Budgeting 101

By: Limheya Lester Glenn

National University-Manila

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Objectives
What is a Budget
01 An Introductory Discussion about Budget

Benefits of a Budget
02 Discussion on why budgeting is essential in an organization

Making a budget
03 Step by Step Guide on Making a basis budget for the
organization.
What is a Budget?
Budget
" A financial and/or
quantitative statement,
prepared and approved
prior to define period of
time, of the policy to be
persued during that
period for the purpose of
attaining a given
objective." - The
Chartered Institute of
Management
Accountants, England,
defines a 'budget' as
under:
Planning
Specific
Measurable
Attainable
Relevant
Timely
Planning
Benefits of a Budget
10 Benefits of a Budget
Planning orientation. The process of creating
a budget takes management away from its short-term,
day-to-day management of the business and forces it to
think longer-term. This is the chief goal of budgeting, even
if management does not succeed in meeting its goals as
outlined in the budget - at least it is thinking about the
company's competitive and financial position and how to
improve it.

Profitability review. It is easy to lose sight of where a

company is making most of its money, during the scramble
of day-to-day management. A properly structured budget
points out what aspects of the business produce money
and which ones use it, which forces management to
consider whether it should drop some parts of the
business or expand in others.
10 Benefits of a Budget
Assumptions review. The budgeting process forces
management to think about why the company is in
business, as well as its key assumptions about its
business environment. A periodic re-evaluation of these
issues may result in altered assumptions, which may in
turn alter the way in which management decides to
operate the business.

Performance evaluations. You can work with employees to

set up their goals for a budgeting period, and possibly also
tie bonuses or other incentives to how they perform. You
can then create budget versus actual reports to give
employees feedback regarding how they are progressing
toward their goals. This approach is most common with
financial goals, though operational goals (such as reducing
the product rework rate) can also be added to the budget
for purposes. nsibility accounting.
10 Benefits of a Budget
Funding planning. A properly structured budget should
derive the amount of cash that will be spun off or which will
be needed to support operations. This information is used
by the treasurer to plan for the company's funding needs.

Cash allocation. There is only a limited amount of cash

available to invest in fixed assets, and the budgeting
process forces management to decide which assets are
most worth investing in.

Bottleneck analysis. Nearly every company has

a bottleneck somewhere, and the budgeting process can
be used to concentrate on what can be done to either
expand the capacity of that bottleneck or to shift work
around it.
10 Benefits of a Budget
Planning orientation. The process of creating
a budget takes management away from its short-term,
day-to-day management of the business and forces it to
think longer-term. This is the chief goal of budgeting, even
if management does not succeed in meeting its goals as
outlined in the budget - at least it is thinking about the
company's competitive and financial position and how to
improve it.

Profitability review. It is easy to lose sight of where a

company is making most of its money, during the scramble
of day-to-day management. A properly structured budget
points out what aspects of the business produce money
and which ones use it, which forces management to
consider whether it should drop some parts of the
business or expand in others.
10 Benefits of a Budget
Planning orientation. The process of creating
a budget takes management away from its short-term,
day-to-day management of the business and forces it to
think longer-term. This is the chief goal of budgeting, even
if management does not succeed in meeting its goals as
outlined in the budget - at least it is thinking about the
company's competitive and financial position and how to
improve it.

Profitability review. It is easy to lose sight of where a

company is making most of its money, during the scramble
of day-to-day management. A properly structured budget
points out what aspects of the business produce money
and which ones use it, which forces management to
consider whether it should drop some parts of the
business or expand in others.
Making a Budget
Essentials of a Budget
(1) It is prepared for a definite future period.
(2) It is a statement prepared prior to a defined period of time.
(3) The Budget is monetary and I or quantitative statement of
policy.
(4) The Budget is a predetermined statement and its purpose is
to attain a given objective.

A budget, therefore, be taken as a document which is

closely related to both the managerial as well as accounting
functions of an organization.
Overall Plan

A master budget is part of an overall organization plan for

the next year made up of three components:
(1) the organization goals,
(2) the strategic long-range profit plan, and
(3) the tactical short-range profit plan.
Top managers establish broad objectives, which serve as organization
goals that company employees work to achieve.

It is important to detail the specific steps required to achieve the goals. These
steps are expressed in a strategic long-range plan.

The plan for the coming year, which is more specific than long-range plans, is
called the master budget, also known as the static budget, the budget plan,
or the planning budget .
 LO
13-1

Organizational and Individual Interaction:

Developing the Master Budget
 LO
13-2

Human Element in Budgeting

Organization Individual
Goal congruence
goals goals

Participative Budgeting
Use of input from lower- and middle-management
employees; also called grass roots budgeting
Sales Forecasting

Forecasting sales is the most difficult aspect of budgeting.

How do we forecast sales?
Sales staff

Market researchers

Delphi technique

Trend analysis

Econometric models
Forecasting by Sales Staff
After evaluating the sales forecasts derived from
various sources, the budgeting task force at ABC co
(Pants Tailoring Shop) arrived at the following sales
budget for the next budget year:
Forecasting Production

A production budget is a plan of resources needed to meet current

sales demand and ensure that inventory levels are sufficient for future
sales.

Basic inventory formula:

Beginning balance Transfers in Transfers out
+ – = Ending balance
BB TI TO

For inventories, production, and sales:

Units in beginning Required Budgeted Units in ending
+ – =
inventory production sales inventory
Production Budget

Rearranging for required production:

Budgeted Units in ending Units in beginning Required
+ – =
sales inventory inventory production

• ABC co’s sales budget is 160,000 units

• Management estimates that there will be 5,000 units

in beginning inventory and 15,000 in ending inventory.

160,000 15,000 5,000 170,000

+ – =
units units units units
Production Budget
Production Costs

Direct Direct Manufacturing

materials labor overhead

Indirect Indirect
Other
labor materials
 LO
13-4

Direct Materials Example

 LO
13-4

Direct Materials Example

ABC Co
Estimated Production
Materials Data
Yards needed:
 LO
13-4

Direct Materials Example

P
 LO
13-4

Direct Labor Example

 LO
13-4

Overhead Example
ABC Co
Schedule of Budgeted Manufacturing Overhead
For the Budget Year Ended December 31
Variable overhead needed to product 170,000 units:
Indirect materials and supplies @ P0.30 per unit P 51,000
Materials handling @ P0.40 per unit 68,000
Other indirect labor @ P0.10 per unit P 17,000
Total variable overhead P136,000

Fixed manufacturing overhead (supervisory labor P102M,

maintenance and repairs P50M, plant administration P85M,
utilities P55M, depreciation P140M, insurance P30M,
property taxes P60M, and other P22M) P544,000
Total manufacturing overhead P680,000
 LO
13-4

Cost of Goods Sold Example

ABC Co.
Budgeted Statement of Cost of Goods Sold
For the Budget Year Ended December 31
Beginning work-in-process inventory P -0-
Manufacturing costs:
Direct materials:
Beginning inventory P 35,000
Purchases 1,715,000
Materials available for manufacturing
P1,750,000
Less: Ending inventory (50,000)
Total direct materials costs P1,700,000
Direct labor 1,870,000
Manufacturing overhead 680,000
Total manufacturing costs P4,250,000
Less: Ending work-in-process -0-
Cost of goods manufactured P4,250,000
Add: Beginning finished goods inventory 120,000aa
Less: Ending finished goods inventory (375,000)bb
Cost of goods sold P3,995,000
a
Management estimate b
Estimate: (15,000 units × P25 value of finished goods)
 LO
13-4

Marketing and Administrative

Budget Example
 LO
13-4

Income Statement Example

 LO
13-5

Cash Budget

The cash budget is a statement of cash on hand at the

start of the budget period, expected cash receipts,
expected cash disbursements, and the resulting cash
balance at the end of the budget period.

• Cash receipts:
– Collection of accounts receivable
– Cash sales
– Sales of assets
– Borrowing
– Issuing stock
– Other
 LO
13-5

Cash Budget

Some cash disbursements:

– Materials purchases
– Manufacturing costs
– Operating activities
– Debt repayment
– Acquisition of new assets
– Income taxes
– Dividends
– Other activities
 LO
13-5

Cash Budget
Santiago Pants
Cash Budget
For the Budget Year Ended December 31
Cash balance beginning of period P 830,000
Receipts:
Collections on accounts P6,840,000
Collections employee loans 100,000
Total receipts 6,940,000
Less: Disbursements:
Payments for accounts payable 1,694,000
Direct labor 1,870,000
Manufacturing overhead less noncash depreciation charges 540,000
Marketing and administrative costs less noncash charges 1,422,000
Payments for federal income taxes 350,000
Dividends 30,000
Reduction in long-term debt 23,000
Acquisition of new assets 1,470,000
Total disbursements 7,399,000
Budgeted ending cash balance P 371,000
 LO
13-5

Cash Collections Example

Santiago Pants
Monthly Collection Experience
Sales on Credit

Expected Sales for Three Months

 LO
13-5

Cash Collections Example

Santiago Pants
Multiperiod Schedule of Cash Collections
For the Quarter Ended March 31
Month Total for
January February March Quarter
Beginning accounts receivable,
January 1, P540,000 P540,000 P 540,000
January sales, P500,000aa 100,000 P375,000 475,000
February sales, P450,000bb 90,000 P337,500 427,500
March sales, P600,000cc 120,000 120,000
Total cash collections P640,000 P465,000 P457,500 P1,562,500
a
20% collected in January, 75% collected in February, and 5% not collected
b
20% collected in February, 75% collected in March, and 5% not collected
c
20% collected in March, 75% collected in April, and 5% not collected
 LO
13-5

Cash Disbursements Example

Santiago Pants
Monthly Disbursements for Purchases Experience
Cash disbursement for current month's purchases 50%
Cash disbursement for prior month's purchases 48
Cash discounts taken
Total cash disbursement for purchases 100%

Expected Purchases for Three Months

January sales P120,000
February sales P200,000
March sales P250,000
 LO
13-5

Cash Disbursements Example

Santiago Pants
Multiperiod Schedule of Cash Disbursements
For the Quarter Ended March 31
Month Total for
January February March Quarter
Beginning accounts payable,
January 1, P256,000 P256,000 P 256,000
January purchases, P120,000aa 60,000 P 57,600 117,600
February purchases, P200,000bb 100,000 P 96,000 196,000
March purchases, P250,000cc 125,000 125,000
Additional cash payments 250,000 250,000 250,000 750,000
Total cash disbursements P566,000 P407,600 P471,000 P1,444,600
a
50% paid in January, 48% paid in February, and 2% discounts taken
b
50% paid in February, 48% paid in March, and 2% discounts taken
c
50% paid in March, 48% paid in April, and 2% discounts taken
 LO
13-6

Budgeted Balance Sheet Example

LO 13-6 Develop budgeted financial statements.
Santiago Pants
Budget Balance Sheet
For the Budget Year Ended December 31 (P000)
Budget Year
Balance Balance
Jan 1 Additions Subtractions Dec 31

Assets
Current assets:
Cash P 830 P 6,940 P 7,399 P 371
Accounts receivable 540 7,200 6,840 900
Inventories 155 4,265 3,995 425
Other current assets 161 -0- 100 61
Total current assets P1,686 P18,405 P18,334 P1,757
Long-term assets:
Property, plant, equipment 1,866 1,470 -0- 3,336
Less: Accumulated depreciation (1,246) (220) -0- (1,470)
Total assets P2,306 P19,651 P18,334 P3,623
 LO
13-6

Budgeted Balance Sheet Example

Santiago Pants
Budget Balance Sheet
For the Budget Year Ended December 31 (P000)
Budget Year
Balance Balance
Jan 1 Additions Subtractions Dec 31

Liabilities and Shareholders Equity

Current liabilities:
Accounts payable P 256 P1,715 P1,694 P 277
Taxes payable 187 550 350 387
Current portion of long-term debt 23 23 23 23
Total current liabilities P 466 P2,288 P2,067 P 687
Long-term liabilities 258 -0- 23 235
Total liabilities P 724 P2,288 P2,090 P 922
Shareholders' equity
Common stock P 437 P -0- P -0- P 437
Retained earnings 1,145 1,149 30 2,264
Total shareholders P1,582 P1,149 30 P2,701
Total liabilities and shareholders equity P2,306 P3,437 P2,120 P3,623
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