Unit 3: Financial Planning Tools and Concepts

Lesson 3.2
Budget Preparation

Contents
Introduction 1

Learning Objectives 2

Quick Look 3

Learn the Basics 4

Budgeting 5
Types of Budgets 6
Sales Budget 7
Production Budget 7
Operating Budget 8
Cash Budget 10

Case Study 14

Keep in Mind 15

Try This 16

Practice Your Skills 17

Challenge Yourself 20

Photo Credit 22

Bibliography 22
Unit 3: Financial Planning Tools and Concepts

Lesson 3.2

Budget Preparation

Introduction

Most households in the Philippines were affected financially when the pandemic hit in 2020.
Filipino families had no choice but to adjust their lifestyle and spending to follow a strict
budget. Impulsive buying was avoided to prioritize household expenditures and savings.
The monthly income was reserved for the most essential expenses such as meals,
medication, and other necessities. Can you recall other steps taken by your family to cope
with the situation?

Similar to households, small and big companies also had to recalibrate their budget to cope
with the economic situation during the pandemic. All possible expenses were listed down to
identify the accumulated amount needed. Fiscal targets and priorities targeted essential
operations to prevent significant loss.

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Although the pandemic brought out the urgent need for budgeting of financial resources,
financial management is a constant function for households and businesses. In this lesson,
you will learn more about the method and importance of creating a budget.

Learning Objectives DepEd Competency

Illustrate the formula and format for the

At the end of this lesson, you should be able to
preparation of budgets and projected financial
do the following:
statements (ABM_BF12-IIIc-d-11).
● Define budget, its purpose, and types.

● Demonstrate the process of creating a

budget.
● Prepare different types of budgets.

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Quick Look

Where Will My Money Go?

"Where will my money go?" This question is commonly asked by many households and
individuals who consider budgeting and finance management. Effective budgeting is simply
living within your means. Setting up realistic life goals and creating a plan for saving and
spending is essential for budgeting. You will understand budgeting better by taking this
activity.

Directions:
1. List at least three short-term or long-term goals.
2. List the corresponding financial resources and action steps needed to achieve each
goal.
3. Write your answer in the table that follows.

Financial Resources and Action Steps

Goals (Short-term or Long-term)
Needed

Questions to Ponder

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1. What is the importance of identifying your financial resources to achieve your goals?
________________________________________________________________________________________
________________________________________________________________________________________
________________________________________________________________________________________

2. What are your possible sources of funds today or in the future (career, part-time job,
etc.)?
________________________________________________________________________________________
________________________________________________________________________________________
________________________________________________________________________________________

3. What does it mean to become financially independent? What steps can you take to
achieve this?
________________________________________________________________________________________
________________________________________________________________________________________
________________________________________________________________________________________

Learn the Basics

Planning is one of the critical aspects of managing resources. A business entity should
employ such functions to avoid miscalculation and bankruptcy.

You can recall from the previous lesson that financial planning guides, coordinates, and
controls the financial actions of business organizations. Two important outputs of financial
planning are (1) the cash budget and (2) the projected income statement and balance sheet.
To produce these, business organizations need to undergo a rigorous budgeting process.

Essential Question

How can a budget preparation be formulated to ensure that policy priorities

are met?

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Budgeting
A budget is part of a financial plan, which presents the expected revenues, spending, and
investment needs over a period of time. It is an important tool and output in financial
planning and control. Budgets guide the company with its spending decisions throughout the
accounting period.

In personal finance, households can only budget the amount of money they expect to receive
or generate. For instance, it would be unwise for a family to plan on spending ₱40,000 per
month, when their household income is only ₱35,000. If they do this, their funds will run
short, and they would need to borrow money.

The principle of living within your means also applies to business organizations. Thus, the
basis for budgets is the sales forecast. Sales forecast is essentially the amount of money
that businesses predict they will receive from the sales of goods and services. It is typically
prepared by the marketing department based on historical data and adjusted in
consideration of internal and external factors.

From the sales forecast, the financial manager can draw up the budget for sales, operations,
and cash flows towards the direction of achieving the company goals. The financial manager
can also determine the amount of financing needed so that the sales and production
forecast can be supported. Thus, budgeting is an important aspect of planning,
implementation, and control.

Check Your Progress

What are the consequences of creating a budget that is not “based on

means?”
__________________________________________________________________________________
__________________________________________________________________________________
__________________________________________________________________________________

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Business organizations have at least three purposes in creating a budget plan. These are as
follows:

1. To project income and expenditures

Budgeting is a crucial part of the business planning process. Financial managers and
business owners need the ability to predict gain or loss1. Budgeting provides a model
of how the business might perform financially.

2. To guide decisions
Budgeting creates a blueprint for the decision-making process. This includes action
plans and strategies. A responsible management will place expenditures under tight
control.

3. To monitor business performance

Budgeting allows the measuring of actual business performance against the projected
business performance. Since the budget predicts the possible expenses or costs, it
tells whether the business is on track to achieve its targets.

Types of Budgets
Budgets are important tools used in financial management and planning. Budgeting requires
good data and sound analysis of financial planners. The process entails difficult choices to
consider the feasibility of implementation. Hence, several types of budgets are used in
financial planning: sales budget, operating budget, production budget, and cash budget.

Figure 1. Types of Financial Budget

1
Loss (noun) – an excess of expenses over revenues

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Sales Budget
The sales budget involves realistic projections of the company's sales revenue2 and
expenses and how much it will sell in a specific period. Companies use sales budgets to
establish goals, estimate earnings, and foresee production requirements.

Projected Sales Revenue = Units to Be Sold × Unit Selling Price

Closer Look

Creating a Sales Budget

For the first quarter, XYZ Corporation needs to produce 200,000 units.
Each quarter, the number of units increased by 15%. The selling price is
₱6.00 per item.

XYZ Corporation
Sales Budget
For the year ending December 31, 2022

Quarter
1 2 3 4 Year

Units to Be Sold 200,000 230,000 260,000 290,000 980,000

Unit Selling Price (₱) 6 6 6 6 6

Sales Revenue (₱) 1,200,000 1,380,000 1,560,000 1,740,000 5,880,000

Production Budget
The production budget reveals how much the business must produce to meet sales and
inventory requirements. The production budget is based on the expected number of units
sold, the required ending inventory level, and the number of beginning inventory units.

2
Sales Revenue (noun) - that comes from sales of product and services

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Required Production (in Units) = Projected Sales + Target Ending Inventories –

Beginning Inventories

Closer Look

Creating a Production Budget

Determine how many units XYZ Corporation will produce in 2022.
Quarter
1 2 3 4
Projected Units 200,000 230,000 260,000 290,000
Target Ending Inventories 23,000 25,000 27,000 29,000

The beginning inventory is 21,000 units.

XYZ Corporation
Production Budget
For the year ending December 31, 2022
Quarter
1 2 3 4 Year
Projected Sales 200,000 230,000 260,000 290,000 980,000
Add: Target Ending Inventories 23,000 25,000 27,000 29,000 29,000
Total 223,000 255,000 287,000 319,000 1,009,000
Less: Beginning Inventories 21,000 23,000 25,000 27,000 21,000
Required Production 202,000 232,000 262,000 292,000 988,000

Note that the first quarter's ending inventory (23,000) equals the second
quarter's beginning inventory. The same can be seen in the following
quarters. The year's ending inventory, on the other hand, is the same as
the fourth quarter’s, and the year's beginning inventory is the same as the
first quarter’s.

Operating Budget
The operating budget shows a business's projected revenue and expenses for a specific
period. It indicates the results of operating decisions. Business owners or companies

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formulate an operating budget near the end of the year to show expected activity during the
following year.

Although the operating budget may vary from one business to another, the following are the
main components of an operating budget.
● Sales (discussed in the preceding section)
● Production (discussed in the preceding section)
● Direct materials: the number of raw materials needed by the business to meet its
production target
● Direct labor: the number of workforce needed and the corresponding cost
● Overhead: other variable cost based on sales activity
● Administrative expenses: other expenses needed to administer the operations of the
business

The amounts for each component are added to determine the projected expenses for a
specific period.

Closer Look

Examining the Operating Budget

Examine the operating budget of Company ABC.

Company ABC
Operating Budget

Target Sales Revenue 8,000,000

Units to Produce 160,000

Cost of Direct Materials ₱ 1,600,000

Cost of Labor 2,000,000

Cost of Overhead 500,000

Cost of Administrative Expenses 250,000

Total Operating Expenses ₱ 4,350,000

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Cash Budget
The cash budget is an estimation of a business's cash flow over a specific period. The
preparation of the cash budget could be weekly, monthly, quarterly, or annually. It assesses
the company's sufficiency in cash to continue the main operation over the given time frame.

Table 1 shows the general format of preparing the cash budget.

Company Name
Cash Budget
For the year ending December 31, 20XX

Jan Feb … Nov Dec

Cash Receipts ₱ XXX ₱ XXG ₱ XXM ₱ XXT
Less: Cash Disbursements XXA XXH XXN XXU
Net Cash Flow ₱ XXB ₱ XXI ₱ XXO ₱ XXV
Add: Beginning Cash XXC XXD ₱ XXJ XXO XXQ
Ending Cash Balance ₱ XXD ₱XXJ ₱ XXQ ₱ XXW
Less: Minimum Cash Balance XX E XXK XXR XXY
Excess Cash Balance ₱ XXF ₱ XXL ₱ XXS ₱ XX Z

Table 1. General Format of the Cash Budget

a. Cash receipts are all of a company's cash inflows over a certain financial quarter.
Cash sales, accounts receivable collections, and other cash receipts are the most
prevalent types of cash receipts.

Closer Look

Calculating the Cash Receipts

The CEO of XYZ Corporation is developing a cash budget that wants to
know whether the company has enough cash to pay off a ₱500,000 loan
by the end of 2022.

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The following are the projected quarterly sales for the year 2022:
Quarter 1 Quarter 2 Quarter 3 Quarter 4

1,212,000 1,312,000 1,412,000 1,512,000

In the fourth quarter of 2021, sales totaled ₱800,000. Seventy-five

percent of the sales are collected during the said quarter. In the next
quarter, the remaining 25% is collected. The schedule of expected cash
receipts for the company is presented below.

Solution:
Quarter 1 Quarter 2 Quarter 3 Quarter 4
Projected Quarterly Sales 1,212,000 1,312,000 1,412,000 1,512,000
Collection from Quarterly Sales (75%) 909,000 984,000 1,059,000 1,134,000
Collection from Previous Quarterly
200,000 303,000 328,000 353,000
Sales (25%)
Cash Receipts 1,109,000 1,287,000 1,387,000 1,487,000

b. Cash disbursements are all cash outlays by the company within a given financial
period. The following accounts are the common cash disbursements:

Cost of sales Fixed-asset outlays

Accounts payable Interest payments
Cash dividend payments Rent (and lease) payments
Wages and salaries Principal payments (loans)
Tax payments Repurchases or retirements of stock

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Closer Look

Calculating the Cash Disbursements

The CEO of XYZ Corporation is developing a cash budget that wants to
know whether the company has enough cash to pay off a ₱500,000 loan
by the end of 2022. The cost of sale is 65% of sales. The company
assumed that the operating expenses from quarters 1 to 4 are ₱105,000,
₱115,000, ₱125,000, and ₱135,000 respectively. The income taxes to be
paid from quarters 1 to 4 are ₱25,000, ₱40,000, ₱45,000, and ₱50,000
respectively. The interest expense paid every quarter is ₱25,000. The
schedule of expected cash disbursements for the company is presented
in the table that follows.

Solution:
Quarter 1 Quarter 2 Quarter 3 Quarter 4
Cost of Sales (Sales × 65%) 787,800 852,800 917,800 982,800
Cash Operating Expenses 105,000 115,000 125,000 135,000
Income Taxes 25,000 40,000 45,000 50,000
Income Expenses 25,000 25,000 25,000 25,000
Loan 500,000
Cash Disbursements 942,800 1,032,800 1,112,800 1,692,800

c. Excess cash balance or the required total financing is calculated by subtracting the
acceptable minimum cash balance from ending cash. Excess cash exists when the
ending cash amount exceeds the minimum cash balance. Any remaining funds are
considered to be invested in a liquid, short-term, and interest-paying vehicle such as
marketable securities.

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Closer Look

Preparing the Cash Budget

The CEO of XYZ Corporation wants to know whether the company has
enough cash to pay off a ₱500,000 loan by the end of 2022. At the end of
2021, the expected cash balance is around ₱50,000. Because of predicted
sales growth, the company aims to maintain a minimum cash balance of
₱150,000 for 2022.

Solution:
XYZ Corporation
Cash Budget
For the year ending December 31, 2022
Quarter
1 2 3 4
Cash Receipts* 1,109,000 1,287,000 1,387,000 1,487,000
Less: Cash Disbursements** 942,800 1,032,800 1,112,800 1,692,800
Net Cash Flow 166,200 254,200 274,200 -205,800
Add: Beginning Cash 50,000 216,200 470,400 744,600
Ending Cash Balance 216,200 470,400 744,600 538,800
Less: Minimum Cash Balance 150,000 150,000 150,000 150,000
Excess Cash Balance ₱66,200 ₱320,400 ₱594,600 ₱388,800

*from Example 3: Calculating the Cash Receipts

**from Example 4: Calculating the Cash Disbursements

Check Your Progress

What is the importance of budget preparation for businesses?

__________________________________________________________________________________
__________________________________________________________________________________
__________________________________________________________________________________

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Case Study

A Collaborative Approach to Budgeting and the Impact on the

Budgeting Process: A Case Study
A budget should be prepared by almost every company. The impact of a
budget affects practically every organization regardless of how big or
small it is. Budgets are essential to a company's success (Wildavsky, 1975).
A budget is a business instrument that may or may not succeed without
the participation of many people. The budget is also seen as an important
instrument for strategic planning as it provides management with critical
data for achieving desired objectives (Coulmas & Law, 2010). Budgets can
also help an organization make the most of its financial resources by
ensuring that they are used effectively (Tanase, 2013). The financial
operations plan of an institution is reflected in the budget (de Waal,
Hermkens, & van de Ven, 2011).

Although most businesses create budgets, there is an increasing need to

alter or replace the current budgeting process. A survey of 346
organizations was undertaken by Vaznoniene and Stonciuviene (2012). Of
the 85 percent of respondents who said they establish an annual budget
on a regular basis, 46 percent said they wanted to enhance the process.
The writers came to the conclusion that a deeper understanding of the
budget process is required to determine what budgeting's role should be
and to improve the interaction between budgeting, planning,
decision-making, and control.

A Collaborative Approach to Budgeting and the Impact

on the Budgeting Process
Michael Van Roestel, “A Collaborative Approach to
Budgeting and the”Impact on the Budgeting Process: A
Case Study,” Walden Dissertations and Doctoral Studies
Collection (2016),
https://scholarworks.waldenu.edu/cgi/viewcontent.cgi?

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article=3440&context=dissertations, last accessed on

August 23, 2022.

Keep in Mind

● A budget is a vital part of a business organization’s financial plan. It presents the

expected revenues, spending, and investment needs over a period of time. The purpose
of budgeting is to project income and expenditure, guide decisions, and monitor
business performance.
● Business organizations prepare different types of budget:

● The sales budget foresees the sales revenue and expenses and how much the unit
should be sold in a specific period.
● The production budget determines the number of finished goods which should be
produced based on the expected number of units sold, the required ending inventory
level, and the number of beginning inventory units.
● The operating budget consists of all possible expenses and revenues a business expects
to use for its operations.
● The cash budget summarizes monthly receipts and payments. It estimates the
business’s cash flow over a specific period.

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Try This

Identification. Write the correct answer on the space provided before each number.

________________ 1. It presents the expected revenues, spending, and investment

needs of a business organization over a period of time.

________________ 2. It estimates the business’s cash flow over a specific period.

________________ 3. It shows a business’s projected revenue and expenses for a

specific period.

________________ 4. It is a component of the budget that comprises collections from

receivables, proceeds from loans, issuance of new shares of
stocks, and advances from the stockholders.

________________ 5. Aside from the revenues from income sources, it is also

identified and planned to secure a proper allocation of
resources.

________________ 6. It is a component of the budget that comprises payments to

suppliers and other service providers, loans, and cash dividends.

________________ 7. It is created to identify how much goods the business would sell.

________________ 8. It determines the number of units of finished goods produced on

each budget period.

________________ 9. It is the amount of sales that businesses predict to receive.

________________ 10. It is a component of the budget that shows the anticipated cash
receipts and outflows for a particular accounting period.

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Practice Your Skills

Preparing Budgets
Perform the task required for each number.

1. JKL Corporation targets a 10% increase in revenue for 2022. In 2021, they sold
120,000 units of their product at ₱23.00 each. How many units should they sell next
year to achieve the target sales? Assume that the unit selling price will not change.
Show your answer by creating their sales budget.

JKL Corporation
Sales Budget

2. Based on your answer in item 1, calculate the required production needed by JKL
Corporation if the target ending inventory is 9,500 and the beginning inventory is
7,800. Show your answer by creating their production budget.

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3. Examine the cash budget of RST Corporation. Complete the data by calculating the
missing values. Write your answers in the spaces provided.

RST Corporation
Cash Budget
For the year ending December 31, 2022

Cash Receipts* 2,309,500

Less: Cash Disbursements** 1,500,203
Net Cash Flow
Add: Beginning Cash 502,300
Ending Cash Balance
Less: Minimum Cash 450,000
Balance
Excess Cash Balance

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4. What decision can the financial manager make based on the data obtained from RST
Corporation’s cash budget in item 3?
__________________________________________________________________________________________
__________________________________________________________________________________________
__________________________________________________________________________________________
__________________________________________________________________________________________
__________________________________________________________________________________________

5. Prepare the production budget of ABC Enterprise for 2022. The necessary data are
provided below. Note that the beginning inventory is 37,000 units.

Quarter 1 Quarter 2 Quarter 3 Quarter 4

Projected units 350,000 425,000 550,000 642,000
Target Ending Inventories 45,000 52,000 62,000 68,000

ABC Enterprise
Production Budget
For the year ending December 31, 2022

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Challenge Yourself

Help the ABC Enterprise management to identify if they have enough cash to settle the
business’ debt amounting to ₱700,000 by the end of 2022.

● The data below shows the enterprise’s projected sales revenue per quarter for the
year 2022:
Quarter 1 Quarter 2 Quarter 3 Quarter 4

₱350,000 ₱425,000 ₱550,000 ₱642,000

During the year 2021, the fourth quarter sales were ₱1,550,000. Eighty percent of
the sales were received in the same quarter while 20% was collected in the
following quarter.

● The following data are the projected operating expenses per quarter:
Quarter 1 Quarter 2 Quarter 3 Quarter 4

₱134,000 ₱145,000 ₱156,700 ₱185,000

● The cost of sales is 64% of sales.

● ₱33,000 is paid quarterly for interest expenses.
● The data below shows the income taxes to be paid quarterly:
Quarter 1 Quarter 2 Quarter 3 Quarter 4

₱42,000 ₱48,000 ₱56,000 ₱60,000

● The expected cash balance is ₱95,000 at the end of 2021. The target cash is ₱250,000
due to expected increase in sales.

Note that you need to compute the amount of cash receipts and disbursements before you
can prepare the cash budget.

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ABC Enterprise
Cash Budget
For the year ending December 31, 2022

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Photo Credit
Man and woman calculating domestic budget at home by Pressfoto is licensed under
Freepik via Freepik Company.

Bibliography
International Budget Partnership. Module 2: Defining the Problem.
https://www.internationalbudget.org/wp-content/uploads/MODULE-2-Defining-the-P
roblem.pdf.

Franklin, Mitchell, Patty Graybeal, and Dixon Cooper. "Budgeting." Chap. 7 in Principles of
Accounting, Volume 2: Managerial Accounting. Houston, Texas: OpenStax, 2019
https://opentextbc.ca/principlesofaccountingv2openstax/chapter/prepare-financial-b
udgets/.

Carlson, Rosemary. “How to Calculate a Production Budget”. The Balance Small Business.
Updated December 9, 2020.
https://www.thebalancesmb.com/the-production-budget-an-example-393025.

Isaac, Leo. "Purpose of Budgeting." Online Learning for Sports. Accessed December 8, 2021.
http://www.leoisaac.com/budget/bud031.htm.

Preece, Aisha. "Advantages and Disadvantages of Budgeting (+Free PDF)." Outandbeyond

(blog).October 19, 2021.
https://outandbeyond.com/advantages-and-disadvantages-of-budgeting/.

Putra, Lie Dharma. “How to Make Budgets [Complete Steps with Examples].” Accounting,
Financial, Tax, March 31, 2012.
http://accounting-financial-tax.com/2010/08/how-to-make-budgets-complete-steps-w
ith-examples/.

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Rajak, Himanshu. “Advantages & Disadvantages of Budgeting.” hmhub, July 14, 2021.
https://hmhub.in/advantages-disadvantages-of-budgeting/.

Schiavo-Campo, S. “The Budget Preparation Process.” GSDRC, September 4, 2015.

https://gsdrc.org/document-library/the-budget-preparation-process/.

Tanski-Phillips, Maria. “10 Types of Business Budgets: Operating, Sales, Cash Flow, &
More.” Patriot Software, February 4, 2021.
https://www.patriotsoftware.com/blog/accounting/types-of-business-budgets/.

“Types of Budgets.” Corporate Finance Institute, January 5, 2021.

https://corporatefinanceinstitute.com/resources/knowledge/accounting/types-of-bud
gets-budgeting-methods/.

3.2. Budget Preparation 23