BUDGETING Meaning: A budget is a record plan of action. It is a statement of anticipated results either in financial terms or even non financial terms. Budgetary planning and control is an effective management toll for planning, coordinating and controlling the various business activities. It guides executives to anticipate the influence and impact of a given set of events on the firm’s business and its resources.
Budgetary control is a systematic process of planning the best use of resources to achieve a business objective.
A budget is a detailed schedule of the proposed combinations of the various factors of production which the management deems to be the most profitable for the ensuring period. It may be a forecast of sales, production costs, distribution costs, and administrative and financial expenses – and, therefore, of profit or loss.
“ Budgetary control is a system which use budgets as a means of planning and controlling all aspects of producing and or selling commodities or services”.
“ Budgetary control is a system of controlling costs which includes the preparation of budgets, coordinating the departments and establishing responsibilities, comparing actual performance with the budgeted and acting upon results to achieve maximum profitability.”
Budgetary control is a process of managing an organization in accordance with an approved budget in order to keep total expenditure within authorized limits. It is designed to assist management in deciding the future course of action and to develop basis for evaluating the efficiency of operations;
A budgetary control consists of:
Preparation of budgets for major activities of the business.
Measurement and comparison of actual results with budgeted targets.
Computation of deviation, if any
Revision if budget, if required.
Objectives of the Budgetary Control:
Budgets provides useful information for formulating future business policies.
Budgetary control helps in economizing cost of production, Effective budgetary control helps in exercising control over costs by preparing separate budgets for each department. Wastage are ascertained and arrangements are made for their removal.
Budgetary control is a powerful tool of business administration as it helps in evaluating the results of various policies and facilitate supervision over the various factors of production.
4. Accurate estimates of fixed and working capital requirements are formed, It eliminate the danger or over capitalization and under capitalization.
5. It locates deficiencies in production system easily as separate production budget is prepared to ascertain the efficiency of production.
Essential characteristics of a good budgetary control:
There must be a common authority to enjoy the rights, actual users must be consulted before actually allocating different resources.
The supervisory staff must be held responsible for all the functions of the business and proper utilization of all the resources of the business.
There must be test checking of the work at regular intervals and the results must be compared with the targets. Shortcomings must be ascertained and methods should be suggested to overcome them.
Take necessary action in execution of plans to correct unsatisfactory performance
4. Develop a statement of profit objectives and policies to guide management in reaching its business goals.
5. Develop a sound plan for organization with clearly defined responsibilities and authorities for each management and supervisory position.
6. Establish a clear understanding of cost behavior and product cost structure.
7. Develop a plan of operations over a given period of time to achieve objectives with minimum of waste and inefficiency.
8. Revised the budgets when required.
Classification of Budgets:
A- According to Activity level:
1. Fixed budget
2. Flexible budget
B – On the basis of nature of transactions:
1. Operating budget
2. Capital budget
C – On the basis of period:
1. Long term budget
2. Short term budget
D – On the basis of Functions:
1. Master budget
2. Subsidiary budget
Subsidiary budgets classified as:
1. Sales budget
2. Production budget
3. Production cost budget
4. Material budget
5. labour budget
6. Manufacturing overhead budget
7. Expenses budget
8. Plant budget
9. Cash budget
A budget which is designed to remain unchanged irrespective of the level of activity actually attained.
The fixed budget is generally a predetermined costs projected at a particular level, Once capacity is projected at a particular level, the individual department gather and classify their costs at that level. It is a plan that expresses only one level of estimated activity or volume, such a budget is also known as static budget.
2. Flexible Budget:
A flexible budget is , by recognizing the difference between fixed, semi-fixed and variable costs, is designed to change in relation to the level of activity attained.
Thus, a flexible budget is a series of cost budgets, each prepared for a different level of capacity. Capacity levels are set at percentages of capacity or at the production of a specified number of units at set levels of capacity.
3. Operating Budget:
The operating budget is a plan of the expected revenues and expenses from normal operations and activities. The operating budget contains a detailed programme of activities that a firm wishes to perform during the budget period. The profit and loss items like sales, production, distribution expenses and administrative overheads are also projected in this budget. The best example of operating budgets are raw material budget, inventory budget, labour force budget etc.
4. Capital Budget:
Capital budget is a plan of future investments in fixed asses and also includes amounts for large expenditure that have a long term impact on the financial worth and prosperity of the firm.
5. Short term Budgets:
Short term budgets cover a budget period of year or shorter. Firms prefer to prepare short term budgets in the sales, cash overheads etc. Such budgets are often broken down to shorter period for 6 months, 3 months and even each month.
6. Long term Budgets:
Long term budgets may cover period of one, three, five and even more years depending upon the nature of the business.
“ A long term budget is a systematic and formalized process for purposeful directing and controlling future operations towards a desired objective for periods extending beyond one year.”
7. Master Budget:
The master budget is expressed in financial terms and sets out management's plan for the operations and resources of the firm for a given period of time.
Thus, master budget is an overall budget of the firm which includes all other small departmental budgets. It is network consisting of many separate budgets that are interdependent. It coordinates various activities of the business and puts them on correct line. In fact the master budgets contains consolidated summary of all the budgets prepared by the organization.
# Preparation of master budget involves the following steps:
1. Preparation of sales budget.
2. Preparation of production cost budget.
3. Preparation of the cost budget.
4. Preparation of the cash budget.
5. Preparation of projected profit and loss A/c on
the basis of information collected from above
stated four steps.
6. Preparation of projected balance sheet from the
information available in last year’s balance sheet
and with the help of five steps stated above.
8. Subsidiary Budgets:
Subsidiary budgets are those budgets which shows income or expenditure appropriate to or the responsibility of a particular activity of the business. They are prepared on the basis of the guidelines framed by the master budgets.
Ex- Sales budget, production budget, production cost budget, materials budget, labour budget, manufacturing overheads budget, expenses budget, plant budget, cash budget.
A sales budget is an estimate of future sales expressed and incorporated in quantities and or money. A company will have some sort of sales projection, which will be made on a periodic basis and the sales budget will be prepared based on both internal and external factors.
The sales manager should be directly responsible for the preparation and execution of the budget. The sales budget may be prepared according to products, sales territories, type of customers, salesman etc.
In the preparation of sales budget, the sales manager should take into consideration the following factors:
Past sales figures and trends.
Availability of raw material and other supplies.
General trade prospects.
Orders in Hand.
Adequate return on capital employed
Example 1: A manufacturing company submits the following figures of product ‘x’ for the first quarter of 2004.
Sales (in units) January 50,000
Selling price per unit Rs.100
Target of 1 st quarter 2005:
Sales quantity increase 20%
Sales price increase 10%
For the first quarter of 2005
66,00,000 52,80,000 79,20,000 ------------- 1,98,00,000 110 110 110 60,000 48,000 72,000 January February March Value Price per unit Units Month
2. Production Budget:
The production budget is an estimate of production for the budget period. It is first drawn up in quantities of each product and when the remaining budgets have been prepared and cost of production calculated, then the quantities of production cost are translated into money terms, what in effect becomes a production cost Budget.
3. Production cost Budget:
This budget shows the estimated cost of production. The production budget shows the quantities of production. These quantities of production are expressed in terms of cost in production budget. The cost of production budget is shown in detail in respect of material cost, labour cost, factory overheads.
Example 2 : The following has been made available from the records of XYZ ltd. For the six months of 2002 (and the sales of January 2003) of product X.
The units to be sold in different months are:
July 2002 1,100 November 2,500
August 1,100 December 2,300
September 1,700 January 03 2,000
2. Finished units equal to half the sales of the next month will be in stock at the end of every month (including June,2002).
3. Budgeted production and production cost for the year ending 31 st Dec. 2002 are:
Production (units) 22,000
Direct materials per unit Rs. 10
direct wages per unit Rs. 4
Total factory overheads
Apportioned to production Rs.88,000
You are required to prepare :
Production budget for the six months of 2002.
2. Summarized production cost budget for the same period.
Production Budget for the six months ending Dec. 2002 1,700 950 ____ 2,650 850 ------- 1,800 Sep.Units 1,900 1,250 ____ 3,150 950 ------- 2,200 Oct. Units 2,500 1,150 ____ 3,650 1,250 ------- 2,400 Nov.Units 1,100 850 ____ 1,950 550 ------- 1,400 Aug.Units 1,100 550 ____ 1,650 550 -------1,100 July Units 11,050 2,300 1,000 ____ 3,300 1,150 ------- 2,150 Estimated sales Add: Closing Stock (half the sales of next month) Less: Opening Stock Production Total Units Dec.Units
Production cost Budget
For the six months ending Dec. 2002
1,10,500 44,200 44,200 ------------- 1,98,900 @Rs.10 x 11,050 @Rs.4 x 11,050 @Rs.4 x 11,050 Direct Materials Direct Wages Factory overheads 88,000/ 22,000 =Rs.4 Total Production cost Cost per unit
4. Material budget:
Material budget is prepared with a view to ensure regular supply of raw material of the required quantity according to the requirements of production schedules. A schedule of materials requirement is prepared, indicating for each product the unit quantities of each material required per unit of finished product.
Example 3: Draw up a material requirement budget from the following information:
Estimated sales of a product – 40,000 units , each unit of the product requires 3 units of Material A and 5 units of material B.
Estimated opening balances at the commencement of the next year: Finished product 5,000 units , Material A 12,000 Material 20,000units; Material on order – Material A – 7,000units Material B-11,000units. The desirable closing balance at the end of next year : Finished product – 7,000 units ; Material A – 15,000 units, Material B – 25,000 units; Material on order – Material A – 8,000 units and Material B – 10,000 units.
Solution: Estimated production during the next year is not given in the question. It is calculated as:
Estimated production = Expected sales + Desired closing
stock of finished goods – estimated opening stock
of finished goods
= 40,000 units + 7,000 units – 5000 units
= 42,000 units
Material Requirement Budget 2,10,000 25,000 10,000 ----------- 2,45,000 1,26,000 15,000 8,000 ----------- 1,49,000 Material required to meet production target: Mat.A-@3 units for 42,000 fin.unit Mat.B-@5 units for 42,000 fin.unit Desired clog. bal. of materials at the end for the budget period Estimated units of materials to be on order at the end of the budget period Material B Units Material A Units
20,000 ---------- 2,25,000 11,000 ----------2,14,000 12,000 ---------- 1,37,000 7,000 ---------- 1,30,000 Less: Estimated opening balance Less: Estimated units of material ordered at the beginning
5. Purchase Budget:
Purchase budget mainly depend on production budget and material requirement budget. This budget provides information about the materials to be acquired from the market during the budget period. The following factors should be considered.
Quantity and quality of raw material needed.
The present stock position and materials expected to arrive.
The dates on which purchase items are required.
Prices of items to be bought and possibility of quantity discount.
5. Sources of supply.
6. Availability of cash to settle accounts of supplies.
7. Transport requirements.
8. Storage capacity and other factors such as handling of stocks, insurance, shrinkage etc.
Example 4: P Ltd. Manufactures two products using one type of material.
Product A Product B
Budgeted sales (in units) 3,600 4,800
Budgeted material consumption
Per product (kgs.) 5 3
Budgeted material cost Rs.12 per kg.
There are twelve 5-day weeks in the budget period and it is anticipated that sales and production will occur evenly throughout the whole period.
It is anticipated that stock at the beginning of the period will be : Product A 1.020 units; Product B 2,400 units; Raw materials 4,300 kgs.
The target closing stocks, expressed in terms of anticipated activity during the budget period are : Product A 15 days sales; Product B 20 days sales ; Raw material 10 days consumption.
Prepare material purchase budget showing the quantities and values for the next period.
Material Purchase Budget
29,400 4,800 1,600 4,800 x 20 60 days ------------------ 6,400 2,400 4,000 3 12,000 3,600 900 3,600 x 15 60 days ----------------- 4,500 1,020 3,480 5 17,400 Budgeted sales (units) Add: closing stock Less: Anticipated op.st. Production requirement Material constn. Per unit Mat. Req. for production (Pro. Req. x Mat. Contn ) Kgs. Product B Product A
4,900 34,300 4,300 30,000 Add: Closing stock of Mat. for 10 days constn. 29,400 60days x 10 Less: Opening stock of Mat. Total Mat. To be Purchase Cost of materials to be Pur. 30,000 x Rs.12 = Rs. 3,60,000
6. Labour Budget:
This budget gives an estimate of the requirements of direct labour essential to meet the production target. This budget may be classified into labour requirement budget and labour recruitment budget.
The labour requirement budget is developed on the basis of requirement of the production budget given and detailed information regarding the different classes of labour required for each department, their scales of pay and hours to be spend.
Ex. Fitters, welders, turners, millers, grinders, drillers etc.
Labour recruitment budget is prepared on the basis of labour requirement budget after taking into consideration the available workers in each department, the expected changes in the labour force during the budget period due to the labour turnover. This budget gives information about the personnel specifications for the jobs for which workers are to be recruited, the degree of skill and experience required and the rates of pay.
Example 5: P Ltd. Manufactures two products using one grade of labour. Shown below is an extract from the company’s working papers for the next period’s budget:
Product A Product B
Budgeted production (units) 3,480 4,000
Standard hours allowed
per product 5 4
Budgeted wage rate Rs.8 per hour.
Overtime premium is 50% and is payable, if a worker works for more than 40 hours a week. There are 90 direct workers.
The target productivity ratio (or efficiency ratio) for the productive hours worked by the direct workers in actually manufacturing the production is 80%; in addition the non-productive downtime is budgeted at 20% of the productive hours worked.
There are twelve 5 days weeks in the budget period.
Calculate the wages budget for direct workers showing hours required and wages paid.
Direct workers wages budget 41,750 3 ,350 50,100 Standard hours for budgeted production at target efficiency ratio is 80% = 33,400 hours x 100 80 Add: Normal Production down time (20% x 41,750) Total labour hours required 33,400 4,000 16,000 (4000 x4) 3,480 17,400 (3480 x5) Production in units Standard hours for production (Standard hours x production) Total Hours Product B Product A
43,200 6,900 3,45,600 82,800 4,28,400 Less: Normal labour hours (90 worker x 12 weeks x 5 days x 8 hours) Overtime Wages for normal hours (43,200 x Rs.8) Overtime wages (6,900 x Rs.12) Total Wages
7. Manufacturing Overheads Budget:
This budget gives an estimate of the works overheads expenses to be incurred in a budget period to achieve the production target. The budget includes the cost of indirect materials, indirect labour and indirect works expenses. The budget may be classified into fixed cost, variable cost and semi-variable cost.
In preparing the fixed works overheads can be estimated on the basis of past information after taking into consideration the expected changes which may occur during the budget period. Variable expenses are estimated on the basis of the budgeted output because these expenses are bound to change with the change in output.
8. Expenses Budget:
The budget covers the expenses incurred in framing policies, during the organization and controlling the business operations. The budget provides an estimate of the expense of the central office and of management salaries.
Expenses budget consists of several sections namely factory overheads, administration expenses, and sales and distribution expense. These budgets are prepared on the basis of figures of income statements of the previous years.
9. Plant Budget:
This budget lays down the requirements of plant capacity to carry out the production as per the production programme. This budget is expressed in terms of convenient physical units as weight or number of products or working hours.
It will show the machine load in each department during the budget period.
It will indicate the overloading on some departments, machine or group of machines.
Idle capacity in some departments may be utilized by making efforts to increase the demand for the products by providing after sale service, advertisement campaign, reducing prices.
10. Cash Budget:
The cash budget is one of the most important and one of the last to be prepared. It is a detailed estimate of cash receipts from all sources and cash payments for all purposes and the resultant cash balance during the budget period. It makes certain that the business has sufficient cash available to meet its needs as and when these arises.
It is a device for coordinating and controlling the financial side of the business to ensure solvency and provide a basis for planning and financing required to cover up any deficiency in
The main purpose of cash budget is
It ensure that sufficient cash is available when required.
It indicates cash excesses and shortages so that action may be taken in time to invest any excess cash or to borrow funds to meet any shortages.
It establishes a sound basis for credit.
It shows whether capital expenditure may be financed internally.
It establishes a sound basis for control of cash position.
Preparation of Cash Budget:
There are three methods of preparing cash budget
1. Receipt and payments method.
2. Adjusted Profit & Loss method.
3. Balance Sheet Method.
1. Receipt and payments methods:
This method is usually used for short term cash forecast and is much more detailed than the other two methods. The cash budget begins with the opening balance of cash in hand and at bank. To this will be added the estimated cash receipts from various sources and from this will be deducted all estimated payments of cash, whether on capital or revenue account .
Cash Budget for the quarter ending 31 st March Total receipts (A+B)
Receipts from debtors
Issue of shares etc.
Total Mar Feb Jan
Closing Balance (A+B-C) Total Payments (C) C . Payments: Cash Purchases Trade creditors Wages and salaries Dividend payable Capital expenditure Taxes
Example 6: Exports Ltd. Wishes to arrange overdraft facilities with its bankers during the period April-June 2003 when it will be manufacturing mostly for stocks. Prepare a cash budget for the period from the following data, including the extent of the bank facilities the company will require at the end of each month.
Period Sales Purchases Wages
Feb. 1,80,000 1,24,000 12,000
March 1,92,000 1,44,000 14,000
April 1,08,000 2,43,000 11,000
May 1,74,000 2,46,060 10,000
June 1,26,000 2,68,000 15,000
50% of the sales are realized in the month following the sales and the remaining 50% in the second month following. Creditors are paid in the month following the month of purchase. Cash at bank on 1 st April 2003 is Rs.25,000.
Example 7: A company is expecting to have Rs.25,000 cash in hand on 1 st April 2003 and it requires you to prepare cash budget for the three months. April to June 2003 from the following.
Months sales Purchase Wages Expenses
February 70,000 40,000 8,000 6,000
March 80,000 50,000 8,000 7,000
April 92,000 52,000 9,000 7,000
May 1,00,000 60,000 10,000 8,000
June 1,20,000 55,000 12,000 9,000
Period of credit allowed by suppliers is two months.
25% of sale is for cash and the period of credit allowed to customers for credit sale is one month.
Delay in payment of wages and expenses one month.
Income tax paid Rs.25,000 is to be paid in June 2003
Cash Budget for three months ending June 2003
91,000 81,000 53,000 Closing Balance (A+B-C) 95,000 66,000 55,000 Total - C 52,000 10,000 8,000 25,000 50,000 9,000 7,000 -- 40,000 8,000 7,000 -- C. Payments: Creditors Wages Expenses Income Tax 1,05,000 94,000 83,000 Total receipts (A+B) 81,000 30,000 75,000 53,000 25,000 69,000 25,000 23,000 60,000
June May April
Calculation of Sales:
For the month of April = 75% of Sales of March
= 80,000 x 75%
2. For the month of May = 75% of sales of April
= 92,000 x 75%
3. For the month of June = 75% of sales of April
= 1,00,000 x 75%
Calculation of Debtors:
For the month of April = 50% of Sales of March
1,92,000 x 50%
2. For the month of May = 50% of sales of April
= 1,08,000 x 50%
3. For the month of June = 50% of sales of May
= 1,74,000 x 50%
Example 8: A department of AXY company attains sales of Rs.6,00,000 at 80% of its normal capacity. Its expenses are given below:
Office salaries 90,000
General expenses 2% of sales
Rent and rates 8,750
Selling costs: Salaries 8% of Sales
Traveling expenses 2% of sales
Sales office 1% of sales
General expenses 1% of sales
Rent 1% of sales
Other expenses 4% of sales
Draw up Flexible Administration, Selling and Distribution costs budget, operating at 90%, 100% and 110% of normal capacity.
Calculation of Sales:
Sales at 80% is Rs.6,00,000
Sales at 90% is 6,00,000 x 90
80 = 6,75,000
Sales at 100% is 6,00,000 x100
80 = 7,50,000
Sales at 110% is 6,00,000 x 110
80 = 8,25,000
Flexible Budget of AXY company 66,000 16,500 8,250 8,250 60,000 15,000 7,500 6,750 54,000 13,500 6,750 6,750 48,000 12,000 6,000 6,000 B- Selling Costs: Salaries 8% of sales Trvlg. Exp. 2% of sales Office sales 1% pf sales Gen. exp. 1% of sales 1,22,750 1,21,250 1,19,750 1,18,250 Total - A 90,000116,500 7,500 8,750 90,000 15,000 7,500 8,750 90,000 13,500 7,500 8750 90,000 12,000 7,500 8,750 8,25,000 7,50,000 6,75,000 6,00,000 Sales A-Administration Costs: Office salaries (fixed) Gen. exp. (2% of sales) Depreciation (fixed) Rent & rates (fixed) 110% 100% 90% 80%
2,78,000 2,63,750 2,49,500 2,35,250 Total Cost (A+B+C) 56,250 52,500 48,000 45,000 Total - C 15,000 8,250 33,000 15,000 7,500 30,000 15,000 6,750 27,000 15,000 6,000 24,000 C – Distribution costs: Wages (fixed) Rent (1% of sales) Other expenses (4% of Sales) 99,000 90,000 81,000 72,000 Total - B