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Summary LU1: Budgeting and Standard Costing
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A summary of LU1: Budgeting and Standard Costing
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Luthando Zulu: 17599770Finance 2B – FINM6212
LU1: Budgeting and Standard Costing
Introduction:
Management plays a pivotal role in determining the way in which a business is run and the direction it is
moving in. The main elements of management are:
Planning
Organizing
Activating
Control
Budgets form an integral part of planning and control. They can be used as a tool for future planning. It
can also be used as a tool for exercising control over cash receipts and payments, as well and income
and expenditure. Budgets originated due to people’s tendency to overspend. By creating and then
sticking to a strict budget, people can ensure that they spend wisely, save, and have sufficient cash on
hand at all times.
Cash budget structure:
Opening balance
+ cash receipts (cash sales, debtors’ collection, rent income)
- payments (cash purchases, creditors paid, wages/salaries)
Closing balance
Let us look at Example 1. 1 on page 2
The cash budget of the business:
Proper cash management is paramount to the success of any modern business. A business needs to
make a proper estimate of future cash flows to ensure that the business does not fall into a debt trap.
Often, businesses declare a large profit, but have no actual cash on hand. This is because a large portion
of a business’s sales could be on credit.
In this case, the profit has not yet been turned into cash as it has not been received from debtors yet.
Therefore, businesses need to ensure that they collect from their debtor’s promptly. An important section
of the cash budget is the schedule of budgeted receipts from debtors.
Let us look at Example 1.2 on page 5
Why do businesses prepare budgets?
The main reason for preparing budgets is to ensure that unexpected surprises do not have detrimental
effects on a business. Many other reasons are as below:
To assist in the planning of annual operations.
To coordinate the activities of the various departments working toward the set goals of the
organization.
To communicate plans to the various departmental managers.
To motivate managers and workers to achieve or surpass the goals of the organization.
To control activities.
To evaluate the performance of managers and workers.
1
, The budgeting process:
Some budgeting processes are relatively short and simple, but others, especially those of large,
established businesses, are so elaborate that they may take several months to complete. Budgeting is
always the responsibility of top management. A typical budgeting process usually comprises of the
following:
1. The formation of a This committee will be responsible for holistic policy matters
budget committee pertaining to the budget program, and for coordinating the
preparation of the budget itself. The committee usually comprises
of the CEO, CFO, as well as senior managers from the different
departments.
This committee will approve the budget at the end of the
budgeting process. It is also the duty of the budget committee to
approve major revisions of the budget during the period. Disputes
often arise due to limited resources needing to be allocated to
many dept.'s. This results in some departments inevitably
receiving more resources than others.
2. Determination of the The most common period of time that a budget is created for is
budget period one year. Often, for control purposes, the budget period is broken
down into smaller periods (i.e. monthly, quarterly, etc.)
Usually, an organization’s budget period will coincide with their
financial year, in order to allow for comparisons to be made
between budgeted and actual results.
3. Specification of budget Budget guidelines for the coming period are based on the org’s
guidelines strategic goals and long-term plan. These budget guidelines need
to be set initially by the budget committee in order to set the tone
for the budget and to govern its preparation. All departments
must follow these initial guidelines.
4. Preparation of the initial Each responsibility center now needs to prepare its initial budget
budget proposal proposal, based on the initial budget guidelines. There are
internal and external factors to consider when preparing an initial
budget proposal. Some examples of internal factors are listed
below:
Changes in availability of equipment or facilities.
Adoption of new manufacturing processes.
Introduction of new products
Changes in product design, etc.
Some examples of external factors are listed below:
Changes in the labor market
Availability of raw materials or components and their
prices
Competitor’s actions
5. Budget negotiation The head of each dept. examines the initial budget proposal to
determine whether it is within the budget guidelines. He/ she will
also verify whether the budget goals can be achieved and
whether they are in line with the org. as a whole. This stage of
the budget process can be time-consuming and involves all
depts.
6. Review and approval As each dept. approves their budget, the budgets go through
successive levels of the org. until they reach the final level, when
the individual budgets from each dept. are combined to form the
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