How can you create a budget?. Planning for revenues and expenditure is very important in real life, we really have to know about how much coming in and how much money coming out. You will learn how to prepare a scale of preference and priorities you are wants.Watch this video to see you can plan your budget as an individual.
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A budget is a set of interlinked plans that quantitatively describe an entity's projected future operations. A budget is used as a yardstick against which to measure actual operating results, for the allocation of funding, and as a plan for future operations.Proper knowledge and application of budgeting procedures are very important for the individual and national development.
The budgeting process typically begins with a strategy planning session by senior management. The management team then applies the agreed strategic direction to a series of plans that roll up into a master budget. The plans include a sales budget, production budget, direct materials budget, direct labor budget, manufacturing overhead budget, sales and administrative budget, and fixed assets budget. All of these plans roll up into the master budget, which contains a budgeted income statement, balance sheet, and cash forecast. There may also be a financing budget in which is itemized the debt and equity structure needed to ensure that the cash requirements of the budget can be met.
A budget is subject to a number of problems, such as the "use it or lose it" mentality, whereby managers spend all funds allocated to their departments on the grounds that those expenditures form the basis for their budgets in the following year; not spending all allocated funds will therefore mean that the budget will likely be reduced in the following year.Are those budgets meeting the expectations of the people? Please watch the analysis of East Africans budget using the video.
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Steps in the Preparation of the Budget
State steps in the preparation of the budget
The main steps to prepare the master budget:
Form a budget committee
Review the long-term plan
Identify the principal budget factor and prepare the budget for it
Prepare the sales budget
Prepare the finished goods stock budget and production budget
Prepare budgets of resources for production: viz:
Material usage budget, based on the production budget, showing quantities and perhaps the cost for each type of material used
Machine utilization budget, showing operating hours required on each machine
Labour or wages budget, for all grades of labour
Prepare overhead cost budgets for maintenance, administration, distribution and others
Prepare the raw materials stock budget which will depend on the central plant’s needs for stock
Prepare the raw materials purchases budget in quantities and value for each type of material purchased. This budget is completed by adjusting the budgeted materials usage for the change in the raw materials stock budget
Prepare, debtors, creditors and cash budgets. The completion of the sales and purchases budgets allows budgets for debtors and creditors to be drawn up. The cash effects of all budgets are then summarized in the cash budget.
Co-ordinate and review budgets, a task which is facilitated by regular meetings of the budget committee. A review may indicate that some budgets need modifying to be compatible with others
Prepare the master budget, as a summary of all other budgets, and submit it to the board of directors for approval as plan for the following budget period.
The Purpose of Central Government Budgeting
Explain the purpose of central government budgeting
1. Reallocation of Resources:
Through the budgetary policy, Government aims to reallocate resources in accordance with the economic (profit maximization) and social (public welfare) priorities of the country. Government can influence allocation of resources through:
(i) Tax concessions or subsidies:
To encourage investment, government can give tax concession, subsidies etc. to the producers. For example, Government discourages the production of harmful consumption goods (like liquor, cigarettes etc.) through heavy taxes and encourages the use of ‘Khaki products’ by providing subsidies.
(ii) Directly producing goods and services:
If private sector does not take interest, government can directly undertake the production.
2. Reducing inequalities in income and wealth:
Economic inequality is an inherent part of every economic system. Government aims to reduce such inequalities of income and wealth, through its budgetary policy. Government aims to influence distribution of income by imposing taxes on the rich and spending more on the welfare of the poor. It will reduce income of the rich and raise standard of living of the poor, thus reducing inequalities in the distribution of income.
3. Economic Stability:
Government budget is used to prevent business fluctuations of inflation or deflation to achieve the objective of economic stability. The government aims to control the different phases of business fluctuations through its budgetary policy. Policies of surplus budget during inflation and deficit budget during deflation helps to maintain stability of prices in the economy.
4. Management of Public Enterprises:
There are large numbers of public sector industries (especially natural monopolies), which are established and managed for social welfare of the public. Budget is prepared with the objective of making various provisions for managing such enterprises and providing those financial help.
5. Economic Growth:
The growth rate of a country depends on rate of saving and investment. For this purpose, budgetary policy aims to mobilize sufficient resources for investment in the public sector. Therefore, the government makes various provisions in the budget to raise overall rate of savings and investments in the economy.
6. Reducing regional disparities:
The government budget aims to reduce regional disparities through its taxation and expenditure policy for encouraging setting up of production units in economically backward regions.
Modern Approaches of Budgeting
Zero Base Budgeting
Explain zero base budgeting
Zero-based budgeting (ZBB) is a method of budgeting in which all expenses must be justified for each new period. Zero-based budgeting starts from a "zero base," and every function within an organization is analyzed for its needs and costs. Budgets are then built around what is needed for the upcoming period, regardless of whether the budget is higher or lower than the previous one.
State the incremental budgeting
The incremental approach budgets costs for a coming period as a dollar or percentage change from the amount budgeted for (or spent during) some previous period. This approach is often used when the relationships between inputs and outputs are weak or nonexistent.
For example, it is difficult to establish a clear relationship between sales volume and advertising expenditures. Consequently, the budgeted amount of advertising for a future period is often based on the budgeted or actual advertising expenditures in a previous period. If budgeted advertising expenditures for 2011 were $200,000, the budgeted expenditures for 2012 would be some increment, say 5 percent, above $200,000. In evaluating the proposed 2012 budget, management would accept the $200,000 base and focus attention on justifying the increment.
The incremental approach is widely used in government and not-for-profit organizations. In seeking a budget appropriation, a manager using the incremental approach need only justify proposed expenditures in excess of the previous budget. The primary advantage of the incremental approach is that it simplifies the budget process by considering only the increments in the various budget items. A major disadvantage is that existing waste and inefficiencies could escalate year after year.
Explain the static budgeting
A static budget is a budget that does not change as volume changes. If a company's annual master budget is a static budget, the budget for sales commissions expense will be one amount such as $200,000 for the year. In other words, in a static budget the budgeted amount for sales commissions expense will remain at $200,000 even if the actual sales during the year are $3 million, $4 million or $5 million.
Explain the flexible budgeting
A flexible budget is a budget that adjusts or flexes for changes in the volume of activity. The flexible budget is more sophisticated and useful than a static budget, which remains at one amount regardless of the volume of activity.
Assume that a manufacturer determines that its cost of electricity and supplies for the factory are approximately $10 per machine hour (MH). It also knows that the factory supervision,depreciation, and other fixed costs are approximately $40,000 per month. Typically, the production equipment operates between 4,000 and 7,000 hours per month. Based on this information, the flexible budget for each month would be $40,000 + $10 per MH.
Now let's illustrate the flexible budget by using some data. If the production equipment is required to operate for 5,000 hours during January, the flexible budget for January will be $90,000 ($40,000 fixed + $10 x 5,000 MH). If the equipment is required to operate in February for 6,300 hours, then the flexible budget for February will be $103,000 ($40,000 fixed + $10 x 6,300 MH). If March requires only 4,100 machine hours, the flexible budget for March will be $81,000 ($40,000 fixed + $10 x 4,100 MH).
If the plant manager is required to use more machine hours, it is logical to increase the plant manager's budget for the additional cost of electricity and supplies. The manager's budget should also decrease when the need to operate the equipment is reduced. In short, the flexible budget provides a better opportunity for planning and controlling than does a static budget.
Explain the continuous budgeting
Continuous budgeting is the process of preparing budgets for future periods, revising them during current periods, and adjusting them at the end of the period. In other words, it’s the process of keeping active, current and future budgets to track expenses and forecast future growth.
Most companies prepare budgets on a monthly, quarterly, or annual basis, but many companies prepare weekly budgets to track sales and shipments. These plans are used in the current period to set financial and performance goals and set benchmarks for the future. When the current period is over, the budgeting process begins again by creating a new plan for the nextaccounting period. Let’s take a look at an example.
Let’s take a look at a monthly continuous budgeting system. Brad’s Machine Shop prepares monthly budgets six months out, so that it can prepare for upcoming demand and anticipate swings in production demand. In January, Brad prepares a financial plan for each month from January to June.
At the end of January, Brad evaluates his performance and analyzes the favorable and unfavorable variances between the actual numbers and the estimated ones. Based on the analysis, Brad can then take his previously made six-month plan and revise the remaining months (February through June). Brad also adds an additional month, July, on the end of the plan to make it a complete six-month plan again. This process repeats itself at the end of each month, so at the end of February the March through July plans are revised and an August one is added.
As you can see, when one budget expires a future one is added. This is why it’s called a rolling budget. When one expires, it is rolled over to the next period and the continuous cycle keeps moving. This is helpful for managers and cost accountants to always have a plan where the company is headed and what to expect from future periods.
Explain the traditional budgeting
A traditional budget indicates the amount of money you allot during a set time period for specific financial obligations, such as rent, entertainment or insurance. The budget is designed to help you spend your income according to a plan. A traditional budget starts with your income and lists the categories on which you expect to spend your money. At the end of the time period, if you keep accurate records, you should know how closely your spending matched your intentions.
Explain th performance budgeting
Performance budget is a budget that reflects the input of resources and the output of services for each unit of an organization. This type of budget is commonly used by the government to show the link between the funds provided to the public and the outcome of these services.
Decisions made on these types of budgets focus more on outputs or outcomes of services than on decisions made based on inputs. In other words, allocation of funds and resources are based on their potential results. Performance budgets place priority on employees' commitment to produce positive results, particularly in the public sector.
Costing of Estimates: Revenue Estimates Procedure
Explain the costing of estimates: Revenue estimates procedure
An approximation of the probable cost of a product, program, or project, computed on the basis of available information.
Four common types of cost estimates are:
Planning estimate: a rough approximation of cost within a reasonable range of values, prepared for information purposes only. Also called ball park estimate.
Budget estimate: an approximation based on well-defined (but preliminary) cost data and established ground rules.
Firm estimate: a figure based on cost data sound enough for entering into a binding contract.
The Meaning of Budget Surplus Deficit and Balanced Budgets
Give the meaning of budget surplus deficit and balanced budgets
Do you know the difference between budget deficit and budget surplus?. Please open the video below before starting exploring the concepts. I am pretty sure that, this will help you to understand their differences and the effects on the economy.
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The amount by which a government's, company's, or individual's income exceeds its spending over a particular period of time. Generally, a government does not need to maintain a budget surplus. However, a government has to be careful about running a budget deficit to make sure that the means of financing the deficit do not cause too much of an interest burden. In general, economists become worried when government debt, the most common way of financing a government deficit, rises sharply as a proportion of Gross Domestic Product.
Budget Deficit. Do you know that budget deficit is also a problem in America?, Do you know what is it?Please watch this video below.
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A status of financial health in which expenditures exceed revenue. The term "budget deficit" is most commonly used to refer to government spending rather than business or individual spending. When referring to accrued federal government deficits, the term "national debt” is used.
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The Objects of Financial Budgets
State the objects of financial budgets
Many companies go through the budgeting process every year simply because they did it the year before, but they do not know why they continue to create new budgets.
There are so many reasons why budget is important to an individual, the company and even the government. This is because a budget is set to achieve certain objectives.The objectives of budgeting include:
Provide structure. A budget is especially useful for giving a company guidance regarding the direction in which it is supposed to be going. Thus, it forms the basis for planning what to do next. A CEO would be well advised to impose a budget on a company that does not have a good sense of direction. Of course, a budget will not provide much structure if the CEO promptly files away the budget and does not review it again until the next year. A budget only provides a significant amount of structure when management refers to it constantly, and judges employee performance based on the expectations outlined within it.
Predict cash flows. A budget is extremely useful in companies that are growing rapidly, that have seasonal sales, or which have irregular sales patterns. These companies have a difficult time estimating how much cash they are likely to have in the near term, which results in periodic cash-related crises. A budget is useful for predicting cash flows, but yields increasingly unreliable results further into the future. Thus, providing a view of cash flows is only a reasonable budgeting objective if it covers the next few months of the budget.
Allocate resources. Some companies use the budgeting process as a tool for deciding where to allocate funds to various activities, such as fixed asset purchases. Though a valid objective, it should be combined withcapacity constraint analysis(which is more of an industrial engineering function than a financial function) to determine where resources should really be allocated.
Model scenarios. If a company is faced with a number of possible paths down which it can travel, you can create a set of budgets, each based on different scenarios, to estimate the financial results of each strategic direction. Though useful, this objective can result in highly unlikely results if management lets itself become overly optimistic in inputting assumptions into the budget model.
Measure performance. A common objective in creating a budget is to use it as the basis for judging employee performance, through the use of variances from the budget. This is a treacherous objective, since employees attempt to modify the budget to make their personal objectives easier to achieve (known as budgetary slack).
Conversely, budgeting may not be of much use for a well-established business that has a consistent track record of performance. In this case, a better approach may be to manage the organization from a rolling forecast that is updated on a regular basis. Doing so reduces the work associated with financial predictions, and also allows the business to shift its operational focus on short notice.