PREPARING BUDGETS

The Importance of Managing Finance

The strategic plans of an organisation will include a financial strategy.

For example:

• Private company – Return on Capital (RoC)

• NGO or Charity – estimate the of amount of money that can be raised

Strategies are developed into plans which need resources

• Budgets are used to define resources available
Budgeting Steps

Generally, budget forecasts are prepared by those who will

spend/generate money. This is a formal process and may include
following steps:

1. Set financial strategy and objectives

2. Managers forecast income/expenditure needs within parameters
set by overall financial objectives
3. Forecasts reviewed/adjusted and built into ‘master budget’
4. Individual budgets finalized and given to manager
Budgeting Process
1. Communicate budget policy and guidelines
2. Identify limiting factors
3. Prepare sales budget
4. Initial preparation of budgets, based on the sales budget
5. Negotiation of budgets
6. Coordination and review of budgets
7. Final acceptance
8. On-going review of budgets
Budgeting Period
Usually for one year

Generally broken down into 12 monthly amounts

Some organisations have continuous or rolling budgets
Types of Budget
Used to show income/expenditure for each department. For example:

• Sales/income budget – for future income showing volume, price,

value
• Production budget – shows quantities produced and cost of
production
• Capital expenditure budget – shows what is spent on long-term assets
• Master budget – includes cash flow forecast, profit and loss forecast
and balance sheet forecast
Purpose of Budgets
In order to manage activities effectively information is needed. Budgets
provide this information to enable:

• Planning
• Coordination – for example between departments
• Communication – budget used as a tool
• Motivation – encourages managers to achieve results
• Control – budget used to compare with actual results
• Evaluation – to check performance
Identifying the Parameters
As already mentioned, the starting point for preparing a budget
forecast is the overall strategy. Other considerations include:

• Limiting factors
• Type of budget forecast
• Basis of budgeting process viz. incremental or zero-based
Limiting Factors
These may include:

• Capital availability
• Plant/machinery capacity
• Market size
• Availability of raw materials
• Legal obligations
• Contractual obligations
Type of budget forecast

As already mentioned, these may include:

• Expenditure (or costs)

• Income
• Income and expenditure
Budgets can be made for a mix of activities and some aspects may be
decided by others
Incremental or Zero-based Budgeting

Incremental Budget – derived from previous year plus adjustments e.g. for
increases in costs, traditional approach

Zero-based Budgets – all items in budget need to be justified, from zero

Zero-based Budgeting
What advantages and disadvantages can you think of for zero-based
budgeting?

• Advantages

• Disadvantages
Gathering Information
The key elements of information for budgeting purposes are:

• What is expected income?

• What is expected expenditure?

Expected Income
Important aspects that you need to know are:

• Type – capital or revenue?

• How much? – may be dependent on pricing or donations
• When will it arrive? – many businesses fail due to poor cash flow
rather than lack of orders
Expenditure
Your budget forecast will also contain information about costs

Costs come in different forms with varying amounts and timing

Costs will behave in different ways depending on whether they are:

- direct or indirect
- fixed, variable or semi-variable
Budget Format
Large organisations may have specific software for drawing up budgets.
Alternatively, spreadsheets may be used. They enable:

• Figures to be checked
• Updates to be made
• Forecasts to be presented
• Evaluation of changes to assumptions
Sales Budget
May June July August
Units 7,000 9,000 5,000 4,000
Sales Revenue £87,500 £112,500 £62,500 £50,000

Why do we produce a sales budget?

1. To motivate sales staff

2. The sales budget is the raw material for the other budgets
3. To help monitor and evaluate actual performance
4. To set bonuses
Production Budget
May June July August
Units to be sold 7,000 9,000 5,000 4,000
(from Sales Budget) (units)

Planned closing stock 1,800 1,000 800 1,000

(20% of next month’s sales)

Total Units Required 8,800 10,000 5,800 5,000

Opening Stock 2,000 1,800 1,000 800
(From previous months closing stock)

Units to be produced (production) 6,800 8,200 4,800 4,200

(sales + closing stock – opening stock)
Production Cost Budget

July August
Units 4,800 4,200
(from Production Budget)
£ £
Materials (units x £2.50) 12,000 10,500

Labour (units x £3.75) 18,000 15,750

Total Cost 30,000 26,250

Budgeted Income Statement (Profit and Loss Account)

July August
Sales (units) 4,800 4,200
£ £
Sales Value 60,000 52,500
(unit price (£12.50) x number sold)
Cost of goods sold 30,000 26,250
(direct costs, material (£2.50) and labour(£3.75)) x units

Gross Profit 30,000 26,250

Fixed Overheads 18,000 18,000

Net Profit 12,000 8,250

Cash Budget

July August
£ £
Opening Balance 8,000 48,250

Receipts:
Trade receivables (cash sales) 30,000 26,250
Trade receivables (credit sales) 56,250 30,0000
Cash available 94,250 104,500
Payments:
Trade payables 12,000 10,500
Labour 18,000 15,750
Fixed costs (less depreciation) 16,000 16,000
Total payments 46,000 42,250

Closing balance 48,250 62,250

Last Stage before Budget Presentation

Before presentation of the budget forecast ask yourself:

• Am I clear how organisational strategy impacts my area of

responsibility?
• Is information accurate and up-to-date?
• What is likelihood of changes to income/outgoings?
• What future events might cause chaos for the forecast
Submitting your Budget Forecast

Budgets often presented to a budget committee

Ensure you have followed any rules on drawing up your budget
Find out who is on budget committee and what arguments might persuade
them
Read agenda and identify key points
Decide how you will explain your forecast
After all budgets accepted, master budget will be drawn up