Chapter 9
Budgetary Planning –
Preparation of the Master Budget
Fixed budget
‘budget set prior to the control period and
not subsequently changed in response to
changes in activity, costs, or revenues.’
Fixed Budget as defined by CIMA Official Terminology
The fixed/master budget
The fixed or master budget sets out the plans for
the business for the next accounting period
based on various assumptions of sales and
sales growth, inflation (in particular labour
inflation), interest rates, taxation and capital
expenditure. This master budget is known as the
fixed budget as it is based on these fixed
assumptions of trading performance and
financial outlook. Its chief role is at the planning
stage, in setting the overall direction or plan for
the business
The master budget
Operating Budgets
Sales revenue
Cost of sales
Payroll and related expenses
Other department expenses
Fixed expenses
Capital Budgets
Cash
Flow
Budget
Capital expenditure
Stocks (related to purchases)
Debtors (related to sales)
Creditors (related to purchases)
Master Budget


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P&L account (Income statement)
Balance sheet
Cash flow
The master budget statements
Profit and Loss
Account
A projected profit and loss
account (income statement)
includes all the revenues and
expenses anticipated for the
budget month under review.
Balance Sheet
Cash Budget
A projected balance sheet is
a statement of the expected
position of an entity at the
end of the budget month. It
contains
the
expected
monetary value of assets,
liabilities and capital at the
end of the budget month.
Cash budgets are prepared
in order to ensure that there
will be sufficient cash in
hand to cope adequately
with budgeted activities.
They must contain every
type of cash inflow (money
received) and every type of
cash outflow (money paid).
Example 9.1: The effect of sales in
the master budget
Example 9.1: The effect of sales in
the master budget
Profit and loss extract (months 1 to 3)
€280,000
Sales revenue
€80,000 + €100,000 +
€100,000
Cash Budget – Cash inflows
Month 1
Month 2
Month 3
Cash sales (90%)
€72,000
€90,000
€90,000
Credit sales (10%)
______
€8,000
€10,000
Total sales receipts
€72,000
€98,000
€100,000
Balance sheet extract as at end month 3
Current Assets
Debtors
10% of
€80,000 sold
in month 1.
€10,000
10% of €100,000
sold in month 3 not
received.
10% of
€100,000 sold
in month 2.
Example 9.2: The effect of
purchases and stock in the master
budget
Profit and loss extract for (months 1 to 3)
€
Opening stock
0
Purchases (€50,000 x 3)
150,000
Closing stock
(20,000)
Cost of goods sold
130,000
Cash Budget - cash outflows
Purchases
Stock
€
Month 3
0
€50,000
€50,000
Month 2
purchases are paid
for in month 3.
20,000
Current liabilities
Creditors
Month 2
Month 1 purchases
are paid for in
month 2.
Balance Sheet extract as at end month 3
Current assets
Month 1
50,000
Month 3 purchases
are unpaid (due to be
paid in month 4).
Other differences between P&L
and cash budget
The purchase cost or sales proceeds of fixed assets.
Proceeds from the issue of shares
Cash flows from the procurement or repayment of
loans
Depreciation of fixed assets
Forecasting
‘A prediction of future events and their
quantification for planning purposes’
A forecast as defined by CIMA Official Terminology
Three essential elements are required before one can
begin to prepare projected financial statements.
Forecast of sales.
Forecast of costs / expenditure.
Forecast of the required investment in net assets to achieve
these sales.
Forecasting - factors influencing
sales
Past sales volume and mix
Level of competition
Quality of the product or service
Consumer behaviour
Strength of the brand name
State of the economy
Planned advertising expenditure
Political and industrial outlook
Pricing policy
Local activities and events
Capacity
Seasonality
Advance bookings
Demand analysis
Forecasting - costs
Fixed cost
Variable cost
Semi-variable cost
Forecasting – balance sheet items
Debtors: Debtors tend to increase as sales increase.
Stock levels: More stock is required to meet increased demand.
Cash: More cash is required to meet increased costs associated with
the increase in sales.
Creditors: More credit is required from suppliers as purchases increase
in line with sales.
Accrued expenses: More accrued expenses occur as a result of
increased overheads.
Bank overdraft: A bank overdraft is frequently used to bridge any
financing gaps caused by increases in activity.
Fixed assets: As the business expands new fixed assets are required.
(Note that fixed assets will not increase as sales increase, but only as
the business reaches capacity and requires expansion). Hence there is
a long-term relationship between sales and the fixed assets
requirement.
Long-term finance: As fixed assets expand, one will also expect longterm finance in the form of equity and more likely long-term debt to
increase.
Other forecasting issues
Taxation and rate of corporation tax.
Variable interest rates on borrowings.
The rate of inflation.
The policies and commitments of the business.
Capital expenditure
Financing methods
Dividend payouts
Example 9.3: Projected financial
statements
Example 9.3: Projected financial
statements
Example 9.3: Projected financial
statements
Example 9.3: Projected financial
statements
Example 9.3: Projected financial
statements
Example 9.3: Projected financial
statements
Projected financial statements and
decision-making
Is the projected profit satisfactory in relation to the risks involved and
the required return on capital? If not, what can be done to improve
this?
Are sales and individual expense items at a satisfactory level?
How adequate are the projected cash flows of the business and can
they be improved?
Should management consider additional financing?
What type of financing is required, long, medium or short-term
financing?
What type of financial instruments are appropriate, debt or equity?
Will there be surplus funds and if so, what plans have the company as
regards investing these funds?
Is the business overly financed through debt?
How liquid is the business?
Is the financial position at the end of the period acceptable?
Alternative approaches to
budget preparation
Incremental budgeting
Zero-based budgeting
Activity based budgeting
Rolling budgets
Incremental budgeting
‘Method of budgeting based on the previous
budget or on actual results, adjusting for
known changes and inflation’
Incremental budgeting as defined by CIMA Official Terminology
This is where the current budget and actual figures
act as the starting point or base for the new budget.
The major disadvantage of this is that the major part
of the expense (the base) does not change and.
Zero-based Budgeting
‘Method of budgeting that requires all costs to
be specifically justified by the benefits
expected’
CIMA official terminology
Advantages
Fosters a questioning attitude to all revenues and costs.
Focuses attention on value for money concept.
Should minimise waste and result in more efficient allocation of
resources.
Disadvantages
Costing and time consuming approch
Activity based budgeting
‘Method of budgeting based on an activity
framework and utilising cost driver data in
the budget setting and variance feedback
processes’
Activity based budgeting as defined by CIMA Official Terminology
ABB is an extension of the zero-based budgeting approach and
goes into far greater detail in identifying value and non-value
activities. It can be more effective than zero-based and
incremental budgeting because:
It avoids slack that is often included in the incremental approach.
ABB focuses attention on each activity, highlighting those that do
not add value.
Rolling budgets
‘Budget continuously updated by adding a
further accounting period (month or quarter)
when the earliest accounting period has
expired’
Rolling budgets as defined by CIMA Official Terminology
A rolling budget is a twelve month budget which is prepared
several times each year (say once each quarter).
The purpose of a rolling budget is to give management the
chance to revise its plans, but more importantly, to make more
accurate forecasts and plans for the next few months.
Rolling budgets
Advantages
Budgets are reassessed
regularly and thus should be
more realistic and accurate.
Because rolling budgets are
revised regularly, uncertainty
is reduced.
Planning and control is based
on a recent updated plan.
The budget is continuous and
will always extend a number
of months ahead.
Disadvantages
Rolling budgets are time
consuming and expensive as
a number of budgets must be
produced during the year.
The volume of work required
with each reassessment of the
budget can be off-putting for
managers.
Each revised budget may
require revision of standards
or stock valuations which is
time consuming.