Monday, December 13, 2010

Preparing Budgets


Difference between Budgeting and Forecasting
Budgets and Forecasts, both relate to the estimation of the future; although conceptually a budget happens to be based on planned events and is constructed based on past actual events whereas, forecasts are just an estimation of uncertain future events to help in planning for the business with such uncertainties in mind.


Budgeting; Why?

The first thing to do is to plan; do it on a month-to-month basis for the entire year. Keep in mind that the sales numbers will be critical since they'll be used to compute the overall production required to keep the company afloat till the next budgeting period; the profit margins, the expenses, receivables, payables and all other ancillary expenses necessary to support the business.

Having said that, how much of your product/service has to be sold will purely depend on the accurateness of the market research conducted for the market in which you operate and how well have you understood the competition, after all, entering in to a price war with a giant monopolist is as good as committing suicide.

Budgeting is the most powerful financial planning tool available to any business. Preparing a budget means arriving at thoroughly planned incomes and expenditures.



Ask yourself the following questions to get that brain working:

  • The borrowing costs?  
  • What will the taxation affect be? 
  • The number of employees needed? 
  • The growth in sales over the years? 
  • What is the credit policy going to be?
  • What payment terms will the suppliers offer? 
  • What will the operating expenses amount to? 
  • How much will it cost to produce the product/service? 
  • How much inventory will there be and would be needed? 
  • What is the volume of sales that the company as a whole is looking at? 
  • What equipment will be needed to start the business and how much would it cost?

The Master Budget

A master budget is usually classified into two individual budgets: the Operational Budget and the Capital Budget (The process in which a business determines whether projects such as building a new plant or perhaps investing in a long-term venture are worth pursuing). I will be talking of the operating budget in this blog.
The operation budget primarily consists of these individual budgets:

Sales budget: The sales budget shows the expected sales in units at their expected selling prices. The sales budget must be done first so as to identify the expected sales orders before embarking on budgeting  plans for any other departments.

The sales budget will set the tone for the entire budgeting process for the period, how much to produce, how many people required to produce, costs of production, the production schedule itself, all depends on the volume of sales that have been planned.

Production Budget: A production budget is a plan for obtaining the needed resources to carry out the manufacturing operations to meet the expected number of sales. The following sub-budgets also need to be prepared (assuming it is a manufacturing/value adding plant/factory)

  1. Direct Material Budget 
  2. Direct Labor Budget 
  3. Factory Overhead Budget

Selling and administrative expenses budget: The selling and administrative expenses budget gives a comprehensive breakdown of various expenses that would be done in order to boost sales for the budgeted period.

Budgeted income Statement: It estimates the expected operating income from budgeted operations. It also gives the management an idea of the likely operating result for the budgeted period.

Cash Budget: By preparing a cash budget the management will be able to ensure that they have sufficient cash on hand to carry out activities. It will also allow them enough time to plan for any additional financing they might need. 

The cash budget should also include; cash available from operating activities, from investing activities and lastly from financing activities.

Budgeted Balance Sheet: The last step in preparing a master budget is the budgeted balance sheet. This is the sheet that will show the expected financial position at the end of the budgeted period.


There are a few other things that need to be brought up as far as budgeting goes and they will be posted on a later date.

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