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BUDGETING is the process or the act of preparing a budget. It encourages planning,

coordination, performance measurement, and corrective action.

A BUDGET is a detailed plan,expressed in quantitative terms, that specifies how resources will
be acquired and used during a specified period of time. It has 5 primary purposes:

1. Planning
2. Facilitating communication and coordination;
3. Allocating resources;
4. Controlling profit and operations; and
5. Evaluating performance and providing incentives.

The most obvious purpose of a budget is to quantify a plan of action. The process of creating
a budget forces the individuals to plan ahead. For any organization to be effective, each
manager must be aware of the plans made by other managers. The budgeting process pulls
together the plans of each manager.

Resources have limited capacity and budgets provide one means of allocating resources
among competing uses. Since budgets are used to evaluate performance, they can also be
used to provide incentives for people to perform well.

Budgetary control is a means of keeping the operating plan within acceptable tolerances which
involves the use of budget in regulating business operations (activities). Control consists of
comparing actual with plans and if deviations exist, management takes action to get back in
line with the budget. Through control, budgeting promotes efficiency and prevents waste and
that means more money in the corporate coffers.

Do all businesses need a budget? Some feel that their operations are so small or self-
contained that they can personally supervise all activities. Plans can be made without using a
budget but planning in a definitive manner, as with a budgetary system, gets far better results
than do individuals carrying around general ideas on their heads. The size of your company
has no bearing on the need for planning. The procedures may be simpler for smaller
organizations or entity, but no less important. Without a budget, a business flounders.
Management never knows where the business is headed. Even with a budget, a company may
not reach its goals but budgetary control points up deviations from plans, thus giving
management a chance to take action.

Most organizations prepare the budget for the coming year during the last 4 or 5 months of the
current year. However, some organizations have developed a continuous budgeting
philosophy. A continuous budget is a moving 12-month budget. As a month expires in the
budget, an additional month in the future is added so that the company always has a 12-
month plan on hand. Proponents of continuous budgeting maintain that it forces managers to
plan ahead constantly.

Typically, the budget is for a one-year period corresponding to the fiscal year of the company.
Yearly budgets are broken down into quarterly budgets and quarterly budgets are broken down
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into monthly budgets. The use of smaller time periods allows managers to compare actual
data with budgeted data more frequently, so problems may be noticed and solved sooner.

Budgeting can no longer be the sole responsibility of the CEO, budget officer or other top
executive in the company. Rather, all levels of the company must participate in the budgeting
process and make commitments to achieve the goals. Greater involvement by more people
commits them to achieving budget goals when they are established. This has important
results in terms of motivation and achievement.

The budget emphasizes that all segments of a company are working toward a common goal.
It demonstrates clearly that only when the efforts of all people in the company are directed
properly can goals be achieved. It pins responsibility on each segment for doing its part in the
planned action. Finally, budgeting results in more rational use of the firm’s resources and
facilities. Management can make more accurate estimates of future labor and capital
requirements. All this interaction in the budgeting process ultimately has a significant impact
right where you want it to - on the bottom line.

3 Levels of Planning for Business Activity:

* STRATEGIC PLANNING involves making long-term decisions such as defining the scope
of the business, determining which products to develop, deciding whether to discontinue
a product, and determining which product niche should be most profitable. Upper-level
management is responsible for these decisions.

* CAPITAL BUDGETING deals with intermediate range planning.

* OPERATIONS BUDGETING involves the establishment of a master budget that will

direct the firm's activities over the short term.

In many companies, responsibility for coordinating the preparation of the budget is assigned to
a budget committee (composed of the sales manager, production manager, chief engineer,
treasurer and the controller) which serves as a review board where managers and supervisors
can defend their budget goals and requests. It is responsible for settling disputes among
various departments over budget matters. After differences are reviewed, modified if
necessary, and reconciled, the budget is prepared by the budget committee, put it in its final
form and approved. Copies of the budget are subsequently distributed to the various levels of
managers who have budget responsibilities. Primary responsibility for the administration of the
budget ultimately rests with the CEO of the firm.

In order to be effective management tools, budgets must be based upon a sound

organizational structure, research & analysis and management acceptance of the budget
program.

MASTER BUDGET is a set of interrelated budgets that constitutes a plan of action for a
specified time period. It normally covers a one-year time span. The preparation of the MB
begins with the SALES FORECAST which is the data source for all of the other budgets.
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3 Major Budget Categories are:

1) OPERATING BUDGET 2) FINANCIAL BUDGET 3) CAPITAL BUDGET

* Sales budget * Cash budget * Budget for plant expansion
* Production budget * Projected balance sheet
* Material Purchase * Projected CFS * Budget for replacement
budget projects
* DL budget * Budget for general
* Overhead budget plant improvement
* Selling & Administrative budget
* Ending finished goods inventory budget
* CGS budget
* Projected income statement

CONTROL (or Responsibility) BUDGET - one which identifies cost items

with those who are responsible for their incurrence. The individual manager or
supervisor prepares his own budget (approved by the higher level management)
and his performance is evaluated by comparing the actual result with that of the
budget.

FIXED BUDGET or STATIC BUDGET - is a budget for a particular level of activity.This

level is not changed regardless of the actual volume of operations
experienced.

FLEXIBLE BUDGET - a budget consisting of various level of activity or volumes. It is

sometimes referred to as VARIABLE BUDGETS.

SHORT-TERM BUDGET - are for shorter period and most often used to
estimate income and expenses. Various phases of short-term
budget may be placed under the direct responsibility of lower
level management personnel such as department head or foreman.

CAPITAL EXPENDITURE BUDGET - involves planning the commitment of funds

or other resources for the purpose of maximizing the long-
term profitability of the firm. Capital expenditures that may
be included in capital budget may be grouped as follows:
1. Investment for replacing present facilities
2. Investment for general plant improvement
3. Investment for expanded facilities.

PROJECT BUDGET - a kind of budget oriented not to time periods but to stages in
the completion of projects. For example: A company building a new
plant is concerned with getting the plant according to time schedule
(finish the exterior by March, the interior by August, begin production by
Dec.)
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STRATEGIC BUDGET - is the budget that describes the long-term position, goals and
objectives of an entity.

BUDGETING IN A SERVICE FIRM

For service firms such as a consulting firm, medical and dental clinics, the critical factor in
budgeting is coordinating professional staff needs with anticipated services. If a firm is
overstaffed, several problems may arise like labor costs will be high, lower profits because of
the additional salaries and an increasing staff turnover due to lack of challenging work.
However, if a service firm is understaffed, revenue may be lost because the existing and
prospective client needs for service cannot be met. There is also a high possibility that
professional staff may seek other jobs due to excessive work loads.

To project their revenues, it is necessary to determine the expected client billings for services
provided. In an accounting firm for instance, the expected output shall include the sum of its
billings in auditing, tax and other consulting services. When input data are used, each staff
member is required to project his billable time using the appropriate billing rates to produce the
expected service revenue.

For a not-for-profit organizations, the budget process is likewise different. In most cases, they
budget on the basis of cash flows (expenditures and receipts), rather than on a revenues and
expense basis. The starting point in the budgeting process is usually expenditures, not
receipts. So, management’s task therefore is to find the receipts needed to support the
planned expenditures.

DUTIES OF A BUDGET DIRECTOR :

1. To coordinate the efforts of those engaged directly in the preparation of the budget.
2. To prepare the master budget and supporting schedules.
3. To issue periodic reports comparing actual with budgeted figures.
4. To recommend such courses of actions as may be indicated by the budget.
5. To conduct special studies pertaining to the budget.

FUNCTIONS OF THE BUDGET COMMITTEE

1. Reviews the budget
2. Provides policy guidelines and budgetary goals
3. Resolves differences that arise as the budget is prepared
4. Approves the final budget
5. Monitors the actual performance of the organization as the year unfolds.

WHAT DOES THE BUDGET PERIOD REFER TO?

It refers to the length of time for which a budget is effected.

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FACTORS WHICH GUIDE DECISIONS TO THE LENGTH OF THE BUDGET PERIOD

1. The purpose of the plan

Budgets prepared for the short-range planning purposes usually cover a period
of one year or less. Most companies probably budget for a twelve-month period.
Budgets for long-range planning purposes cover several years.

2. The reliability of information

Companies which operate under conditions that make it relatively easy to forecast
may adopt longer budget periods than others.

3. Other factors such as normal turnover periods, seasonal cycles, length of production
period, type of budget, the nature of the organization, the need for periodic
appraisal and prevailing business conditions.

PARTICIPATIVE BUDGETING or GRASSROOTS BUDGETING

It allows subordinate managers considerable say in how the budgets are established.
Typically, overall objectives are communicated to the manager, who helps develop a budget
that will accomplish these objectives. In participative budgeting, the emphasis is on the
accomplishment of the broad objectives, not on individual budget items. Advocates of
participative budgeting argue that individuals involved in setting their own standards will work
harder to achieve them. In addition to the behavioral benefits, participative budgeting has the
advantage of involving individuals whose knowledge of local conditions may enhance the
entire planning process. Participative budgeting has 3 potential problems:
1. Setting standards that are either too high or too low;
2. Building slack into the budget (often referred to as padding the budget)
3. Pseudo participation

If goals are too easily achieved, a manager may lose interest and performance may actually
drop. Similarly, setting the budget too tight ensures failure to achieve the standards and
frustrates the manager. This frustration can lead to poorer performance.
Slack must be avoided if a budget is to have its desired effects.

Budgetary slack (or padding the budget) exists when a manager deliberately underestimates
revenues or overestimates costs. Padding the budget also unnecessarily ties up resources that
might be used more productively elsewhere. Slack in budgets can be virtually eliminated by
having top management dictate lower expense budgets; however, the benefits from
participation may far exceed the costs associated with padding the budget. Top management
should carefully review budgets proposed by subordinate managers and provide input, where
needed, in order to decrease the effects of building slack into the budget.

The 3rd problem occurs when top management assumes total control of the budgeting
process, seeking only superficial participation from lower-level managers. This practice is
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termed PSEUDOPARTICIPATION. Top management is simply obtaining formal acceptance of

the budget from subordinate managers, not seeking real input.

DISTINGUISH between a BUDGET AND a FORECAST

A budget is the expected target which management strives to achieve whereas a forecast is a
level of revenue or cost that an organization predicts will occur.

A forecast is an estimate or prediction of what will happen as a result of a given set of

circumstances. A Budget is a planned result that an enterprise aims to achieve. Forecasts
serve as the basis for preparing budgets.

BUDGETING AND PROFITABLE PLANNING DISTINGUISHED

PROFIT PLANNING is establishing profit objectives and then organizing all efforts to meet
them. BUDGETING is often considered synonymous with profit planning. In particular, profit
planning has come to be associated with the flexible budgeting technique in planning
operations. Some, however, consider profit planning a broader term than budgeting.
According to this view, budgeting is a tool of profit planning. Budgeting quantifies the various
parts of the profit plan.

DISTINCTION between FORECASTING AND PLANNING

Planning is the determination of what is to be done, and of how, when, where, and by whom it
is to be done. Forecasting is the basis of planning because it projects the future. Forecasting
and planning can either be short or long term. Forecasting is often more technical than
planning. It can involve a variety of mathematical models. Budget formulation is a planning
function.

Define STRATEGIC ANALYSIS

It is the process of long-range planning. It includes identifying organizational objectives,

evaluating the strengths and weaknesses of the organization, assessing risk levels, and
forecasting the future direction. The final step is to derive the best strategy for reaching the
objectives.

Define STRATEGIC PLANNING (also called LONG-TERM PLANNING)

It is the process of setting overall organizational objectives and goals. It is a long-term process
aimed at charting the future course of the organization. It is based on strategic analysis.
Analysis of the current month's budget variances is not an aspect of strategic planning.

Define MANAGEMENT BY OBJECTIVES (MBO)

It is a behavioral, communications-oriented responsibility approach to employee self direction.

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Define a BUDGET PLANNING CALENDAR

It is the schedule of activities for the development and adoption of the budget. It should
include a list of dates indicating when specific information is to be provided by each information
source to others. It is not associated with sales.

Define a LIFE-CYCLE BUDGET

It is a budget tool that estimates a product's revenues and expenses over its expected life
cycle. It is useful when revenues and related costs do not occur in the same periods. It
emphasizes the need to budget revenues to cover all costs, not just those for production.
Hence, costs are determined for all value-chain categories: upstream (R & D, design),
manufacturing, and downstream (marketing, distribution and customer services).

OBJECTIVES OF BUDGETING

1. PLANNING 2. COORDINATION 3. CONTROL

ADVANTAGES OF BUDGETING:

1. It forces managers to plan.

2. It provides resource information that can be used to improve decision making.
3. It provides a standard for performance evaluation.
4. It improves communication and coordination.
5. It results in greater management awareness.
6. It contributes to positive behavior patterns.
7. It creates an early warning system for potential problems.

LIMITATIONS OF BUDGETING:

1. Budgets are based on estimates which may require revisions or modifications.

2. It takes time to develop a reasonably good budgetary program.
3. It cannot be affected without the cooperation and participation of all members of
management.
4. The budget program is merely a guide not a substitute for good management ability.

TWO (2) DIMENSIONS OF BUDGETING:

1. How the budget is prepared;

2. How the budget is used to implement the organization's plans.

The first dimension concerns the mechanics of budget preparation.

The second involves how individuals within an organization react to a budgetary system. In
fact, the success or failure of budgeting depends on how well management considers its
behavioral implications.
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REQUISITES OF A GOOD BUDGETARY PROGRAM

1. It must have the complete support of top management.

2. The basic consideration of achieving an acceptable return on capital should be
kept uppermost in mind.
3. The budget must be sold up and down the line.
4. Responsibility for the preparation of budget estimates should rest on those
individuals responsible for the performance.
5. The budget must be realistic and the goals attainable.
6. A budget committee should be established consisting of the budget director, the
CEO, and the executives of the various divisions of the organization.
7. The budget should cover all phases of operations.
8. Budgeting should be continuous.
9. Periodic reports should be prepared promptly, comparing budget and actual results.
10. The good accounting system must be adequate.
11. A good organization must be developed.

Distinguish between an operating budget and financial budget.

An operating budget is the projected income statement portion of a master budget. A

financial budget is the projected balance sheet portion of a master budget.

APPROPRIATION-TYPE BUDGET

Appropriation type budgets are those in which a particular amount is established as the limit to
be spent on a given activity. Appropriation type budgets are commonly found in government
budgeting. In business, they are used for the purpose of controlling capital expenditures or
programs such as advertising and research, where it may be difficult, because of the absence
of past experience or developed standards to relate performance to expenditure in detail.

MASTER BUDGET

The master budget is the comprehensive financial plan for the organization as a whole; it is
made up of various individual budgets. Its format depends upon the size and nature of the
business.

A master budget can be divided into operating and financial budgets. OPERATING BUDGETS
describe the income-generating activities of a firm: sales, production and finished goods
inventories. The ultimate outcome of the operating budgets is a pro forma or budgeted income
statement. FINANCIAL BUDGETS detail the cash inflows and outflows and the overall
financial position. Planned cash inflows and outflows appear in the cash budget. Expected
financial position at the end of the budget period is shown in a budgeted or pro forma balance
sheet. Since many of the financing activities are not known until
the operating budgets are known, the operating budget is prepared first.
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The projected income statement is an important end-product of the operating budgets. It

indicates the expected profitability of operations for the budget period and provides the basis
for performance evaluation.

The projected balance sheet is a projection of financial position at the end of the budget
period. It is developed from the projected balance sheet of the previous year and the budgets
for the current year. After the budget data are entered into the computer, the various budgets
can be prepared as well as the projected financial statements. Management can also
manipulate the budgets in “what if” or sensitivity analyses based on different hypothetical
assumptions.

The major difference between the master budget of a merchandiser and the master budget of
a manufacturer is that a merchandiser uses a purchases budget rather than a production
budget. Such purchases budget shows the estimated cost of goods to be purchased to meet
expected sales. The formula for determining budgeted purchases is:

BUDGETED C G S + DESIRED MDSE. INVTY. END – MDSE. INVTY BEGINNING

THE BUDGETING PROCESS

Essential Steps in Preparing Master Budget are

1. Specification by top management of the overall objectives, plans policies, and assumptions
that are to serve as guidelines in the preparation of budget estimates.

2. Making a sales forecast, and preparation of sales estimates.

3. Preparation of individual budgets by heads of each responsibility center, and negotiation of

an agreed budget between the budgeted and his superior.

4. Assembly and coordination of all individual budgets into a tentative master budget.

5. Review discussion, and adjustment of the tentative master budget until an acceptable
budget emerges.

6. Approval by top management of the final master budget, and dissemination of the approved
budget to all management levels.

Some parts of the master budget should not be prepared until other parts have been
completed. A logical sequence of steps for preparing a master budget follows:

1. PREPARING A SALES BUDGET - Sales forecast is the starting point in

preparing a master budget because production levels, material purchases
and operating expenses depend upon sales volume.

2. PREPARE BUDGETS FOR PRODUCTION, MANUFACTURING COSTS &

OPERATING EXPENSES - These forecasts depend in part upon the sales
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forecast and also upon the relationships between costs and the volume of
activity.

3. PREPARE A BUDGETED INCOME STATEMENT - Budgeted income state-

ment is based upon the sales forecast and estimates of CGS
and Operating Expenses. It does not require estimates of the
timing of cash receipts and cash payments.

4. PREPARE A CASH BUDGET - This is one of the largest tasks in

the preparation of a master budget. Cash receipts depend upon the sales forecast
and the company's experience in collecting amounts receivable from customers.
Cash payments depend upon the budgeting levels of material purchases, capital
expenditures and operating expenses as well as the credit terms offered by
suppliers . Anticipated borrowing, debt repayment, cash dividends and issuances
of CS are also reflected in the cash budget. The cash budget may also take the
form of a schedule of cash receipts and disbursements wherein all estimated cash
receipts and disbursements are summarized to arrive at the ending cash balance.

5. PREPARE A BUDGETED BALANCE SHEET - A projected balance sheet cannot

be prepared until the effect of cash transactions upon the various Asset, Liabilities
& Owner's Equity accounts has been determined.

What is a Budget Manual?

Budget manual is a written set of instructions and pertinent information which serves as a rule
and reference book for the implementation of a budget program. Co. policies and procedures
in connection with the preparation and use of budgets are specifically and clearly written in the
budget manual. Its size and scope vary among companies.

In General, What Should a Budget Manual Contain?

In general, the contents of a budget manual should include:

1. A statement of purpose and principles

2. Definition or lines of authority and responsibility
3. Statement of duties of various personnel in preparing the budget
4. Time schedules for budget preparation
5. Terms of schedule
6. Procedures for obtaining approval
7. Form and nature of performance report
8. Procedures of budgetary control.

Advantages of Preparing a Budget Manual are:

1. It defines authority and responsibility in matters related to the budget.

2. It promotes standardization and simplification of the budgetary process.
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3. It assists in coordinating effort.

4. It provides a convenient reference source for questions relating to budgetary procedures or
responsibility.
5. It assists in training a new employee and in transfer of duties because many phases of the
new job have been reduced to writing.
6. It permits better supervision in that the time of supervision conserved to the extent that
explanations are covered in the manual.
7. It assists in "selling" the budget by explaining its advantages.

SALES FORECAST AS CORNERSTONE OF BUDGETING

The sales forecast is considered the "cornerstone" of budgeting because inventory levels and
production, (and hence costs) are usually based on the rate of sales activity. It is a passive
statement of the expected sales volume. The sales forecast is the basis for the sales budget,
which , in turn, is the basis for all other operating budgets and financial budgets.

Factors to be Considered in Making Sales Forecasts:

1. Past sales volume

2. General economic outlook
3. Conditions within the industry
4. Market research studies
5. Attitudes and characteristics of potential customers
6. Trend in government controls, attitudes, and regulations
7. Pricing policies
8. Plant capacities
9. Advertising and promotional efforts planned
10. Nature and extent of competition
11. Distribution costs involved.

FORECASTING LIMITATIONS

While no person, group of persons or system can forecast in precise terms what will happen
in the future, this is one of the soundest reasons for budgeting. A system of budgetary control
forces management to look into the future and use all available techniques to help it shape a
forecast.

No business or industry for that matter, remains static. Consequently, efforts to determine the
course of future events accurately nedd to be made. At least part of what is to come can be
foreseen. Even if a forecast is wrong, at least it provides a basis for adjustment. Budgets are
kept flexible to accommodate changes.

SELECTING A FORECASTING METHOD

Different product groups within a company may require different forecasting method. But most
successful planners use the following six (6) methods most frequently:
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1. Sales trends
2. Sales force composite
3. Executive opinion
4. Industry analysis
5. Correlation analysis
6. Multiple approaches

The forecasting method which the management in a company selects depends to some extent
on its size. Most large companies use sales trends as their primary method, supported by
sales force composite and executive opinion.

Small companies lean more heavily on industry analysis supported by their own sales trends
and executive opinion. Salespeople’s estimates may not be as important a forecasting tool
among small companies because senior executives may be closer to the sales effort. In fact,
in many small companies, top executives are primarily responsible for brining in sales. As a
result, they have a greater feel for the marketplace than do the chief executives of large
companies. But whether you are the owner of a small business or the manager of a
department in a larger firm, certain standard forecasting techniques are equally applicable.

Approaches used in Forecasting Sales:

1. Time-series analysis
2. Correlation analysis
3. Bottom-up Approach
4. Econometric Modeling

SALES BUDGET

The Sales Budget refers to the planned volume and amount of sales chosen by management
to serve as basis in the financial planning of all sub-units in an enterprise. Sometimes a sales
forecast indicates a decrease in sales but sales budget show an increase instead because
management has adopted plans of intensifying sales campaigns through additional sales
force or increasing promotional activities.

Sales estimates may be made based on an analysis of general business conditions, sales
trend in the past and market conditions. This analysis is supplemented by internal forecast
whereby opinions of executives and salesmen are considered. A Co. engaged in the
construction business may estimate its SV based on the number of building permits issued
by the government. Another Co. may estimate its SV based on the governments forecasts of
personal disposable income.

Accordingly, the accuracy of the sales forecast strongly affects the soundness of the entire
master budget. In developing the sales budget, sales may be classified and sub-classified like
the following:

1. Products or commodities 8. Methods of delivery

2. Territories 9. Size of units of products
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3. Channels of distribution 10. Size of orders

4. Organization division (branches, departments, etc.)
5. Salesmen 11. Periods (months, etc.)
6. Terms of sales
7. Method of sales

Creating the sales forecast is usually the responsibility of the marketing department. One
approach to forecasting sales is the BOTTOM - UP APPROACH, which requires individual
salespeople to submit sales predictions. These are aggregated to form a total sales forecast.

ILLUSTRATION # I

The annual sales forecast for a particular product is 240,000 units. The seasonal variation
index for the first three months of the year is
January 90
February 100 (normal)
March 120
How many units are expected to be sold in each of the first three month?

Solution:
Disregarding seasonal variations, the estimated monthly sales are 20,000 units (240,000
units divided by 12 months). The monthly forecasted sales, as adjusted for seasonal
variations for the first three months of the year are:

January 90% x 20,000 or 18,000 units

February 100% x 20,000 or 20,000 units
March 120% x 20,000 or 24,000 units

ILLUSTRATION # 2

Rite Co. manufactures air-conditioning units for automobiles. A survey of the potential
market shows that 100,000 automobiles are registered in the area. It is estimated that sales
can be made for 20% of these automobiles, and that Rite Co. will get 40% share of the
potential market next year. How many air-conditioning units can Rite Co. expect to sell next
year?

Solution: The sales estimates for Rite Co.’s air-conditioning units is:

Total automobile registrations 100,000

Potential market, 20% 20,000
Market for Rite Co., 40% of 20,000 8,000
Estimated sales (in units) 8,000
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ILLUSTRATION # 3

In making sales forecast using the PROBABILITY concept, the expected value of sales
estimates is arrived at by multiplying the different sales estimates by their corresponding
probability percentages.
Example:
SV Probability Expected Value
4,000 20% 800
12,000 30% 3,600
20,000 50% 10,000
14,400
=======
Sometimes sales estimates are made using the BOP method (best or most likely, Optimistic
and pessimistic estimates). Based on the normal curve distribution, most likely or best
estimates are given a weight of 4 so that a divisor of 6 is used.

Example: The following estimates have been made:

SV
Optimistic (o) 20,000 EVE= O + 4m + P
Most likely (m) 12,000 6
Pessimistic (p) 4,000

The expected value of these estimates must be:

= 20,000 + [ 4(12,000) ] + 4,000
----------------------------------------- = 12,000 units
6
PRODUCTION BUDGET

The production budget describes how many units must be produced in order to meet sales
demand and satisfy ending inventory requirements. In the JIT firm, units sold equal units
produced since a customer order triggers production. Usually however, the production budget
must consider the existence of beginning and ending inventories since traditional
manufacturing firms use inventories as buffer against uncertainties in demand or production.

FACTORS TO BE CONSIDERED IN DETERMINING THE VOLUME OF PRODUCTION FOR

A GIVEN PERIOD ARE:
1. The sales budget
2. Plant capacity
3. Finished goods inventory levels
4. Policy governing manufacture or outside purchase of parts

METHODS or PROCEDURES in Setting Profit Objectives

1. In a PRIORI Method, profit objectives take precedence over the planning process.
Management specifies a desired rate of return and then draws up plans to achieve
such rate.
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2. In a POSTERIORI Method, management draws up plans and then sets the profit
rate resulting from the plans. The profit objectives emerge as the product of the
planning itself.

3. In a PRAGMATIC Method, mgmt. uses an acceptable profit standard that is set

based on the company's business experience.

DIFFERENCES
-----------------------------------------------------------------------------------------------------
TRADITIONAL BUDGETING : ZERO-BASE BUDGETING
-----------------------------------------------------------------------------------------------------
* Starts with last year's : * starts with a minimal (or zero)
funding appropriation : figure for funding
* Focuses on money : * Focuses on goals and objectives
* Does not systematically : * Directly examines alternative
consider alternatives to : approaches to achieve similar
current operations : results
* Produces a single level : * Produces alternative levels of
of appropriation for an : funding based on fund availabi-
activity : lity and desired results

Program Budgeting is an approach that relates resource inputs to service outputs. This is also
known as program and performance budgeting. It focuses on the relationship of benefits to
cost expenditures. It is useful in gov't. & not for profit entities. This process can help managers
evaluate & control discretionary costs, avoid excessive cost expenditures, & make certain
that expenditures are used for programs & activities that generate the most beneficial results.

INCREMENTAL BUDGETING or BASELINE BUDGETING

In incremental (or traditional) budgeting, the budgeted amount of the previous year is used
as the base or starting point in determining the budget for the current year. In other words, it
starts with last year's budget & adds or subtracts from that budget to reflect changing
assumptions for the coming year. In accepting the existing base, only the increment is subject
to examination. It does not encourage innovation.

Zero-base budgeting(ZBB) is a comprehensive budgeting process that systematically

considers the priorities & alternatives for current & proposed activities in relation to
organizational objectives. Annual justification of programs & activities is required. ZBB requires
that managers reevaluate all activities at the start of the budgeting process to make decisions
about which activities should be continued, eliminated, or funded at a lower level. It is difficult
to implement because of the significant effort needed to investigate the causes of prior costs &
justify the purposes of budgeted costs. To be workable, it also requires a wholehearted
commitment by the organization's personnel. Without the necessary time, effort & commitment,
ZBB should not be attempted.
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ZBB has been defined as a management process which provides systematic consideration of
all programs, projects and activities. It refers to the process of allocating resources based on
expected results. It identifies activities and operations in decision packages and by
systematic analysis, ranks these decision packages in the order of importance. As such,
this planning technique is applied only to indirect costs and discretionary items.

ZBB is a budget-planning procedure for the revaluation of an organization's program and

expenditures. It starts with the assumption that zero will be spent on each activity-thus, the
term "zero-base". Ordinarily, in the more commonly used budgeting programs, those in charge
are required to justify only the increases requested above the previous period's budget or
actual expenses. What they are already spending is considered necessary and automatically
accepted.

ZBB does not imply the discontinuance of all existing programs and the adoption of
entirely new ones. It merely requires periodic evaluation of existing and new programs to
determine their relevance. A project started last year may not be of much importance
this year so that priority in the allocation of resources must be given to other projects
which rank higher in the order of priority. The old projects may be continued,
temporarily shelved, or totally dropped depending on how important they are in the
attainment of predetermined objectives considering changes in the environment.

In ZBB, the present expenditures are not accepted as the starting point. Instead, every
budget period is a fresh start, where the managers are required to justify the entire budget,
not just the increase over the last period's expenditures. Nowadays, this ZBB procedure has
gained increased attention and wide acceptance among government agencies and business
organizations. However, this approach is time consuming & costly.

CASH BUDGET

Knowledge of cash flows is critical in managing a business. Often a business is successful in

producing & selling a product but fails because of timing problems associated with cash flows.
By knowing when cash deficiencies & surpluses are likely to occur, a manager can plan to
borrrow cash when needed & to repay the loans during periods of excess cash. Bank loan
officers use the cash budget to document the need for cash, as well as the ability to repay.
Because cash flow is the lifeblood of a company, the cash budget is one of the most important
budgets in the master budget.
Beginning Cash Balance
+ Estimated Cash Receipts
= Cash Available for Use
- Cash Disbursements
- Desired Minimum Cash Balance
= Excess Cash (Cash Deficit or Shortage)
+ Loan proceeds
- Repayments
+ Minimum Cash Balance
= Ending Cash Balance
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CASH BUDGET contains 3 sections: Cash Receipts, Cash Disbursements & Financing
sections. The financing section shows expected borrowings and the repayment of the
borrowed funds + interest. This section is needed when there is a cash deficiency or when the
cash balance is below management's minimum required cash balance. Data for preparing this
budget are obtained from other budgets and from information provided by management. In
practice, they are often prepared for the year on a monthly basis. Monthly data provide the
timely feedback necessary to take corrective action.

Expected cash receipts include all sources of cash for the period being considered. The
principal source of cash is from sales. Because a significant portion of sales is usually on
account, a major task is to determine the pattern of collection for its A/R. If a company has
been in business for a while, it can use past experience in creating an A/R aging schedule.
The company can determine, on the average, what percentages of its A/R are paid in the
months following sale. The excess cash or deficiency line compares the cash available with
the cash needed. Cash needed is the total cash disbursements + the minimum cash balance
required by company policy. The minimum cash balance is simply the lowest amount of cash
on hand that the firm finds acceptable but it varies from one company to another & is
determined by each company's particular needs & policies. When a deficiency exists, a short-
term loan will be needed but with an excess cash (cash available is greater than the firm's
cash needs), the firm has the ability to repay loans & perhaps make some temporary
investments. The minimum cash balance is not a disbursement, so it must be added back to
yield the planned ending cash balance.