Budgeting and Profit Planning 101

7/23/2019 Budgeting and Profit Planning 101

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Budgeting and ProfitBudgeting and Profit

PlanningPlanning



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BUDGETING AND PROFIT

PLANNING

Planning Process

Preparation/Tpes of Budgets

Budget!Definition" #eaning

and Purpose



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Planning ProcessPlanning Process

Budgeting is a tool of planning$ Planning in%ol%es specification of

t&e 'asic o'(ecti%es t&at t&e organisation )ill pursue and t&e

funda*ental policies t&at )ill guide it$ In operational ter*s"

it in%ol%es four steps+

,-. O'(ecti%es

O'(ecti%es are 'road and long!range desired state or position in future$

,. Goals

Goals are 0uantitati%e targets to 'e ac&ie%ed in specified period$

,1. 2trategies2trategies represent specific course of action to ac&ie%e goals$

,3. Plans

T&e final step is t&e preparation of 'udgets/profit plans$ It con%erts goalsand strategies into annual operating plans$$



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BudgetBudget

A 'udget is defined as a co*pre&ensi%e and coordinated plan"

e4pressed in financial ter*s" for t&e operations and resources

of an enterprise for so*e specified period in t&e future$

T&e essential ele*ents of a 'udget are+

,-. Plan

,. Financial ter*s

,1. Operations and resources

,3. 2pecific future period

,5. 6o*pre&ensi%e co%erage

,7. 6oordination




T&e first ingredient of a 'udget is its plan$ It includes t)o aspects )&ic&

&a%e a 'earing on t&e operations of an enterprise$ One set of factors" )&ic&

deter*ine a fir*8s future operations are )&oll e4ternal and 'eond its

control$ T&e second set of factors affecting future acti%ities are )it&in t&efir*8s control and discretion" t&at is" t&e are internal$

A 'udget is a *ec&anis* to plan for t&e fir*8s operations and resources$

T&e operations are reflected in re%enues and e4penses$T&e plan also co%ers t&e resources of t&e fir*$ T&e planning of resources

*eans t&e planning of t&e %arious assets and t&e sources of capital to

finance t&ese assets$ T&e assets could 'e fi4ed assets as )ell as current

assets$

Budgets are prepared in financial ter*s" t&at is" in ter*s of *onetar %alue

suc& as t&e rupee" dollar" and so on$ T&e reason is t&at t&e *onetar unit is

a co**on deno*inator$

-$ Plan

$ Operations and Resources

1$ Financial Ter*s




A 'udget relates to a specified period of ti*e" usuall one ear$

A 'udget is co*pre&ensi%e in t&at all t&e acti%ities and operations of

an organisation are included in it$ It co%ers t&e organisation as a

)&ole and not onl so*e seg*ents$ T&e *odus operandi is t&at

'udgets are prepared for eac& seg*ent/facet/acti%it/di%ision of an

organisation$

Budgets are prepared for t&e different co*ponents/

seg*ents/di%isions/ facets/acti%ities of an organisation so as to ta9e

care of t&e situations and pro'le*s of eac& co*ponent$ T&e'udgets for eac& of t&e co*ponents are prepared in &ar*on )it&

eac& anot&er$ T&is is called coordination$

3$ 2pecified Future Period

5$ 6o*pre&ensi%eness

7$ 6oordination


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Budget PurposeBudget Purpose

T&e *ain o'(ecti%es of 'udgeting are+

-$ E4plicit state*ent of e4pectations

$ 6o**unication

1$ 6oordination"

3$ E4pectations as a fra*e)or9 for (udging perfor*ance


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One purpose of 'udgeting is to state e4pectations in for*al ter*s so t&at

*ost of t&e underling assu*ptions *a 'e identified$ A fir* &as t&e

'asic o'(ecti%e of opti*ising long!run profit$ Its long!range goalsalso include sur%i%al" consu*er satisfaction" e*ploee

)elfare" personal po)er and prestige" and so on$

Anot&er purpose of 'udgeting is to co**unicate or infor* ot&ers of t&e

goals and *et&ods selected ' top *anage*ent$ 2ince 'udgetingdeals )it& funda*ental policies and o'(ecti%es" it is

prepared ' top *anage*ent$

:o)e%er" a 'udget does not la do)n a state*ent of e4pectations in rigid

ter*s$ A 'udget s&ould 'e *odified )&en necessar in t&e lig&t of

t&e c&anges in t&e factors/assu*ptions on )&ic& t&e

original esti*ates )ere 'ased$

-$ E4plicit 2tate*ent of E4pectations

$ 6o**unication


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;et anot&er purpose of 'udgeting is coordination$ T&e ter* <coordination8

refers to t&e operation of all depart*ents of an organisation insuc& a )a t&at t&ere is no 'ottlenec9 or i*'alance$

Finall" a 'udget esta'lis&es e4pectations as a fra*e)or9 for (udging

e*ploee perfor*ance$

In %ie) of t&e a'o%e" coordination is a *a(or function of 'udgeting$

Budgets s&ould 'e drafted in suc& a )a t&at t&e operations

of t&e %arious depart*ents are related to eac& ot&er for

t&e ac&ie%e*ent of t&e o%erall goal$

1$ 6oordination

3$ E4pectations as a Fra*e)or9 for =udging Perfor*ance


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T;PE2 OF BUDGET2T;PE2 OF BUDGET2

T&e o%erall 'udget is 9no)n as t&e *aster 'udge$ A*aster 'udget nor*all consists of t&ree

tpes of 'udgets+

,i. Operating Budgets

,ii. Financial Budgets

,iii. 2pecial Decision Budgets



-$ Operating Budget-$ Operating Budget

-. 2ales 'udget"

. Production 'udget"

1. Purc&ase 'udget"

3. Direct la'our 'udget"

5. #anufacturing e4penses 'udget" and

7. Ad*inistrati%e and selling e4penses 'udget" andso on$

Operating 'udgets relate to p&sical acti%ities/

operations suc& as sales" production"

and so on$

Operating 'udget &as t&e follo)ing co*ponents



$ Financial Budget$ Financial Budget

-. Budgeted inco*e state*ent"

. Budgeted state*ent of retained earnings"1. 6as& 'udget" and

3. Budgeted 'alance s&eet$

Financial 'udgets are concerned )it& e4pected

cas& flo)s" financial position and

result of operations$

Financial 'udget &as t&e follo)ing co*ponents



6as& Budget6as& Budget6as& 'udget is a de%ice to &elp a fir* to plan for and control t&e use of

cas&$ It is a state*ent s&o)ing t&e esti*ated cas& inflo)s and cas&outflo)s o%er t&e planning period$ T&e principal ai* of t&e cas&

'udget" as a tool to predict cas& flo)s o%er a period of ti*e"

is to ascertain )&et&er t&ere is li9el to 'e e4cess/s&ortage of cas& at an

ti*e$

T&e preparation of a cas& 'udget in%ol%es se%eral steps$

T&e first ele*ent of a cas& 'udget is t&e selection of t&e period oft&e 'udget" t&at is" t&e planning &ori>on$

T&e second ele*ent of t&e cas& 'udget is t&e selection/identification

of t&e factors t&at &a%e a 'earing on cas& flo)s$T&e factors t&at generate cas& are generall di%ided into t)o 'roadcategories+

,i. Operating ,ii. Financial



Operating 6as& Flo)Operating 6as& Flo)

T&e *ain operating factors/ite*s )&ic& generate cas&

outlfo)s and inflo)s o%er t&e ti*e span of a

cas& 'udget are ta'ulated in E4&i'it -$

E4&i'it -$ Operating 6as& Flo) Ite*s6as& inflo)s/Receipts 6as& outflo)s/Dis'urse*ents

-$6as& sales

$6ollection of accountsrecei%a'le

1$Disposal of fi4ed assets

-$ Accounts paa'le/Paa'le pa*ents

$ Purc&ase of ra) *aterials

1$ ?ages and salar ,pa roll.

3$ Factor e4penses

5$ Ad*inistrati%e and selling e4penses

7$ #aintenance e4penses

@$ Purc&ase of fi4ed assets



Financial 6as& Flo) Ite*sFinancial 6as& Flo) Ite*s

T&e *a(or financial factors/ite*s affecting generation

of cas& flo)s are depicted in E4&i'it $

E4&i'it $ Financial 6as& Flo) Ite*s

6as& inflo)s/Receipts 6as& outflo)s/Pa*ents

-$ Loans/'orro)ings

$ 2ale of securities

1$ Interest recei%ed

3$ Di%idend recei%ed

5$ Rent recei%ed

7$ Refund of ta4

@$ Issues of ne) s&ares andsecurities

-$ Inco*e ta4/ta4 pa*ents

$ Rede*ption of loan

1$ Re!purc&ase of s&ares

3$ Interest paid

5$ Di%idends paid



E4a*ple -

T&e follo)ing data relate to :pot&etical Li*ited+

Balance 2&eet as at #arc& 1-" 6urrent ;ear

Lia'ilities A*ount Assets A*ountAccounts paa'le

,all for #arc& purc&ases.

Ta4es paa'le

,all for #arc& inco*e.

2&are capital

Retained earnings

Rs 3"

5"

--""

-"7"

CCCCCCC -"-"

6as&

Accounts recei%a'le

,all fro* #arc& sales.

In%entories+

Ra) *aterials ,"7 9gs Rs 1.

Finis&ed goods

,-" units Rs 15.

Fi4ed assets+

6ost Rs ""

Less+ Accu*ulated

depreciation ,3"5".

Rs 1""

"5"

"

71"

-5"5"-"-"



$ 2ales forecasts+ Assu*e t&e *ar9eting depart*ent &as de%eloped t&efollo)ing sales forecast for t&e first 0uarter of t&e ne4t ear and t&e sellingprice of Rs 5 per unit$

#ont& Units sales

April #a

=une

"-"

-7"

1$ T&e *anage*ent desires closing in%entor to e0ual per cent of t&efollo)ing *ont&8s sales$

3$ T&e *anufacturing costs are as follo)sDirect *aterials+ ,5 9gs Rs 1. ,per unit.

Direct la'our

aria'le o%er&eads

Total fi4ed o%er&eads ,per annu*.

Rs -5

5

@""5$ Nor*al capacit is -"" units per annu*$ Assu*e a'sorption costing

'asis$

7$ Eac& unit of final product re0uires 5 9gs of ra) *aterials$ Assu*e*anage*ent desires closing ra) *aterial in%entor to e0ual per centof t&e follo)ing *ont&8s re0uire*ents of production$



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@$ Assu*e fi4ed selling and ad*inistrati%e e4penses are Rs " per*ont& and %aria'le selling and ad*inistrati%e e4penses are Rs 5 perunit sold$

$ All sales are on account$ Pa*ent recei%ed )it&in - das fro* t&e dateof sale are su'(ect to a per cent cas& discount$ In t&e past" 7 per cent

of t&e sales )ere collected during t&e *ont& of sale and 3 per cent arecollected during t&e follo)ing *ont&$ Of collections during t&e *ont& ofsale" 5 per cent are collected during t&e discount period$ Accountsrecei%a'le are recorded at t&e gross a*ount and cas& discounts aretreated as a reduction in arri%ing at net sales during t&e *ont& t&e areta9en$

$ Ta4 rate is 15 per cent$

-$ Additional infor*ation+

,a. All purc&ases are on account$ T)o!t&irds are paid for in t&e *ont&of purc&ase and one!t&ird" in t&e follo)ing *ont&$

,'. Fi4ed *anufacturing costs include depreciation of Rs " per*ont&$

,c. Ta4es are paid in t&e follo)ing *ont&$,d. All ot&er costs and/or e4penses are paid during t&e *ont& in )&ic&

incurred$

Fro* t&e foregoing infor*ation prepare a *aster 'udget for t&e *ont& ofApril onl$




2olution

-$Production Budget

Particulars April #a

2ales ,units. Add+ Desired closing in%entor ,$ ne4t *ont&8s sales.

Total finis&ed goods re0uire*ent

Less+ Opening in%entor

Re0uired production ,units.

""3

--"3

,-".

"7

-"1"

-5"

,"3.

-"

$#anufacturing 6ost Budget Particulars April

Re0uired production ,units.

Direct *aterial cost ,5 9gs Rs 1 per 9g.

Total direct *aterial cost

Total direct la'our cost ,Rs 5 per unit.Total %aria'le o%er&ead cost ,Rs per unit.

Total %aria'le *anufacturing costs

All fi4ed *anufacturing o%er&eads ,Rs @"" - *ont&s.

Total *anufacturing cost

"7

Rs -5

Rs -"33"

3" 7"3

"@"3

7"

1"1"3




1$Purc&ase Budget ,Ra) #aterials.

Particulars April #a

Production re0uire*ent ,units.

Ra) *aterial re0uired for production H 5 9gs per unit,9gs.

Add+ Desired closing in%entor ,$ #are0uire*ents.

Total re0uire*ents

Less+ Opening in%entor

Purc&ase re0uire*entPurc&ase re0uire*ent ,a*ount H Rs 1 per 9g.

"7

CCCCCC 3"

-"

7"

,"7.

5-"

Rs -"51"7

-"

CCCCC 73"

3$2elling and Ad*inistrati%e E4penses Budget

Particulars April

Units salesaria'le costs H Rs 5 per unit

Fi4ed costs

Total selling and ad*inistrati%e e4penses

"Rs 35"

"

75"




5$ 6ost of Goods 2old Budget

Particulars April

Units sold

6ost per unit

aria'leFi4ed ,Rs 7" -" units.

Total cost

Rs 7

"

Rs 15

1"-5"

7$ Budgeted Inco*e 2tate*ent for t&e #ont& of April

Gross sales ," Rs 5.

Less+ 6as& discount ,Rs 3"5" $7 $5 $.Net sales

Less+ 6ost of goods sold

Gross *argin ,unad(usted.

Less+ 6apacit %ariance unfa%oura'le ,3 units Rs 7.

Gross *argin ,ad(usted.

Less+ 2elling and ad*inistrati%e e4pensesEarnings 'efore ta4es

Less+ Ta4es ,$15.

Earning after ta4es

Rs 3"5"

"@3"3@"1

1"-5"

-"1"1

"3

-""

75"73"

"@-5

3"-5




@$Budgeted 2tate*ent of Retained Earnings

Opening 'alance Add: Earnings after ta4es6losing 'alance

Rs -"7" 3"-5

-"7"5

$6as& Budget ,April.

Opening 'alance6as& inflo)s+ 6ollection fro* de'tors+#arc& salesApril sales ,gross. ,Rs 3"5" $7.Less: 6as& discount

,Rs "@" $5 $.6as& outflo)s+ Pa*ent to creditors+ For #arc& purc&ases For April purc&ases ,Rs -"51"7/1.Direct la'our aria'le *anufacturing o%er&ead

Fi4ed *anufacturing o%er&eadLess: Depreciationaria'le selling and ad*inistrati%eo%er&eadsFi4ed selling and ad*inistrati%eo%er&eadsTa4es6losing 'alance

Rs "@"

"@

Rs "5"

"7@"1

3"

-""3

7",".

Rs 1""

5"-@"1

-"3"33"7"3

3"35"

"5"

Rs "-@"1

3"7"3"-"5




$ Profor*a Balance 2&eet as at #arc& 1-" Ne4t ;ear

Liabilities Amount Assets Amount

Accounts paa'le

,Rs 3" Rs -"51"7 J

Rs -"3"3.

Ta4es paa'le

,Rs 5" Rs "@-5

J Rs 5".

2&are capitalRetained earnings

Rs 5-"

"@-5

--""-"7"5

CCCCCCCC

"3"

6as&

Accounts recei%a'le ,Rs 3"5" $3.

In%entories+

Ra) *aterial

,-" Rs 1.

Finis&ed goods

,"3 Rs 15.Fi4ed assets+

6ost

Less+ Accu*ulated

depreciation

Rs 1"3

3"

""

,3"@".

Rs 3"-"5

-""

-""3

-5"1"

"3"




2pecial Decision Budgets2pecial Decision Budgets

T&e t&ird categor of 'udgets are special decision'udgets$ T&e relate to in%entor le%els" 'rea9!e%en

analsis" and so on$

Fi4ed Budgets

Budgets prepared at a single le%el of acti%it" )it& no prospect of*odification in t&e lig&t of c&anged circu*stances" are referred to

as fi4ed 'udgets$Fle4i'le Budgets

T&e alternati%e to fi4ed 'udgets are fle4i'le/%aria'le/sliding'udgets

Fi4ed and Fle4i'le BudgetsFi4ed and Fle4i'le Budgets




Fle4i'le BudgetsFle4i'le Budgets

T&e ter* <fle4i'le8 is an apt description of t&e essential

features of t&ese 'udgets$ A fle4i'le 'udget esti*ates costs

at se%eral le%els of acti%it$

Its *erit is t&at instead of one esti*ate" it contains se%eralesti*ates/plans in different assu*ed circu*stances$ It

is a useful tool in real )orld situations" t&at is" unpredicta'le

en%iron*ent$

A fle4i'le 'udget" in a sense" is a series of fi4ed 'udgets and

an increase/decrease in t&e le%el/%olu*e of acti%it *ust 'e

reflected in it$




Eac& e4pense in eac& depart*ent/seg*ent is to 'e

categorised into fi4ed" %aria'le and *i4ed co*ponents$A 'udget *a first 'e prepared at t&e e4pected le%el of

acti%it" sa" - per cent capacit$ Additional

colu*ns *a t&en 'e added for costs 'elo) and a'o%e"

per cent and -- per cent capacit and so on$

T&e conceptual fra*e)or9 of fle4i'le 'udgeting relates

to+ ,i. #easure of %olu*e and ,ii. 6ost 'e&a%iour )it&

c&ange in %olu*e




Ta'le - :pot&etical LtdKFle4i'le Budget ,#aintenance Depart*ent.

olu*e ,la'our!&ours. 3" 3"5 5" 5"5 7"

aria'le costs+

La'our

#aterial

Ot&ers

#i4ed costs+

La'our

#aintenance

Ot&er suppliesDiscretionar fi4ed costs+

Training

E4peri*ental *et&ods

6o**itted fi4ed costs+

Depreciation

Rent" lease cost

Total

Rs 7"

"3

"1

-"3

"5

-"5

1"5

5"

1"5

"

Rs 7"@5

"@

"3

-"35

"@5

"

3"

5"

1"5

1-"35

Rs @"5

1"

-"

"5

-"5

1"

"

3"

5"

1"5

11"

Rs "5

1"1

-"-

"7

-"55

1"5

"

3"

5"

1"5

13"55

Rs "

1"7

-"

"@

-"7

1"5

"5

3"5

5"

1"5

1@"-




Ta'le + :pot&etical LtdKFle4i'le Budget ,#anufacturing Depart*ent.

olu*e ,*ac&ine!&ours. 5 7 @

aria'le costs+

Po)er

:elpers

Discretionar fi4ed costs+

Training

Tools

6o**itted fi4ed costs+

Depreciation

Rent

Total

Rs 5

5

-"

-"

1"5

Rs 7

1

-"

-"

3"

Rs @

15

-"

-"

3"15

Rs

3

1

-"

-"

3"7

Rs

35

-"

1

-"

-"

3"5




#odified Fle4i'le Budgets#odified Fle4i'le BudgetsFle4i'le 'udgets" as a tool of planning and control" are superiorto fi4ed 'udgets$

T&e *a(or )ea9nesses of fi4ed 'udgets are t&eir ina'ilit to+

,i. 2&o) t&e potential %aria'ilit of %arious esti*ates used in t&epreparation of t&e 'udget" and

,ii. Indicate t&e range )it&in )&ic& costs *a 'e e4pected to %ar$ T&eare" t&erefore" not useful in an uncertain and unpredicta'le en%iron*ent$

Fle4i'le 'udgets present esti*ates at different le%els of acti%it" and are*ore useful$

Li*itations

Fle4i'le 'udgets suffer fro* one li*itation in t&at t&e do not e4plicitlconsider t&e relati%e pro'a'ilit of a particular %olu*e/cost 'eing ac&ie%ed$T&is li*itation can 'e o%erco*e ' using a *odifiedfle4i'le 'udget )&ic& )ill include colu*ns for different le%elsof esti*ates+ *ost li9el" opti*istic and pessi*istic$



© T t M G Hill P bli hi C Li it d M t !

Ta'le 1+ :pot&etical LtdK#odified Fle4i'le Budget ,#anufacturingDepart*ent.

Pessi*istic #ost li9el Opti*istic

olu*e ,la'our!&ours. 3"5 5" 5"5aria'le costs+

La'our

#aterials

Ot&ers

#i4ed costs+

La'our

#aintenance

Ot&er supplies

Discretionar fi4ed costs+

Training

E4peri*ental *et&ods6o**itted fi4ed costs+

Depreciation

Rent" etc$

Total

Rs 7"1@5

"75

5

"15

-"35

"75

-"@5

1"@5

5"

1"5

1"@5

Rs @"5

1"

-"

"5

-"5

1"

"

3"

5"

1"5

11"

Rs "@@5

1"5-

-"-@

1"35

-"55

"7@

"5

3"5

5"

1"5

17"-15

Documents

Budgeting and Profit Planning 101