Budgeting

Budgeting is a forecast, a prediction of the results and performance of carrying on business over a future period of time. The future position of the business at the end of that time is worked out in the present, considering future conditions and trends.

Budgets are prepared in terms of money by the management of management’s plans for operating a business over a future time period. Budgets are prepared for parts of the organization known as budget centres. The recognition of a budget centre depends upon the nature of the business, its operations and functions and the organization structure. Budget centre must be under control of a manager who is responsible for its revenue and expenditure. Budget centres may consist of revenue centres that earn revenue, cost centres that incur costs along with revenue and profit centres which earn revenue and incur costs.

Budgets are of two types, operational (functional) budgets and master budgets which are prepared for the budget periods. Operational budgets are prepared for each individual department or function operating in a business showing the responsibility of a manager. Where as master budget consists of a forecasted profit and loss account and balance sheet based on the operating budgets.

Operating budgets are prepared for budget centres and consist of sales budgets, production budgets, purchase budgets and cash budgets. These budgets must be prepared in coordination with one another otherwise there will be huge variances in the actual and budgeted values. The sales and the production budgets must match taking the volume to be sold and produced. Similarly the material purchase budget and the production budget should be well coordinated so that the requirements for the production budget are met accordingly.

Sales budget is based upon the forecast demand for the goods. The forecast is made considering the market research, reports from salesman and other trade information. The budget is expressed in sales volume and the revenue to be generated by the volume is also expressed.

Production budget is made to forecast the production of finished goods. It shows the change in stock level of the finished goods, the units sold and also the amount of units produced.

Purchase budget is made for the purchases of supplies of materials used for production which is prepared in order to meet the requirement of production. The procedure is similar to the production budgets, the change in stock and the stock to be purchased are calculated from the requirement of production. This budget might be expressed in units and cost both.

Cash budget is compiled on a cash basis and includes all receipts and payments, capital as well as revenue. It does not include non-monetary items such as depreciation

Master budgets are prepared on a accrual basis and include revenue, receipts and payments only. They also include non-monetary items such as depreciation, profits and losses on sales and fixed assets along with provisions for bad debts.

The management may need to anticipate the actual level of activity being greater or less than budget, the budget is therefore flexed, that is, prepared for various levels of activity to enable realistic comparisons of actual with budgeted values. This flexed budget is known as a Flexible Budget. Flexible budgets recognize the different behaviors of fixed and variable costs at different levels of activity.

To monitor the performance of managers against their functional budgets budgetary controls are applied, there is continuous comparison of actual and budgeted results at frequent time intervals. So that corrective action may be taken when necessary. The budget periods may be broken down to control periods to ease the check on the managers.