Budget is a short-term financial plan. It can be defined as “a plan expressed in monetary terms.” A budget can also be expressed as a plan of what an organization is aiming to achieve and what has been set as a target whereas a forecast is an estimate of what is likely to occur in the future.
A functional budget is prepared for each individual department of an organization showing the budget responsibility of each manager.
On the other hand, a master budget is a budgeted Income Statement and Statement of Financial Position prepared from sales, purchases, expenses and cash budgets. All budgets are drawn together to prepare a master budget. The most appropriate sequence of events in the preparation of budgets are:
- Sales budget
- Production Budget
- Purchases Budget
- Trade Receivables Budget
- Trade Payables Budget
- Cash Budget
- Budgeted Income Statement
- Budgeted Statement of Financial Position
Let’s take a look at each of these budgets.
The sales budget shows the quantities of each product that the company plans to sell and the intended selling price. It provides the predictions of total revenue. The sales budget is prepared before the other budgets since all expenditure is ultimately dependent on the volume of sales. If the sales budget is inaccurate, the other budget estimates will be unreliable.
For many organizations, the principal budget factor is sales volume. The sales budget is, therefore the primary budget from which the majority of the other budgets are derived.
The production budget is expressed in quantities only and is prepared to ensure that production is sufficient to meet sales demand together with any increase in inventory levels that might be required.
A purchases budget is prepared to determine the purchases (quantities) required for resale or for use in manufacturing. The calculation is similar to the production budget.
Trade Receivables Budget
Trade receivables budget forecasts the amounts that credit customers over to the business at the end of each month. Cash sales are ignored in the trade receivables budget.
Trade Payables Budget
Trade payables budget forecasts the amount that a business owes to the supplies at the end of each month.
In a business organization, cash budget is one of the most important budgets prepared. The cash budget is prepared on a cash basis and includes both Capital and Revenue receipts and payments. It does not include non-monetary items such as depreciation. The objective of this type of budget is to ascertain the company’s cash position.
A cash budget helps the management department in the following ways:
- It shows the expected cash inflows and outflows and highlights times when there will be a shortage. However, in case of cash shortages:
- Loans may be arranged
- Payments to suppliers may be delayed in order to maintain the desired cash position.
- Credit period allowed may be reduced and customers may be pressed for payments.
- It also indicates periods when surplus cash is available. It therefore becomes important to make arrangements so that the excess cash can be used to the best advantage of the business.
Top-Down Budget (Imposed Budget)
An imposed or top-down budget is prepared by top management with little or no input from operating personnel and imposed upon the departmental managers who are responsible for putting them into action. However, departmental managers may not feel committed because they are not involved in the preparation of the budget.
Bottom-up Budget (Participatory Budget)
Participative or bottom-up budgeting is a budgeting system in which all budget holders are given the opportunity to participate in setting their own budgets. These budgets are prepared by departmental managers who then submit the budgets to their superiors. In general, bottom-up budgets are more realistic and coordination between units is improved.
Why don’t you tell us how you perceive budgetary control?