Budget

Definition:

In the general sense, the budget is described as a precise statement, representing a financial
estimate of income and expenditure of the government for a certain period. In cost accounting,
budget means a quantitative statement, prepared before a particular period to serve as an
estimate of future receipts and disbursements.

Features of Budget

 It is an estimate of the economic activities of an entity which related to a specified future

period.
 It must be written and approved by the appropriate authority.
 It should be modified or corrected, whenever; there is a change in circumstances.
 It plays the role of a business barometer that helps in measuring the performance of the
business by comparing actual and budgeted results.
 It is prepared on the basis of past experiences and trends in the business.
 It is a business practice, which is used to forecast the operating activities and financial position
of the business.

Types of Budget

Based on time

 Long-term Budget: The budget designed by the management for a long-term, i.e. three to ten
years is called as long-term budget.
 Short-term Budget: As the name suggests, the budget which is prepared for a period ranging
from 1 to 2 years, is called short-term budget.

Based on Capacity
 Fixed Budget: The budget created for a fixed activity level, i.e. the budget remains constant
regardless of the level of activity, is called as fixed budget.
 Flexible Budget: The budget which changes with the change in the level of activity is a flexible
budget. It identifies the fixed cost, semi-variable cost and variable cost, to show the expected
results at different volumes.
 Based on Scope

 Functional Budget: The budget which is concerned with the business functions is called as
functional budget. It can be further classified as:

 Sales Budget: Sales budget is used to determine the quantity of anticipated sales and the
expected selling price per unit.
 Production Budget: It is prepared to indicate the production for the specified period and
is expressed in the units of outputs produced.
 Materials Budget: The budget prepared to show the quantities of direct material and raw
material required to manufacture the finished product.
 Purchase Budget: Purchase budget is designed to estimate the quantity and value of
different items to be bought at different points of time, considering the production
schedule and inventory required.
 Cash Budget: The budget highlights the cash needed by the business in a specified period,
taking into account all the receipts and payments of the business.
 Master Budget: Once all the functional budgets are created, then the financial officer will
prepare a master budget. It is an integrated budget that reflects the estimated profit and loss
and financial position using Budgeted Profit & Loss Account and Budgeted Balance Sheet of
the concern.

Based on Receipts and Expenditure

 Capital Budget: The budget takes into account the estimated capital receipts and expenditure
of the business for a specified period.
 Revenue Budget: The budget that covers all the revenue receipts and expenses of a particular
financial year is a revenue budget.
 Benefits of Budgeting

 Increases the efficiency as well as probability that the government/company’s goals and
objectives will be achieved
 Helps in defining strengths and weaknesses on which the entity can concentrate
 Problems can be anticipated and avoided by possible remedial
 compels forward-looking process within the organization
 Ensure the proper allocation and understanding of the responsibilities and objectives
 Better co-ordination of activities with different parts
 What is Public Budgeting?
• Public Budgeting:
– It is a financial plan that estimates the
expenditures and revenues of a state for the next
or future financial year (usually one year period).

– This process reflects the economical, social

policies in the country.
 The difference between public and
private budgeting
1- The purpose of public budgeting is more
comprehensive that aims to provide services to
citizens. However, Private aims to focus on the
financial center of the company.

2- The economical and social effects caused by

public budgeting are bigger than private budgeting.
– The public budgeting affects more at different levels
of the country.
 The difference between public and
private budgeting
3- The controlling or regulatory agencies that
monitor on executing public budgeting are
various (e.g. regulatory agencies inside and
outside the organization.).

4- The stages of public budgeting preparation is

longer and more complex than private
budgeting.
– (We will discuss the steps later at this chapter)
 Public Revenues
• Different sources of revenues:
– Services fees and charges. (e.g. electricity fees, traffic
charges).
– Taxes. (property and income tax in U.S.A).
– Public debt.
• government borrows money from investors so that
government will obligate (by issuing bonds) to pay the
money back with interests to the investors or institutions.
– External loans (e.g. country borrowing from other
countries).
– Other country’s properties and assets.
 Public Expenditures
• Different examples of expenditures:
– Spending on continuous services and programs
offered by governmental organizations. (e.g.
education, defense, and health)
– Spending on public personnel salaries and wages.
– Spending on public capital projects and
investments.
– Spending on office needs or demands.
– Spending on unusual crisis, such as natural
disasters.
 Kinds of Public Budgeting
1- Traditional Budget.
2- Performance Budget.
3- program Budget.
4- Zero-based Budget.
5- New performance Budget.
 1) Traditional Budget
• It is also called “Line-item budget”

• Expenditures and money allocation are made on

an administrative-department basis, not on the
basis of what departments really want to achieve.
(e.g. money allocation for defense department,
Health dept., education dept. etc.).

• This kind is most used in many developing

countries.
 1) Traditional Budget
• Traditional Budget is characterized with inputs
(what is purchased). For example:

– primary education:
• Teachers.
• Computers.
• Papers.
• Utilities.
• Etc.
 2) Performance Budget
• The expenditures and money allocation would be
determined based on how the activity/project
would be performed.

• “In performance budgets, information should be

organized in terms of activities (repairing roads,
planting trees, treating patients, teaching
students, etc.). The activities should be
measured; costs should be identified for these
activities; and efficiency of performing these
activities should be evaluated.” (Mikesell, 2011)
 2) Performance Budget
• Performance Budget is characterized with
outputs or activities (what is done). For
example:

– Primary Education:
• Person hours of teaching.
• Number of students taught.
 3) Program Budget

• The major idea of this kind is how the specific

program would achieve the public objectives
regardless of what the agency would perform
this program.
 3) Program Budget
• Program Budget is characterized with
outcomes or results (what is accomplished).
For example:

– Program: decreasing the number of smokers

• Departments responsible: education dept, health dept.
 4) New Performance Budget
• focusing on results or outcomes of an agency.

• “The idea of new performance budgeting is that

social goal, the outcomes or results, is what
matters for government performance, not the
direct outputs or activities of an agency.”
(mikesell, 2011)

• “new performance budgeting tests an agency on

results.”(Mikesell, 2011)
 4) New Performance Budget
• New Performance Budget is characterized
with outcomes or results (what is
accomplished). For example:

– Primary Education:
• Educational attainment and development.
• Number of students getting good grades by
empowering classes/courses.
 5) Zero-based Budget

• Every agency would develop its budget every

year, without looking at the previous year’s
budgets.

• Every year, the budget would start from the

beginning, from the Zero base, estimating new
spending and revenues, and new programs. Thus,
the effects from the past years will not be
considered at the current year budget.
 Stages of Budget Preparation
1- Preparation Stage.
2- Approval Stage.
3- Executive Stage.
4- Oversight Stage.
5- Final Account or Statement.
 1- Preparation.

• Steps:
1- Evaluating the economical situation and estimating the
public revenues.

2- Issuing the document of budget preparation to ministries

and other governmental agencies, done by finance ministry.

3- The start of making the budget in each ministry.

4- Study and evaluating of ministries' budgets by Finance

Ministry.
 2- Approval
• After studying the public budget and
approved by the finance minister, the finance
minister will present the proposed public
budget to the legislative body to give the
approval.
 3- Executive stage
• Finance ministry will send the public budget to
each ministry or governmental agency
attached with some instructions. Thus, each
agency will start implementing its budget’s
items as determined before.
 4) Oversight Stage
• Basically, the legislative authority would make sure if
the executive agencies would perform its budget as
determined.

• The finance department would make sure if there is

any deviations in spending or any violations.

• There are internal and external oversights:

– Internal oversight: done by the same administrative
agency.
– External oversight: done by representatives of finance
ministry.
 5) Final account and statement
• Each agency or ministry must make the final
statement. The ministry will make and collect
the required data about its results through the
previous year and send to the finance
ministry.

• This is very important to show the real

revenues and expenditures from the previous
year.
Effects of deficit
budget on
different sectors
2. Evaluation of bad effects of budget deficit:

Traditionally there are some bad effects of budget deficit which are likely to be present in some
situation but these are not experienced by all the countries in the same proportion. The
traditional reasons are evaluated here in the context of relativity of different factors of our
country.

Crowding out, a dilemma of public investment:

When government will borrow a huge amount of loan from the banking sector, private sector
do not get loan for investment purposes. This situation is called crowding out effect of budget
deficit. But in our country what we see that there is a gap between the national savings and
investment and national savings is large than national investment. So crowding out effect of
theoretical discussion is obsolete here. Rather the reason behind low private sector investment
is the high cost of capital.

Source: Adopted from www.unnayn.org

 Increase in Inflation due to budget deficit or different reasons? :

Inflation rate may be increased by extra circulation of money. Budget deficit causes to increase
the circulation of money. But according to the monetarist view point the budget deficit can
cause inflation only to the extent the deficit is monetized. This theory was developed by the
Hamburger and Zwick in 1981. Actually the deficit budget is not that much monetized in our
country because government allocation for public safety framework which can influence the
inflation rate is small. In developed countries a number of people are provided with
unemployment benefits and other benefits. So the portion of budget deficit can easily influence
the inflation rate as the money is monetized by the people. But in Bangladesh a small portion of
total budget is spent on public safety framework. When people have extra money which cannot
be supported by the existing supply of money it causes the demand pull inflation. Too much
money running behind too few goods causes demand pull inflation Bangladesh bank controls
inflation by controlling money supply. But inflation is not caused by money supply in
Bangladesh which is suggested by different researchers. So deficit budget is not responsible for
inflation. In our country inflation is occurring due to increase in price level of factors of
production, lack of supply of food items caused by low production, illegal price fixing of
middleman which is termed as syndicate, transportation problems like shutdown, poor
condition of roads and bridges, storage problem and Increase in international price level.
Government cannot reduce the food price without reducing the price of factors of production.
Inflation has nothing to do with circulation of money and budget deficit. Budget deficit
increases the interest rate, inflation rate sometimes. But in Bangladesh budget deficit is not
responsible for the inflation and thus government spending or money circulation have nothing
to do with budget deficit. If government wants to reduce the rate of inflation, government has
to address the problems that are responsible for the increase in interest rate.

Supply shock

Can be controlled
Inflation Demand pull through money
supply

Cost push
 Increasing
international price
level of food and
non-food items

Reasons of inflation in
Bangladesh

Increasing price of factors Lack of Supply of items Due to:

of production Due to: Storage problems
1. Low production
1. Power
2. Transportation problems
2. Oil
3. Illegal price fixing
3. Labor
 Interest rate Increase due to budget deficit or wrong monetary policy:

Interest rate may increase due to budget deficit. But it is seen in our country that interest rate
high due to wrong monetary policy of the Central Bank. Central bank wants to control inflation
by controlling money supply. As a result central bank follows Contractionary monetary policy.
Because of Contractionary monetary policy the interest rate or the cost of capital is much
higher. Actually the reasons behind the increase in inflation rate are different which is discussed
earlier. So controlling money supply for the purpose of restricting inflation rate at the desired
level is not working in favor of our economy as it creates difficulty in disbursement of private
sector credit. So it is actually government failure to identify the real reasons of inflation as a
result the interest rate prevails at an extreme level.

Removing lending
interest rate cap

Contractionary policy High interest rate

High CRR, SLR, Repo Low growth of

and Reverse repo rate Investment

Supply shock

Rising
inflationary
pressure
Impact of wrong monetary policy
Government is pursuing a tight monetary policy assuming that the country is facing inflation
because of demand pull nature of inflation. In reality the inflation is cost push and there are
other problems associated with like as supply shock. Tight monetary policy cannot be a suitable
policy for our country from the perspective of economic expansion. Without economic
expansion government cannot have a sufficient amount of tax to meet the expenditures and
thus it will lead to larger budget deficit. On the other side private sector investment cannot
grow at the expected level due to the increase in interest rate which will lead to the low
production or in other words low GDP growth rate. Low production will add fuel to the existing
level of inflation which is presented by the above chart.

High debt interest payments making a debt Mountain:

Last year (2013-14) Bangladesh government paid 277.43 billion as interest and installment and
this year (2014-2015) the expenditure on this interest and installment is set at 310.4 billion.
These are creating a great debt burden on the shoulder of the future generation. This debt
burden will be a problem of our economy in long run. According to Unnayan Onneshon the per
capita debt burden of Bangladesh has been rapidly mounting since FY 2008-09 and stood at Tk.
3389.84 in FY 2012-13 from Tk. 2982.19 in FY 2011-12.

Increase in Tax rate and broadening the tax net:

When Government increases the expenditures which in turn become large budget deficit, it has
to increase the tax rate and broaden the tax net. Imposing more tax on people though direct
and indirect taxes can harm the economy by decreasing the disposable income of the people of
our country. It will decrease the disposable income of people which will be followed by a
decrease in aggregate demand. Expected level of growth will be difficult to attain as the lesser
the demand and the lower the amount of investment. Due to the introduction of VAT all the
people of our country are falling under VAT and paying tax. This tax burden reduces the
disposable income of the mass people.
Ways for managing budget deficit for
the purpose of achieving of goals and
objectives
 Management of budget deficit:

Budget deficit is not a problem if it is managed well. Management means the utilization of
funds and combination of different sources of funds. Utilization of funds means the efficient
use of funds. Funds are often used inefficiently which turns into larger budget deficit. Such as
the carryover projects which cause more budget deficit can be the best example of
mismanagement problem of funds. Another problem which is encountered by government is
inefficient combination of different sources of funds. There are several sources of funds which
are available for the government to finance budget deficit. But government relies on banking
sector much as the other sources cannot supply sufficient funds to finance huge budget deficit
and in this regard government needs to restore the balance by putting some burden on other
sector and removing the existing pressure of the banking sector. Because of the pressure
created on banking sector sometimes it becomes difficult for the sector to provide sufficient
fund to the private sector.

Macroeconomic goal achievement:

There are several macroeconomic goals government pursues. Government has to try to
accelerate the economic growth, to increase the rate of unemployment and to control the
inflation rate. The goals are somewhat problematic to pursue as the change in one factor can
cause to change the other negatively. Whenever money supply is increased for the purpose
increasing private sector investment, the rate of inflation may increase. Government has to
make some trade-off between the goals. In this regard government needs to use the deficit
budget as a tool of achieving the macroeconomic goals and to restore the imbalance in the
sectors that need more funds.

Acceleration of economic growth:

Government needs to accelerate the economic growth and in this regard infrastructure
development, employment creation, health care facility, power generation, agricultural
production and education facilities should be improved to make the economic growth
sustainable. Government is to work as the bridge among the different components of the
economy to maximize the economic revenues and economic transactions to maximize
government revenues. In this regard government needs to integrate all of policies including
economic, financial and monetary policy.
 Economic transactions

(Indirect taxes are

Import duty,
supplementary duty,
Government VAT etc.)
revenues

(Major sources are

direct tax and
Economic revenues
indirect tax)
(Direct tax on income
and profits)

Economic
Government revenues
revenues
And

Economic
transactions

Economic
revenues

And
Government
revenues Economic
transactions
 Financial policy
(For implementing
economic policy)

Economic policy Monetary policy

(Evolved from economic (For controlling money

condition)
Supply)

Integration

Among all the policies

Research

Economic expansion

(Innovative products and

services)
Economic policies mean the actions that influence the economy. Economic policies evolved
from economic condition of a country. For example our economic condition requires more
expenditure on infrastructure development, education, power, healthcare, employment
generation as our economy is developing one and a number of people of our country are living
under the poverty line. So the government has to make a lot of expenditure to improve the
infrastructure such as building new roads, bridges. Government has to give subsidy on different
prioritized sector like agriculture, education, power health care.

Financial policy of government is a tool to implement different economic policy. As it is

mentioned earlier the government spends on different sector for infrastructure development,
education power, healthcare, employment generation actually government spend on the
sectors because of its economic policy. For example our economy is in need of infrastructure
development. As a result government spends more on infrastructure development every year.

Government wants to have a GDP growth rate of 7.3 percent in 2014-2015. To achieve this rate
public sector investment has to grow significantly. But with existing monetary policy it is not
possible to grow at the desired level as the monetary policy is based on the assumption that
inflation is caused by money supply and because of this wrong assumption private sector
investors have to pay more interest which is helpful for the private sector investors.

Because of wrong monetary policy the private sector investment is not growing at the desired
level. To grow at the desired level government must make the monetary policy expansionary.

The integration between these policies is the only way to have a growth rate at the desired
level. If there is significant growth in private sector investment than there will be generation of
revenues and profit from those investments and government will have sufficient tax revenue
from those profits generated by investors.

To find the ways of integration and to expand the economic activities government must spend
more on research projects. Research can help to grow the economy with innovative products
and services. On the other side with the help of research government can find the ways of
integration of different economic, financial and monetary policy.