Means an estimation of revenue and expenses over a specified future period of time and is utilized by government, business, and individual. Is a detailed plan of operations for some specific future period. It is an estimate prepared in advance of the period to which it applies, it acts as a business barometer as it is a complete program of activities of the business for the period covered.
The essentials of Budgeting.
A budget can
provide a whole host of useful insights to aid business operations. However, as
the yardstick for measuring success, it is a process business owners and
managers alike need to grips with. These include:
i.
Effective reporting.
A well planed budget helps to
effectively report back to governmenting bodies about progress on goals. Also,
it gives investors confidence in your operation. Seeing your anticipated
income, expenditure and profit expectations planned out may make them more
likely to take that leap and invest.
ii.
Improving staff motivation.
It help to improve staff motivation when
having a budget and discussing it regularly with your management team and wider
staff base. Also, it improve confidence in your business’s leaders. Example,
when income targets are being met or exceeded, it gives you a chance to thank
people for their hard work and successes.
iii.
Protection from the unexpected.
Budgeting allows you to protect your
business from the unexpected as well as enabling you to plan your company’s
expenditure, from monthly outgoings, expansion plans and equipment updates.
Financially planning for unforeseen and
unavoidable circumstances such as a key piece of equipment breaking down, means
funds will be available if you need them. Budgeting helps to avoid the risk of
debt or half tooperations caused by the need to redirect funds from one area to
another.
iv.
Supporting big decisions.
You will have the data you need to make
big decisions which may involve funds moving in and out of your business by
budgeting every year. Decision about whether you can afford pay increases, a
premises move or equipment updates can all be aided with data from the budget.
Profits may be slightly higher or expenditure lower than expected, meaning
these additional costs will be covered easily.
v.
Business goal setting.
Budget can provides a whole host of
useful insights to avoid business operations. Tracking income and expenditure
can help managers to set goals around production targets, sales forecasts and
marketing campaigns as well as problem solve if things aren’t going as planned.
(b)
The objectives
and Importance of budget.
Many companies
go through the budgeting process every year simply because they didi it the
year before, but they do not know why they continue to create new budgets.
Objectives of budget are:
i.
Allocate
resources.
Budgeting process some companies use as
a tool for deciding where to allocate funds to various activities. Example.
Fixed asset purchases.
ii.
Predict cash
flows.
The companies that are growing rapidly
use a budget extremely that have seasonal sales, or which have irregular sales
patterns.
iii.
Provide
structure.
A budget is especially useful for giving
a company guidance regarding the direction in which it is supposed to be going.
Thus, it forms the basis for planning what to do next.
iv.
Measure
performance.
A common objective in creating a budget
is to use it as the basis for judging employee performance, through the use of
variances from the budget.
v.
Model scenarios.
You can create a set of budgets, each based on
different scenarios, to estimate the financial results of each strategic
direction, if a company is faced with a number of possible paths down which it
can travel.
Importance
of Budget.
Creating a budget is an important pillar of your
overall success and security. Since it allows you to oversee and better
understand whether your business has enough revenue to pay its expenses.
i.
It helps you
keep your eye on the prize.
A budget helps you figure out your long
term goals and work toward them.
ii.
It helps to
ensure you don’t spend money you don’t have.
Far too many consumers spend money they
don’t have and we owe it all to credit cards.
iii.
It helps to save
for unexpected costs.
Careful budgeting can help take the
sting out of unexpected bills by making sure you have a pot of money to fall
back on when you need it the most.
iv.
Makes it easier
to stay aware of your savings and debts.
A good budget will keep you aware of
when your debts will be paid off and
identify when you may have additional money that you can redirect into savings
or spend on an occasional treat.
v.
Helps you focus
on your financial goals.
Planning for the future and working to
an objective allows you to plan big purchases, like houses and cars, without
worrying you will miss the mark.
(c)
The process of
budget preparation.
1. Assess your financial resources
The first step
is to calculate how much money you have coming in each month. This might be
investment income, government assistance, student loans, employment income,
disability benefits, retirement pensions or money from other sources.
2. Determine your expenses
Next you need to
determine how you spend your money by reviewing your financial records. If your
records aren't clear, consider keeping a financial diary to track your
spending. Be sure to separate the fixed expenses that you must meet (mortgage,
rent, car payments, and insurance) from variable expenses (food, clothing,
entertainment, charitable gifts). Once you see your spending patterns, you may
be able to make adjustments to certain expenses.
3. Set goals
Establish a list
of the goals you wish to achieve. These can be long-term goals like purchasing
property or funding your retirement. Or they can be short-term goals such as
home improvements or car maintenance.
4. Create a plan
Once you've
figured out how much money is coming in and where it's going, you can put
together a plan that matches your goals with your financial situation.
5. Pay yourself first
When you pay
yourself first you simply set aside a certain amount of money each month to go
into an account that you will not touch. You can set up a separate savings
account for infrequent but anticipated expenses, such as property taxes,
vacations, automobile insurance or car maintenance. Our Jumpstart® is specially
designed for these types of savings plans.
6. Track your progress
At the end of
each month, you should re-evaluate your budget. Compare your actual expenses
and income to your budget and make appropriate adjustments.
(d)
A master budget.
Is a financial
document that includes how much an organization plans to make and how much it
plans to spend over a fiscal year. This document typically reports financial
information in quarters or month.
Example, A
company may incorporates its sales budget, the cost of goods sold, cash budget,
capital expenditures, inventory, total assets, etc.
(e)
Budgets which
are included in the master budget.
A master budget
will show all the details of the company’s income generating actions via the
operating budget, with an overview of revenue and expenses. It will also
show cash inflow and outflows from the
cash flow statement, and estimation of what will appear on the balance sheet at
the end of the accounting period.
(f)
The first step
in preparation of master budget.
The first step
in creating the master budget is the sales budget. Since the budgets of other
departments are predicted on the sales budget, it is critical to anticipate the
sales budget accurately. The sales budget includes information about the sales
forecast based on past sales data, price per unit, the number of unit sold, and
total revenue generated.
(g)
By using
example, the following budgets are prepared as follows.
i.
Sales budget.
The sales budget details the expected
sales in units and the sales price for the budget period. The information from
the sales budget is carried to several places in the master budget. The sales
budget requires the business to generate a sales forecast for the year that
will use the following information to generate sales.
·
Sales activity
for the business from previous year
·
Competition
sales activity
·
Industry trends
·
Economy wide
trends
·
Planned
marketing campaigns
·
Weather
Example.
Big bad bikes use information to estimate the number of units
that will be sold in each quarter of the coming year. The number of units is
multiplied by the sales price to determine the sales by quarter as shown in the
table below.
SALES BUDGET FOR THE YEAR ENDED DECEMBER 31st 2019.
|
|
Quarter1 |
Quarter2 |
Quarter3 |
Quarter4 |
TOTAL |
|
Expected sales
(units) |
1,000 |
1,000 |
1,500 |
2,500 |
6,000 |
|
Sales price per unit |
$ 70 |
$ 70 |
$ 75 |
$ 75 |
-------- |
|
Total sales revenue |
$ 70,000 |
$ 70,000 |
$112,500 |
$187,500 |
$440,000 |
ii.
Production budget.
In creating the production budget a
major issue is how much inventory should be on hand. Having inventory on hand
helps the company avoid losing a customer because the product isn’t available.
It is prepared as: The number of units expected to be sold plus the desired
ending inventory equals the numbers of units are available. When the beginning
inventory is subtracted from the number of unit’s available, management knows
how many units must be produced during that quarter to meet sales.
Example.
To illustrate the steps in developing a production
budget, recall that big bad bikes is introducing a new product that the market
department thinks will have strong sales. It is shown in the figure below.
PRODUCTION
BUDGET FOR THE YEAR ENDED DECEMBER 31st 2019.
|
|
Quarter1 |
Quarter2 |
Quarter3 |
Quarter4 |
|
Expected sales |
1,000 |
1,000 |
1,500 |
2,500 |
|
Desired Ending
inventory |
300 |
450 |
750 |
1,050 |
|
Total required units |
1,300 |
1,450 |
2,250 |
3,550 |
|
Beginning inventory |
0 |
300 |
450 |
750 |
|
Required production |
1,300 |
1,150 |
1,800 |
2,800 |
iii.
Material usage budget.
It is typically presented in either a
monthly or quarter format in the annual budget. The material usage budget
calculates the materials that must be purchased, by time period, in order to
fulfill the requirements of the production budget.
Example.
LEE company plan to produce a variety of plastic
goods and 98% of its raw materials involve plastic resin. Thus, there is only
one key commodity to be concerned with. Its production needs are outlined as
follows.
iv.
Material Purchase budget.
Material purchase budget will tell the
estimated amount which you will spend on buying of raw material which is used
in production. Because, it is big amount, so you should forecast it in advance
by using simple accounting techniques.
Example.
Your estimated cost of production is $10,000 of the
month of January, 2015. At the end of January, it is estimated, you will have
closing raw material of $5,000. At the beginning of January, opening raw
material is $2,000. Calculate the budgeted value of material purchase.
CALCULATION
OF BUDGETED MATERIAL PURCHASE.
Estimated Cost of Production $
10,000
Add: Estimated closing stock of raw
material
$ 5,000
$ 15,000
Less: Estimated opening stock of raw
material
$ 2,000
Budgeted
value of Material Purchases $ 13,000
v.
Labour budget.
These are wages paid to employees to manufacture a
product. Because of rising and falling demand, you need to create a budget for
the coming year. This will tell you how much you need to spend in each month,
and help predict when you need to hire or layoff employee.
(h) Using the financial data to prepare simple cash
budget.
A cash budget is an
estimation of the cash flows of a business over a specific period of time. This
could be for a weekly, monthly, quarterly, or annual budget. This budget is
used to assess whether the entity has sufficient cash to continue operating over
the given time frame. The cash budget provides a company insight into its cash
needs (and any surplus) and helps to determine an efficient allocation of cash.
Methods of preparing
cash budget.
The financial managers
make use of the following methods for the preparation of cash budgets:
·
Receipt and
Payment Methods
·
Adjusted Profit
and Loss Account Method
·
Balance Sheet
Method
Example.
By using the data in
the Balance sheet and Projected Profit & Loss A/c, prepare Cash Budget for
December 31 2007.
SOLUTION:
Conclusion.
To conclude, Cash
Budget lays attention on the actual flow of cash within and outside the
business. It provides an insight into the cash position and vital information
for financial planning.
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