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3.6 Types of Budgets
3.6.1 Master Budget
Master Budget is a combination of all other budgets prepared for a specific period. It shows the overall budget plan. All the budgets are coordinated into one harmonious unit.
According to Rowland and William H. Harr, “Master Budget is a summary of the budget schedules in capsule form made for the purpose of presenting in one report the highlights of the budget forecast.” Thus, Master Budget sets out the plan of operations for all departments in considerable detail for the budget period. The budget may take the form of a Profit and Loss Account and a Balance Sheet as at the end of the budget period.
The budget generally contains details regarding sales (net), production costs, cash position, and key account balances like debtors, fixed assets, bills payable, etc. It also shows the gross and the net profits and the important accounting ratios. It is prepared by the Budget Officer and it requires the approval of the Budget Committee before it is put into operation. If approved, it is submitted to the Board of Directors for final approval. The Board may make certain alterations if necessary before it is finally approved.
3.6.2 Sales Budget
The sales budget is usually the keystone in planning and control of operation of a business. Sales forecast serves as a base for the sales budget. The sales budget is prepared in quantitative terms of units expected to be sold and the value expected to be realised. The Sales Manager should be made directly responsible for the preparation and execution of sales budget. This is prepared according to the requirements of the business while preparing sales budget. The useful classification may be-products, territories, customers, salesmen, etc. More than one classification may be employed. However, at the time of preparing sales budget the following factors should be kept in mind:
(a) salesmen’s estimates (b) orders in hand (c) Past behaviour (d) Management policies for future (e) seasonal fluctuations (f) availability of materials (g) plant capacity (h) availability of finance (i) potential market (j) level of competition (k) position of competitors, etc. Look at the following illustration how a sales budget is to be prepared.
3.6.3 Production Budget
The Production Budget is a forecast of the production for the budget period. It provides an estimate of the total volume of production product-wise with the scheduling of operations by days, weeks and month and also a forecast of the closing finished product inventory. It is based on sales budget. The Factory Manager is the person generally made responsible for its preparation, administration and execution. This budget can also be prepared department-wise. This budget is prepared in quantity terms only. The main factors, which are useful in preparing production budgets, are:
- (a) Inventory Policies
- (b) Sales Requirements
- (c) Uniformity of Production
- (d) Plant
- (e) Availability of inputs
- (f) Duration of Production.
Production may be computed as follows:
Units to be produced = Budgeted Sales + Desired Closing Stock of finished goods – Opening Stock of finished goods.
3.6.4 Materials Budget
Materials are either direct or indirect. The Material budget generally deals only with the direct materials. Indirect materials are generally included in overhead budget. The material requirements are estimated on the basis of quantity of each class of products to be produced by multiplying the exact material requirement for each class of product by the number of units of that class. Material budget can be prepared on the basis of standards or, historical data regarding percentage of raw materials to total cost, adjusted for current price and normal wastage of material.
The factors to be considered while preparing the Material Budget are: the quantity of material required for the production budget, tentative dates by which required material must be available, the availability of storage facilities as well as credit facilities, price trends in the market, nature of the materials required etc.
Only direct materials are to be taken into account and indirect materials are not taken into account as they are considered under overheads budget. The material budget helps the management for proper planning of purchases. The object of the budget is to ensure the availability of adequate quantities of materials as and when required. It will be included in the Master Budget after the approval of Budget Committee.
3.6.5 Purchase Budget
Purchase Budget gives the details of material purchases to be made in the budget period. It correlates with sales forecast and production planning. It deals with purchases that are required for planned production. Purchases would include both direct and indirect materials and goods. While placing the purchase orders material manager has to see the orders on hand and unfulfilled orders at the beginning of the budget period and adjust the purchases accordingly. Purchase budget enables the budget officer to provide funds in the cash budget according to delivery schedules, terms of payment and credit period. While preparing purchase budget the factors like the opening and closing stock to be maintained, maximum and minimum stock quantities to be maintained, economic order quantity level, the resources available, the policy of management etc., should also be taken into account.
Budgeted Purchase Quantity = Budgeted Consumption Quantity + Required Closing Stock – Opening Stock.
3.6.6 Direct Labour Budget
The direct labour budget tells about the estimates of direct labour requirements essential for carrying out the budgeted output. The quantity of labour, e.g. skilled, unskilled, semi-skilled etc are estimated first. The time taken by them can be measured in terms of man hours Thereafter, the total cost of labour is estimated by multiplying the rates of pay with the labour hours. The purpose of this budget is to ensure optimum utilization of labour force.
3.6.7 Overhead Budget
The overheads budget should be prepared in three parts as follows:
1) Manufacturing Overhead Budget
2) Administration Overhead Budget, and
3) Selling and Distribution Overhead Budget.
Manufacturing Overhead Budget
The budget is an estimate of the manufacturing overhead costs to be incurred in the budget period to achieve the targeted production. Manufacturing overheads include indirect material, indirect labour, and indirect expenses related to the factory. The cost of each and every item of these three components of manufacturing overhead Is separately estimated as per the requirements of production.
Administration Overhead Budget
Administration overhead includes the costs of framing policies, directing the organisation and controlling the business operations. Most of the administration expenses are normally unconnected with the volume of activity, therefore, experience and anticipated changes in conditions are the guides for the preparation of this budget.
Selling and Distribution Overhead Budget
The budget includes all expenses relating to selling, advertising, delivery of goods to customers, etc. The overheads may be determined on the basis of sales targets being allocated to different territories or salesman etc. Those expenses which generally vary with the sales quantity are estimated on sales basis, others which are of a fixed nature, are estimated on the basis of past experience and anticipated changes. The responsibility for the preparation of this budget lies with the executives of the sales departments.
3.6.8 Cash Budget
A Cash Budget is a summary statement of the firms’ expected cash inflows and outflows over a projected time period. In other words, cash budget involves a projection of future cash receipts and cash disbursements over various time intervals. While preparing cash budget seasonal factors must be taken into account and in practice cash budget is prepared on a monthly basis. The availability of other budgets is tested in terms of cash availability. Cash budget is also called as cash flow statement which indicates cash inflow and cash outflows. It is generally prepared for a maximum period of one year.
A cash budget helps the management in (i) determining the future cash needs of the firm, (ii) planning for financing of the needs; (iii) exercising control over cash and liquidity of the firm.
The overall objective of a cash budget is to enable the firm to meet all its commitments in time and at the same time prevent accumulations of unnecessary large balance with it.
Methods of Preparing Cash Budgets
There are basically three methods for preparing cash budgets.
1) Receipts and Payments Method
2) Adjusted Profit and Loss Account Method
3) Balance Sheet Method
Let us study about these methods in brief.
1) Receipts and Payments Method
Under this method, all receipts are added and out of the total, the sum of all payments is deducted to arrive at the balance in hand. The closing balance in hand say, for a particular month is the opening balance of the next month and is added to the total of receipts so as to know the total availability of cash during the month. The receipts and payments during the budget period are found out from various functional budgets prepared. The credit allowed to debtors, the credit allowed to us by suppliers, the delay in payment of wages and other expenses etc. are the factors, which are taken into account to determine the timing of receipts and payments. Advance payments and receipts are to be included but the payment in abeyance and income accrued on outstanding are excluded from cash budget. Revenue as well as capital receipts and payments are recorded in cash budget.
2) Adjusted Profit and Loss Account Method
The budgeting done by Adjusted Profit and Loss account method is known as cash flow statement and is more suitable for long-term forecasting. Under this method profit is taken as equivalent to cash and necessary adjustments are done in respect of non-cash transactions. The net estimated profit is taken as the base and non-cash items like depreciation, outstanding expenses, provisions etc. already deducted to arrive at the net profit are added back. The capital receipts, reduction in debtors, stocks, increase in liabilities, issue of share capital and debentures are other items which are added to compute the total cash receipts. The payments of dividends, prepayments, capital payments, increase in debtors, and increase in stock and decrease in liabilities are deducted out of the total cash receipts. The profit adjusted this way denotes the estimated cash available.
3) Balance Sheet Method
Under this method, at the end of budget period a projected balance sheet is drawn up setting out the various assets and liabilities, except cash and bank balances. The balancing figure would be the estimated closing cash/bank balance. Thus, under this method, closing balances other than cash/bank will have to be found out first to be put in the budgeted balance sheet. This can be done by adjusting the anticipated transaction of the year in the opening balances. If the liabilities are more than assets, this reveals a balance of cash/bank and if assets exceed liabilities, it reveals a bank overdraft. Thus, under Adjusted Profit and Loss method, the amount of cash is computed by preparing a Cash Flow Statement and the same amount is computed as a balancing figure under Balance Sheet method.
3.6.9 Fixed Budget
According to C.I.M.A., London, “a fixed budget is a budget which is designed to remain unchanged irrespective of the level of activity actually attained.” Thus, a budget prepared on the basis of a standard or fixed level of activity is known as a fixed budget. It does not change with the change in the level of activity. Therefore, it becomes an unrealistic yardstick in case the level of activity actually attained does not confirm to the one assumed for budgeting purposes. The management will not be in a position to assess the performance of different heads on the basis of budgets prepared by them because they can serve as yardsticks only when the actual level of activity corresponds to the budgeted level of activity. Fixed budget is useful when there is no significant variation between the budgeted output and the actual output. It does not consider variances due to changes in the volume. In the industries where the pattern of demand is stable a fixed budget may be adequate, especially where the budget period is comparatively short. In such concerns it is possible to forecast sales with a considerable degree of accuracy.
3.6.10 Flexible Budget
Flexible budget, also known as variable or sliding sale budget, is a budget which is designed to furnish budgeted costs for any level of activity actually attained. Flexible budgeting technique may be employed to adjust other budgets according to current conditions arising out of seasonal variations or changes in the length of the working period etc.
According to C.I.M.A., London, “a flexible budget is a budget designed to change in accordance with the level of activity actually attained.” Thus, a budget prepared in a manner so as to give the budgeted cost for any level of activity is known as a flexible budget. Such a budget is prepared after considering the fixed and variable elements of cost and the changes that may be expected for each item at various levels of operations.
Under this method, a series of budgets would be prepared at different levels of activity. Variable items are shown in the budget as per the level of output. Fixed costs are shown at the same amount irrespective of level of output. Sales value is computed and entered into the flexible budget. The position of profit or loss will be revealed at the various levels of activity. Management will take a decision to operate at a particular level of activity where the profit is maximum taking into account all other factors.
A flexible budget is more realistic, useful and practical. The likely changes in the actual circumstances are taken into account while preparing a flexible budget. The technique is highly useful for control purposes. Actual performance of an executive may be compared with what he should have achieved in the actual circumstances and not with what he should have achieved under quite different circumstances.
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