Management Accounting – Budgeting
March 24, 2010 1 Comment
Preparing budgets is what happens right after making long term strategic plans. Budget adjustment sometimes occurs after variances are observed.
A budget is pretty much three smaller budgets that combine to make a ‘superbudget’ of sorts:
Budgeted balance sheet
Budgeted income statement
Budgeted cash flow statement
Budgets have 5 main benefits:
- Promote forward thinking
- Co-ordinate various business areas
- Provide an authorisation system
- Provides a system of control
- Motivates managers to perform better
We’ll talk now about how a budget is made and then go through an example or two.
Starting a budget
To begin with you normally prepare the budget for what is affected by your limiting factor. What’s the limiting factor? It’s the property that is preventing your business from fully achieving it’s objectives. So, let’s say your objective is to produce a million units, then your limiting factor is production limits. If you’re limited by sales demand, then you would prepare your sales budget first.
Once this is done you would do your inventories budget (so this is in terms of stock rather than cash), then your production budget, purchases, cash and so on
There isn’t one!
You can basically lay it out how you want but you should try to make things as clear as possible. A good approach is to have one column per month (you’ll see in the example later).
Every type of item should ideally have it’s own row in the table.
They say that ‘Cash is King’ (I’m not sure who actually says that). And as most transactions end up as cash in the end, a lot of businesses do their cash budget first.
As mentioned earlier, it’s split into months. It starts with the opening cash balance, then after each month it’s the opening balance – that month’s closing balance.
Different headings are used to identify the different cash receipts and payments. Example time!
ZX900T is a robot. He is about to start robot university. He’s been advised to make a cash budget for the months when he’s away to see if he can manage on the money he gets at Robo-University.
- The uni year is Oct to June, and ZX900T will live at home in December and April.
- Robo-student loan cheques come into ZX900T’s bank account in Oct, Jan and May (£2,500 each time)
- Rent of £2,200 is payable in Oct and Jan and £1,600 in May
- During term time he’ll work part time and get £240/month
- During holidays he works and gets £600/month
- ZX900T will need to spend £150 on books in Oct and Jan
- He’ll spend £450/month on misc items when at uni, and £250/month when at home
How much overdraft should he apply for (if any)?
Can he go on robo-vacation at a cost of £400 (payable in July)?
So now it’s a case of going through each month and working out what’s being paid in and out of the bank account. The completed budget is below (click for bigger).
So to answer the questions from earlier, he should opt for a £400 overdraft for when he goes £400 overdrawn in March (but he might want a little more as a buffer incase he goes over budget), and he has £780 left at the end of July so can spend the holiday money.