Management Decisions

and Control
Lecture 2

Budgeting and Cash

Budgets

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 Lecture Objectives
 Introduction

 Budgeting: A Strategic Approach

 Preparation of Budgets and Responsibility Areas

 Master budget: A Planning Tool

 Example

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 Introduction
Budgets: a detailed financial plan summarising the consequences of an
organisation's operating
activities resulting from the implementation of a firm's strategy for a
specified time period

Purpose of budgeting
 Planning - to quantify a plan of action
 Allocating resources - evaluating alternative use of resources among
competing users
 Facilitating communication and coordination of subunits in large
organisations
 Controlling profit and operations - budgets can serve as a
benchmark to allow comparison with actual results
 Evaluating performance and providing incentives - a basis for
evaluation of the performance of individuals, subunits or the
organisation

Technical aspects of budgeting draw from economic theory. Eg.

Allocation of scarce resources
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through demand and supply, technical optimisation (efficiency), and
 Budgeting: A Strategic Approach
Mission
 Mission statement: statement of broad purpose and reason for
organisation's existence

Goals and Objective

 More specific desired states or results

Strategy
Strategy: means to achieve goals and objectives
 Corporate strategy: decisions about the type of businesses to
operate in, which businesses to acquire and divest, how best to
structure and finance the organisation
 Business strategy: the way a business competes within its chosen
market

Strategic planning
 Decisions about the type of businesses and markets that the
organisation operates in, and how those businesses and activities
will be financed

Budgeting 4
 Budgeting: A Strategic Approach
Framework of Management Control Systems

External
Environment

Strategy Outcomes
MCS
Corporate Financial
Budgets
Competitive Performance

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 Preparation of Budgets and
Responsibility Centres
Budget Timetable
 Budgets are developed for specific time periods, e.g. annually,
monthly, or quarterly etc.
 Budgets will vary in their level of detail, often dependent on the size
and complexity of the firm; some organisations prepare the first,
three month in detail, and the rest of year by quarters.
 Rolling budgets (or continuous budgets) are continually updated by
periodically adding a new time period, e.g. add a new quarter, while
dropping the period just completed.
 The components of the budget are interdependent, thus
management is required to develop a time table that specify the
sequence in which activities are to be prepared.

Incremental or Zero Based

 Incremental budgets: when last years budget is used as a starting
point and changes are made on an incremental basis in relation to
this.
 Zero based budgets: where the organisation or department starts 6
 Preparation of Budgets and
Responsibility Centres
Budgeting and Responsibility accounting
 Responsibility Accounting: Holding managers responsible for the
activities and performance of their area of the business or
responsibility centre

 The basis of responsibility accounting system is the designation of

each subunit of the organisation as a particular responsibility centre,
for which a manager is held accountable.

Types of responsibility centres

 Cost centres
 Standard cost centre
 Discretionary expense centre
 Revenue centres
 Profit centres
 Investment centres

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 Master Budget: A Planning Tool
Annual Master Budget: a comprehensive set of budgets that cover
all aspects of a firm's activities:
 Financial Budget
 Operating Budget
 Cash Budget
 Capital Expenditure Budget

Financial budgets
 Statement of Financial Performance: shows the expected revenue
and planned expenses of the firm during the budget period
 Statement of Cash Flow: details the expected cash receipts and
planned cash payments for the budget period
 Statement of Financial Position: outlines the expected assets and
liabilities of the firm at the end of the budget period

Operating budget
 Sales budget: estimated sales units and revenues from the
organisation's products
 Internal factors: past sales levels, new products planned, intended
pricing policy and planned advertising and promotion 8
 External factors: general economic trends, specific industry trends,
 Master Budget: A Planning Tool
 Production budget: number of production units to be manufactured
to meet sales and satisfy inventory requirements, including
budgeted costs for direct materials, direct labour and overheads
 Cost or expense budgets: detail the cost of operations needed to
support forecast sales demand

Retailers and wholesalers: uses a purchasing budget to determine the

quantity and cost of goods
purchased for resale
Service firms: uses a set of budgets that show how demand for services
will be met

Cash Budget
 The operating budget is prepared in terms of revenues and
expenses, in order to allow financial planning it must be translated
into cash receipts and payments that is the cash budget.
 The cash budget shows the planned sources and uses of cash. It
facilitates effective cash management identifying the timing of all
cash movements to minimise the risk of cash shortages and
extensive cash surpluses
 The Indirect Method: starts with net profit and adjust for non-cash
items and changes in the budgeted statement of financial position9

 Master Budget: A Planning Tool
Capital Expenditure Budget
 The capital expenditure budget shows the estimate cost proposed
projects (list of acquisitions of facilities and equipment) and the
timing of related expenditures and revenues.

Project Budgets
 Some organisations work on defined projects, - buildings, aircraft,
ships, road, and motion pictures. If this is the case the project
manager may use personnel and other resources from various
functional departments. If so, the project budget is contains
amounts that are also reported in the budgets for functional
responsibility centres.

Project Proposal Cases

 Capital investments originate for reasons of: cost reduction,
expansion and improvement of existing products, new products,
health and safety, pollution control. As with the operating budget
many organisations have procedures for proposal, approvals. Often 10
 Concept Map of Budgeting

Project Budget

Cash Budget Operating Capital

Budget Expenditure
Receipts Budget
Sales Budget
Payments Acquisitions
Production
Budget Assets

Cost or Expense Financing:

Budget Debt
Equity

Case Budget
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 Example
Budgeted sales 500 units
Budgeted selling price $115
Opening finished goods inventory 100 units
Closing finished goods inventory 50 units

Production Total Fixed Unit variable

costs
Material $1,000 $15
Labour 3,500 35
Other overheads 5,500 10
$10,000 $60
Other Expenses
S & A expenses $3,800 $8

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Cash collection from customers:
 30% in the month of sales
 60% in the month following sales
 8% in the third month

Accounts receivable at beginning of month: $46,000

 $42,000 from previous month sales
 $4,000 from the month before

Accounts payable at beginning of month: $9,800

 40% of suppliers give a 2% cash discount. The company's policy is
to take full advantage of cash discount.

Opening and closing raw material inventory was $2,700 and $1,950
respectively
Overhead include depreciation expense of $1,800
The company pay 50% of overheads and expenses in the month they
are incurred
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Cash at the beginning of the month: $28,000
Full Unit Cost
Direct materials $ 15
Direct labour costs 35
Variable Overheads 10
Fixed Overheads 10,000
Denominated level ÷ 500 20
of activity
Unit absorption costs $ 80

Budgeted Production
Sales (Qs) - units 500
Closing stocks 50
Sales 500
550
Opening stocks 100
Production (Qp) - units 450
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 Operating Budget
Sales Revenue Qs x $115 $57,500
Other Income (Discount Received) 56
Total Income 57,556

Cost of goods sold

Opening stocks (100*$80) 8,000
Production Costs:
Material (Qp x $15) + $1,000 7,750
Labour (Qp x $35) + $3,500 19,250
Overhead (Qp x $10) + 5,500 10,000
Total costs of production 37,000
F.G. available for sales 45,000
Less: closing stocks (50*$80) 4,000

Cost of goods sold 41,000

Gross profit 16,556 15
 Operating Budget cont.
Gross profit 16,556

Operating Expenses
S&A Expenses (Qs x $8) + 3,800 7,800
Bad Debt Expense (2% of Sales 57,500) 1,150
Total Operating Expenses 8,950

Profit 7,606

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Budgeted Statement of Cash Flows
Cash Receipts
Receive: 30% in the month of sales
60% in the month following sales
8% in the third month
Bad debt expense of $1,150 (2% of sales, $57,500)

Accounts receivable: $46,000

 $42,000 from the previous month
 $4,000 from the month before

Current month: $57,500 x 30% 17,250

Previous month: $42,000 ÷ (1 – 0.30) = 36,000

$60,000 x 60%
Two months ago: $4,000 ÷ (1 – 0.90) = 3,200
$40,000 x 8%
Total cash receipts from customers 56,450
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Cash payment

Current month's purchases = current month production $7,750 +

closing RM inventory ($1,950)
opening RM inventory ($2,700) = $7,000

Discount received of $56 (40% of suppliers gives of 2% cash discount

of $7,000)

Overhead include depreciation expense of $1,800

Overhead cash payment: = ($10,000 - $1,800) x 50% (50% of

overheads and expenses are paid
in the month they are incurred) = $4,100

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 Cash Budget
Cash Receipt
Current month 17,250
Previous month 36,000
Two month ago 3,200 $56,450
Cash Payment
Materials ($7,000 x 40% x 98%) 2,744
Labour (all paid in same month) 19,250
Overhead - current month (see above) 4,100
Selling & Administrative Expenses:
Current month ($7,800 x 50%) 3,900
Previous months' material, O/H, S & A 9,800 $39,794
expenses (accounts payable) - info given
Changes in cash balance 16,656
Cash balance at beginning of month 28,000
Cash balance at end of month $44,656
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