Budgeting and Forecasting
Budget systems and purposes
Candidates must know the purposes of budgeting (planning, control, coordination, motivation, communication) and the main approaches: incremental, zero-based, rolling, and activity-based. Fixed budgets suit stable environments; flexible budgets are flexed to actual activity for control. A master budget links functional budgets (sales, production, materials, labour, overhead, cash) and ends with budgeted financial statements.
Forecasting techniques
High-low analysis splits a semi-variable cost into fixed and variable elements using the highest and lowest activity levels. Time-series analysis decomposes data into trend, seasonal variation, cyclical and random components. Linear regression and learning curves may also be examined. The learning curve reduces cumulative average time per unit by a fixed percentage each time output doubles.
Traps in questions
- Building a production budget without adjusting for inventory: production = sales + closing inventory − opening inventory.
- Including depreciation or bad debts in a cash budget; only cash movements belong there.
- In high-low, selecting the highest and lowest cost rather than the highest and lowest activity.
- Mixing cash timing with profit recognition, e.g. credit sales are not cash receipts.
- Forgetting that a rolling budget is continually extended, usually by adding a quarter.
Worked example
Budgeted sales are 10,000 units; closing inventory is 2,000 and opening inventory 1,500. Production = 10,000 + 2,000 − 1,500 = 10,500 units. If each unit uses 3 kg of material, material purchases must also allow for raw material inventory changes.
Rule of thumb
Always reconcile volumes through a flow: opening + produced = sold + closing. Apply the same logic to materials and cash.