Module 12 - Budgeting
12.2 Why bother with budgets?
A budget is a plan of action, usually expressed in number and amounts which set
targets for individuals and departments
 Co-ordination of effort across different departments
 Planning - forces managers to plan to reach a common objective
 Motivation – each division is given a goal they can aim for
 Control – provides a benchmark against which actual performance can be measured
12.3 What gives budgeting a bad name?
 Time taken – the budget process should start as late as possible in the current year
so as to allow managers to access this years actual performance, but not too long
whereby some iterative process can take place
 Lack of top management commitment – the whole management team must share the
goal of constant improvement in operating performance
 Form of punishment – rather than just a means of control, budgets are the means by
which planning occurs, this planning should include open consultation with employees
that will be tasked with implementing the budget
 Responsibilities are blurred – only those in control of expenditure and revenues
should be held accountable for their budgeting
 Moving goalposts – what if circumstances change which invaidate the original budget
(e.g. major customer goes bankrupt)? Either
a) budget is maintained as is and at the end of the year the variance is stripped
out, so as to see the actual performance during the year; or
b) a rolling 12 month budget is used – updated every month
 Rewards inefficiency- e.g. dept. budgets are increased by, say, 10% each year – its
up to management to encourage competition for scarce resources and avoid blanket
increases
12.4 Budgeting Example
Sales:
 They think $70 /unit is reasonable
 5% increase in sales forecasted
Quarter
1(to June 30 1997)
2 (to Sept 97)
3 (to Dec 97)
4 (to March 98)
5 (to June 98)
Estimated Sales Units
2500
2800
1700
3000
3000
Advertising: 5% of sales revenue + $3000 /quarter in fixed salaries
Production Dept:
 Raw materials on hand of 10% of next quarters sales requirement
 Finished goods inventory of 20% of next quarters sales requirement
 Cost per meter of metal = $1
per trolley $
Direct Material
10 mtrs of wire metal @ $1 per meter
10
Direct Labor
1.5 hrs @ $20 per hour
30
Variable Overhead (absorbed by direct labor hours)
1.5 hours @ $10 per trolley
15
55
Fixed Manufacturing Overhead
$2400 per quarter
(includes depreciation on fixed assets)
($1500 per quarter)
Consumables
$2000 per quarter
Finance
 70% of sales collected in the quarter of the sales
 Balance collected next quarter – no bad debts planned for
 Raw Materials purchases should be paid for 60% in quarter of purchase and 40%
next quarter
 All other selling, advertising and admin costs, including admin salaries of $2000, are
paid for in the quarter they are incurred
12.4.1 Sales Budget for year ending 31st March 1998
Sales Turnover
Turnover in units
Price
Revenue
Q1
2500
70
175000
Q2
2800
70
196000
Q3
1700
70
119000
Q4
3000
70
210000
Total
10000
70
700000
Q1
75001
122500
130000
Q2
52500
137200
189700
Q3
58800
83300
142100
Q4
35700
147000
182700
Total
154500
490000
644500
Cash Inflow
Last Quarters collection
This Quarters collection
1
Taken from last years balance sheet debtors figure
This quarter collection = 70% of sales, other 30% in next quarters ‘Last quarter
collection’
Note: Q4 sales = 210,000, of which 147,000 are collected in Q4 and 63,000 will be
debtors for Q4 in the balance sheet
12.4.2 Production Budget for year ending March 31st 1998
Sales Units
Add: Planned Units
in Closing Inventory
Less: Planned Units in
Opening Inventory
Units required
Q1
2500
Q2
2800
Q3
1700
Q4
3000
Total
10000
5601
3060
340
3140
600
2300
600
3600
2100
12100
4802
2580
560
2580
340
1960
6003
3000
1980
10120
1
20% of next quarters figure
Taken from the balance sheet finished goods figure
3 20% of Q5 figure
2
12.4.3 Direct Materials Budget for Year Ending 31 March 1998 (Schedule)
(a) Consumption of Direct Material
Units required
Meters of metal per unit
Total Meters required
Cost per meter
Totl Cost of Metal
Consumed
Q1
2580
10
25800
1
Q2
2580
10
25800
1
Q3
1960
10
19600
1
Q4
3000
10
30000
1
Total
10120
10
101200
1
25800
25800
19600
30000
101200
Q1
25800
2580
(600) 1
27780
1
Q2
25800
1960
(2580)
25180
1
Q3
19600
3000
(1960)
20640
1
Q4
30000
3000
3000
30000
1
Total
101200
11120
(8720)
103600
1
27780
25180
20640
30000
103600
(b) Purchases Budget
Direct Matrls rqd (metrs)
Add Closing Inv
Less Opening Inv
Meters Required
Cost per meter
Total Cost of
Metal Purchased
1
2
Taken from last years balance sheet
10% of next quarters direct material requirement
(c) Cash Outflow for purchases
Q1
Creditors end 97
2500
Purchases:
Q1
166681
Q2
Q3
Q4
Total
19168
1
2
Q2
8334
15108
26220
Q3
10072
12384
22456
Q4
8256
180002
26256
Total
2500
27780
25180
20640
18000
94100
60% of 27780
60% of 30000 = 18000, so $12,000 will be creditors at end of year
12.4.4 Direct Labor Budget for Year end March 31st 1998
Units required
Hours per unit
Total No of hours
Cost per hour
Total Cost of direct labor
Q1
2580
1.5
3870
20
77400
Q2
2580
1.5
3870
20
77400
Q3
1960
1.5
2940
20
58800
Q4
3000
1.5
4500
20
90000
Total
10120
1.5
15180
20
303600
12.4.5 Manufacturing Overhead Budget for year end March 31st 98
Total Cost of direct labor
Variable Overhead
Absorption Rate
Variable O/h
Fixed O/H
Total Manufacturing OH
Less Depreciation
1
Q1
77400
Q2
77400
Q3
58800
Q4
90000
Total
303600
0.501
38700
2400
41100
1500
39600
0.50
38700
2400
41100
1500
39600
0.50
29400
2400
31800
1500
30300
0.50
45000
2400
47400
1500
45900
0.50
151800
2400
161400
6000
155400
Absorption = $10 per labor hour whereas labor is $20 per hour, hence absorption rate
of variable o/h is $0.50 for every $1 of labor
12.4.6 Selling and Administration Budget
Sales1
Selling & Admin variable
Advertising (5%)
R&D (3%)
Total Variable Sell & Adm
Fixed
Salaries
Consumables
Advertising
Total Selling and Admin
1
Q1
175000
Q2
196000
Q3
119000
Q4
210000
Total
700000
8750
5250
14000
9800
5880
15680
5950
3570
9520
10500
6300
16800
35000
21000
56000
2000
2000
3000
21000
2000
2000
3000
22680
2000
2000
3000
16520
2000
2000
3000
23800
8000
8000
12000
84000
Sales revenue, rather than actual cash received
12.4.7 Closing Inventory Budget for year ending March 31st 98
Direct Materials
Units x $1
Finished Goods
Units
x Var. Cost
Q1
Q2
Q3
Q4
Total
2580
1960
3000
3000
11120
560
55
30800
340
55
18700
600
55
33000
600
55
33000
2100
Q1
175001
130000
147500
Q2
(9668)
189700
180032
Q3
14132
142100
156232
Q4
28156
182700
210856
Total
17500
644500
662000
19168
77400
39600
21000
157168
(9668)
26220
77400
39600
22680
165900
14132
22456
58800
30300
16520
128076
28156
26256
90000
45900
23800
185956
24900
94100
303600
155400
84000
637100
24900
12.4.8 Cash Budget
Opening Balance
Cash from Sales
Cash Inflows
Direct Materials
Direct Labor
Manufacturing OH
Selling & Admin
Closing Balance
1
Taken from Cash on hand in last years balance sheet
12.4.9 Budgeted Profit and Loss a/c
Q1
2500
175000
Sales Units
Sales Revenue
Variable Cost
of manufacturing
(137500) 1
Var Selling & Admin (14000)
Contribution Margin 23500
Fixed Cost of
Manufacturing
(2400)2
Fixed Selling
& Admin costs
(7000)
Profit before Tax
14100
Q2
2800
196000
Q3
1700
119000
Q4
3000
210000
Total
10000
700000
(154000)
(15680)
26320
(93500)
(9520)
15980
(165000)
(16800)
28200
550000
(56000)
94000
(2400)
(2400)
(2400)
(9600)
(7000)
16920
(7000)
6580
(7000)
18800
(28000)
56400
1 Variable cost per unit = $55, so $55 x 2500 = 137500
2
Include Depreciation
12.4.10 Budgeted Balance Sheet
Q1
Plant & Equipment 75000
Accumlated Depr. (26500)1
Inventory:
Raw
2580
Finished
30800
Debtors
52500 2
Cash
(9668)
Total Assets
124712
Q2
75000
(28000)
Q3
75000
(29500)
Q4
75000
(31000)
Total
75000
(31000)
1960
18700
58800
14132
140592
3000
33000
35700
28156
145356
3000
33000
63000
24900
167900
3000
33000
63000
24900
167900
Ordinary Shares
Retained Earnings
Creditors
Total equity &
Liabilities
30000
83600 3
111124
30000
100520
10072
30000
107100
8256
30000
125900
12000
30000
125900
12000
124712
140592
145356
167900
167900
1 Start with 25000 depreciation from last years balance sheet and add 1500 per Qtr
2 Debtors = 12.4.1: Q2 ‘Last Qtr collection’
3 Retained Earnings: start with 69500 from last years balance sheet and cumulatively
add the profit for each of the quarters
4 Creditors: 12.4.3 ( c ) : Q1 creditors is money paid out in Q2
12.5 Discretionary Expenditure and Zero-Base Budgeting
 Engineered costs are those that have to be incurred to produce a unit of output
 Discretionary costs are those that do not need to be incurred, at least in the short term
– costs like R&D
 Discretionary costs are difficult to budget for:
- sometimes the outputs are best measured negatively, e.g. a good legal dept
is one which avoids lawsuits
- discretionary budget holders can be unaware of corporate objectives and are
so unsure where their efforts should be focused, this leads to pockets of work
being done without focus, a budget can bring focus
- these type of costs often are difficult to control over one year – R&D may run
into many years
 Zero base budgeting (ZBB)allows certain activities to bid for their resources, as if they
were starting from scratch, or a zero base
 ZBB is only used in areas of discretionary spending where management must decide
the appropriate level of expenditure at the current time
 With engineered costs, the spending is based on the production output required
 ZBB breaks up the analysis of an activity such as R&D into packages of work, starting
with the most fundamental activity and building up to the activity which, if resources
were available, would be beneficial to undertake
 These package are compared to other packages from other discretionary activities
and ranked in order of management priority
Example:
The discretionary budget of the following company has been set at $250,000.
R&D
Legal Services
Package 4 of 4: One lawyer to handle IPR
issues, new computer facilities $40,000
Package3 of 3: Two software engrs
write customized operating systems
$70000
Package 3 of 4: Two lawyers handle contracts
New datqbase: $80000
Package 2 of 3: Two electronic engrs
design & build prototypes $70000
Package 2 of 4: One lawyer handles routine
contract problems: $30000
Package 1 of 3: development engineer Package 1 of 4: Partially qualified assistant
to test componets $40000
liases with external consultant for all legal work
$1000
A likely scenario:
1. Each package 1 is acccepted as representing the absolute minimum ($50000)
2. Both level two accepted ($150,000 spent so far)
3. Depends upon strategy of company, possible accepting of R&D package 3
($220,000 so far) and the company could ask both depts to come back with a
proposal for a package covering the remaining $30,000
ZBB has two major drawbacks:
1. The process of cutting up homogenous activities into discrete packages is often very
difficult and takes a lot of time to do
2. The definition of packages is still left to the management of the function under
review, they can skew it any way they want
Review Questions
1. c
2. FALSE
3. d
4. FALSE
5. b
6. b
7. a
8. d
9. a
10. c
11.Cash Inflows:
Jan
32500
Feb
29250
37500
March
13000
22500
25000
April
15000
15000
25600
May
10000
22400
20800
June
16000
18200
28800
Ans: 55600 = d
12.53200 = b
13. At end of June: 0.25 of May sales = 13000 left remaining to be paid and the balance
of June’s sales (72,000 – 28800) = 43200. So total still outstanding at June 30 =
13000 + 43200 = 56,200 = c
14. Budgeted Production = 10000 + 2000 – 1000 = 11000 = b
15. 10000 + (5 x 11000) –30000 = 35000 = b
16. Units required = 7400 + 72600 – 6000 = 74000, If 100 of these are produced, only
95 will be accepted.
so, 74000 = 95
? = 100
74000 x 100/95 = 77,895 will need to be produced to get 74000.
77895 x 4= 311,580 = c
17.
Jan
Purchases
10000
Cash from debtors 7600
Feb
18000
2300
March
8600
9200
Early payments get 5% discount on 30% of their purchases
The remaining purchases have a month after the purchase month to pay, with a
maximum overdraft facility of $1000
1st priority – use the discount as much as possible
2nd – accommodate suppliers payement terms
Opening balance of $2200 at bank
Jan
2850
Feb
x
5130
(x+5130)
March
1880
y
2451
(y+4331)
Budgeted Cash Statement
Opening Balance
Cash Inflow
Payments to Creditors
Closing Balance
Jan
2200
7600
(2850)
6950
Feb
6950
2300
(x+5130)
(1000)
March
(1000)
9200
(y+4331)
(1000)
17. Ans: d
18. We need to hold payments in check to ensure that we do not exceed the $1000
limit at the bank, hence: 9200 – 1000 – (y+4331)= -1000, y=4869.
Total payments to creditors in March is (4869+4331)= 9200 = a
19. We need to hold payments in check to ensure that we do not exceed the $1000
limit at the bank, hence
6950+2300 – (x+5130) = -1000, x =5120,
Total payments to creditors in Feb = 5120 + 5130 = 10250 = b
20. False
21. Manufacturing Cost of sales= (4300+16600) + 60,000 + 70,000 + (6 x 15000) –
(6100+10200) = 20900 + 220,000 – 16300 = 224600 = c
22. Profit:
Sales Rev
460,000
Cost of Sales
224,600
Contribution
235,400
Selling & distr
60,000
Admin
50,000
125400 = a
23. Full Absorption! Budgeted fixed manufacturing = actual – under absorption =
$43200 – $3200 = $40,000. 4000 actual direct labor hours, so $40,000/4000 = $10 /
hour absorption rat ***** Don’t understand*****8
24. $10 + 9200/4000 = $10 + $2.30 = $12.30
25. On July 31st, Cash Statement:
Overdraft
(10,500)
Sales revenue
22,500
Cash from debtors 75,000
Creditors
(17,750)
Purchases
0
Expenses
(17,000) [20,000-3000 (depreciation)]
52,250 = c
26. Cash Inflow
Sales
Debtors
27. Outflow:
Purchases:
Creditors
Expenses
Quarterly Interest
28.
Aug:
Opening Balance
Inflows
Outflows:
Dividend
Creditors
Expenses
September
Opening
Debtors
Sales
Outflows
29. P&L
Sales
Cost of Sales
Contribution
Less Expenses
Less Loan Interst
17500
22,500
40000 = d
0
50,000
22,000
500
72,500 = c
52,250
40,000
(7500)
(30,000)
(19,500)
35,250
35,250
17,500
35,000
(72,500)
15250 = b
150,000
100,000
50,000
(67,500)
(500)
(18,000) = d
30. c
31. b+ c
32. a
33. FALSE
34. a