BudgetClassificationsSUBMITTED BY:-

KUNDAN GANVIR

What is a Budget?

ICMA defines budget as:

“A budget is a quantitative statement, for a defined period of time, which may include planned revenues, expenses, assets, liabilities and cash flows. A budget provides a focus for the organizations, aids in the co-ordination of activities and facilitates control.”

Classification of Budgets

According to time

Long term budget

Short term budget

Classification of Budget according to Time

Short Term Budget• May cover periods of three to

twelve months depending upon nature of business

• Should be long enough to allow completion of a season or all aspects of a business

• The period should coincide with financial accounting period to facilitate evaluation of performance

e.g. A budget allocated to manufacturing of lots for spring-summer season, Fashion Retailing, etc.

Long Term Budget• A systematic and formalized

process for directing & controlling operations for period extending beyond one year

• It evaluates future implications associated with present decisions

• Market trends, change in demographics, national income, etc. play important role in preparing long term budget

• It proves useful in forecasting and evaluation of an organization over period of time

e.g. A father planning money requirement for his child’s future

Examples on short term and long term budget • Short Term budget:

A student allocating his/her pocket money to his monthly expenses like food, clothing, rent, leisure activities, stationaries, etc.

• Long Term budget:

A father planning future of his children:

College expenses –

Child 1 (current age 8); $20,000/year beginning in 10 years

Child 2 (current age 3); $24,000/year beginning in 15 years

New car purchase - $30,000 in two years ($4,000 upfront + $400/month for seven years)

Classification of Budget according to Function

Sales Budget

• The most important budget, all other budgets are contingent upon

• Production budget, selling and distribution, etc. are affected by sales budget

E.g.

Quarter 1

Quarter 2

Quarter 3

Quarter 4 Yearly

Sales units 120 130 150 165 565

Price per unit 20 22 25 27

Total Sales 2400 2860 3750 4455 13465Sales forecasting:Developing a sales budget requires forecasting future sales, which depends upon three main factors:1. Information concerning past performance2. Information about present conditions within industry and sales territory and3. Data concerning the industry and general business conditions

Classification of Budget according to Function Production Budget

• It is stated in physical units• It specifies the number of units of each product that must

be produced to satisfy the sales forecast• The number of units to be produced can be formulated

using:

Units to Produce = Budgeted sales + Desired closing inventory of finished goods – Beginning inventory of finished goods

E.g.Budgeted sales = 70,000,Desired closing finished goods inventory = 20,000Beginning finished goods inventory = 40,000Units to be produced = (70,000 + 20,000 – 40,000) = 50,000

Classification of Budget according to Function Production Cost Budget• It summarizes the materials budget, labor budget and the

factory overhead budget • It is made up of three budgets:

• Materials• Labor• Factory overhead

Direct Materials budget:• It specifies the cost of direct materials used and cost of the

direct materials purchased.• It helps in developing purchasing and delivery schedule• Helps to meet production targets

Direct Labor Budget:• It estimates the labor, in number and grades, to enable

production budget to be achieved• It must disclose: grade of labor along with cost (wages) and

period of trainingFactory Overhead Budget:

• Prepared on basis of chart of accounts which reflects different expense accounts and details of cost center or departments

Example on Production Cost budget

Material Usage budget

Product A Product B Total

Budgeted production

50,000 80,000

Direct materials

requirements

Product A X 5

Product B X 8

Direct materials usage (kg)

2,50,000 4,80,000

Cost per kg Rs. 1 Rs. 1.50

Cost of Direct materials used

Rs. 2,50,000 Rs. 7,20,000 Rs. 9,70,000

Classification of Budget according to FunctionResearch and Development Budget

• A tool for planning and controlling research and development costs

• Helps in coordination with company’s other plans and projects

• Helps allocation of funds for R&D by coordinating company’s immediate and long-term plans

• Helps in planning staff and equipment requirements for R&D

It contains details of cash inflows and cash outflows for the budget period of some other specific period.

• It indicates effect on cash positions of seasonal requirements, unusual receipts and slowness in collecting receivables

• Indicates availability of cash

• Shows availability of excess funds for short term investments

• Helps in planning bond redemptions, income tax installments and payments to employees

Classification of Budget according to Function Cash Budget

Period of Cash budget1. Operational: May be prepared monthly, weekly even daily to meet

requirements2. Short range: Prepared annually and is in correspondence with annual

profit plan. Indicates cash inflows and outflows as generated by annual profit plan

3. Long range: Does not disclose detailed estimates of revenue and expenses.

It is prepared according to:• The timing of the capital expenditure projects• The timing of long range profit plan

Classification of Budget according to Function Master Budget

• It is summary or total budget package for a business firm

• It can be called end product of budget making process• IT reveals the top management’s goals of revenues,

expenses, net income, cash inflows and financial positions

• Takes the macro view of business and coordinates with production, raw materials, manpower and other resources with production targets

• It cuts across divisional boundaries to coordinate firms’ diverse activities

• The operating budgets constitute the building block used to complete the master budget

Classification of Budget according to Function Fixed Budget

• Fixed budget is designed to remain unchanged irrespective of the level of the activity actually attained

• It is based on single level of activity• It compares data from actual operations with single

level of activity reflected in budget• Fixed budget is good for performance measurement, if

output can be estimated within close limits

Classification of Budget according to Function Flexible Budget

• It is prepared for a range, for more than one level of activity• It is a set of alternative budgets to different levels of activity• Flexible budget is prepared considering that a business is

dynamic, ever changing and never static• Important features of flexible budget:• It covers a range of activity• It is easy to change with variation in production levels• It facilitates performance measurement and evaluation

Advantages of Flexible budgeting:1. Accurate budgeting: Output factor is considered while preparation, since cost of goods may fluctuate time to time2. Coordination: Production is planned in relation to expected sales, materials and labor are acquired to meet expected production requirements3. Control tool: Comparison between the budgeted costs and actual costs form basis for analyzing cost variances and fixing responsibility for same. This motivates managers to feel themselves motivated in controlling costs for which they are responsible.

Zero Base Budgeting (ZBB)

• Zero base budgeting is method of budgeting where by all the activities are re-valuated each time budget is formulated.

• It involves starting from zero• In ZBB, each department’s functions are reviewed completely• ZBB rejects incremental nature of traditional budgeting,

instead states that expenditure of each program must start from base zero with each new budget being compiled as if the programs were being launched for first time

Advantages of ZBB:• It identifies and eliminates wastage and obsolete operations• Develops questioning attitude• Leads to staff involvement which may lead to improved motivation• Increases communication and coordination within organizationDisadvantages of ZBB: • Cost involved in preparing a vast number of decision packages in large firm are very high• Time consuming and large amount of paperwork is involved• Managers may oppose new ideas and changes

Zero Base Budgeting (ZBB)

Steps followed in application of ZBB:

1. Decision packages are prepared so that management can:• Evaluate and rank it against other activities and• Decide to approve of disapprove it

2. Each decision package is justified that it promotes the goals of enterprise

3. If justifies, then the cost of minimum efforts needed to sustain is determined

4. Alternatives for each package are considered5. Incremental decision package are also justified and

costed to describe benefits of additional work that would be done

6. Managers rank their decision packages in order of priority for resource allocation

7. Resources are allocated to the decision package.

Thank You