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Introduction to Budgeting

Guruprasad V
ACA, ACMA, ACS, CMA, MIPA, AFA

Abstract: Budgeting is an essential step in effective finan-


cial planning for the business entities, the government,
not-for-profit organizations, and individuals. There are
various types of budget prepared with a set of process
depending on the size and nature of the business entity.
In order to control the business, dashboards are used. In
this time of digital era, budgeting software is used and
it is increasingly moving toward cloud-based platform.
Budget is also made by the business entities in their
enterprise resource planning (ERP) and/or enterprise
­
risk management(ERM)–based environment.

Keywords: budget, dashboard, enterprise resource


Planning, fixed budget, flexible budget, master budget,
responsibility budget, rolling budget.

Introduction
When you want to host a party to your friends, you would
do some basic calculations of how much money you are
planning to spend for the party and on what categories
of expenses, based on how much money you have with
you, how many friends you are planning to invite, and
so forth. Congratulations! Once you follow those proce-
Guruprasad V, ACA, ACMA, ACS, dures, you have prepared a budget in an informal way,
CMA, MIPA (Australia), AFA (UK), is
a consultant. He is presently the
perhaps without even knowing it.
vice president of IMA’s Bengaluru But, preparing a budget is not always such a simple
chapter and has more than 23 years and easy task when it is done for business entities, the
of extensive experience in industry government, not-for-profit organizations like universi-
as general manager (finance and
ties, trusts, churches, and others.
accounts), controller of finance and
company secretary, head of finance, Every year in most of the countries in the world,
and in practice as partner of a firm. He government finance ministers or chancellors propose
is also a passionate speaker in various budgets, giving the details of the planned outlays and
professional forums and has been sources of revenue for the government, which is in the
invited as a guest faculty by various
institutes. His crossword puzzles
form of taxes on individuals, corporations, indirect taxes,
on international taxation has been loans, and so forth.
published by Taxmann Publications For example you can view the U.S. Budget at www
in their monthly magazine .gpo.gov/fdsys
International Taxation. He is a
Budgeting is a tool similar to GPRS or a ship’s mari-
commerce graduate from Vivekananda
College (Evening), Chennai. ner compass that gives the direction in which the entity
should move ahead to reach its short-term goals and long-
term goals based on the size and nature of its business.

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Introduction to Budgeting

Budgeting is an essential step in effec- Budgeting has come to be accepted


tive financial planning. A budget is a tool as an efficient method of short-term
that managers use to plan and control the and long-term planning and control.
use of resources. An organization that does Budgeting is an important application
not have a budget chooses to deal with the in management accounting both for
future by default and reacts to events only larger businesses and small businesses.
as they occur.
Meaning of Budget as per the
Profit Rich But Cash Merriam Webster Dictionary
Poor—Illustration An amount of money available for spend-
Is it possible that a company has earned ing that is based on a plan for how it
lots of profit but does not have adequate will be spent.
cash at the yearend even though there was A plan used to decide the amount of
no fraud or manipulation in maintaining money that can be spent and how it
the books of account? Yes, that is possible. will be spent.
Exe Inc, a small-and-medium-sized man- An official statement from a government
ufacturing company, was able to finish the about how much it plans to spend dur-
first year of operation with a net sales of ing a particular period of time and how
$1  million and net income of $200,000. it will pay for the expenses.
But it had severe cash flow problems and
reported $250,000 negative cash flow from Definition of Budget
operations. As per the Chartered Institute of Manage-
How is it possible that this company is ment Accountants (CIMA), UK Official Ter-
rich in profit but has no cash to spend? In minology, 2005, budget is “A quantitative
order to meet the demand from its custom- expression of a plan for a defined ­period
ers, Exe Inc had ramped up its production of time. It may include planned sales vol-
and hence its cash was tied up in raw mate- ume and revenues, resource quantities,
rials, work in progress, and finished goods. cost and expenses, assets, liabilities and
Its cash also got tied up in accounts receiv- cash flows.”
able due to aggressive credit sales. Based
on the inventory turnover and accounts Types of Budgets Classified Based on
receivable turnover, it was noted by the Time, Function, and Capacity
management accountant that cash was tied Time
up in inventory for 165 days and cash was Long-Term Budgets: budgets prepared for
tied up in accounts receivable for 80 days. a longer period varying between 5 to 10
Therefore, its cash is tied up in inventory years, like new product development,
and receivables for 245 days before getting capital expenditure and so forth.
converted to cash. Short-Term Budgets: budgets prepared
However, material purchases, debt servic- for a period of 1 year are broken into
ing, payroll, and so forth were required to be monthly and quarterly to make com-
paid by Exe Inc. on a timely basis (30 days). parison with actual performance.
Therefore, obviously Exe Inc reported Current Budget: budgets prepared for use
negative cash flow from operations. Hence, over a short period of time, such as
the company is profit rich, but cash poor! weekly cash flow budget, weekly sales
If the management accountant of Exe forecast, and so forth.
Inc develops a comprehensive plan called
as a master budget to control its operations, Function
it may be possible to correct the cash flow Functional Budgets: budgets which
shortage. relate to any of the functions of an

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Introduction to Budgeting

organization like sales budget, pur- like Microsoft, Amazon, Exxon Mobil, and
chase budget, production budget, man- Shell, have carefully developed budgets for
power budget, selling and distribution every aspect of their operation. However,
budget, administrative budget, cash companies with weak or inexperienced
budget, capital expenditure budget, management have an inadequate or sloppy
and so forth. budgeting process.
Master Budget: A summary budget incor-
porates all functional budgets and is fi- Preparation of Sales Budget: Forecast-
nally approved, adopted, and employed. ing of sales revenue is the starting
It usually includes a sales forecast, pro- point in the preparation of budget for
duction schedule, manufacturing cost business enterprises. It is based on a
budget, operating expense budget, cash business strategic plan and depends
budget, capital expenditure budget, pro- upon the general business and eco-
jected income statement, and projected nomic conditions, past experience, the
financial statements. level of competition, and the produc-
tion capacity. Based on the nature and
Capacity size of the business, both in terms of
Fixed Budget: A budget which remains quantity and in dollars, a consolidated
unchanged irrespective of the level of sales budget is prepared by the sales
activity actually attained. It assumes head and presented before the CEO
single-plan volume level and is not and COO.
altered or adjusted regardless of the Preparation of Production Budget and
changes in volume or other condition Operating Expenses: After the level
during the budget period. of sales has been forecast, a production
Flexible Budget: A budget which is de- budget is prepared in terms of quan-
signed to change in accordance with tity and value and the estimate made
the various level of activity (sales and of the forecast manufacturing cost and
production) actually attained. It takes operating expenses. Depending on the
into account the behavior of variable level of sales and cost-volume relation-
costs, semi-variable costs, and fixed ship, a production budget comprised
costs. It makes use of cost-volume-profit of a direct labor budget, a direct mate-
relationships. Budgeted variable manu- rial budget, and overheads budget is
facturing costs change with the level prepared.
of production, whereas budgeted fixed Preparation of Selling and Adminis-
costs remain the same until a certain trative Expense Budget: Based on
point of time. the expected level of sales, the market-
Responsibility Budget: A portion of the ing budget, the administrative expense
master budget showing the budgeted budget, and the research and develop-
performance of a particular responsi- ment budget are prepared as a part of
bility center within an organization. operating budget.
Rolling Budget: A technique of extending Preparation of a Budgeted Income State-
the budget period by 1 month as each ment: The budgeted income statement
month passes and the budget always is based on the sales budget, production
covers the upcoming 12-month period. and operating expenses, selling and
administrative expenses, and financ-
Key Steps in the Budgeting Process ing costs like bank charges, interest,
The extent to which plans are formalized in and so forth.
written budgets varies from one business Preparation of Cash Budget: The cash
to another. Large multinational companies, budget is a forecast of the cash receipts

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