Budgeting

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Budget:- A financial plan.
A budget is a quantitative (measurable) expression of a plan of action for a future period.
A budget period is how long the budget is for —for example, one month, one quarter (three months)
or one year.

Budget helps us:-

• Communicate the activities of the organisation
• Coordinate the plans of the organisation
• Control the performance of the organisation.

Budgets are often set as targets for what the organisation wants and a detailed plan of how the
business intends to make that happen.
Principal budget factor – The primary factor that limits an organisation’s activities ( starting point of the budget )

The principal budget factor of most organisations is sales. This is because there will be a limit to
the demand for an organisation’s products.

For example, there is no point in an organisation producing 500,000 units of a product in a year if
demand is never likely to be more than 1,000 units in a year.

Sometimes there may be other factors that limit the level of activity of an organisation.
Use of Budgeting
The Planning And Control Cycle
Planning – Developing objectives and selecting a plan that will achieve these objectives.
Control – The steps taken by management to ensure that the objectives are achieved.

Compare actual results with budget = VARIANCE

Process:-
1. Identify objectives of organisation
2. Identify possible strategies to achieve objectives
3. Identify best strategy
4. Prepare budgets – use selected strategy
End of planning stage

Beginning of control stage

5. Measure actual results
6. Calculate variance
7. Investigate significant variance
8. Act on variance
And repeat from stage 2
The Budgeting Process
Budgeting stage
1. Budget Committee:- The primary responsibilities of the budget committee are:
• To co-ordinate the budget preparation process
• To prepare the budget manual
• To communicate details of the budgeting process to the budget holders.
The budget committee is headed up by the chairman (often the managing director of the organisation)
and includes a budget officer and the functional budget holders.

2. Budget Manual:- It includes forms that should be used and instructions on preparing individual
budgets.
usually prepared by a finance team member who is also a member of the budget committee.
it is simply a reference for preparing budgets.

3. Limiting factor identified:- also known as the principal budget factor

Once the principal budget factor has been identified, the relevant budget is prepared.
So, for example, if sales is the limiting factor, then the sales budget is prepared first.
4. Functional budgets prepared (first draft):- Once the principal budget factor has been identified
and the relevant budget prepared by the budget holders and their team members.
These budgets will be the first drafts and will be subject to review until the budget committee agrees to
the final budgets.

5. Review of first draft budgets:- Once the first drafts have been reviewed, they need to be adjusted.

6. Master budget:- The master budget is prepared once the budget committee has agreed to the final
drafts of the functional budgets.
These three budgets are then summarised in the master budget.
• Budgeted statement of profit or loss – functional budgets
• Budgeted statement of financial position – cash budget:

7. Budget review process:- The budgets are compared with the actual results in the budget process.
Any significant variances are investigated.
Forecasts
Forecast – An estimate of future performance, usually created referring to actual results for the period.

Whereas a budget is a financial plan, a forecast predicts the future. It is the expected financial results
for a future period.
Forecasting techniques include
• Using index numbers to forecast future prices and quantities.
• Regular contracts with customers and clients can be used to forecast sales.
• Market research methods can indicate the likely level of sales demand for a product, especially if
there are plans to launch a new product in the future.
• Linear regression analysis can forecast future sales demand by estimating a linear function.
• Time series analysis estimates the trend of something from historical data taken over time.
Problems with forecasting
The further a prediction is into the future, the more difficult it is to get it right.
For example, accurately predicting how much a chocolate bar will cost tomorrow accurately is easy.
However, the price of the chocolate bar 12 months into the future is more uncertain.
Economic Environment Impact on Budgeting
The general economic environment will affect organisations at a local (or national) level and a
global (or international) level.
When the economy is strong, it can be described as a boom time. In a boom time, the
economy is growing, and confidence in the future is high.
At these times:
• Businesses can increase the prices of their products, and so revenues increase
• Suppliers may increase their prices, so costs may increase
• There are lots of jobs for people
• Investments perform well.
When the economy is weak, it can be described as a bust time – the economy is no longer
growing, and people will be less confident about the future. During these times:
• Businesses will struggle and may even become bankrupt
• There will be less money in the economy
• Unemployment will increase
• Investor confidence will weaken.
Political and other factors will also have a bearing on the confidence of consumers and
people in companies who make investment decisions.
There is a range of economic factors that can influence a business’ costs and revenues.
Sustainability in Budgeting
Sustainability in budgeting refers to the practice of incorporating environmental, social, and governance
(ESG) factors into the budgeting process.
Traditionally, budgets have been set using a financial principal budget factor, which focuses the budget
on economic aspects only.
must read the text and study hub

Sales Budgets
The main aspects to consider are:
• Expected demand
• Expected selling price
Production Budget
The main aspects to consider are:
• Expected demand
• Opening inventory
Opening inventory at the beginning of a period will reduce the required production amount.
• Desired level of closing inventory.
Increasing closing inventory at the end of a period will increase the amount required to be
produced in a period.

At the beginning of the budget period, Winston’s Football Factory has 350 footballs in the warehouse.
The number of footballs required to be in closing inventory at the end of the budget period is 550.
Given the above data, prepare the 20X5 production budget for Winston’s Football Factory.
forecast sale units X
Add : closing inventory X
Less : opening inventory (X)
Equals: No of units to be produced X
Raw Materials Budgets
There are two types of raw materials budgets:
• Raw materials usage budget
• Raw materials purchases budget.
The raw materials usage budget is calculated first to inform the purchase budget.

Raw materials usage budget

Formula to learn
Production budget (units) x material usage per unit = material usage budget
Case study
1. The budgeted production is 5,000 footballs.
The standard cost information in the earlier example shows that 1 kg of Plastic F is required for each
football produced.
2. Budgeted production = 275 units
material usage per unit = 2 kg
3. A company manufactures two products from X and Y. 12 kg of material X is used to produce one unit of
product 1 and 10 kg is used to produce one unit of product 2. Similarly, 6 kg of material Y is used to
produce one unit of product 1 and 8 kg is used to produce one unit of product 2.
The production budget for product 1 is 6000 and the production budget for product 2 is 1000.
calculate the material usage budget for material X and material Y?
Raw materials purchases budget
The raw materials purchases budget must account for any opening or closing inventory of raw
materials and production usage.
Formula to learn
Material usage budget X
Add : Closing inventory of materials X
Less : Opening inventory of materials (X)
Equals : Material purchase budget X
Case study
1. Material usage budget 550kg
Opening inventory 120kg
Closing inventory 50kg
Cost per kg = $2/kg
2. Previous question material X and Y. Additional information :-
Material X op inv 5000kg, cls inv 6000kg and material Y op inv 5000kg, cls inv 1000kg
Labour Budgets
Labour budget helps to calculate No of labours hour required and the cost for same.
Formula to learn
Production budget ( units ) X
Multiplied by : Labour usage per unit X (hour)
Equals : Total labour hours requires X (hours)
Multiplied by : Rate per hour X ($)
Equals : Total labour cost X ($)

Case study
1. Product A’ production budget 275 units and product A requires 3 labour hours to make a unit and
the hourly rate is $2 per hour. Calculate the labour budget?
2. Previous question product 1 and 2. additional information:-
P1 P2
Labour usage per unit 8 hours 12 hours
Rate per hour $5.2/hr $5.2/hr
Overhead Budgets
Estimate overhead cost
Eg:-
Product A
Variable overhead $1.5/hr
Fixed overhead $1/hr
Labour hours 825 hours
Cash Budget
A cash budget details an organisation’s estimated cash inflows and outflows for a future period.
Cash inflows :- include the cash received by an organisation,
Cash outflows :- include the cash payments made by an organisation.
Non-cash item
Some items in the statement of profit or loss are not cash items and are excluded from the cash budget.
Example:- Depreciation of a non-current asset.
Timing of cash flows:- Cash receipts and payments do not always occur immediately after a
transaction happens.

Case study
1. Sales of footballs at Winston’s Football Factory are spread evenly throughout the year.
Total sales = $168,000, therefore monthly sales = $168,000/12 = $14,000 per month.
40% of the sales of footballs at Winston’s Football Factory are cash sales, and 60% of sales are on
credit, with the cash expected to be received the month after the sale.
Irrecoverable debts
Money the organisation will never receive for sales made.

• Cash receipts must be adjusted for information about irrecoverable debts