning cash balance
Ending cash balance

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(ii).Capital expenditure Budget:
It shows the acquisition of fixed assets in the expectations
of getting long term benefits from them.
e.g. Purchase of Plant & Machinery, Vehicles, construction
of building, etc.

iii).Budgeted Balance sheet:

It shows the financial positions of the company
in the form of Assets, liabilities & stock holders’
equity on a particular date.
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……The end……
☺Thanks☺

Prepared by: S. Z. Jafar

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