CHAPTER THREE

INFORMATION FOR BUDGETING, PLANNING AND CONTROL PURPOSES

 What is a budget?
A budget is a plan expressed in quantitative, usually monetary terms, covering a specific period
of time, usually one year. In other word, a budget is a systematic plan for the utilization of
manpower and material resources. In a business organization a budget represents an estimate of
future costs and revenues.
What is a budgeting?
Budgeting: It is a means of coordinating the combined intelligence of an entire organization into a
plan of action based on past performance and governed by rational judgment of factors that will
influence the course of business in the future.
 Budgeting and Behavioral influence
 Factors Affecting the Budget may including;-
 Income of the Family.
 Size of the Family.
 Composition of the Family.
 Occupation of the Family members.
 Intercity Differences.
 Family Goals.
 Socio-economic Status of the Family.
 Gainful Employment.
 Activity-Based Budgeting Definition
Activity-based budgeting is often used in cost accounting. Managers make budgets and
spending recommendations based on past production activities. Management examines the
costs of performing particular activities, like bending a fender for a car, to budget the overall
costs of manufacturing a product.
Activity-Based Budgeting is a management accounting tool that does not look at the past year’s
budget to arrive at the current year’s budget. Instead, the activities that acquire the cost are
deeply studied and analyzed. Based on the study, the resources are allocated to an activity.

 Steps of Activity-Based Budgeting

There are 4 steps in Activity-Based Budgeting:
 Identifying various activities.

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 Identifying the costs of various activities.
 Project the number and the costs of units:
 Calculate the total cost.
1, Identifying the Various Activities:
Activity-Based Budgeting starts with identifying activities that revolve around resource
consumption. These activities are mainly classified as major activities and secondary activities
that denote involvement and importance of an activity to the organization as per their priority.
Therefore, major activities are activities that are directly related to the objectives and are
essential.
Activities that create added value to the customer and change its preference in the
organization’s favor may involve many resources that are considered secondary activities.
2, Identifying the Costs of Various Activities:
The 2nd step in Activity-Based Budgeting is to identify the cost drivers of various previously
identified activities, that are the cost drivers for a manufacturing facility can be the total labor
hours and wages paid to employees.
3. Project the number and the costs of units
After identifying the various activities and their costs, the next step is to identify the type and
the number of the units (as shown in the table: Type of the units; per person, per item, per
product & per service.
After identifying the type and number of units, we have to evaluate the cost of the total units.
For example, the cost for the accommodation of every person: $20.
4. Calculate Total Cost:
After identifying and projecting the activities and the costs, the next step is to calculate all the
values and the costs to complete the budget.
THE MAIN CHARACTERISTICS OF A BUDGET
 It is prepared in advance and is derived from a long-term strategy of the organization.
 It relates to future period for which objectives or goals have already been laid down.
 It is expressed in quantitative form, physical or monetary units, or both.
ADVANTAGES OF BUDGET
1. It brings efficiency and improvement in the work of the organization.
2. It is a way of communicating the plans to various units of the organization. By establishing the
divisional, departmental, sectional budgets, exact responsibilities are assigned. It thus,
minimizes the possibilities of back-passing/or get loss, if the budget figures are not met.
3. It is a way of motivating managers to achieve the goals set for the units.
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 4. It serves as a benchmark for controlling on-going operation.
5. It helps in developing a team sprit where participation in budgeting is encountered.
6. It helps in reducing wastages and losses by revealing them in time for corrective action.
7. It serves as a basis for evaluating the performance of managers.
8. It serves as a means of educating managers.

BUDGETARY CONTROL
No system of planning can be successful without having an effective and efficient system of control. The
exercise of control in the organization with the help of budgets is known as budgetary control.
The process of budgetary control includes:
 Preparation of various budgets
 Continues comparison of actual performance with budgetary performance, and
 Revision of budgets in the light of changed circumstances.
A system of budgetary control should not be rigid. It should have enough scope for flexibility to
provide for individual initiatives and derive. Budgetary control is an important device for making the
organization more efficient on all fronts. It is an important tool for controlling costs and achieving
the overall objectives.
PRINCIPAL BUDGET FACTOR OR KEY FACTOR: It is also termed as budget limiting factor,
i.e. the factor that can limits production and sales of a product. A key factor or a principal budget
factor [also called as constraint] is that factor the extent of whose influence must first be assessed in
order to prepare the functional budgets. Normally a sale is the key factor or principal budget factor
but other factors like production purchase, and skilled labor may also be the key factors. For
example, a company has production capacity to produce 30,000 tones per annum but if the sales
forecast tells that the market can absorb only 20,000 units, there is no point in producing 30,000
units. Thus the sale is the key factor in this case. On the other hand, if the company has capacity to
produce 30,000 units and the market has the capacity to absorb the entire production which means
that sales is not the key factor but if raw material is available in limited quantity so that only 25,000
units can be produced, the raw material will become the key factor.
The key factor puts restrictions on the other functions and hence it must be considered carefully in
advance. So, continuous assessment of the business situation becomes necessary. In all conditions the
key factor is the starting point in the process of preparation of budgets. A typical list of some of the
key factors is given below.
Sales: Consumer demand, shortage of sales staff, inadequate advertising
Material: Availability of supply, restrictions on import
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 Labor: Shortage of labor
Plant: Availability of capacity, bottlenecks in key processes
Management: Lack of capital, pricing policy, shortage of efficient executives, lack of know- how,
faulty design of the product etc.
CLASSIFICATION OF BUDGET
Budget can be classified into different categories on the basis of time, function, capacity utilization /or
flexibility. So, budgets can be classified as per the following basis.
 On the basis of Area of Operation /or activity
A. Functional /operational Budgets
B. financial budget
 On the basis of Capacity Utilization
A. Fixed Budget
B. Flexible Budgets
 On the basis of Time
A. Short Term
B. Medium Term
C. Long Term
1. Activity Perspective
i. Operating Budgets: These are budgets that reflect day-to-day activities or operations of an
organization. This category deals with items of manufacturing, trading and profit and loss accounts
like material purchases, labor cost, production and overhead, sales, purchases, ending inventory,
opening inventory, etc, budgets. It also deals with revenue or incomes budgets and expenses or
expenditure budgets. Operating budget is synonymous with recurrent expenditure budget of the
government financial year.
ii. Financial Budget: This relates to financing of assets and generally indicates cash inflow and outflow.
Capital budgeting is part of financial budget. This category is the budget to be prepared on the funds to
be generating through different sources for the financing of various projects. The budget would
indicate ownership of assets and insurance of liabilities and, so it gives the information which would
enable a budgeted balance sheet to be prepared. Capital budgeting, which is part of financial budget, is
synonymous with capital expenditure budget of the government financial year.
2. Classification of Budgets Capacity Utilization perspective
i. Fixed Budgets: When a budget is prepared by assuming a fixed percentage of capacity utilization, it is
called as a fixed budget. If the budget is prepared on the assumption of producing 50, 000 units and
actually the number of units produced are 40, 000, the comparison of actual results with the budgeted
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 ones will be unfair and misleading. The budget may reveal the difference between the budgeted costs
and actual costs but the reasons for the deviations may not be pointed out. A fixed budget may be
prepared when the budgeted output and actual output are quite close and not much deviation exists
between the two. In such cases, maximum control can be exercised between the budgeted performance
and actual performance.
ii. Flexible Budgets: A flexible budget is a budget that is prepared for actual levels of capacity
utilization. The basic principle of flexible budget is that if a budget is prepared for showing the results
at say, 15, 000 units and the actual production is only 12, 000 units, the comparison between the
expenditures, budgeted and actual will not be fair as the budget was prepared for 15, 000 units. The
flexible budget thus, provides a reliable basis for comparisons because it is automatically geared to
changes in production activity.
Finally the profit or loss at different levels of activity will be computed by comparing the costs with
the revenues.

3. Classification of Budgets According to Time: According to this classification, budgets are divided in
the following categories.
i. Short Term Budget: Any budget that is prepared for a period up to one year is known as Short Term
Budget. Functional budgets are normally prepared for a period of one year and then it is broken down
month wise.
ii. Medium Term Budget: Budget prepared for a period 1-3 years is Medium Term Budget. Budgets like
Capital Expenditure, Manpower Planning are prepared for medium term.
iii. Long Term Budgets: Any budget exceeding 3 years is known as Long Term Budgets. Master Budget
is normally prepared for long term. In the modern days due to uncertainty, very few budgets are
prepared for long term.
 Zero base budgeting
“A method of budgeting whereby all activities are re-evaluated each time a budget is set. Discrete
levels of each activity are valued and a combination chosen to match funds available.”

As the term suggests, it examines a programmed or function or responsibility from scratch. The
manager proposing this activity has, therefore, to prove that the activity is essential and the various
amounts asked for are really reasonable taking into account the volume of activity. Zero base
budgeting is based on the premise that every rupee of expenditure requires justification.
a) Zero base budgeting means budgeting from the beginning is i.e. it prepared without any reference to
any base (past budgets and actual figures).
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b) Zero Base budgeting may be defined as a planning and budgeting process which requires each
manager to justify its budget in detail from scratch and justify why he should spend any money.
c) Concentration of efforts is not simply on “how much” a unit will spend but “why” it needs to spend
d) Under zero base budgeting, all activities are identified and evaluated by systematic analysis and ranked
in order of importance.
e) Thus, the burden of proof is on manager to justify why the expenditure should be made at all and to
indicate what would happen if the proposed activity is stopped and no expenditure is made.
f) Under zero base budgeting, all activities and costs are re-evaluated each time budget is set. It provides
number of advantages to the organizational efficiency and effectiveness.
Static budget variance
Variance is the difference between the actual and budgeted amounts.
The static budget variance is the difference between the actual result and the corresponding budgeted amount
in the static budget.
A variance may be favorable or unfavorable. On an income statement budget report, think of how the variance
affects operating income and you will know if it is a favorable or unfavorable variance.
A favorable variance (F)-has the effect of increasing the operating income relative to the budgeted amount.
For revenue items, F means actual revenues exceed budgeted revenues. For cost items, F means actual costs
are less than budgeted costs.
An unfavorable variance (U)-has the effect of decreasing operating income relative t o the budgeted amount.
Unfavorable variances are also called adverse variances.

Example: assume Webb Company manufactures and sells jackets. For simplicity, we assume that Webb’s
only costs are manufacturing costs; it incurs no costs in other value chain functions, such as marketing and
distribution. We also assume that all units manufactured in May 2011 are sold in May 2011. Therefore all
direct materials are purchased and used in the same budget period, and there is no direct materials inventory at
either the beginning or at the end of the period. There are also no work-in-process or finished goods
inventories at either the beginning or the end of the period.
The number of units manufactured is the cost driver. The relevant range for the cost driver is from 0 to 25,000
jackets.
Given the following information related to Webb’s company.
Actual amounts budgeted amounts Variance
Selling price per jacket $38 $40 $2
Units of jackets produced and sold 23,000 20,000 $3000
Variable cost per jacket $27.40 $25 $2.40
Fixed costs $195,000 $200,000 $5,000

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 Developing an operating Budget
The first section of the master budget is the operating budget. Most companies have a budget manual
that contains a company’s particular instructions and relevant information for preparing its budgets.
Although the details differ among companies, the following basic steps are common for developing the
operating budget for a manufacturing company. Beginning with the revenues budget, each of the other
budgets follows step-by-step in logical fashion.
1. The Revenue Budget/Sales Budget
2. Production Budget
3. Direct Materials Usage & Purchases Budget
4. Direct Labor Costs Budget
5. Manufacturing Overhead Costs budget
6. Ending Inventory Budget
7. Cost of Goods Sold Budget
8. Nonmanufacturing Costs Budget
9. Budgeted Income Statement

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Step 1: Prepare the Revenues Budget: A revenues budget, calculated in Schedule 1, is the usual starting
point for the operating budget. That’s because the production level and the inventory level and therefore
manufacturing costs as well as nonmanufacturing costs, generally depend on the forecasted level of unit
sales or revenues. Many factors influence the sales forecast, including the sales volume in recent periods,
general economic and industry conditions, market research studies, pricing policies, advertising and sales
promotions, competition, and regulatory policies.

Budgeted = Total units expected to be F

Xorecasted Selling Price
Revenues sold

For the illustration purpose, throughout this chapter we will use the information taken from the accounting
records of Slopes Incorporation, so you should always assume it in every discussion of the chapter.
Slopes, Inc. manufactures and sells snowboard. Slopes manufacture a single model, the Pipex. In the summer
of 2017, Slopes’ management accountant gathered the following data to prepare the sales budget for 2018:
Slopes’ CEO expects to sell 1,000 snowboards during 2018 at an estimated retail price of $450 per board.
Based on the above data, the revenues budget for 2018 is developed as follows:

Slopes Incorporation
Schedule 1: Revenues Budget
For the Year Ending December 31, 2018
Units Selling Price Total Revenues
Snowboards 1,000 $450 $450,000

The $450,000 is the amount of revenues in the budgeted income statement. The revenues budget is
often the result of elaborate information gathering and discussions among sales managers and sales
representatives who have a detailed understanding of customer needs, market potential, and
competitors’ products. This information is often gathered through a customer response management
(CRM) or sales management system. Statistical approaches such as regression and trend analysis can
also help in sales forecasting. These techniques use indicators of economic activity and past sales data
to forecast future sales. Managers should use statistical analysis only as one input to forecast sales. In
the final analysis, the sales forecast should represent the collective experience and judgment of
managers.
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Step 2: Prepare the Production Budget (in units): After the revenues are budgeted, the
manufacturing manager prepares the production budget, which is calculated in schedule 2. The
production budget is prepared after the sales budget. The production budget lists the number of units
that must be produced to satisfy sales needs and to provide for the desired ending inventory. The total
finished goods units to be produced depend on budgeted unit sales and expected changes in units of
inventory levels: The following formula will help us to determine the amount of unit that must be
produced:

Budgeted Target ending - Beginning Finished

Production = Budgeted + finished goods goods inventory
(Units) Sales (units) inventory (units) (units)

For the illustration purpose, assume that in the summer of 2017, Slopes’ management accountant gathered the
following data to prepare the production budget for 2018: Slopes’ CEO further expects 2018 beginning
inventory of 100 snowboards and would like to end 2018 with 200 snowboards in stock.
Using the above data, the production budget for Slopes Incorporation will developed be as follows:
Slopes Incorporation
Schedule 2: Production Budget

For the Year Ending December 31,2018

Budgeted unit sales (Schedule 1) 1,000
Add: Target ending finished goods inventory 200
Total requirements 1,200
Deduct: Beginning finished goods inventory 100
Units to be produced 1,100

Step 3: Prepare the Direct Material Usage Budget and Direct Material Purchases Budget: The
number of units to be produced, calculated in Schedule 2, is the key to computing the usage of direct
materials in quantities and in dollars. The direct material quantities used depend on the efficiency with
which materials are consumed to produce a snowboard. In determining budgets, managers are
constantly anticipating ways to make process improvements that increase quality and reduce waste,
thereby reducing direct material usage and costs.

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Like many companies, Slopes Incorporation has a bill of materials, stored and updated in its computer
systems. This document identifies how each snowboard is manufactured, specifying all materials (and
components), the sequence in which the materials are used, the quantity of materials in each finished
unit, and the work centers where the operations are performed. For example, the bill of materials
would indicate that 5 board feet of wood and 6 yards of fiberglass are needed to produce each
Snowboard. Assume also that Slopes uses a FIFO inventory method for both direct materials and
finished goods. Other data include the following:

Beginning Ending Inventory 2017 Unit Price 2018 Unit Price

Direct Materials Inventory 1/1/2017 12/1/2018
Wood 2,000 b.f. 1,500 b.f. $28.00 per b.f. $30.00 per b.f.
Fiberglass 1,000 yards 2,000 yards $ 4.80 per yard $ 5.00 per yard
These data are then used to calculate the amounts in Schedule 3A.
Slopes Incorporation
Schedule 3A:
Direct Material Usage Budget in Quantity and Dollars
For the year Ending December 31,2018
MATERIALS
Wood Fiberglass Total
Physical Units Budget:
Wood: 1,100 × 5.00 b.f. 5,500
Fiberglass: 1,100 × 6.00 yards 6,600

To be used in production 5,500 b.f. 6,600 yards

Cost Budget:
Available from beginning inventory(FIFO)
Wood: 2,000 b.f. × $28.00 $ 56,000
Fiberglass: 1,000 b.f. × $4.80 $ 4,800
To be used from purchases this period
Wood: (5,500 – 2,000) × $30.00 105,000
Fiberglass: (6,600 – 1,000) × $5.00 _28,000
Total cost of direct materials to be used $161,000 $32,800 $193,800

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 The purchasing manager prepares the budget for direct material purchases based on the budgeted direct
materials to be used in production, the beginning inventory of direct materials, and the target ending
inventory of direct materials.

The direct materials purchases budget for Slopes Incorporation will then be developed as follows:

PurchaseofDirect = DirectMaterials + Targetending - Beginning Materials

tobeusedin inventoryof inventoryof

Production directmaterials direct

Slopes Incorporation
Schedule 3B: Direct materials purchases Budget
For the year ending December 31,2018
MATERIALS
Wood Fiberglass Total
Physical Unit Budget
To be used in production (from schedule 3A) 5,500 b.f. 6,600 yards
Add: target ending inventory 1,500b.f. 2,000 yards.
Total Requirements 7,000 b.f. 8,600 yards
Deduct: beginning inventory 2,000 b.f 1,000 yards
Purchases to be made 5,000 b.f. 7,600 yards
Cost Budget
Wood: 5,000 × $30.00 $150,000
Fiberglass: 7,600 × $5.00 $38,000
Purchases $150,000 $38,000 $188,000

Step 4: Prepare the Direct Manufacturing Labor Costs Budget: In this step, manufacturing managers use
labor standards, the time allowed per unit of output, to calculate the direct manufacturing labor costs budget in
Schedule 4. These costs depend on wage rates, production methods, process and efficiency improvements and
hiring plans.

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For the illustration purpose, consider the following data gathered by the management accountant of slopes
Incorporation in the summer of 2017 to prepare DLCs budget for the coming year:
Labor requirements ………………………… 5 labor hours per snowboard 2018 unit
price…………………………….… $25.00 per hour

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 Slopes Incorporation
Schedule 4: Direct Manufacturing Labor Costs Budget
For the year Ending December 31, 2018
Output Unit produced Direct Manufacturing Hourly
(Schedule 2) Labor-Hours per unit Total Hours Wage Rate Total
Snowboards 1,100 5 5,500 $25 $137,500

Step 5: Prepare the Manufacturing Overhead Costs Budget: The total of these costs depends on how
individual overhead costs vary with respect to the cost driver, which is a variable, such as level of activity or
volume that casually affects costs over a given time span.

Budgeted Manufacturing Overhead Costs = Budgeted Fixed Overhead Costs + Budgeted Variable
Overheads

For the illustration purpose, again consider the following data gathered by the management accountant of
Slopes Incorporation in the summer of 2017 to prepare budget for 2018:

Variable manufacturing overhead is $7 per direct manufacturing labor-hour. There are also $66,000 in fixed
manufacturing overhead costs budgeted for 2018. Slopes combines both variable and fixed manufacturing
overhead into a single rate based on direct manufacturing labor-hours (i.e., Both variable and fixed
manufacturing overhead costs are allocated to output units/finished goods based on direct manufacturing
labor hours).
The manufacturing overhead costs budget for Slopes Incorporation will be as follows:

Slopes Incorporation
Schedule 5: Manufacturing Overhead Costs Budget
For the year Ending December 31,2018
Variable manufacturing overhead costs ($7.00 × 5,500) $ 38,500
Fixed manufacturing overhead costs _66,000
Total manufacturing overhead costs $104,500

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Step 6: Prepare the Ending Inventories Budget. The management accountant prepares the ending
inventories budget, calculated in Schedules 6A and 6B. The dollar amount for the ending inventory of
finished goods is needed below to determine the budgeted amount of cost of goods sold. The dollar amounts
for ending direct materials and finished goods are also needed for the preparation of the budgeted balance
sheet.
Budgeted Cost of Ending Direct Materials inventory = Target Ending DMs in units x Budgeted Price

Budgeted Product Cost per Output Unit = Budgeted DMC/output unit + Budgeted DLC/output unit+
Budgeted manufacturing overhead cost per output unit

The budgeted product (inventoriable) cost per output unit can be calculated at any time after the budgeted
quantities per output unit and input prices are obtained. The calculation is placed here because it is needed
for determining budgeted cost of ending Finished Goods Inventories (FGIs).
Budgeted cost of Ending FGIs = Desired Ending FGIs in units x Budgeted Product Cost per Output Unit
As stated earlier, Slopes Incorporation uses direct manufacturing labor hours to allocate manufacturing
overhead costs to finished goods inventory. As a result, manufacturing overhead costs are allocated to
finished goods inventory at the budgeted rate of $19 per direct manufacturing labor-hour(total budgeted
manufacturing overhead,
$104,500 ÷ 5,500 budgeted direct manufacturing labor-hours). Schedule 6A shows the computation of the
unit cost of Snowboards started and completed in2018.

Slopes Incorporation
Schedule 6A: Unit Costs of Ending Finished Goods Inventory
December 31, 2018
Cost per unit of Input Input per unit of Output Total
Direct Material Wood $30 5 b.f. $150
Inventories Fiberglass 5 6 yards 30
Direct manufacturing labor 25 5 hrs 125
Manufacturing overhead 19 5 hrs 95
Total $400
N.B. Under FIFO method, this unit cost is used to calculate the cost of target ending inventories of finished
goods in Schedule 6B:

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 Slopes Incorporation
Schedule 6B: Ending Inventory Budget
December 31, 2018
Quantity Cost per Unit Total
Direct Materials
Wood 1,500 $30 $45,000
Fiberglass 2,000 5 10,000 $55,000
Finished Goods
Snowboards 200 400 80,000 80,000
Total ending inventory $135,000
N.B: This is based on 2018 Costs of manufacturing finished goods because under the FIFO costing method,
the units in finished goods ending inventory consists of units that are produced during 2018.

Step 7: Prepare the Cost of Goods Sold Budget: The manufacturing and purchase managers, together with the
management accountant, use information from schedules 3 through 6 to prepare schedule 7.

Slopes Incorporation
Schedule 7: Cost of Goods Sold Budget
For the year Ending December 31, 2018
From Schedule Amount
Beginning finished goods inventory, Jan. 1, 2018 See the Note below $ 37,480
Direct material used…… 3A $193,800
Direct manufacturing labor….. 4 137,500
Manufacturing overhead…… 5 104,500
Cost of goods manufactured…… 435,800
Cost of goods available for sale…. 473,280
(-)ending finished goods inventory, Dec. 31,2018 6B (80,000)
Cost of Goods sold……. $393,280
Note: Assume that the data collected by the management accountant shows that the inventoriable unit cost for
ending finished goods inventory on December 31, 2017, is $374,80. Thus, the cost of the beginning
finished goods inventory on Jan. 1, 2018 is computed as follows: $374,80*100 (Schedule 2) = $37,480

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Step 8: Prepare the Nonmanufacturing Costs Budget: Schedules 2 through 7 cover budgeting for Slopes
Incorporation’s production function of the value chain. For brevity, other parts of the value chain—product
design, marketing, and distribution—are combined into a single schedule. Just as in the case of
manufacturing costs, managers in other functions

of the value chain build in process and efficiency improvements and prepare nonmanufacturing cost budgets
on the basis of the quantities of cost drivers planned for 2018.

To illustrate, assume the following data for Slopes Incorporation. Variable marketing costs are allocated at
the rate of $250 per sales visit. The marketing plan calls for 30 sales visits during 2018. Finally, there are
$30,000 in fixed nonmanufacturing costs budgeted for2018.

Based on the above data the non-manufacturing costs budget for Slopes is developed as follows.

Slopes Incorporation
Schedule 8: Nonmanufacturing Costs Budget
For the year Ending December 31,2018
Non-manufacturing costs Total
Variable marketing costs ($250 × 30) $ 7,500
Fixed non manufacturing costs 30,000
Total $37,500

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Step 9: Prepare the Budgeted Income Statement: The CEO and managers of various businesses
functions, with help from the management accountant, use information in Schedule 1, 7, and 8 to
finalize the budgeted income statement.
Budgeting is a cross-functional activity. Top management’s strategies for achieving revenue and
operating income goals influence the costs planned for the different business functions of the
value chain. For example, a budgeted increase in sales based on spending more for marketing
must be matched with higher production costs to ensure that there is an adequate supply of
Snowboards and with higher distribution costs to ensure timely delivery of Snowboards to
customers.

Slopes Incorporation
Budgeted Income Statement
For the year Ending December 31,2018
Revenue Schedule 1 $$450,000
Less: Cost of goods sold Schedule 7 393,280
Gross margin 56,720
Less: Nonmanufacturing Costs Schedule 8 37,500
Operating Income $ 19,220

Capital Expenditures Budget

The capital expenditures budget identifies the amount of cash a company will invest in projects
and long-term assets. Although funds for expenditures may be identified and approved in total
during the budget process, most companies have a separate process for approving funds for the
specific items included in a capital expenditures budget. The process includes a financial
evaluation to determine whether the company's return on investment targets are met and, once
the targets are known to be met, a qualitative review by a top management team. Many
companies include long-term assets, such as joint ventures, purchases of other companies, and
purchases or leases of fixed assets, as well as new products, new markets, research and
development, significant marketing programs, and information technology items in their capital
expenditures budgets

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 The Cash Budget
The cash budget is prepared after the operating budgets (sales, manufacturing expenses or
merchandise purchases, selling expenses, and general and administrative expenses) and the
capital expenditures budget are prepared. The cash budget starts with the beginning cash
balance to which is added the cash inflows to get cash available. Cash outflows for the period
are then subtracted to calculate the cash balance before financing. If this balance is below the
company's required balance, the financing section shows the borrowings needed. The
financing section also includes debt repayments, including interest payments. The cash
balance before financing is adjusted by the financing activity to calculate the ending cash
balance. The ending cash balance is the cash balance in the budgeted balance sheet.
The cash budget is composed of four major sections:
1. The receipts section
2. The disbursements section
3. The cash excess or deficiency section
4. The financing section.
The receipts section lists all of the cash inflows, except from financing, expected during the
budget period. Generally, the major sources of receipts are from sales. The disbursement section
summarizes all cash payments that are planned for the budget period. These payments include
raw materials purchases, direct labor payments, manufacturing overhead costs, and so on, as
contained in their respective budgets. In addition, other cash disbursements such as equipment
purchases and dividends are listed. The cash excess or deficiency section is computed as follows:

Cash balance, beginning………………………………………….. xxxxx

Add: Receipts…………………………………………………….. xxxxx
Total Cash available………………………………………………. xxxxx
Less: Disbursements……………………………………………… xxxxx
Excess (deficiency) of cash available over disbursements………. xxxxx
If a cash deficiency exists during any budget period, the company will need to borrow funds. If
there is a cash excess during any budget period, funds borrowed in previous periods can be
repaid or the excess funds can be invested. The financing section details the borrowings and
repayments projected to take place during the budget period. It also lists interest payments that

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 will be due on money borrowed.
The cash balance at both the beginning and end of the year may be adequate even though a
serious cash deficit occurs at some point during the year. Consequently, the cash budget should
be broken down into time periods that are short enough to capture major fluctuations in cash
balances. While a monthly cash budget is most common, some organizations budget cash on a
weekly or even daily basis
 Manufacturing Sector Companies
They purchase raw materials and other components and convert them into finished products.
Examples are textile manufacturing companies, TV manufacturing companies etc. In the case of
manufacturing organization the product costs include the cost of direct materials, direct labor
and manufacturing overhead.
 Merchandising – Sector Companies
They purchase and sell tangible products without changing their basic form. This sector includes
companies engaged in retailing, distributing or wholesaling.
For a retail organization, the cost of a purchased product includes adjustments like freight in
costs, purchase returns and allowances and purchase discounts.
 Service Sector Companies
They provide services or intangible products to their customers. Examples are law firms,
accounting & audit firms, banks, insurance companies, transportation companies, advertising
agencies, radio and television stations and internet based companies.
The costs incurred to provide a service in such organizations include the cost of labor and related
overhead.

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