Budget Classification


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Classification of budget according to Time, Function and Flexibility. Long term budget, Short term budget, Long term budget, Short term budget, Sales budget, Production budget

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Budget Classification

  1. 1. Budget Classifications SUBMITTED BY:- KUNDAN GANVIR
  2. 2. What is a Budget? ICMA defines budget as: “A budget is a quantitative statement, for a defined period of time, which may include planned revenues, expenses, assets, liabilities and cash flows. A budget provides a focus for the organizations, aids in the co-ordination of activities and facilitates control.”
  3. 3. Classification of Budgets According to time Long term budget Short term budget According to function Sales Budget Production Budget Cost of Production Budget R&D Budget Cash Budget Master Budget According to flexibility Fixed Budget Flexible Budget
  4. 4. Classification of Budget according to Time Short Term Budget • May cover periods of three to twelve months depending upon nature of business • Should be long enough to allow completion of a season or all aspects of a business • The period should coincide with financial accounting period to facilitate evaluation of performance e.g. A budget allocated to manufacturing of lots for spring- summer season, Fashion Retailing, etc. Long Term Budget • A systematic and formalized process for directing & controlling operations for period extending beyond one year • It evaluates future implications associated with present decisions • Market trends, change in demographics, national income, etc. play important role in preparing long term budget • It proves useful in forecasting and evaluation of an organization over period of time e.g. A father planning money requirement for his child’s future
  5. 5. Examples on short term and long term budget • Short Term budget: A student allocating his/her pocket money to his monthly expenses like food, clothing, rent, leisure activities, stationaries, etc. • Long Term budget: A father planning future of his children: College expenses – Child 1 (current age 8); $20,000/year beginning in 10 years Child 2 (current age 3); $24,000/year beginning in 15 years New car purchase - $30,000 in two years ($4,000 upfront + $400/month for seven years)
  6. 6. Classification of Budget according to Function Sales Budget • The most important budget, all other budgets are contingent upon • Production budget, selling and distribution, etc. are affected by sales budget E.g. Quarter 1 Quarter 2 Quarter 3 Quarter 4 Yearly Sales units 120 130 150 165 565 Price per unit 20 22 25 27 Total Sales 2400 2860 3750 4455 13465 Sales forecasting: Developing a sales budget requires forecasting future sales, which depends upon three main factors: 1. Information concerning past performance 2. Information about present conditions within industry and sales territory and 3. Data concerning the industry and general business conditions
  7. 7. Classification of Budget according to Function Production Budget • It is stated in physical units • It specifies the number of units of each product that must be produced to satisfy the sales forecast • The number of units to be produced can be formulated using: Units to Produce = Budgeted sales + Desired closing inventory of finished goods – Beginning inventory of finished goods E.g. Budgeted sales = 70,000, Desired closing finished goods inventory = 20,000 Beginning finished goods inventory = 40,000 Units to be produced = (70,000 + 20,000 – 40,000) = 50,000
  8. 8. Classification of Budget according to Function Production Cost Budget • It summarizes the materials budget, labor budget and the factory overhead budget • It is made up of three budgets: • Materials • Labor • Factory overhead Direct Materials budget: • It specifies the cost of direct materials used and cost of the direct materials purchased. • It helps in developing purchasing and delivery schedule • Helps to meet production targets Direct Labor Budget: • It estimates the labor, in number and grades, to enable production budget to be achieved • It must disclose: grade of labor along with cost (wages) and period of training Factory Overhead Budget: • Prepared on basis of chart of accounts which reflects different expense accounts and details of cost center or departments
  9. 9. Example on Production Cost budget Material Usage budget Product A Product B Total Budgeted production 50,000 80,000 Direct materials requirements Product A X 5 Product B X 8 Direct materials usage (kg) 2,50,000 4,80,000 Cost per kg Rs. 1 Rs. 1.50 Cost of Direct materials used Rs. 2,50,000 Rs. 7,20,000 Rs. 9,70,000
  10. 10. Classification of Budget according to Function Research and Development Budget • A tool for planning and controlling research and development costs • Helps in coordination with company’s other plans and projects • Helps allocation of funds for R&D by coordinating company’s immediate and long-term plans • Helps in planning staff and equipment requirements for R&D
  11. 11. It contains details of cash inflows and cash outflows for the budget period of some other specific period. • It indicates effect on cash positions of seasonal requirements, unusual receipts and slowness in collecting receivables • Indicates availability of cash • Shows availability of excess funds for short term investments • Helps in planning bond redemptions, income tax installments and payments to employees Classification of Budget according to Function Cash Budget Period of Cash budget 1. Operational: May be prepared monthly, weekly even daily to meet requirements 2. Short range: Prepared annually and is in correspondence with annual profit plan. Indicates cash inflows and outflows as generated by annual profit plan 3. Long range: Does not disclose detailed estimates of revenue and expenses. It is prepared according to: • The timing of the capital expenditure projects • The timing of long range profit plan
  12. 12. Classification of Budget according to Function Master Budget • It is summary or total budget package for a business firm • It can be called end product of budget making process • IT reveals the top management’s goals of revenues, expenses, net income, cash inflows and financial positions • Takes the macro view of business and coordinates with production, raw materials, manpower and other resources with production targets • It cuts across divisional boundaries to coordinate firms’ diverse activities • The operating budgets constitute the building block used to complete the master budget
  13. 13. Classification of Budget according to Function Fixed Budget • Fixed budget is designed to remain unchanged irrespective of the level of the activity actually attained • It is based on single level of activity • It compares data from actual operations with single level of activity reflected in budget • Fixed budget is good for performance measurement, if output can be estimated within close limits
  14. 14. Classification of Budget according to Function Flexible Budget • It is prepared for a range, for more than one level of activity • It is a set of alternative budgets to different levels of activity • Flexible budget is prepared considering that a business is dynamic, ever changing and never static • Important features of flexible budget: • It covers a range of activity • It is easy to change with variation in production levels • It facilitates performance measurement and evaluation Advantages of Flexible budgeting: 1. Accurate budgeting: Output factor is considered while preparation, since cost of goods may fluctuate time to time 2. Coordination: Production is planned in relation to expected sales, materials and labor are acquired to meet expected production requirements 3. Control tool: Comparison between the budgeted costs and actual costs form basis for analyzing cost variances and fixing responsibility for same. This motivates managers to feel themselves motivated in controlling costs for which they are responsible.
  15. 15. Zero Base Budgeting (ZBB) • Zero base budgeting is method of budgeting where by all the activities are re-valuated each time budget is formulated. • It involves starting from zero • In ZBB, each department’s functions are reviewed completely • ZBB rejects incremental nature of traditional budgeting, instead states that expenditure of each program must start from base zero with each new budget being compiled as if the programs were being launched for first time Advantages of ZBB: • It identifies and eliminates wastage and obsolete operations • Develops questioning attitude • Leads to staff involvement which may lead to improved motivation • Increases communication and coordination within organization Disadvantages of ZBB: • Cost involved in preparing a vast number of decision packages in large firm are very high • Time consuming and large amount of paperwork is involved • Managers may oppose new ideas and changes
  16. 16. Zero Base Budgeting (ZBB) Steps followed in application of ZBB: 1. Decision packages are prepared so that management can: • Evaluate and rank it against other activities and • Decide to approve of disapprove it 2. Each decision package is justified that it promotes the goals of enterprise 3. If justifies, then the cost of minimum efforts needed to sustain is determined 4. Alternatives for each package are considered 5. Incremental decision package are also justified and costed to describe benefits of additional work that would be done 6. Managers rank their decision packages in order of priority for resource allocation 7. Resources are allocated to the decision package.
  17. 17. Thank You