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Sandeep Vilas Shirsekar Batch 13 B Roll No 93
Sandeep Vilas Shirsekar Batch 13 B Roll No 93
Budgeting
* * * INTRODUCTION TYPES METHODS
INTRODUCTION:
For effective running of a business, management must know:
where it intends to go i.e. organizational objectives how it intends to accomplish its objective i.e. plans overall
whether operations conform to the plan of operations relating to that period i.e. control
Budgetary control is the device that a company uses for all these purposes.
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WHAT IS A BUDGET?
A plan expressed in money. It is prepared and approved prior to the budget period and may show income, expenditure and the capital to be employed. May be drawn up showing incremental effects on former budgeted or actual figures, or be compiled by Zero-based budgeting.
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CLASSIFICATION OF BUDGETS
ACCORDING TO TIME ACCORDING TO FUNCTION ACCORDING TO FLEXIBILITY
1. 2. 3. 4.
Long term budget Short term budget Current budget Rolling budget
1. Sales budget 2. Production budget 3. Cost of Production budget 4. Purchase budget 5. Personnel budget 6. R & D budget 7. Capital Expenditure budget 8. Cash budget 9. Master budget
1. SALES BUDGET:
Sales budget is the most important budget based on which all the other budgets are built up. This budget is a forecast of quantities and values of sales to be achieved in a budget period.
2. PRODUCTION BUDGET:
Production budget involves planning the level of production which in turn involves the answer to the following questions:
a. What is to be produced?
b. When is it to be produced? c. How is it to be produced?
d. Where is it to be produced?
This budget is an estimate of cost of output planned for a budget period and may be classified into
Material Cost Budget
4. PURCHASE BUDGET: This budget provides information about the materials to be acquired from the market during the budget period.
5. PERSONNEL BUDGET:
This budget gives an estimate of the requirements of direct labour essential to meet the production target.
This budget may be classified into
A R&D budget is prepared taking into consideration the research projects in hand and new R & D projects to be taken up.
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This is an important budget providing for acquisition of assets necessitated by the following factors:
a. Replacement of existing assets.
9. MASTER BUDGET:
CIMA defines this budget as The summary budget incorporating its component functional budget and which is finally approved, adopted and employed.
Thus master budget is a summary of all functional budgets in capsule form available in one report. 10. FIXED BUDGET:
This is defined as a budget which is designed to remain unchanged irrespective of the volume of output or turnover attained. This budget will, therefore, be useful only when the actual level of activity corresponds to the budgeted level of activity.
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CIMA defines this budget as one which, by recognising the difference in behaviour between fixed and variable costs in relation to fluctuations in output, turnover or other variable factors such as number of employees, is designed to change appropriately with such fluctuations.
12. PERFORMANCE BUDGETING: These days budgets are established in such a way so that each item of expenditure is related to specific responsibility centre and is closely linked with the performance of that standard.
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The zero base budgeting is not based on the incremental approach and previous figures are not adopted as the base.
Zero is taken as the base and a budget is developed on the basis of likely activities for the future period. A unique feature of ZBB is that it tries to help management answer the question, Suppose we are to start our business from scratch, on what activities would we spent out money and to what activities would we give the highest priority?
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Responsibility accounting fixes responsibility for cost control purposes by establishing responsibility centres namely
a. Cost centre
b. Profit centre
c. Investment centre
CONCLUSION:
Preparation of budgets is the first step in the budgetary
control system.
But preparation and implementation of budgets alone will not achieve much unless a comparison is made regularly between the actual performance and the budgeted performance. Continuous and proper reporting makes this possible.
To ensure the success of budgetary control system, proper follow up action has to be taken immediately for the reports submitted.
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CAPITAL BUDGETING
Capital budgeting is a decision situation where large funds are committed (invested) in the initial stages of the project and the returns are expected over a long period of time. These decisions are related to allocation of investible funds to different long-term assets.
Capital budgeting is a continuous process and it is carried out by different functional areas of management such as production, marketing, engineering, financial management etc.
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CAPITAL BUDGETING
DECISION INVOLVES
THREE STEPS 1. Estimation of costs and benefits of a proposal or of each alternative. 2. Estimation of the required rate of return, i.e., the cost of capital 3. Selection and applying the decision criterion.
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The cash flows may be grouped into relevant and irrelevant cash flows as follows:
Relevant cash flows
Cost of new project Scrap value of old / new plant Trade-in-value of old plant Cost reduction / savings Effect on tax liability Incremental repairs Working capital flows Revenue from new proposal Tax benefit of incremental depreciation
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Calculation of different cash flows may be summarized as follows: INITIAL CASH OUTFLOW:
Cost of new plant + Installation expenses + Other Capital expenditure
2. DECISION CRITERIA
TECHNIQUES OF EVALUATION
Traditional or
Time-adjusted or
Non-discounting
# The payback period may be suitable if the firm has limited funds available and has no ability or willingness to raise additional funds.
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income earned on the average funds invested in a project. # The annual returns of a project are expressed as a percentage of the net investment in the project.
COMPUTATION OF ARR:
Average Annual profit (after tax) ARR = Average Investment in the Project
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x 100
OR
TIME
These are based upon the fact that the cash flows occurring at different point of time are not having same economic worth. I. NET PRESENT VALUE (NPV) METHOD:
The NPV of an investment proposal may be defined as the sum of the present values of all the cash inflows less the sum of present values of all the cash outflows associated with the proposal. The decision rule is Accept the proposal if its NPV is positive and reject the proposal if the NPV is negative.
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II. PROFITABILITY INDEX METHOD: This technique is a variant of the NPV technique and is also known as BENEFIT - COST RATIO or PRESENT VALUE INDEX.
Accept the project if its PI is more than 1 and reject the proposal if the PI is less than 1.
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Capital budgeting decisions are of paramount importance as they affect the profitability of a firm, and are the major determinants of its efficiency and competing power.
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GOAL:
To manage the firms current assets and liabilities in such a way that a satisfactory level of working capital is maintained.
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CONCEPTS:
GROSS WORKING CAPITAL The current assets which represent the proportion of investment that circulates from one form to another in the ordinary conduct of business. NET WORKING CAPITAL The portion of current assets financed with long term funds or current assets current liabilities
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PURPOSE:
The NWC is necessary because the cash outflows and inflows do not coincide.
The purpose of NWC is to measure the liquidity of the firm.
DETERMINING FINANCING MIX: Financing mix is the choice of sources of financing of current assets.
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HEDGING APPROACH
(MATCHING APPROACH)
This is the process of matching maturities of debt with the maturities of financial needs. According to Hedging approach, the permanent portion of funds required should be financed with long term funds and the seasonal portion with short term funds.
Under this approach working capital = 0 since CA are not financed by long term funds (CA = CL).
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This is a strategy by which the firm finances all funds requirement, with long term funds and uses short term funds for emergencies or unexpected outflows. TRADE OFF BETWEEN HEDGING AND CONSERVATIVE APPROACHES:
One possible trade off could be equal to the average of the minimum and maximum monthly requirements of funds during the given period of time. This level of requirement of funds may be financed through long run sources and for any additional financing need, short term funds may be used.
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FACTORS DETERMINING AMOUNT OF WORKING CAPITAL Purchase resources Payment for resource purchase Sell product on credit Receive cash
Payables period
Operating cycle
The length of the operating cycle is the most widely used method to determine working capital need. The longer the production cycle, the larger is the working capital need or vice versa. Manufacturing and trading enterprises require fairly large amount of working capital to support their production and sales activity. Service enterprises like hotels, restaurants etc., need less working capital.
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