BUDGETING

What is Budget?

It is the comprehensive and coordinated plan,

expressed in financial terms, for the operations

and resources of an enterprise for some

specified period in the future.

Elements of Budget

It is an expression of what “the management expects and what it intends to happen”.

Research means planning of the various assets and sources of capital.

Budgets are prepared in monetary terms to provide a measure. Budget is prepared for a specified period (usually 1 year). Budget includes all the activities and operations of an

organization. Operations are reflected in revenues and expenses. The different component’s of a budget are taken care of to

maintain coordination between them.

Purpose of Budgeting

Budgets serve as a guide to the conduct of operations and a basis for evaluating results

Main Objectives• Explicit Statement of Expectation: congruence between short

term goals & long term objectives• Communication : facilitates in understanding of the methods &

goals taken by the management• Coordination : explains the roles to be played by the every

departments of the organization .• Framework for judging performance :it comes with standards ,

which gives us parameter to evaluate the performance , to control the deviations

Fixed and Flexible Budget

Fixed Budget (static budget) is prepared for only one level of activity. It does not take into consideration the fact that all items of costs do not change proportionately with the change in the activity level.

Flexible Budget is prepared for a range of activity levels rather than a single activity level. It recognizes the difference in behaviour between fixed and variable costs in relation to the fluctuations in output, turnover or other variable factors such as number of employees etc

Rs.

Fixed Expenses: 9,50,000

Wages and Salaries 6,60,000

Tent, Rates and Taxes 7,40,000

Depreciation 6,50,000

Administrative Expenses

Semi Variable Expenses: (at 50% capacity)

Repairs and Maintenance 3,50,000

Indirect Labour 7,90,000

Salaries of the Sales Department 3,80,000

Administrative Expenses 2,80,000

Variable Expenses: (at 50% capacity)

Materials 21,70,000

Labour 20,40,000

Other Expenses 7,90,000

98,00,000

Illustration 1The following data are available in a manufacturing company for an yearly period:

Assume that the fixed expenses remain constant for all levels of production, semi- variable expenses remain constant between 45% and 65% of capacity, increasing by 10% between 65% and 80% and by 20% between 80% and 100% capacity.

50% Capacity 100 lakh

60% Capacity 120 lakh

75% Capacity 150 lakh

90% Capacity 180 lakh

100% Capacity 200 lakh

Prepare flexible budget for the year and forecast profits at 60% , 75% , 90% and 100% of the capacity.

Capacity ( Rs Lakh)

50% 60% 75% 90% 100%

Sales 100,00,000 120,00,000 150,00,000 180,00,000 200,00,000

Variable Expenses:

Materials 21,70,000 26,04,000 32,55,000 39,06,000 43,40,000

Labour 20,40,000 24,48,000 30,60,000 36,72,000 40,80,000

Other Expenses 7,90,000 9,48,000 11,85,000 14,22,000 15,80,000

Total 50,00,000 60,00,000 75,00,000 90,00,000 100,00,000

Semi Variable Expenses:

Repairs and Maintenance

3,50,000 3,50,000 3,85,000 4,20,000 4,20,000

Indirect Labour 7,90,000 7,90,000 8,69,000 9,48,000 9,48,000

Salaries of the Sales Department

3,80,000 3,80,000 4,18,000 4,56,000 4,56,000

Administrative Expenses

2,80,000 2,80,000 3,08,000 3,36,000 3,36,000

Total 18,00,000 18,00,000 19,80,000 21,60,000 21,60,000

Fixed Expenses:

Wages and Salaries 9,50,000 9,50,000 9,50,000 9,50,000 9,50,000

Tent, Rates and Taxes

6,60,000 6,60,000 6,60,000 6,60,000 6,60,000

Depreciation 7,40,000 7,40,000 7,40,000 7,40,000 7,40,000

Administrative Expenses

6,50,000 6,50,000 6,50,000 6,50,000 6,50,000

Total 30,00,000 30,00,000 30,00,000 30,00,000 30,00,000

Total Cost of Sales 98,00,000 108,00,000 124,80,000 141,60,000 151,60,000

Operating Income 2,00,000 12,00,000 25,00,000 38,40,000 48,40,000

Profit as % of Sales 2% 10% 16.80% 21.33% 24.20%

ILLUSTRATION 2: [ Budgeted Income Statement ]

Perimal Ltd is a manufacturer of video conferencing products . Regular units are manufactured to meet marketing projections and specialized units are made after an order is received. Maintaining the video-conferencing equipment is an important area of customer satisfaction . With the recent downturn in the computer industry , the video-conferencing equipment segment has suffered ,leading to a decline in Perimal`s financial performance .The following income statement shows the results of 2006.

Perimal Ltd Income Statement for the year ended Dec31,2006 :

Revenues :(Rs) (Rs)

Equipment 6,00,000

Maintenance Contract 1,80,000

Total Revenue 7,80,000

Less: Cost of Goods Sold (4,60,000)

Gross Margin 3,20,000

Operating Costs :

Marketing 60,000

Distribution 15,000

Customer Maintenance 1,00,000

Administration 90,000

Less: Total Operating Cost (2,65,000)

Operating Income 55,000

Perimal management team is in the process of preparing the 2007 budget and is studying the following information :

1.Selling price of equipment are expected to increase by 10% as the economic recovery begins. The selling price of each maintenance contract is unchanged from2006 .

2. Equipment sales in units are expected to increase by 6 % growth in units of maintenance contracts .

3. Cost of each unit is expected to increase by 3 % to pay for the necessary technology and quality improvements.

4. Marketing costs are expected to increase by Rs 25,000 , but administration costs are expected to remain at 2006 levels.

5. Distribution costs vary in proportion to the number of units of equipment sold.

6. Two maintenance technicians are to be added at a total cost of Rs 13,000 which covers wages and related travel costs .The objective is to improve customer service and shorten response line.

7. There is no beginning or ending inventory of equipment.

Perimal Ltd Budgeted Income Statement for 2007 :

Revenues :(Rs) (Rs)

Equipment [ Rs 6,00,000 * 1.06*1.10 ] 6,99,000

Maintenance Contract [ Rs 1,80,000 * 1.06] 1,90,800

Total Revenue 8,90,400

Less: Cost of Goods Sold [ Rs 4,60,000*1.03*1.06 ]

(5,02,228)

Gross Margin 3,88,172

Less : Operating Costs :

Marketing [ Rs 60,000 + Rs 25,000 ] 85,000

Distribution [ Rs 15,000 * 1.06 ] 15,900

Customer Maintenance [Rs 1,00,000(1.06)+Rs 13,000 ]

1,19,000

Administration 90,000

Total Operating Cost (3,09,900)

Operating Income 78,272

Types of Budgets

• Production Budget

• Purchase Budget

• Labour Budget

• Sales Budget

• Cash Budget

• Master Budget

Production Budget• This is based on sales budget, as to provide for the output

needed to meet the requirement of the budget.• It is prepared in two parts one showing the estimates in

volume or quantities, and the other showing production costs.• Production cost budget includes the costs of raw-material,

labour and other expenses of production.

Key Point For Preparing Production Budget

1. Production Planning.

2. Volume of Production.

3. Quantities to be held in stock.

4. Integration with sales budget.

ILLUSTRATION 3:

The Surya Ltd. expects to sell 1,00,000 units of tube lights in the current year .The beginning inventory for the current year is 7,000 tube lights and the target end inventory is 11,000 units. Ascertain the number of tube lights which should be budgeted for production in the current year .

Solution: Production Budget

Budgeted Sales Units 1,00,000

Add : Target End Finished Goods Inventory 11,000

Total Requirement 1,11,000

Less: Beginning Finished Goods Inventory 7,000

Units to be Produced 1,04,000 units

Purchase Budget

1. Purchase Budget is based on production budget

2. Purposes of Purchase Budget

3. Different aspects of Purchase Budget

4. Reasons for preparing Purchase Budget

5. Usefulness of the Purchase Budget

Labour Budget

• Its is a part of Production budget like the Raw material budget .• First the labour requirements is ascertained in terms of grades

and trades of workers ,and their supply through the personnel department is assured.

• Prepared by the Personnel dept.

Information covered by Labour Budget

• Number of workers required.• Grade and trade-wise classification of the no. of workers

required.• Rates of wages for different grades of workers• Production hours employed and the cost of labour for the

budget period.• Cost of training or apprenticeship required• Period when labour would be needed in maximum number.• Facilities and Holidays made available to the workers etc.

Sales Budget• Acc. W.W Bigg”This is probably the most important budget, as it is usually

the most difficult to forecast or attain.”• Acc. Olwer & Brown”This is probably the most difficult functional budget to

prepare.”

Basis of preparation• Product –wise• Territory –wise• Customer –wise• According to salesman• Period –wise

Sales Budget usually include:• Sales estimation;• Area –wise analysis of estimated sales;• The methods of increasing sales if the sales are shown increased over the

past period;• Cost of additional sales – promotion activities, etc

ILLUSTRATION 4:

Pearlpet Company , bottles and distributes mineral water. The company makes two products : 1 litre plastic bottle and 25 litre re-usable plastic containers.

1. For 2006 Pearlpet Marketing Manager projects monthly sales of 2,00,000 units of 1 litre bottle and 50,000 units of 25 litre containers .Average selling prices are estimated at Rs. 10 / 1litre bottles and Rs. 50 / 25litre container.

Prepare a revenue budget for Pearlpet company, for the year ending Dec. 31, 2006.

Solution:

1. Sales (Revenue) Budget :

Products Selling PricesPer unit (Rs.)

Units Sold Total Revenue (Rs.)

1 litre Bottle 10.00 24,00,000 240,00,000

25 litre Container 50.00 6,00,000 300,00,000

540,00,000

2.

Pearlpet begins 2006 with 4,50,000 1 litre bottles in inventory .The vice president of operations requests that I litre bottle inventory on Dec31, 2006 be no less than 3,00,000 units .

Based on sales projections as budgeted above

What is the minimum number of I litre bottle that should be produced during 2006 ?

2. Production Budget

Budgeted Units Of Sales 24,00,000

Add: Target End Inventory of Finished Goods

3,00,000

Total Requirement 27,00,000

Less: Beginning Finished Goods Inventory

4,50,000

Units to be Produced 22,50,000

3.

The VP of operation requests that ending inventory of 25 litre containers on Dec31, 2006 , should be 1,00,000 units. If the production budget calls for Pearlpet to produce 6,50,000 25 litre containers during 2006 .

What is the beginning inventory of 25 litre container ,on Jan 1, 2006 ?

3. Beginning Inventory of 25 liter containers:

Budgeted Units Of Sales

(+)Target End Inventory of Finished Goods

(-)Beginning Finished Goods Inventory

= Units to be Produced , therefore

Beginning Finished Goods Inventory = Budgeted Units Of Sales (+)Target End Inventory of Finished Goods

(-)Units to be Produced

= 6,00,000 (+) 1,00,000(-) 6,50,000

= 50,000 units of 25 liter containers

ILLUSTRATION 5:The Royal Goods Ltd . manufacture and sells 2 products , Royal Bucket and Royal Drum . In July 2005 , Royal Goods Ltd gathered the following information to prepare budget for 2006 :

Products 2006-07 Projected Sales 2006-07 Inventories (units)

Units Price (Rs.) April 1, 2006 March31,2007

Royal Bucket 60,000 165 20,000 25,000

Royal Drum 40,000 250 8,000 9,000

Direct Material Used in the Two Products:

Direct Material Units Royal Bucket Royal Drum

A Kg 4 5

B Kg 2 3

C kg 0 1

Projected data for 2006-07 with respect to direct material are as follows:

Direct Material

Anticipated Purchase Price (Rs)

Expected Inventories April1,2006

Target Inventories March 31,2007

A 12 32,000 kg 36,000 kg

B 5 29,000 kg 32,000 kg

C 3 6,000 units 7,000 units

Projected direct manufacturing labour requirement and rates for 2006-07:

Product Hours per Unit Rate per Hour (Rs.)

Royal Bucket 2 12

Royal Drum 3 16

Manufacturing overhead is allocated at the rate of Rs. 20 per direct manufacturing labour hour.

Prepare the following budgets:

a) Revenue Budget in rupees .b) Production Budget in units .c) Direct material purchase budget (in quantities) .d) Direct material purchase budget (in rupees) .e) Direct manufacturing labour budget (in rupees) .f) Budgeted finished goods inventory at March 31,

2006-07 ( in rupees) .

Solution:

I) Revenue Budget for 2006-07 :

Products Units Price (Rs) Total (Rs)

Royal Bucket 60,000 165 99,00,000

Royal Drum 40,000 250 100,00,000

Total 199,00,000

I) Production Budget in units for 2006 :

Royal Bucket Royal Drum

Budgeted Units Of Sales 60,000 40,000

Add: Target End Inventory of Finished Goods March 31,2007

25,000 9,000

Total Requirement 85,000 49,000

Less: Beginning Finished Goods Inventory April1, 2006

20,000 8,000

Units to be Produced 65,000 41,000

iii) Direct material purchase budget (in quantities) for 2006-07:

Direct Materials

A B C

Direct Materials to be used in production :

Royal Bucket[ 65,000 units ;4kg of A , 2kg of B ]

2,60,000 1,30,000 -

Royal Drum[ 41,000 units ;5kg of A , 3kg of B , 1 kg of C]

2,05,000 1,23,000 41,000

Total 4,65,000 2,53,000 41,000

Add: Target End Inventory of March 31,2007

36,000 32,000 7,000

Total Requirement 5,01,000 2,85,000 48,000

Less: Beginning Inventory April1, 2006

32,000 29,000 6,000

Direct Material to be purchased (units)

4,69,000 2,56,000 42,000

iv) Direct material purchase budget (in rupees) for 2006-07:

Budgeted Purchases

(kgs)

Expected Purchase

Price per kg (Rs)

Total (Rs)

Direct Material A

4,69,000 12 56,28,000

Direct Material B

2,56,000 5 12,80,000

Direct Material C

42,000 3 1,26,000

70,34,000

v) Direct manufacturing labour budget (in rupees) for 2006- 07

Budgeted Production

(units)

Direct Manufactu

ring Labour-

hr per unit

Total Hours

Rate per

Hour

Total (Rs)

Royal Bucket

65,000 2 1,30,000 12 15,60,000

Royal Drum

41,000 3 1,23,000 16 19,68,000

35,28,000

Vi) Budgeted finished goods inventory at March 31, 2006-07 ( in rupees) :Royal Bucket :

Particulars Amount (Rs) Amount (Rs)

Direct Material Cost:

A : 4 kg * Rs 12 48

B : 2 kg * Rs 5 10

58

Direct Manufacturing Labour Cost :2 hr * Rs 12

24

Manufacturing Overhead Cost per unit : 2hr* Rs20

40

122

Finished Goods Inventory (25,000 units Rs 122/- per unit )

30,50,000

Royal Drum :

Particulars Amount (Rs) Amount (Rs)

Direct Material Cost:

A : 5 kg * Rs 12 60

B : 3 kg * Rs 5 15

C : 1 kg * Rs 3 3

78

Direct Manufacturing Labour Cost :3 hr * Rs 16

48

Manufacturing Overhead Cost per unit : 3hr* Rs20

60

Budgeted Manufacturing cost per unit

186

Finished goods inventory (9,000 units @ Rs186/- per unit)

16,74,000

Total budgeted finished goods inventory , March 31, 2007 is Rs 47,24,000.

• ILLUSTRATION 6: [ Cash Budgeting ]• Retail outlet purchases snowboards from J.K. Woods throughout the year .

However, in anticipation of late summer and early fall purchases , outlets ramp up inventories from may through August . Outlets are billed when board are ordered . Invoices are payable within 60 days .From past experience , J.K`s accountant projects 20 % of invoices are paid in the month invoiced , 50 % are paid in the following month, and 30 % of invoices are paid two months after the month of invoice .The average selling price per snowboard is Rs 1,000.

• To meet demand, J.K increases production from April through July , because the snowboards are produced a month prior to their projected sale. Direct materials are purchased in the month of production and paid for during the following month ( terms are : payment in full within 30 days of the invoice date ) . During this period there is no production for inventory and no materials are purchased for inventory .

• Direct manufacturing labour and manufacturing overheads are paid monthly .It may be noted that the firm has annual fixed –manufacturing overhead costs of Rs 1,92,000. Variable manufacturing overhead is incurred at the rate of Rs 14 per direct manufacturing labour-hour. Variable marketing costs are driven by the number of sales visits .However, there are no sales visits during the months studied . J.K also incurs fixed manufacturing overhead costs of 11,000 per month and fixed manufacturing overhead costs of Rs 5,000 per month.

Projected Sales :

MonthUnits Month Units

May 80 August 100

June 120 September 60

July 200 October 40

Direct Material and Direct Manufacturing Labour Utilization and Cost :

Units per BoardPrice per Unit(Rs) Unit

Wood 5 60 Board feet

Fiberglass 6 10 Yard

Direct Manufacturing Labour

5 25 Hour

• On September 1, 20006 J.K. had a cash crunch and borrowed Rs 1,00,000 on a 10 % one-year note with interest payable monthly. The note is due on October 1,2007.– Prepare a cash budget for the months of July through

September 2007. Assume the beginning cash balance for July 1, 2007 is Rs 10,000 .

– Will J.K. be in a position to pay off Rs1,00,000 one-year note on Oct.1,2007? If not , what actions would you recommend to its management ?

Working Note 1: Sales Budget ( Projected Sales in Units and Rs)

May June July August September

Sales in Units 80 120 200 100 60

Revenues Rs 80,000 Rs 1,20,000 Rs 2,00,000 Rs 1,00,000 Rs 60,000

Working Note 2: Collections of Receivables

May June July August September

May [ 30% * 80,000 ] 24,000 - -

June [ 50%; 30%*1,20,000] 60,000 36,000 -

July[20%;50%;30%*2,00,000] 40,000 1,00,000 60,000

August[20%;50%*1,00,000] - 20,000 50,000

September[20%*60,000] - - 12,000

Total 1,24,000 1,56,000 1,22,000

Working Note 3 : Material and Labour Usage Budget

May June July Augt Sept Oct

Budgeted Production (units)

200 100 60 40

Direct Material :

Wood (board feet) 1,000 500 300 200

Fiberglass (yards) 1,200 600 360 240

Direct Manufacturing Labour (hours)

1,000 500 300 200

Working Note 4 : Calculation of Payables/Disbursements

Disbursement of Payments July August September

Direct Material:

Wood [ 1,000;500;300*Rs 60 ] 60,000 30,000 18,000

Fiberglass [ 1,200;600;360*Rs 10 ] 12,000 6,000 3,600

Direct Manufacturing Labour [ 500;300;200*Rs 25 ]

12,500 7,500 5,000

Interest Payment [ 10%*Rs 1,00,000 / 12 ] 1,000 1,000 1,000

Variable Overhead Calculation :

Variable Overhead Rate Rs 14 Rs 14 Rs 14

OHD Driver 500 300 200

Variable Overhead Expense Rs 7,000 Rs 4,200 Rs 2,800

Solution :1. Cash Budget for the month of July , August , September 2007 :

July (Rs) August (Rs) September(Rs)

Beginning Cash Balance 10,000 25,500 1,16,800

Add Receipts :

Collection of Receivables 1,24,000 1,56,000 1,22,000

Total Cash Available 1,34,000 1,81,500 2,38,800

Less Disbursements :

Material Purchases 72,000 36,000 21,600

Direct Manufacturing Labour 12,500 7,500 5,000

Variable Costs 7,000 4,200 2,800

Fixed Costs 16,000 16,000 16,000

Interest Payments 1,000 1,000 1,000

Total Disbursements 1,08,500 64,700 46,400

Ending Cash Balance 25,500 1,16,800 1,92,400

2. Yes, J.K has a budgeted cash balance of Rs 1,54,600 on 10.1.2007 and so will be in a position to pay off the Rs 1,00,000 one-year note on Oct.1, 2007.

• Thank you