Budgeting

AFZAL AHMED, ACA

HEAD OF ACCOUNTS
LANKABANGLA FINANCE LIMITED
 Budget

A budget is a quantitative expression of a financial plan for a defined period

of time. It may include planned sales volumes and revenues, resource quantities,
costs and expenses, assets, liabilities and cash flows.

It expresses strategic plans of business units, organizations, activities or events in

measurable terms

The budget of a company is often compiled annually, usually requiring considerable

effort, is a plan for the short-term future, typically allows hundreds of people in
various departments (operations, human resources, IT, etc.) to list their expected
revenues and expenses in the final budget.

If the actual figures delivered through the budget period come close to the budget,
this suggests that the managers understand their business and have been
successfully driving it in the intended direction. On the other hand, if the figures
diverge wildly from the budget, this sends an 'out of control' signal.
 Reasons for preparing budgets

Function Detail

Budgeting forces management to look ahead, to set

out detailed plans for achieving the targets for each
Compel planning
department, each operation and (ideally) each
manager and to anticipate problems.
A formal system is necessary to ensure that each
Communicate ideas and
person affected by the plans is aware of what he or
plans
she is supposed to be doing.
The activities of different departments need to be
Coordinate activities coordinated to ensure everyone in an organisation is
working towards the same goals.
It can be used to decide how many resources are
needed and how many should be given to each area of
Means of allocating
the organisation's activities. Resource allocation is
resources
particularly important when some resources are in
short supply.
 Reasons for preparing budgets

Function Detail

A formal budget delegates authority to budget holders

Authorisation to take action and, within specified control limits, to
incur expenditure on the organisation's behalf.
Budgets require that managers are made responsible
Provide a framework for
for the achievement of budget targets for the
responsibility accounting
operations under their personal control.
Control over actual performance is provided by the
comparison of actual results against the budget plan.
Establish a system of
Departures from budget can then be investigated and
control
the reasons can be divided into controllable and
uncontrollable factors.

Budgets provide targets that can be compared with

Provide a means of actual outcomes in order to assess employee
performance evaluation performance. They also provide a means to establish
a personal incentive and bonus scheme.
 Sales
Budget

Inventory Other Costs Receivables

Budget (FG) Budget Budget

Production
Budget

Raw
Direct Machine
materials
Labour Usage
usage
Budget Budget
Budget

Recruitment
Inventory / Production
Budget (RM) Redundancy OH Budget
Budget

RM
purchased
Budget

Capital
Payable CASH
Expenditure
Budget BUDGET
Budget
 Sample example: Functional Budget

ECO Co manufactures two products, S and T, which use the same raw materials, D
and E.
One unit of S uses 3 litres of D and 4 kilograms of E. One unit of T uses 5 litres of D
and 2 kilograms of E.
A litre of D is expected to cost CU3 and a kilogram of E CU7.
Budgeted sales for 20X7 are 8,000 units of S and 6,000 units of T;
finished goods in inventory at 1 January 20X7 are 1,500 units of S and 300 units of
T, and the company plans to hold inventories of 600 units of each product at 31
December 20X7.
Inventories of raw material are 6,000 litres of D and 2,800 kilograms of E at 1
January 20X7 and the company plans to hold 5,000 litres and 3,500 kilograms
respectively at 31 December 20X2.
The warehouse and stores managers have suggested that a provision should be made
for damages and deterioration of items held in store, as follows.
Product S : loss of 50 units Product T : loss of 100 units
Material D : loss of 500 litres Material E : loss of 200 kilograms
Requirements:
Prepare a material purchases budget for the year 20X2
 Sample example: Master Budget

A new business is to be started and details of budgeted transactions are as follows.

 Non-current assets will be purchased for CU12,000. Depreciation will be charged

on a straight line basis, assuming that the assets will have a useful life of five years
after which they will have no residual value.
 Month-end inventories will be maintained at a level sufficient to meet the forecast
sales for the following month.
 Forecast monthly sales are CU4,000 for January to March, CU5,000 for April to
June and CU6,000 per month for July onwards.
 The gross profit margin is budgeted to be 20% of sales value.
 Two months' credit will be allowed to customers and one month’s credit will be
received from suppliers of inventory.
 Operating expenses (excluding depreciation) are budgeted to be CU350 each
month.
 The budgeted closing cash balance as at 30 June is CU16,700.

Requirements:
Prepare a budgeted income statement for the six months ended 30 June and a
budgeted balance sheet at that date
 Budgetary control

A fixed budget is a budget which is set for a single activity level

A flexible budget recognises different cost behaviour patterns and is designed to

change as the volume of activity changes.

Effective budgetary control involves comparing a flexible budget (based on the

actual activity level) with the actual results. The differences between the flexible
budget figures and the actual results are called budget variances
 Sample example: Flexible Budget
a) Prepare a budget for 20X7 for the variable direct labour costs and overhead
expenses of a production department flexed at the activity levels of 80%, 90%
and 100%, using the information listed below.
(i) The variable direct labour hourly rate is expected to be CU7.50
(ii) 100% activity represents 60,000 direct labour hours
(iii) Variable costs Indirect labour CU0.75 per direct labour hour Consumable
supplies CU0.375 per direct labour hour Canteen and other welfare services 6%
of direct and indirect labour costs
(iv) Semi-variable costs are expected to relate to the direct labour hours in the same
manner as for the last five years.

Year Direct labour hour Semi-variable cost

20X2 64,000 20,800
20X3 59,000 19,800
20X4 53,000 18,600
20X5 49,000 17,800
20X6 40,000 (estimated) 16,000(estimated)
 Sample example: Flexible Budget
(i) Fixed costs:
Depreciation 18,000
Maintenance 10,000
Insurance 4,000
Rates 15,000
Management salaries 25,000

(b) Calculate the budget cost allowance (i.e. expected expenditure) for 20X7
assuming that 57,000 direct labour hours are worked.
 Alternative approaches to budgeting

Incremental budgeting
concerned mainly with the increments in costs and revenues which will occur in the
coming period.

Zero based budgeting

instead of using the current year's results as a starting point, each budget should be
prepared from the very beginning or zero. Every item of expenditure must be
justified separately to be included in the budget for the forthcoming period

Rolling Budget
Rolling budgets are sometimes called continuous budgets. They are particularly
useful when an organisation is facing a period of uncertainty so that it is difficult to
prepare accurate plans and budgets.

Instead of preparing a periodic budget annually for the full budget period, budgets
would be prepared, say, every one, two or three months (four, six, or even twelve
budgets each year). Each of these budgets would plan for the next twelve months so
that the current budget is extended by an extra period as the current period ends:
hence the name rolling budgets.
 Cash Budget & The Cash Cycle
Cash Budget
A cash budget is a statement in which estimated future cash receipts and payments
are tabulated in such a way as to show the forecast cash balance of a business at
defined intervals

Cash Position Appropriate Management Action

Short-term surplus
Short-term shortfall
 Pay suppliers early to obtain discount
 Attempt to increase sales by increasing
receivables and inventories
 Make short-term investments
 Increase accounts payable (delay payments to
suppliers)
 Reduce receivables, for example by tightening
credit control
 Arrange an overdraft
 Cash Budget & The Cash Cycle

Cash Position Appropriate Management Action

Long-term surplus  Make long-term investments

 Expand or diversify, for example by acquisition
 Increase dividends
 Replace/update non-current assets
 Buy back shares

Long-term shortfall  Raise long-term finance (such as via issue of

share capital)
 Consider selling non-current assets
 Consider shutdown/disinvestment opportunities
 Plan a controlled shut down
 Sample example: Cash Budget

ABC operates a retail business. Purchases are sold at cost plus 331/3%
1. Budgeted Sales, Labour cost and expenses:
Sales (CU) Labour (CU) Expenses
Jan 40,000 3,000 4,000
Feb 60,000 3,000 6,000
Mar 160,000 5,000 7,000
Apr 120,000 4,000 7,000

2. It is management policy to have sufficient inventory in hand at the end of each

month to meet half of next month's sales demand.
3. Suppliers for materials and expenses are paid in the month after the purchases are
made/expenses incurred. Labour is paid in full by the end of each month.
4. Expenses include a monthly depreciation charge of CU2,000.
5. 75% sales are on cash and rest are on one month’s credit
6. The company will buy equipment costing CU18,000 for cash in February and will
pay a dividend of CU20,000 in March. The opening cash balance at 1 February is
CU1,000.
Requirements:
Prepare a cash budget for February and March and comment on the result
Thank you