Chapter 9 Budgeting

Suggested Solutions

Discussion Questions

9.1
A budget can be defined as a financial plan for a future period of time. Thus, it
sets out the intentions which management has for the period concerned.
Achieving the budget plans should help to achieve the long-term plans of the
business. Achievement of the long term plans should mean that the business is
successfully working towards its objectives.

A budget differs from a forecast in that a forecast is a statement of what is

expected will happen without the intervention of management, perhaps because
they cannot intervene as with a weather forecast. A plan is an intention to
achieve.

Normally management would take account of reliable forecasts when making its
plans.

9.16
It is the function of management to set-long term plans and budgets.

9.17
In the top down approach the senior management of each budget area originates
the budget targets, perhaps discussing them with lower levels or management.
With the bottom up approach the targets are fed upwards from the lowest level.

Top down probably results in a more strategic approach, but runs the risk of
getting out of touch with the grass roots staff. Bottom up may result in lower
targets being set. The ideal situation probably requires top management to set
the strategic parameters and then involve the staff members who have to
implement. This is likely to lead staff accepting the budget as their own.

9.18
I. Establish who will take responsibility for the budget setting process
II. Communicate budget guidelines to relevant managers
III. Identify the key or limiting factor
IV. Prepare the budget for the area of the limiting factor
V. Prepare draft budgets for all other areas
VI. Review and co-ordinate the budgets
VII. Prepare the master budgets
VIII. Communicate the budgets to all interested parties
IX. Monitor performance relative to the budgets
9.20
The master budgets typically include:
Balance Sheet
Income Statement (Profit and Loss account)
Cash Flow Statement

9.21
That aspect of the business that will stop it from achieving its objectives to the
maximum extent (eg finance; specialist skills; scarce raw materials; machine
time etc).
The budgeting process must be geared to maximise the return on the scarce
input factor (limiting factor).

Application Exercises

9.1
Cash budget for Noel for the year ending 31 December 2008 $

Opening Cash 10,000

Cash Receipts
Cash Received from customers
(Sales + decrease in accounts receivable (debtors)
= 360,000 +5,000 = 365,000) 365,000
375,000

Cash Payments
Cash paid for inventory
(cost of sales + increase in inventory
- increase in accounts payable) (209,000)
(210,000 + 6,000 7,000 = 209,000)
Cash expenses (other expenses + increases in prepayments increase in
accruals)
(75,000 + 1,500 1,500) (75,000)
(284,000)

Closing cash $91,000

Alternative

Use Cashflow statement reconciliation

Net Profit 50,000

Plus: Depreciation 25,000
75,000
Working capital changes
Decrease in accounts receivable 5,000
Increase in inventory (6,000)
Increase in accounts payable 7,000
Increase in prepaid expenses (1,500)
Increase in accrued expenses 1,500
6,000
Change in cash 81,000

Opening cash balance 10,000

Increase in cash 81,000
Closing cash balance 91,000

9.4
Cash budget

June July August Sept October

November
Opening balance 20000 12000 -6000 -50000 -50000 -45000
Inflows
receipts from debtors 100000 100000 100000 150000 250000 250000

Outflows
payments to creditors 80000 90000 130000 270000 200000 200000
wages 20000 20000 20000 28750 30000 30000
rent 5000 5000
general expenses 8000 8000 8000 13250 15000 15000
fixed assets 200000
Total outflows 108000 118000 363000 312000 245000 250000
Net cash flow -8000 -18000 -263000 -162000 5000
Closing balance 2000 -6000 -269000 -212000 -45000 -45000
Loan needed 219000 162000
closing balance -50000 -50000

In fact the loan must be taken in one go, as soon as is necessary to maintain the
overdraft within the limit.
This means that the loan will be taken up in August, for 381,000 (219,000 +
162,000) with a consequent effect on the September cash flow