Budgeting

BUDGETING

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BUDGETING Dr. T.K. Jain.

AFTERSCHO☺OL Centre for social entrepreneurship Bikaner M: 9414430763 [email protected] www.afterschool.tk, www.afterschoool.tk

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WHAT IS BUDGETING ? • IT IS A DETAILED PLAN OF OPERATIONS PREPARED IN ADVANCE. IT GIVES DETAILED FINANCIAL PROJECTIONS. IT HELPS US IN IDENTIFYING THE MONETARY AND PHYSICAL UNITS OF OPERATIONS REGARDING THE PROJECTED FUTURE. www.afterschoool.tk

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What is control? • When we compare actual performance to the planned performance and evaluation the deviations (if any) and take corrective action, this entire process is called control. Control is just to ensure that we are on the right track and doing the right things as planned. Control is a means of comparing actual performance to the standard performance. Controls are standards, which have been carefully set, well in advance. www.afterschoool.tk

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What is budgetary control? • When budgeting is used as a means of control, we called it budgetary control. Here we establish budgets and fix responsibilities of executives in terms of targets, working, objectives, results etc. it helps us in comparison of actual performance with the planned performance. Budgets may be revised as per changed circumstances. www.afterschoool.tk

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How is budgetary control established? • Determine the objectives • Prepare action plan for the objectives • Prepare detailed budget and discuss it with all key executives and finalise it. • Define the constraints, assumptions, and precautions in advance. • Prepare budget manual and circulate it to all concerned • Review the performance periodically and modify the budget if required. www.afterschoool.tk

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What are the key issues in budgeting? • Fix budget period • Prepare an estimate of planned activities (a forecast is just an enstimate, but budget is more than an estimate, it is a plan document and specifies how we will achieve what we wish to achieve). • Fix responsibilities for budget implementation • Determine key factor • Appoint budget committee and budget controller www.afterschoool.tk

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Types of budgets : • As per time: (long term, short term, medium term, very short period / current period) • As per function: (marketing, finance, HR, sales, production, operations, research, cash, personnel, master, & capital expenditure budget). • As per flexibility : (fixed budget v/s flexible budget). • Others : zero base budget, performance budgeting etc. www.afterschoool.tk

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Operating budgets… 1. Programme budget: this budget is prepared around a product / project. It identifies revenues and expenditure to be undertaken. It is complete budget relating to a project / product. There are various persons involved in this budget = therefore it is not a very good control device for individual performance. It is a good tool for organisational performance assessment. www.afterschoool.tk

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2. Responsibility budgeting… • Here we fix individual responsibilities relating to the work to be accompalished. It is a very good tool for individual performance assessment and evaluation. It is used along with other tools of management like Balanced Scorecard, in order to assess the performance of the employee. • It can be used along with the tools like responsibility centre, cost centre, revenue centre, profit centre, expense centre etc. here we are fixing the budgets relating to revenues and costs along with individuals responsible for achieving it. www.afterschoool.tk

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Zero base budgeting… • Peter A Pyhrr used it for the first time in 1970 in its present form, although it was used by US dept. of Agriculture in 1961 and by some other agencies earlier also. • The basic assumption is that we start a fresh. Historical elements in budgets are minimised.

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Definition… of ZBB • the manager preparing ZBB reviews each activity from scratch. Nothing is allowed just because it was done in the past. Each activity / work is reviewed from the beginning. We try to make a budget for each activity from the beginning. • Here each activity is critically examined and reviewed in order to fix responsibilities and duties. www.afterschoool.tk

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Steps in ZBB? • Decide about objectives… • Decide the extent to which ZBB will be implemented • Identify decision units • List down and formulate decision packages • Review and rank decision packages • Prepare the budget www.afterschoool.tk

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Advantages of ZBB • Identifies wastes, unnecessary activities etc. • It is a pre-curser to the BPR exercise • It links each activity to the organisational corporate mission, objectives and plans • It is a systematic way to evaluate the performance of the organisation on different dimensions. www.afterschoool.tk

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Limitations of ZBB • More time, more cost, more resources are required • It is difficult to rank different decisional packages • Implementation is not always easy

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A factory makes two products - A and B. A takes 10 hours to make and B takes 20 hours to make. In a month (25 days of 8 hours) 500 units of A and 300 units of B are produced. Budgeted hours are 8500 per month. 60 workers are working. Compute various ratios. • • • • • • •

Standard hours for actual work: Actual production * no. of hours A = 500 * 10 = 5000 hours B = 300 * 20 = 6000 hours Total std. hours = 11000 Budgeted hours = 8500 hours Actual hours = 25*8*60 = 12000

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Solution… • Activity ratio : std. hours for actual perofrmance / budgeted hours * 100 • = 11000/8500*100 = 129% • Capacity ratio : • Actual hours / budgeted hours * 100 • = 12000/85000 * 100 = 141% • Efficiency ratio : • Std. hours / actual hours * 100 • 11000/12000 * 100 = 91.6% answer. www.afterschoool.tk

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Z Ltd. had a profit plan approved for selling 5,000 units per month at an average price of Rs. 10 per unit. The budgeted variable cost of production was Rs. 4 per unit and the fixed costs were budgeted at Rs. 20,000, the planned income being Rs. 10,000 per month, Due to shortage of raw materials, only 4,000 units could be produced and the cost of production increased by 50 paise per unit. The selling price was raised by Re. 1.00 per unit. In order to improve the production process, an expenditure of Rs. 1,000 was incurred for research and development activities. You are required to prepare a Performance Budget and a Summary Report. www.afterschoool.tk

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Solution… Particulars

Original plan

Adjusted plan

Actual position

Sales Variable cost Contribution Fixed cost Profit

5000*10 5000*4

4000*10 4000*4

4000*11 4000*4.5

30000 20000 10000

26000 20000 6000

26000 21000 5000

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Performance analysis • • • • • • • •

Selling price variance (act. Price – std. price) * act. Qty =(11-10) * 4000 = 4000 Variable cost variance = (std. – act) * act. Production =(4 – 4.5) * 4000 = - 2000 Fixed cost variance = 20000-21000=-1000 Profit volume variance =reduction in volume * actual profit per unit= 1000 *6 = -6000 • Total variance = - 5000 • Actual difference = 5000 – 10000 = -5000 answer. www.afterschoool.tk

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Prepare cash budget from the following figures: first row is for material received, second column is for sales and third column is for other expenses. We receive payment from debtors after 3 months and we make payment after 2 months to suppliers. Balance of cash on 1 april is 10000.

january

20,000

30,000

9,500

february

22,000

33,000

10,000

March

24,000

36,000

10,500

april

26,000

39,000

11,000

may

28,000

42,000

11,500

june

30,000

45,000

12,000

july

32,000

48,000

12,500

august

34,000

51,000

13,000

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Solution… it is clear that we have to withdraw more cash in the month of August to meet our cash requirements in September.

cl. opening balance receipts april :

payments

Balanc e

10,000

30,000

33,000

7,000

May

7,000

33,000

35,500

4,500

June

4,500

36,000

38,000

2,500

July

2,500

39,000

40,500

1,000

August

1,000

42,000

43,000

0

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A company requires you to calculate and present thø budget for the next year from the following information • SALES : Toughened glass . 3,00,000 Bent toughened glass Rs. 500000 • Direct material cost 60% of sales • Direct wages 20 workers © As. 150 per month. • Factory overheads: • Indirect labour: • Works managerRs. 500 per month • Foreman Rs. 400 per month • Stores and spares 2.5 % of sales • Depreciation on machinery Rs. 12,600 • Light and power 5,000 • Repairs and maintenance 10% on direct wages • Administration, selling and distribution expenses Rs.14,000 per year. www.afterschoool.tk

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Solution… • • • • • • • • • • • • • •

Sales (3+5) 800000 Direct material : 480000 Direct labour : 36000 Prime cost = 516000 Add : factory overhead: Stores 2.5% of 8 lakhs : 20000 Repairs : 3600 Foreman+works manager 10800 Power : 5000 Depreciation : 12600 Works cost : 570000 Gross profit : 230000 Less selling exp : 14000 Net profit : 216000 (answer)

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Flexible budget … • a company produces 1,000 units at 100% capacity, and the costs at this level are as follows: • Fixed Rs. 5,000 Variable Rs. 3 per unit • Semi-variable Rs. 4 per unit (40% variable) • In case the budgeted levels of activity are 80%, 90% and 100%, prepare the flexible budget. www.afterschoool.tk

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Solution… (flexible budget) particulars

100% 90%

80%

No. of units

1000

900

800

Fixed cost

5000

5000

5000

Variable cost

3000

2700

2400

Semi variable : fixed : Semi variable : variable

2400 1600

2400 1440

2400 1280

Total cost :

12000 11540 11080

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Question on financial budgeting… •

Jitu International sells goods on a gross profit of 25%. Depreciation Ii taken into account as a part of cost of production. The following are the annual figures given to you: Sales (two month’s Credit) 18,00,000 • Materials consumed (one month’s credit) 4,50,000 • Wages paid (one month lag in payment) 3,60,000 • Cash manufacturing expenses (one month lag in payment) 4,80,000 • Administration expenses (one month lag in payment) 120,000 • Sales promotion expenses (paid quarterly in advance) 60,000 • Income tax payable in 4 instalments of which one lies in the next year 1 ,50,000 • The company keeps on month’s stock each of raw materials and finished goods. It alnu keeps Rs.1 00,000 in cash. You are required to estimate the working capital requirements assuming 15% safety margin. www.afterschoool.tk

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Solution… • • • • • • • • • • • •

Current assets : Debtors : 18 *2/12 = 300000 sales Cost of sales : 300000*100/125 =240000 Cash : 100000 Raw material : 37500 Finished goods: 120000 Advance payment : 15000 (60000/4) Less current liabities : Tax : 37500 Creditors : 37500 admn. 10000 Wages 30000, Working capital = 394500 + 15% Total working capital requirement: 453675 answer.

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