Budgeting
Purposes and the budget cycle
Budgets provide planning, control, coordination, communication, motivation, resource allocation and a basis for performance evaluation. The cycle is: set objectives → identify the principal budget factor (the limiting factor) → prepare functional budgets → prepare the master budget (budgeted income statement, statement of financial position and cash budget) → monitor actual results and feed back.
Order of preparation
The principal budget factor dictates the order. Normally sales volume is the limit, so prepare the sales budget first, then:
- Production units = sales units + required closing inventory − opening inventory
- Material usage, then material purchases = usage + closing inventory − opening inventory
- Labour, overheads, and finally the cash budget
In a cash budget include only cash flows: exclude depreciation and other non-cash items, include capital expenditure and the timing of receipts from credit customers and payments to suppliers.
Types of budget
Incremental (last year adjusted by a percentage), zero-based (every activity justified from scratch), rolling (continually updated), activity-based, and flexible. A flexible budget is restated for the actual activity level and is the correct comparator for cost control; a fixed budget is not.
Behavioural aspects
Top-down budgets are imposed; bottom-up budgets are participative and improve commitment but encourage budgetary slack. Feedforward control compares forecast outcomes with plan and allows corrective action before the event.
Rule of thumb
Production budget units = sales units + closing inventory − opening inventory. Learn this and its materials equivalent as one pattern.