The budgetary process
The budget manual is a collection of instructions governing the
responsibilities of persons and the procedures, forms and records
relating to the preparation and use of budgetary data.
Managers responsible for preparing budgets should ideally be the
managers responsible for carrying out the budget.
The budget committee is the co-ordinating body in the preparation
and administration of budgets.
The budget period is the time period to which the budget relates.
budget manual
Responsibility for the preparation of
budgets
Managers responsible for preparing budgets should ideally
be the managers who are responsible for carrying out the
budget. For example, the sales manager should draft the
sales budget and selling overhead cost centre budget and
the purchasing manager should draft the material purchases
budget.
Budget committee
The co-ordination and administration of budgets is usually
the responsibility of a budget committee (with the
managing director as chairman). The budget committee is
assisted by a budget officer who is usually an accountant.
Every part of the organisation should be represented on the
committee, so there should be a representative from sales,
production, marketing and so on.
Functions of the budget committee
Co-ordination of the preparation of budgets, which includes the issue
of the budget manual
Issuing of timetables for the preparation of functional budgets
Allocation of responsibilities for the preparation of functional budgets
Provision of information to assist in the preparation of budgets
Communication of final budgets to the appropriate managers
Continuous assessment of the budgeting and planning process, in
order to improve the planning and control function
The budget preparation timetable
The budget preparation process is as follows.
Communicating details of the budget policy and budget guidelines
Determining the factor that restricts output
Preparation of the sales budget
Initial preparation of budgets
Negotiation of budgets with superiors
Co-ordination and review of budgets
Final acceptance of the budgets
Budget review
The principal budget factor should be identified at the beginning of the
budgetary process, and the budget for this is prepared before all the others.
Functional budgets
Functional (or departmental) budgets are the budgets for the various
functions and departments of an organisation. They therefore include
production budgets, marketing budgets, sales budgets, personnel
budgets, purchasing budgets and research and development budgets.
Production cost budget
If the principal budget factor was production capacity then the production
cost budget would be the first to be prepared.
To assess whether production is the principal budget factor, the production
capacity available must be determined. This should take into account the
following factors.
(a) Available labour, including idle time, overtime and standard output rates per
hour
(b) Availability of raw materials, including allowances for losses during
production
(c) Maximum machine hours available, including expected idle time and
expected output rates per machine hour
The production cost budget will show the quantities and costs for each
product and product group and will tie in with the sales and inventory
budgets. This co-ordinating process is likely to show any shortfalls or
excesses in capacity at various times over the budget period. If there is
likely to be a shortfall then consideration should be given to overtime,
subcontracting, machine hire, new sources of raw materials or some
other way of increasing output. A significant shortfall means that
production capacity is, in fact, the limiting factor.
Labour budget
A useful concept in budgeting for labour requirements is the standard
hour.
A standard hour is the quantity of work achievable at standard
performance, expressed in terms of a standard unit of work done in a
standard period of time.
Illustration
Cash budgets
A cash budget is a detailed budget of cash inflows and outflows incorporating
both revenue and capital items.
A cash budget is a statement in which estimated future cash receipts and
payments are tabulated in such a way as to show the forecast cash balance of
a business at defined intervals.
Before we look at preparing cash budgets in detail, we need to consider cash
and profit and the differences between them.
A business which fails to make profits will go under in the long term. However,
a business which runs out of cash, even for a couple of months, will fail,
despite the fact that it is basically profitable. Why? If an organisation makes a
loss, the value of the business falls and if there are long-term losses the
business may eventually collapse.
The importance of cash
An organisation needs to have enough cash in order to pay
for the following.
Goods and services
Capital investment (plant, machinery and so on)
Labour costs
Other expenses (rent, rates, taxation and so on)
Dividends
Net profit and net cash flow
Reasons why net profit and net cash flow differ are mainly due to timing
differences:
1) Purchase of non-current assets
2) Sale of non-current assets
3) Matching receipts from receivables and sales invoices raised
4) Matching payments to payables and cost of sales
5) Loans, share issues and overdrafts
The usefulness of cash budgets
The usefulness of cash budgets is that they enable management to make any
forward planning decisions that may be needed, such as advising their bank of
estimated overdraft requirements and strengthening their credit control
procedures to ensure that customers pay more quickly.
The cash budget is one of the most important planning tools that an
organisation can use. It shows the cash effect of all plans made within the
budgetary process and therefore its preparation can lead to a modification
of budgets if it shows that there are insufficient cash resources to finance the
planned operations.
Potential cash positions
Illustration
Budgeted statement of profit or loss
and statement of financial position
As well as wishing to forecast its cash position, a business might want
to estimate its profitability and its financial position for a coming
period. This would involve the preparation of a budgeted statement of
profit or loss and statement of financial position, along with the cash
budgets which form the master budget.
Just like historical financial statements, budgeted accounts are
based on the accruals concept.
The master budget
When all the functional budgets have been prepared, they are
summarised and consolidated into a master budget which consists of the
budgeted statement of profit or loss, budgeted statement of financial
position and cash budget and which provides the overall picture of the
planned performance for the budget period.