BUDGETINGCOOP 4073 Cooperative Business Planning and

Budgeting

Submitted By:

Bernard ArpilledaJudy Grace Barcarse

Ma. Joana BarrionAbigail Espera

Willesa GoAdrian Paolo Ruiz

Submitted To:

Prof. Al A. Fontamillas2nd Semester, SY 2013-2014

BCFMA3-1

DEFINITION

A budget (derived from old French word bougette, purse) is a quantified financial

plan for a forthcoming accounting period.

Budget is a detailed plan defining or outlining the sourcing and uses and

financial and other resources of the company in a given period of time. This is the plan

expressed in quantitative terms. Every organization or individual has to budget their

scarce resources to make the best use of resources (time, money, and energy.)

A budget is an important concept in microeconomics, which uses a budget line to

illustrate the trade-offs between two or more goods. In other terms, a budget is an

organizational plan stated in monetary terms.

Budgeting is a necessary exercise in a business firm that should be performed in

order to plan for the present and the future. Budgeting is the process of stating in

quantitative terms their operations, usually in units and pesos and planned their

organizational activities for a given period of time. Budgeting is the best approach to

planning, controlling as well as cost reduction program of the company.

ADVANTAGES OF BUDGETING

Budgeting forces managers to do better forecasting. Managers should be

constantly scanning the business environment to spot changes that will impact the

business. Vague generalizations about what the future may hold for the business are

not good enough for assembling a budget. Managers must put their predictions into

definite and concrete forecasts.

Budgeting motivates managers and employees by providing useful yardsticks

for evaluating performance. The budgeting process can have a good motivational

impact by involving managers in the budgeting process and by providing incentives

to managers to strive for and achieve the business’s goals and objectives.

Budgets provide useful information for superiors to evaluate the performance

of managers and can be used to reward good results. 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

performance appraisal purposes. This system of evaluation is called responsibility

accounting. For example, budgets supply baseline financial information for incentive

compensation plans. And the profit plan (budget) for the year can be used to award

year-end bonuses according to whether designated goals were achieved.

Budgeting can assist in the communication between different levels of

management. Putting plans and expectations in black and white in budgeted

financial statements — including definite numbers for forecasts and goals —

minimizes confusion and creates a kind of common language. Well-crafted budgets

can definitely help the communication process.

Budgeting is essential in writing a business plan. New and emerging businesses

need to present a convincing business plan when raising capital. Because these

businesses may have little or no history, the managers and owners must

demonstrate convincingly that the company has a clear strategy and a realistic plan

to make profit. A coherent, realistic budget forecast is an essential component of a

business plan.

Planning orientation. The process of creating 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.

Provide structure. A budget is especially useful for giving a company guidance

regarding the direction in which it is supposed to be going. Thus, it forms the basis

for planning what to do next. A CEO would be well advised to impose a budget on a

company that does not have a good sense of direction. Of course, a budget will not

provide much structure if the CEO promptly files away the budget and does not

review it again until the next year. A budget only provides a significant amount of

structure when management refers to it constantly, and judges employee

performance based on the expectations outlined within it.

Model scenarios. If a company is faced with a number of possible paths down

which it can travel, you can create a set of budgets, each based on different

scenarios, to estimate the financial results of each strategic direction.

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. However, this advantage only applies to a budget

sufficiently detailed to describe profits at the product, product line, or business unit

level.

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 managements decides to

operate the business.

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.

Predict cash flows. Companies that are growing rapidly, have seasonal sales, or

which have irregular sales patterns have a difficult time estimating how much cash

they are likely to require in the near term, which results in periodic cash-related

crises. A budget is useful for predicting cash flows in the short term, but yields

increasingly unreliable results further into the future.

Cash allocation. There is only a limited amount of cash available to invest in fixed

assets and working capital, 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.

Cost reduction analysis. A company that has a strong system in place for continual

cost reduction can use a budget to designate cost reduction targets that it wishes to

pursue.

Shareholder communications. Large investors may want a benchmark against

which they can measure the company’s progress. Even if a company chooses not to

lend much credence to its own budget, it may still be valuable to construct a

conservative budget to share with investors. The same argument holds true for

lenders, who may want to see a budget versus actual results comparison from time

to time.

Price Setting. Market conditions such as your competitors’ prices aren’t the only

parameters you need to set your fees, rates and prices. You must know your

manufacturing and overhead costs before you set your prices. A budget lets you

project your utility, health care, marketing, rent, wages, debt service and other costs

so you can learn the true cost per unit of making your products or delivering your

service. Once you know this, you can set your prices to make the profit you want. If

this price is too high for you to be competitive in your marketplace, you can use your

budget to identify areas where you can reduce your costs.

Capital and Credit Procurement. Few venture capitalists, banks, suppliers or other

lenders will give you money or credit unless you have financial data to demonstrate

you are a going concern. Unless you have assets you can use as collateral, you’ll

need to show financial statements that prove you are stable. If you are a new

business, or are expanding, a budget will show potential partners how their

participation will affect your sales and profits.

Flexibility. A budget lets you track your business’ performance throughout the year,

allowing you to make necessary changes to rein in costs or increase spending to

take advantage of growth opportunities. If your marketing is effective, a budget will

let you know if you have funds available to increase your advertising to grow your

sales. If your sales are slow, a budget identifies areas where you can cut

discretionary costs to make you more competitive or tide you through slow periods.

PURPOSE OF BUDGETING

Planning

First and foremost, a business budget is a planning tool. It allows businesses

to attain their goals through planning how to use revenue and expenses. Businesses

should use budgeting to look back at previous time periods and to look forward at

future time periods. A business’s master budget is a plan of financial activities

involving assets, liabilities, equity, revenue, expenses, and costs for a given time

period.

Owners first develop a master or static budget with the numbers based on the

planned inputs (sales revenue) and outputs (expenses) for the firm. Think of this in

very simple terms. The owner is looking at what the firm will take in from sales

revenue and what the firm will pay out in expenses. The budget is done for a specific

period of time, perhaps a month, a quarter, or a year.

Control

Businesses also use budgets for the purpose of control. If owners have a

master budget to follow, then they can carefully control expenditures during the time

period of the budget by comparing them to the master budget. Budgets help prevent

overspending. The budget also gives the company a benchmark to use by which to

evaluate the firm. Not only can expenditures be monitored, but so can revenue

inputs.

Budgets cannot always stay static or the same. There are times when

expenditures must change from the budgeted amount and revenues will change

from that which is forecasted. Budgets are not designed to stay the same. Business

owners know when they are developed that there will be changes in just about every

line item by the end of the time period. Budgets, however, give some guidelines to

the firm and prescribe some sort of limits.

Motivation

Budgeting helps to motivate managers and employees to strive to achieve

budget goals.

Evaluation of Performance

Budgets are a valuable tool for owners to use to evaluate the performance of

their firm at the end of the time period that the budget covers. Owners should look at

actual expenses, for example, as compared to budgeted, or planned, expenditures.

By doing this, the owner can see how much actual expenses varied from planned

expenses in order to improve the budgeting process in the next time period.

The same is true for the revenue side of the equation. Owners want to see if

planned revenue equaled actual revenue as this will help them plan revenue inputs

for the future.

Accountability

It also helps co-ordinate the activities of the organization by compelling

managers to examine relationships between their own operation and those of other

departments.

In summary, the purpose of budgeting is tools:

1. Tools provide a forecast of revenues and expenditures, that is, construct a model

of how a business might perform financially if certain strategies, events and

plans are carried out.

2. Tools enable the actual financial operation of the business to be measured

against the forecast.

3. Lastly, tools establish the cost constraint for a project, program, or operation.

CLASSIFICATION AND SCOPE OF BUDGET

Master Budget 

The master budget is also known as the financial plan. Master budgets form the

basis of the control systems in organizations. The master budget may take the form of a

profit and loss account and a balance sheet at the end of the budget period. It shows

the gross and the net profits and the important accounting ratios. It has three

components:

A. Capital budget. Capital budgeting is budgeting for the large expenses in a

business firm. This is used to determine whether an organization's long term

investments such as new machinery, replacement machinery, new plants, new

products, and research development projects are worth pursuing. It is the

process of budgeting for obtaining, expanding, and replacing fixed assets. Doing

a good job budgeting for fixed assets like buildings, equipment, tools, and other

fixed assets that last more than one year is important simply because they last a

long time.

B. Cash Flow/ Cash Budget. This is a prediction of future cash receipts and

expenditures for a particular time period. It usually covers a period in the short

term future. The cash flow budget helps the business determine when income

will be sufficient to cover expenses and when the company will need to seek

outside financing. The cash flow budget is incredibly important for the business

firm. It is a budget showing expected cash inflows (receipts) and cash outflows

(expenses). The cash flow budget shows whether or not enough cash will be

available to meet monthly expenses. If not, the cash flow budget shows how you

can borrow if you don't have enough money to meet expenses and how you can

invest if you have more money than you need in a given month.

C. Operating Budget – This is the detailed schedule for each item in the operation

of business (sales, production, purchases and operating expenses). A business's

forecasted revenues along with forecasted expenses, usually for a period of one

year or less. The operating budget is based primarily on the firm's sales forecast.

It is a budget of sales revenue minus expenses and essentially ends up with

gross profit. In the operating budget, you have to determine what you need in

sales revenue to meet your expenses and achieve your profit goal.

Sales budget – or Sales Forecast, is the starting point of all operating

budget. It is a detailed schedule showing the expected sales for the

coming year. It shows both peso sales and units of products or level of

services. It is used to create company sales goals.

Revenue budget – consists of revenue receipts of government and the

expenditure met from these revenues. Tax revenues are made up of taxes

and other duties that the government levies.

Expenditure budget – includes spending data items; an estimate

prepared for travel, utilities, office supplies, telephone, and many other

common business expenses for a given period.

Production budget – starts with the sales budget's estimates of the total

number of units projected to be sold to meet the sales goals, then

translates this information into estimates of the cost of labor, material, and

other expenses required to produce them. Production budget involves

planning the level of production which in turn involves the answer to the

following questions:

What is to be produced?

When is it to be produced?

How is it to be produced?

Where is it to be produced?

Marketing budget – an estimate of the funds needed for promotion,

advertising, and public relations in order to market the product or service.

Project budget – a prediction of the costs associated with a particular

company project. These costs include labor, materials, and other related

expenses. The project budget is often broken down into specific tasks,

with task budgets assigned to each. A cost estimate is used to establish a

project budget.

Cost of Goods Sold budget – shows the total number of units sold and

its average unit prices; includes direct labor and manufacturing overhead

budgets for a manufacturing firm which are related to production budget.

Budgeted Income Statement – is prepared based on the detailed

operating budgets and will show how profitable operations in the period.

This will be used as the basis for evaluating the performance of the

company by comparing the budget and the actual results at the end of

each year.

BUDGETING PROCESS

Sales Budget

Production BudgetPurchases Budget

Cost of Goods Sold Budget

Operating Expenses Budget

Budgeted Statement of Income

Budgeted Balance Sheet

Cash Budgets

Capital Budget

s

Ending- Inventory Budget

Operating Budget

Financial Budget

BUDGET PERIOD

Even though yearly budgets are the most commonly used, the length of time of a

budget depends on its purpose and nature. A capital budget may extend for a couple of

years if, for example, it entails building a warehouse. But, whether a budget is a capital

or operating budget, they are usually broken down into smaller periods of time to better

control their activities. Budget periods are usually years, quarters or months and directly

link to the completion of specific portions of a project or activity.

Activity-based budget is the budget for the costs of individual activities. In

activity-based budgeting, all costs are allocated to cost centers and then are

assigned to activities. Products or customers are allocated the costs based on

the amount of activity they consume. Activity-based budgets ensure cost

reduction and performance improvement. As activity-based budgeting requires a

new budgeting model, it requires careful planning and implementation.

Add-on budget is the budget based on the previous years’ budgets adjusted for

current information. For example, add-on budgets can be adjusted for new levels

of inflation, employee wage rates, or new requirements.

Bracket budget is the budget at higher and lower levels than the base estimate.

Essentially bracket budgets are contingency expense plans for downside risks.

For example, such budgets allow management to estimate an impact of

decreased sales on earnings. In bracket budgeting, management identifies

potential problems and acceptable profit. In this way, management can test

different alternatives and improve planning process.

Continuous (rolling) budget is the budget revised on a regular basis. As the

period ends, a new budget period is added. For example, the budget can be

regularly extended for another month (or quarter) at the end of each month (or

quarter). As the result, continuous budgets are based on the most recent

information and ensure proper planning and performance. The drawback of

continuous budgets is that they require continuous planning. Computer

technology permits companies to employ continuous or perpetual budgets.

These budgets may be constantly updated to relate to the next 12 months or next

4 quarters, etc. as one period is completed, another is added to the forward

looking budgetary information. This approach provides for continuous monitoring

and planning and allows managers more insight and reaction time to adapt to

changing conditions. An analogy might be made to driving. A bad driver might

focus only on getting from one intersection to the next. A good driver will

constantly monitor conditions well beyond the upcoming intersection, anticipating

the need to change lanes as soon as distant events first cone into view.

Encumbrances. In working with budgets, especially budgets of governmental

units, you may encounter an “encumbrance”. An encumbrance is a budgetary

restriction occurring in advance of a related expenditure. The purpose of an

encumbrance is to embark funds for a designated future purpose. For instance, a

department may have $100,000 budgeted for office supplies for the upcoming

year. However, the department may have already entered into a $500 per month

contract for copy machine repair service. Although $100,000 is budgeted, the

remaining free balance is only $94,000 because $6,000 has already been

committed for the repair service. At any point in time, the total budget, minus

actual expenditures, minus remaining encumbrances, would result in the residual

free budget balance for the period.

Flexible Budgets. Flexible budgets relate anticipated expenses to observed

revenue. To illustrate, if a business greatly exceeded the sales goal, it is

reasonable to expect costs to also exceed planned levels. After all, some items

like cost of sales, sales commissions, and shipping costs are directly related to

volume. Failing to meet sales goals should be accompanied by a reduction in

variable costs. A flexible budget is one that reflects expected costs as a function

of business volume; when sales rise so do certain budgeted costs, and vice

versa.

Incremental budget is the budget adjusted for incremental increases in terms of

dollars or percentages. Historically incremental budgeting has been the most

common budgeting method. It is based on the prior’s year expenditures. In

incremental budgeting, each budget line receives the same increment (e.g., 10%

percent) increase or decrease for the next budget cycle.  Projects can also be

segregated in multiple increments, and each increment is then allocated labor

and other resources to complete the project. Incremental budget are easy to

prepare. However, they have multiple drawbacks. Incremental budgets are based

on aggregate data. They might not match company’s targets. Incremental

budgets can potentially cause over- or underfunding of certain areas.

Strategic budget is the budget adjusted for strategic planning. Strategic budgets

are used under conditions of uncertainty or instability. Strategic budgeting is the

mixture between the top-down approach – when top management allocates

resources – and the bottom-up approach – when lower management participates

in resource allocation.

Stretch budget is the budget based on sales and marketing forecasts that are

higher than estimates. Stretch budgets are not used for estimating expenditures;

expenses are estimated at the budget target. Stretch budgets can be too

subjective or complex.

Supplemental budget is the budget for an area that is not included in the main

(base) budget.

Target budget is the budget that matches major expenditures to company’s

goals.

RESPONSIBILITY FOR BUDGETING

Operations and responsibilities are normally divided among different segments

and managers. This introduces the concept of “responsibility accounting.” Under this

concept, units and their managers are held accountable for transactions and events

under their direct influence and control. Budgets should provide sufficient detail to

reflect anticipated revenues and costs for each unit. This philosophy pushes the budget

down to a personal level, and mitigates attempts to pass blame to others. Without the

harsh reality of an enforced system of responsibility, an organization will quickly become

less efficient. Deviations do not always suggest the need for imposition of penalties.

Poor management and bad execution are not the only reasons things don’t always go

according to plan. But, deviations should be examined and unit managers need to

explain/justify them.

Budget Committee

The budget committee is responsible for the over-all policy matters related to

budgeting process. It is responsible in making the budget program and in coordinating

with the preparation of the budget itself. It is usually composed of the president, vice

presidents in charge of various functions. It resolves any difficulties or conflicts between

the departments or segments of the organization. The budget committee approves the

final budget and receives periodic reports on the progress of the company in attaining

budgeted goals. Further, the budget committee is tasked to prepare the budget manual.

Budget manual is the handbook where all rules, procedures, and policies are outlined.

Contents of Budget Manual:

Objectives and policies of the enterprise

Definition of line of authority and responsibility

Functions and responsibilities of the budget committee and the budget

officer

Time schedules for budget preparation

Instructions and forms to be used

Program for preparation of budgets

Procedures for obtaining approval

Forms, nature and responsibility for the preparation of the budget

Procedures for budgetary control and account codes in use

Some Basic Factors to Consider in Preparing the Budget

Nature of demand for the product

Length of trade cycle

Length of production cycle

Functional area covered

Need for control of operations

Time interval necessary for financing production well in advance of actual results

The accounting period

Some Limitations of Budgeting

Accuracy of estimates. As budgets are prepared for the future, data are purely

based on estimates and those estimates are the product of different bases on

hand at present which may lead to some errors.

Adverse reactions from employees. People preparing the budget must consider

the reasonable degree at achievability; otherwise, it may demoralize the

concerns.

Amount of work used in developing good budget. As the budget has to be

completed at a specified period, the time used may not be enough to come up

with good estimates.

BUDGET STRUCTURE

The best kind of budget is the one that works. You can choose from three key

approaches to developing a budget. Each has its advantages and disadvantages, and

each approach can work well, although the pendulum is clearly swinging in favor of the

bottom up approach.

Top down (or mandated budgets): Budgets are prepared by top management

and imposed on the lower layers of the organization. They can cover sales goals,

expenditure levels, guidelines for compensation, and more. Top down budgets

clearly express the performance goals and expectations of top management, but

can be unrealistic because they do not incorporate the input of the very people

who implement them.

Bottom up (or participative budgets): Supervisors and middle managers

prepare the budget for their units. These individual budgets are then grouped and

regrouped to form a divisional budget with mid-level executives adding their input

along the way and then forward them up the chain of command for review and

approval. These budgets tend to be more accurate and can have a positive

impact on employee morale because employees assume an active role in

providing financial input to the budgeting process.

Zero-based budgeting: Each manager prepares estimates of his or her

proposed expenses for a specific period of time as though they were being

performed for the first time. Zero is taken as the base and a budget is developed

on the basis of likely activities for the future period. In other words, each activity

starts from a budget base of zero. By starting from scratch at each budget cycle,

managers are required to take a close look at all their expenses and justify them

to top management, thereby minimizing waste.

REFERENCES

Walther, L. M. & Skousen, C. J. (2009). Budgeting and decision making. USA: Ventus

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