The following notes contain theory concepts relating to budgeting. This includes:
Budget period
Budget classification
Budget preparation
Reasons for budgeting
Projected income statement format
Analysis, interpretation and comparison of projected income statement
Cash budget
Debtor's collect...
Budgeting
Period, classification, preparation
• Budgeting is used by the management of a business to plan, monitor, and
anticipate future income and expenditure.
• A budget is a written financial plan that is prepared for a future period.
Budget period
The period of time over which the budget is drawn up is called the budget period.
They generally cover one of 3 periods:
• Short term budget: less than a year.
• Medium term budget: usually one year (12 months).
• Long-term budget: usually prepared for a number of years.
Budget classification
The operating budget
• Consists of budgets which relate to income and expenses of a business.
• Include the sales budget, cost of sales budget and operating expenses
budget.
• Plan and forecast income and expenses for the budget period.
• Combined to form projected income statement.
The financial budget
• Consists of budgets which relate to the assets and liabilities of a business.
• Include the cash budget, the capital budget and budgets for debtors, creditors
and inventory.
• Plan and forecast changes relating to assets and liabilities over the budget
period.
• A budgeted balance sheet may be prepared using information contained in
various financial statements, together with the projected net profit/loss in the
projected income statement.
Budget preparation
When preparing a budget, management will attempt to plan and forecast the
business activities that are required to take place in order to attain the objective es of
the business. It is important for the information in the budget to be realistic and
provide an accurate representation of future expectations. Management usually uses
the records of the previous periods as a basis for the budget as well as:
• The business objectives.
• Existing business agreements.
• Past, current and seasonal trends.
• Economic climates.
• Other external factors.
, Reasons for budgeting
Planning
• Management express future plans of the business in financial terms.
• Allows management to assess the feasibility of their strategic plans and
determine whether those plans are likely to result in the business achieving its
objectives.
Internal control
It provides management with an effective tool that can be used to monitor and
control the activities of the business. They are used to ensure that:
• The planes of the business are followed.
• Cash flow problems are avoided.
• Expenditure is kept under control.
• Budget targets and business objectives are achieved.
Where there are significant differences between actual and budgeted figures,
management will conduct further investigations to establish the reasons for the
deviations. Based on their findings, management will either:
• Take corrective action to resolve issues.
• Modify business operations.
• Implement control measures to prevent similar problems from happening in
the future.
Communication and co-ordination
• Helps ensure that there’s good communication and co-ordination within a
business.
• Allows management to communicate their expectations and convey the
business’s objectives to the various departments and employees throughout
the business.
Motivation and evaluation
Can help motivate employees by:
• Involvement in budgeting process helps motivate employees – employees
who are involved in creating and setting their own budgets will be more likely
to strive to achieve the objectives of these budgets.
• Budgets may motivate employees by setting performance targets based on
the budgets. Employees are often offered benefits such as bonuses or
promotions for achieving or exceeding those targets.
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