Description
This is a PPT explaining Budgeting and Profit Planning.
Budgeting and Profit Planning
BUDGETING AND PROFIT PLANNING
Planning Process
Budget-Definition, Meaning and Purpose Preparation/Types of Budgets
Planning Process
Budgeting is a tool of planning. Planning involves specification of the basic objectives that the organisation will pursue and the fundamental policies that will guide it. In operational terms, it involves four steps:
(1) Objectives
Objectives are broad and long-range desired state or position in future.
(2) Goals Goals are quantitative targets to be achieved in specified period. (3) Strategies
Strategies represent specific course of action to achieve goals.
(4) Plans The final step is the preparation of budgets/profit plans. It converts goals and strategies into annual operating plans.
Budget
A budget is defined as a comprehensive and coordinated plan, expressed in financial terms, for the operations and resources of an enterprise for some specified period in the future. The essential elements of a budget are:
(1) Plan (2) Financial terms (3) Operations and resources (4) Specific future period (5) Comprehensive coverage (6) Coordination
1. Plan
The first ingredient of a budget is its plan. It includes two aspects which have a bearing on the operations of an enterprise. One set of factors, which determine a firm’s future operations are wholly external and beyond its control. The second set of factors affecting future activities are within the firm’s control and discretion, that is, they are internal.
2. Operations and Resources
A budget is a mechanism to plan for the firm’s operations and resources. The operations are reflected in revenues and expenses. The plan also covers the resources of the firm. The planning of resources means the planning of the various assets and the sources of capital to finance these assets. The assets could be fixed assets as well as current assets.
3. Financial Terms
Budgets are prepared in financial terms, that is, in terms of monetary value such as the rupee, dollar, and so on. The reason is that the monetary unit is a common denominator.
4. Specified Future Period A budget relates to a specified period of time, usually one year. 5. Comprehensiveness A budget is comprehensive in that all the activities and operations of an organisation are included in it. It covers the organisation as a whole and not only some segments. The modus operandi is that budgets are prepared for each segment/facet/activity/division of an organisation. 6. Coordination Budgets are prepared for the different components/ segments/divisions/ facets/activities of an organisation so as to take care of the situations and problems of each component. The budgets for each of the components are prepared in harmony with each another. This is called coordination.
Budget Purpose
The main objectives of budgeting are:
1. Explicit statement of expectations
2. Communication
3. Coordination,
4. Expectations as a framework for judging performance
1. Explicit Statement of Expectations
One purpose of budgeting is to state expectations in formal terms so that most of the underlying assumptions may be identified. A firm has the basic objective of optimising long-run profit. Its long-range goals also include survival, consumer satisfaction, employee welfare, personal power and prestige, and so on. However, a budget does not lay down a statement of expectations in rigid terms. A budget should be modified when necessary in the light of the changes in the factors/assumptions on which the original estimates were based.
2. Communication
Another purpose of budgeting is to communicate or inform others of the goals and methods selected by top management. Since budgeting deals with fundamental policies and objectives, it is prepared by top management.
3. Coordination
Yet another purpose of budgeting is coordination. The term ‘coordination’ refers to the operation of all departments of an organisation in such a way that there is no bottleneck or imbalance. In view of the above, coordination is a major function of budgeting. Budgets should be drafted in such a way that the operations of the various departments are related to each other for the achievement of the overall goal.
4. Expectations as a Framework for Judging Performance
Finally, a budget establishes expectations as a framework for judging employee performance.
TYPES OF BUDGETS
The overall budget is known as the master budge. A master budget normally consists of three types of budgets:
(i) Operating Budgets (ii) Financial Budgets
(iii) Special Decision Budgets
1. Operating Budget
Operating budgets relate to physical activities/ operations such as sales, production, and so on. Operating budget has the following components Sales budget, Production budget, Purchase budget, Direct labour budget, Manufacturing expenses budget, and Administrative and selling expenses budget, and so on.
1) 2) 3) 4) 5) 6)
2. Financial Budget
Financial budgets are concerned with expected cash flows, financial position and result of operations. Financial budget has the following components Budgeted income statement, Budgeted statement of retained earnings, Cash budget, and Budgeted balance sheet.
1) 2) 3) 4)
Cash Budget
Cash budget is a device to help a firm to plan for and control the use of cash. It is a statement showing the estimated cash inflows and cash outflows over the planning period. The principal aim of the cash budget, as a tool to predict cash flows over a period of time, is to ascertain whether there is likely to be excess/shortage of cash at any time.
The preparation of a cash budget involves several steps.
The first element of a cash budget is the selection of the period of the budget, that is, the planning horizon.
The second element of the cash budget is the selection/identification of the factors that have a bearing on cash flows.
The factors that generate cash are generally divided into two broad categories:
(i) Operating (ii) Financial
Operating Cash Flow
The main operating factors/items which generate cash outlfows and inflows over the time span of a cash budget are tabulated in Exhibit 1.
Exhibit 1. Operating Cash Flow Items Cash inflows/Receipts 1. Cash sales 2. Collection of accounts receivable 3. Disposal of fixed assets Cash outflows/Disbursements 1. Accounts payable/Payable payments 2. Purchase of raw materials 3. Wages and salary (pay roll) 4. Factory expenses 5. Administrative and selling expenses 6. Maintenance expenses 7. Purchase of fixed assets
Financial Cash Flow Items
The major financial factors/items affecting generation of cash flows are depicted in Exhibit 2.
Exhibit 2. Financial Cash Flow Items Cash inflows/Receipts Cash outflows/Payments
1. 2. 3. 4. 5. 6. 7.
Loans/borrowings Sale of securities Interest received Dividend received Rent received Refund of tax Issues of new shares and securities
1. 2. 3. 4. 5.
Income tax/tax payments Redemption of loan Re-purchase of shares Interest paid Dividends paid
Special Decision Budgets
The third category of budgets are special decision budgets. They relate to inventory levels, break-even analysis, and so on.
Fixed and Flexible Budgets
Fixed Budgets Budgets prepared at a single level of activity, with no prospect of modification in the light of changed circumstances, are referred to as fixed budgets. Flexible Budgets The alternative to fixed budgets are flexible/variable/sliding budgets
Flexible Budgets
The term ‘flexible’ is an apt description of the essential features of these budgets. A flexible budget estimates costs at several levels of activity. Its merit is that instead of one estimate, it contains several estimates/plans in different assumed circumstances. It is a useful tool in real world situations, that is, unpredictable environment.
A flexible budget, in a sense, is a series of fixed budgets and any increase/decrease in the level/volume of activity must be reflected in it.
The conceptual framework of flexible budgeting relates to: (i) Measure of volume and (ii) Cost behaviour with change in volume Each expense in each department/segment is to be categorised into fixed, variable and mixed components. A budget may first be prepared at the expected level of activity, say, 100 per cent capacity. Additional columns may then be added for costs below and above, 90 per cent and 110 per cent capacity and so on.
Table 1 Hypothetical Ltd—Flexible Budget (Maintenance Department) Volume (labour-hours) Variable costs: Labour Material Others Mixed costs: Labour Maintenance Other supplies Discretionary fixed costs: Training Experimental methods Committed fixed costs: Depreciation Rent, lease cost Total 4,000 Rs 6,000 2,400 800 2,300 1,400 2,500 1,500 3,500 5,000 3,500 28,900 4,500 Rs 6,750 2,700 900 2,400 1,450 2,750 2,000 4,000 5,000 3,500 31,450 5,000 Rs 7,500 3,000 1,000 2,500 1,500 3,000 2,000 4,000 5,000 3,500 33,000 5,500 Rs 8,250 3,300 1,100 2,600 1,550 3,250 2,000 4,000 5,000 3,500 34,550 6,000 Rs 9,000 3,600 1,200 2,700 1,600 3,500 2,500 4,500 5,000 3,500 37,100
Table 2: Hypothetical Ltd—Flexible Budget (Manufacturing Department) Volume (machine-hours) 50 60 70 80 90
Variable costs:
Power Helpers Discretionary fixed costs: Training Tools Committed fixed costs: Depreciation Rent Total 1,200 1,000 3,950 1,200 1,000 4,200 1,200 1,000 4,350 1,200 1,000 4,600 1,200 1,000 4,850 800 200 900 200 900 200 900 300 1,000 300 Rs 500 250 Rs 600 300 Rs 700 350 Rs 800 400 Rs 900 450
Modified Flexible Budgets
Flexible budgets, as a tool of planning and control, are superior to fixed budgets. The major weaknesses of fixed budgets are their inability to: (i) Show the potential variability of various estimates used in the preparation of the budget, and (ii) Indicate the range within which costs may be expected to vary. They are, therefore, not useful in an uncertain and unpredictable environment. Flexible budgets present estimates at different levels of activity, and are more useful.
Limitations
Flexible budgets suffer from one limitation in that they do not explicitly consider the relative probability of a particular volume/cost being achieved. This limitation can be overcome by using a modified flexible budget which will include columns for different levels of estimates: most likely, optimistic and pessimistic.
Table 3: Hypothetical Department) Volume (labour-hours) Variable costs: Labour Materials Others Mixed costs: Labour Maintenance Other supplies Discretionary fixed costs: Training Experimental methods Committed fixed costs: Depreciation Rent, etc. Total
Ltd—Modified
Flexible
Budget
(Manufacturing Optimistic
Pessimistic Most likely 4,250 Rs 6,375 2,650 850 2,350 1,425 2,625 1,750 3,750 5,000 3,500 30,275 5,000 Rs 7,500 3,000 1,000 2,500 1,500 3,000 2,000 4,000 5,000 3,500 33,000
5,850 Rs 8,775 3,510 1,170 3,425 1,585 2,670 2,250 4,250 5,000 3,500 36,135
doc_760437718.ppt
This is a PPT explaining Budgeting and Profit Planning.
Budgeting and Profit Planning
BUDGETING AND PROFIT PLANNING
Planning Process
Budget-Definition, Meaning and Purpose Preparation/Types of Budgets
Planning Process
Budgeting is a tool of planning. Planning involves specification of the basic objectives that the organisation will pursue and the fundamental policies that will guide it. In operational terms, it involves four steps:
(1) Objectives
Objectives are broad and long-range desired state or position in future.
(2) Goals Goals are quantitative targets to be achieved in specified period. (3) Strategies
Strategies represent specific course of action to achieve goals.
(4) Plans The final step is the preparation of budgets/profit plans. It converts goals and strategies into annual operating plans.
Budget
A budget is defined as a comprehensive and coordinated plan, expressed in financial terms, for the operations and resources of an enterprise for some specified period in the future. The essential elements of a budget are:
(1) Plan (2) Financial terms (3) Operations and resources (4) Specific future period (5) Comprehensive coverage (6) Coordination
1. Plan
The first ingredient of a budget is its plan. It includes two aspects which have a bearing on the operations of an enterprise. One set of factors, which determine a firm’s future operations are wholly external and beyond its control. The second set of factors affecting future activities are within the firm’s control and discretion, that is, they are internal.
2. Operations and Resources
A budget is a mechanism to plan for the firm’s operations and resources. The operations are reflected in revenues and expenses. The plan also covers the resources of the firm. The planning of resources means the planning of the various assets and the sources of capital to finance these assets. The assets could be fixed assets as well as current assets.
3. Financial Terms
Budgets are prepared in financial terms, that is, in terms of monetary value such as the rupee, dollar, and so on. The reason is that the monetary unit is a common denominator.
4. Specified Future Period A budget relates to a specified period of time, usually one year. 5. Comprehensiveness A budget is comprehensive in that all the activities and operations of an organisation are included in it. It covers the organisation as a whole and not only some segments. The modus operandi is that budgets are prepared for each segment/facet/activity/division of an organisation. 6. Coordination Budgets are prepared for the different components/ segments/divisions/ facets/activities of an organisation so as to take care of the situations and problems of each component. The budgets for each of the components are prepared in harmony with each another. This is called coordination.
Budget Purpose
The main objectives of budgeting are:
1. Explicit statement of expectations
2. Communication
3. Coordination,
4. Expectations as a framework for judging performance
1. Explicit Statement of Expectations
One purpose of budgeting is to state expectations in formal terms so that most of the underlying assumptions may be identified. A firm has the basic objective of optimising long-run profit. Its long-range goals also include survival, consumer satisfaction, employee welfare, personal power and prestige, and so on. However, a budget does not lay down a statement of expectations in rigid terms. A budget should be modified when necessary in the light of the changes in the factors/assumptions on which the original estimates were based.
2. Communication
Another purpose of budgeting is to communicate or inform others of the goals and methods selected by top management. Since budgeting deals with fundamental policies and objectives, it is prepared by top management.
3. Coordination
Yet another purpose of budgeting is coordination. The term ‘coordination’ refers to the operation of all departments of an organisation in such a way that there is no bottleneck or imbalance. In view of the above, coordination is a major function of budgeting. Budgets should be drafted in such a way that the operations of the various departments are related to each other for the achievement of the overall goal.
4. Expectations as a Framework for Judging Performance
Finally, a budget establishes expectations as a framework for judging employee performance.
TYPES OF BUDGETS
The overall budget is known as the master budge. A master budget normally consists of three types of budgets:
(i) Operating Budgets (ii) Financial Budgets
(iii) Special Decision Budgets
1. Operating Budget
Operating budgets relate to physical activities/ operations such as sales, production, and so on. Operating budget has the following components Sales budget, Production budget, Purchase budget, Direct labour budget, Manufacturing expenses budget, and Administrative and selling expenses budget, and so on.
1) 2) 3) 4) 5) 6)
2. Financial Budget
Financial budgets are concerned with expected cash flows, financial position and result of operations. Financial budget has the following components Budgeted income statement, Budgeted statement of retained earnings, Cash budget, and Budgeted balance sheet.
1) 2) 3) 4)
Cash Budget
Cash budget is a device to help a firm to plan for and control the use of cash. It is a statement showing the estimated cash inflows and cash outflows over the planning period. The principal aim of the cash budget, as a tool to predict cash flows over a period of time, is to ascertain whether there is likely to be excess/shortage of cash at any time.
The preparation of a cash budget involves several steps.
The first element of a cash budget is the selection of the period of the budget, that is, the planning horizon.
The second element of the cash budget is the selection/identification of the factors that have a bearing on cash flows.
The factors that generate cash are generally divided into two broad categories:
(i) Operating (ii) Financial
Operating Cash Flow
The main operating factors/items which generate cash outlfows and inflows over the time span of a cash budget are tabulated in Exhibit 1.
Exhibit 1. Operating Cash Flow Items Cash inflows/Receipts 1. Cash sales 2. Collection of accounts receivable 3. Disposal of fixed assets Cash outflows/Disbursements 1. Accounts payable/Payable payments 2. Purchase of raw materials 3. Wages and salary (pay roll) 4. Factory expenses 5. Administrative and selling expenses 6. Maintenance expenses 7. Purchase of fixed assets
Financial Cash Flow Items
The major financial factors/items affecting generation of cash flows are depicted in Exhibit 2.
Exhibit 2. Financial Cash Flow Items Cash inflows/Receipts Cash outflows/Payments
1. 2. 3. 4. 5. 6. 7.
Loans/borrowings Sale of securities Interest received Dividend received Rent received Refund of tax Issues of new shares and securities
1. 2. 3. 4. 5.
Income tax/tax payments Redemption of loan Re-purchase of shares Interest paid Dividends paid
Special Decision Budgets
The third category of budgets are special decision budgets. They relate to inventory levels, break-even analysis, and so on.
Fixed and Flexible Budgets
Fixed Budgets Budgets prepared at a single level of activity, with no prospect of modification in the light of changed circumstances, are referred to as fixed budgets. Flexible Budgets The alternative to fixed budgets are flexible/variable/sliding budgets
Flexible Budgets
The term ‘flexible’ is an apt description of the essential features of these budgets. A flexible budget estimates costs at several levels of activity. Its merit is that instead of one estimate, it contains several estimates/plans in different assumed circumstances. It is a useful tool in real world situations, that is, unpredictable environment.
A flexible budget, in a sense, is a series of fixed budgets and any increase/decrease in the level/volume of activity must be reflected in it.
The conceptual framework of flexible budgeting relates to: (i) Measure of volume and (ii) Cost behaviour with change in volume Each expense in each department/segment is to be categorised into fixed, variable and mixed components. A budget may first be prepared at the expected level of activity, say, 100 per cent capacity. Additional columns may then be added for costs below and above, 90 per cent and 110 per cent capacity and so on.
Table 1 Hypothetical Ltd—Flexible Budget (Maintenance Department) Volume (labour-hours) Variable costs: Labour Material Others Mixed costs: Labour Maintenance Other supplies Discretionary fixed costs: Training Experimental methods Committed fixed costs: Depreciation Rent, lease cost Total 4,000 Rs 6,000 2,400 800 2,300 1,400 2,500 1,500 3,500 5,000 3,500 28,900 4,500 Rs 6,750 2,700 900 2,400 1,450 2,750 2,000 4,000 5,000 3,500 31,450 5,000 Rs 7,500 3,000 1,000 2,500 1,500 3,000 2,000 4,000 5,000 3,500 33,000 5,500 Rs 8,250 3,300 1,100 2,600 1,550 3,250 2,000 4,000 5,000 3,500 34,550 6,000 Rs 9,000 3,600 1,200 2,700 1,600 3,500 2,500 4,500 5,000 3,500 37,100
Table 2: Hypothetical Ltd—Flexible Budget (Manufacturing Department) Volume (machine-hours) 50 60 70 80 90
Variable costs:
Power Helpers Discretionary fixed costs: Training Tools Committed fixed costs: Depreciation Rent Total 1,200 1,000 3,950 1,200 1,000 4,200 1,200 1,000 4,350 1,200 1,000 4,600 1,200 1,000 4,850 800 200 900 200 900 200 900 300 1,000 300 Rs 500 250 Rs 600 300 Rs 700 350 Rs 800 400 Rs 900 450
Modified Flexible Budgets
Flexible budgets, as a tool of planning and control, are superior to fixed budgets. The major weaknesses of fixed budgets are their inability to: (i) Show the potential variability of various estimates used in the preparation of the budget, and (ii) Indicate the range within which costs may be expected to vary. They are, therefore, not useful in an uncertain and unpredictable environment. Flexible budgets present estimates at different levels of activity, and are more useful.
Limitations
Flexible budgets suffer from one limitation in that they do not explicitly consider the relative probability of a particular volume/cost being achieved. This limitation can be overcome by using a modified flexible budget which will include columns for different levels of estimates: most likely, optimistic and pessimistic.
Table 3: Hypothetical Department) Volume (labour-hours) Variable costs: Labour Materials Others Mixed costs: Labour Maintenance Other supplies Discretionary fixed costs: Training Experimental methods Committed fixed costs: Depreciation Rent, etc. Total
Ltd—Modified
Flexible
Budget
(Manufacturing Optimistic
Pessimistic Most likely 4,250 Rs 6,375 2,650 850 2,350 1,425 2,625 1,750 3,750 5,000 3,500 30,275 5,000 Rs 7,500 3,000 1,000 2,500 1,500 3,000 2,000 4,000 5,000 3,500 33,000
5,850 Rs 8,775 3,510 1,170 3,425 1,585 2,670 2,250 4,250 5,000 3,500 36,135
doc_760437718.ppt