SECTION –B – PLANNING BUDGETING AND FORCASTING

Planning in general refers to the process that provides guidance and directions regarding what
an organization need to do throughout its operation.

It determines answer to the questions of business operation such as who, what, when, where
and how

Planning is the first step in budgeting and making other decision that affect company’s future.

Planning provides coordination, controlling, monitoring, performance standards, adaptability,

quick response to changes, create opportunities and escape from declines.

Primary factor of success is management competence – the ability of the company to plan,
lead and control

Top level management is responsible for planning and controlling activities.

SUPERIOR PERFORMANCE- WITH THEIR COMPETITOR

 Achieving superior performance will increase profitability

 When profit increased shareholders value increased

 Publicly owned company’s primary goal is to maximize its shareholders value

 Shareholders value means return for buying shares of a company that will be capital
appreciation and dividend

 Shareholders value increased by profitability and profit growth

 Shareholders want to see PROFITABLE GROWTH-* high profitability*sustainable

profit growth

 Challenge that faced by managers: to maintain short term profitability and long
term profit growth

 Strategic leaders ( top level management) are responsible for making strategy that
will increase the performance of the company and maximize shareholders value.

 Strategy (thanthram)is a set of actions taken by the managers of a company to

increase the company’s performance.* It is a plan of action designed to achieve goals
of an organisation.eg: jio sim for 2 years free sim in india with free internet to rebuild
the trust. After building the trust they started charging price for their service.

 The strategy making process includes both formulation and implementation

 Strategy formulation – selecting strategy

 Strategy implementation- putting the selected strategies into action.

  Result of superior performance is COMPETITIVE ADVANTAGE.

 COMPETITIVE ADVANTAGE- it is the advantage over the competitors that is

gained by offering customers greater value than the competitor give

 Greater value – lower price or greater benefits in products and service or both than the
competitor do

 Company with competitive advantage will be highly profitable

 Highly profitable company will have competitive advantage.

Strategy formulation gives competitive advantage; strategy planning is this formulation of

strategy.

Business model is the managers idea of how to set of strategies and capital investment
that will give profitability and profitable growth.

The purpose of strategic planning is to guide the company in achieving its superior
performance, competitive advantage and maximize shareholders value

Role of management in attaining profitable growth

 Market theory- passive role

 Planning and control theory – active role

Strategic planning- thandramgal menayuga – creating strategy

Types of planning

Strategic plans(long term plans)– mare than 5 years or long and it is updated and rolled
forward each year.- top level management develops

Part of strategic plan- capacity -the ability to produce its products and services

Capital resources- equipments, buildings, tools and infrastructure

 Strategic plan are directional rather than operational

 Strategic plan broken into tactical plan and operational plans

Tactical plans (intermediate plan)- 1 year to more than 5 years

 Top and middle level develops

Short term (operational plan)- one week to less than 1 year

 Middle and lower level manages develop

 It plans day today operations of a company

 Tactical plan and operational plan are the basis of budgets

Other types of plan

Single purpose plan- eg construction of fixed asset

Standing purpose plan- plans used for the activities that occur during the
regular intervals , they are used repeatedly .eg; marketing and operational
plans

Contingency plan-what if- prepare for future negative events, it enable us to

respond quickly

STRATEGIC PLANNING PROCESS

1. defining companies vision, mission,values and goals.

2. Analysing external factors to identify opportunities and threats

3. Analyzing internal factors to identify strength, weakness and limitations

4. Formulating and selecting strategies that consistent with organizations mission

and goals

5. Developing and implementing the choosen strategies.

1. DEFINING COMPANY’S VISION, MISSION, VALUES AND

GOALS.
 Vision - it is the statement describing desired future position of the company,
what the company wants to become or achieve- eg: jio want to become the top
telecom company in India

 Mission - it the statement showing what the company does- reason to be- what
it does- what it is - eg: jio targets to achieve 40% of market share

 Value - companies values are the foundation of organization culture. culture

consists of values, norms, and standards that governs how the company’s
employees work to achieve the mission and goals.

 Goals – it is the targets set to achieve the mission and vision of the company.
It is precise and measurable- two types of goals- eg artel ported to jio of
railway employees of 100000 sim

1. strategic goals- long term focused - more than 1 year

2. tactical goals- short term focused

 Characteristics of goals - precise, measurable, limited, challenging, realistic, sense of
urgency, clearly stated in specific terms, crucial and address important issues.

 Objectives- it is the series of step taken to attain the goals. Objectives provides
detailed action that required to support goal

Characteristics of objectives

SMART -specific, measurable, attainable, realistic, timely.

MARKETING MYOPIA- it refers to narrow focus on products and services

rather than identifying and satisfying board needs and wants of customers.

TUNNEL VISION- it occurs when the employees concerned about their own
goals that they fail to care about large goals of organization.

Two factors of accomplishment of goals and objectives

 Efficiency – minimum input for maximum output

 Effectiveness- degree of success

2. ANALYSING EXTERNAL FACTORS TO IDENTIFY

OPPORTUNITIES AND THREATS.
Opportunities – make more profit

Threats – danger to profitability

3 external environments should be examined

1.Industry 2. National and international environment 3. Macro

environment(economics)

1. industry is a group of companies that offer similar products and services to satisfy
the needs of customer.*it involves assessing company’s industry , its competitive
position. Competitors competitive position all the history of industry, nature of
industry (growth, decline, price, marketing, R&D depending on the industry the
company is in)

national and international environment- political risk and impact of globalization

International political risk includes* expropriation*war

 3.macro economics

Economic growth Economic recession

Consumer spending + -less
Operation expanding + Less
Profit -reduces
Growth and recession will affect the demand thus affect the revenue and net
income(profit)

Level of interest rate- interest rate increases demand decreases, interest rate
decreases demand increases.

It also affect the company’s cost of capital

Currency exchange rate-

Depreciation of local currency- it increases international sales and decrease foreign

competition And you get a competitive advantage.

Appreciation of local currency- it decreases international sales and increase in foreign

competition.

Inflation and deflation

Inflation – increase in price

Deflation – decrease in price

During this no investments so no growth and no opportunities

social factors-

ENVIRONMENTAL PROTECTION LAW- IN SIMPLE laws and rules created by

government can affect the operation of business

TAX CREDIT – when tax credit are available demand increases

When tax credits are expired demand decreases

MICHAEL PORTERS FIVE FORCE MODEL

IF ONE AMONG THE FIVE FORCE IS STRONG IT IS A LIMITATION –

TO RAISE PRICE AND EARN PROFIT

a strong competitive force reduces profit and so it is a threat.

a weak competitive force increases profit and so it is opportunity.

1. THE RISK OF ENTRY BY POTENTIAL COMPETITORS

THREATS
  Low brand loyality

 Current brand names are not wellknown

 Low initial capital is required

 Access to suppliers and distribution channel are easy

 Weak gov regulation

 Technology not required

2.RIVALRY AMONY EXISTING COMPETITORS

 No of competitors: high-threat, low – opportunity

 Diversity of competitors: same product – threat, different product-opportunity

 Quality: high quality- threat, low quality- opportunity

3.THE BARGAINING POWER OF BUYERs- low bp ; opportunity-high

bp;- threat
High No of customers- low B : Low no of customers- high BP

Large size of order- high BP ; small orders – low bp

High Availability of substitutes – high bp; Low availability of substitutes – low bp

Buyers information available more- high bp: Buyers information available less – low bp

Switching cost is high – low bp; switching cost is low – high bp

Diversity of product- same produt-high bp, different product- low bp

4. THE BARGAINING POWER OF SUPPLIER( low bp-oppertunity; high

bp- threat)
No and size of supplier= high – low bp; lower- high bp

Uniqueness= high bp –threat

Availability of substitutes = low bp-OPP

No availability of substitute goods = high bp-T

5. CLOSENESS TO SUBSTITUTES TO INDUSTRY PRODUCTS

Switching cost = high –opportunity; low- threat
Price of substitute=high price –opportunity; low price – threat

No of substitute products= high number- threat;lower number-opportunity

Buyers tendency to substitute-threat

3. ANALYZING INTERNAL FACTORS TO IDENTIFY STRENGTH,

WEAKNESS AND LIMITATIONS – to find strength superior performance and
weakness& limitation – inferior performance

Primary objective of strategy is competitive advantage

Competitive advantage-----1. Differentiation advantage distinctive competency

2. cost advantage

Resources + capabilities = distinctive competency +profitability +utility=

competitive advantage

Strategy gives distinctive competency

Distinctive competency shapes strategy

Four generic superior distinctive competency

Superior efficiency- minimum input and maximum output – reduce cost- lead to increase
profit it lead to competitive advantage

Superior quality- charge high price – lead to high profit

Superior innovation- innovation reduce cost so it reduce cost

Superior customer responsiveness-it occurs when identifying the needs and wants of
customer than the competitors. *The time taken to deliver the product or services to the
customer is customer response time it is also important aspect of customer responsiveness.

Profitability created= value the customer place on the product+

price it charge+ cost of creating
Utility (value)is customer satisfaction
Utility created by = product performance+ design +quality
Greater the utility= greater the pricing options
CREATED VALUE=U-C
U=UTILITY C= COMPANY’S COST TO PRODUCE
CONSUMER SURPLUS = U-P
P=PRICE OF THE PRODUCT
Durability of competitive advantage dependends upon three
factors
1. Barriers to imitation- competitor face difficulty to imitate
Eg ; your company has a new technology for making solar panels and you just
patented the new idea so your competitor connot use the idea with out your
permission it is subject to copyright

2. Capability of a competitor to imitate prior strategic commitment

Absorptive capacity

prior strategic commitment- it is tricky and expensive to copy the idea of other company

Absorptive capacity – the ability to learn new things or to make use of new knowledge

3. Dynamism of an industry environment – how quickly the industry

changes eg-smartphone company the market can be taken by the competitor by realising new
smartphones with new features.

Thee factors that contribute failure

1. inertia – not adapting to new changes happened in environment
2. prior strategic commitment- already huge investment had
done so they cannot change as per the competitors does
3. Icarus paradox –Greek myth- it is a story of a person named
Icarus – Icarus is in prison, to escape from their he used wax
wings , using this strategy he escaped from imprisonment but
using the wax wings he flew very well , closer to the sun , the heat
of sun melted the wax wings and Icarus died
Internal analysis to avoid failure

 Hold 4 generic distinctive competencies to create competitive

advantage-superior efficiency, quality, innovation, customer
responsiveness.

 Practice continuous learning and improvement

 Identify and adopt best practice through bench marking

 Overcome inertia and implement change in organisational

structure and control system
Importance of business models in strategic planning
Business model is the mangers idea to set strategies and capital
investment to achieve the above average profit and to maintain
profit growth.
Important part of internal analysis is analysis of financial
performance
 Using comparison or benchmarking

 The company’s current performance can be compared with the

competitor company’s performance or the previous years
performance with financial statement analysis can help to find the
strength and weakness

 By this the company can understand the company is more profitable

than the competitor or the company is improving or deteriorating

 Using the selected strategies

 Maximizing the value

 Cost is lined with competitor

 Resource are effectively used

4. FORMULATING AND SELECTING STRATEGIES THAT CONSISTENT
WITH ORGANIZATIONS MISSION AND GOALS

Next step is to perform SWOT Analysis

S-Strength- Optimization

W-Weakness- Correct

O-Opportunity- Make Advantage

T- Threat- Countering (Opposing)mitigate

Strategic alternative – it is the different option or plans to address the

company’s situation.-swot of the company

General classification of strategy global level

Corporate level

Functional level business level

1. Functional level - improving operation inside the company such as

marketing, manufacturing , product developing, material
management and customer service.

It is to improve the efficiency of operation, if the operation improves

company can achieve superior efficiency, quality, innovation,
customer responsiveness.

Superior efficiency can be increased by

 Utilizing self managing team

 Linking pay to performance

 Training to employees

 Making use of technology

 Adopting just in time inventory system

Superior quality
1.reliability – avoid defects by using six sigma -3.4 defects- six sigma is a total quantity
management
2.excellence – product,service,personnel attributes must be improved

Superior innovation- R& D department- innovating the new products gives

competitive advantage

Superior customer responsiveness –giving customers what they want by

this the company can build brand loyality

2. business level= it is related to business position in the market –by

successful business model- to create business model the business must
be defined ,to define the business 3 decisions should be set

 decision about customer needs and what needs to be satisfied

 decision about what product should be offered and to which

customer group it should be offer

 decision about how customer needs are to be satisfied, using the

company’s distinctive competencies

four generic competitive strategy

1. cost leadership - cost is reduced so the price is reduced

disadvantages-*competitor also reduces the cost and then price* quality

is affected

2. focused cost leadership- reduce cost to a particular narrow market

segment –no disadvantage

3. differentiation- uniqueness of product by superior Q,I,CR – can

charge high price-disadvantage is imitation by competitor

4. focused differentiation- differentiation is to niche market or to one

/two market segment eg ; baby,elder people

disadvantage – niches groups disappears

advantage- customer responsiveness

3. Corporate level- long term perspective – it is used to redefine and

reposition the company’s business model to take advantage of
opportunities and defend against threats
Horizontal integration

Merging or acquiring competitor’s company- to achieve competitive

advantage such as economies of scale –( production cost reduce and
quantity produced increased)

Advantages -*increased profitability *increased product

differentiation *reduced competition *increased company’s
bargaining power with customers and suppliers

Disadvantage-* no value is created to the shareholders *difference in

company culture and management turnover in acquired company*
high cost for horizontal integration

Vertical integration-

it expands its operation either into industry producing inputs to

company(backward) or into the industry uses company
products(forward)

Advantages -*increased profitability *increased product

differentiation *reduced competition.* lowers cost *increased
product quality.

Disadvantage- can be developed when technology is changing the

acquire company can be obsolete * demand is unpredictable

Strategic alliance – alternative to vertical integration

It is a long-term cooperative relationship between two or more

company to develop a new product. it provides benefits of a vertical
integration and avoid managing a merged company.

Strategic outsourcing – a company giving the works to an

independent specialist company to complete it

Advantages- *lowers cost *focus on distinctive competency* better

differentiation

Disadvantage- * company become dependent* outsourcer make use

of this dependency and increase price* risk of loss of valuable
 information e.g.; customer service is outsourced the complains can be
spread

Diversification- entering into one or more new industry to take

advantage of companies distinctive competency and business model.
It can be with related or unrelated industry- eg tata industry.

5. DEVELOPING AND IMPLEMENTING THE CHOOSEN STRATEGIES.

It is the process of translating strategy into action

Strategy implementation takes place in the context of the organizations

organisational design

THREE ELEMENTS OF ORGANISATIONAL DESIGN

1. organizational structure

2. control system

3. organizational culture

1. ORGANIZATIONAL STRUCTURE- who should do what, how it

should be done, how they should work together – it is integrated and
coordinated employees effort at all levels-corporate, business and
functional.

2. CONTROL SYSTEM- provides incentives and motivates employees.

It also provides feedback to the management

3. ORGANIZATIONAL CULTURE – it includes norms, values, beliefs,

attitude of people in an organization shares to achieve the
competitive advantage.*Structure is affected by culture.

Priority levels:

1. Business model and strategy

2. Organizational design
Other planning tools
1. Situational analysis-swot-it is the systematic collection and
evaluation of external and internal forces

2. PEST analysis
P-political: trade& wage regulation, industry health, product labelling, political
stability.

E-economic; exchange rate, interest rate, economic growth and contraction,

business cycle, unemployment rate, economic system,

S-social; countrys culture, population rate, average age of population, attitude

towards health and careers, entertainment interest

T-technological; it help to reduce cost and increase profit

3. Competitive analysis
Defining the competitors

Analysing the strength and weakness of competitor

Analysing the own company’s strength and weakness

Analysing customers needs and wants

Studying impediment for the company and competitor such as patents, high start up
cost, high level of knowledge required for success.

Contingency planning, scenario planning, what if planning

Respond quickly to future events generally external events that are not with in the control of
organization

Internal contingency is with in control of organisation

BCG GROWTH SHRE MATRIX

BONSTONE CONSULTING GROUP

MARKET SHARE

HIGH LOW
HIGH
MARKET GROWTH RATE

STAR QUESTION
MARK

COW DOG
LOW

Question mark;

Market share –low

Market growth- high

Cash generation -low

Investment –high

Pricing- aggressive pricing

Star;
Market share –high

Market growth- high

Cash generation -high

Investment –moderate

Pricing- adjusted pricing

Cash cow;
Market share –high

Market growth- low

Cash generation -high

Investment –low

Pricing- stable pricing

Dog;
Market share –low

Market growth- low

Cash generation -low

Investment –low

Pricing- not concerned (chance of sell off)

21According to the Boston Consulting Group’s portfolio model for competitive analysis, the strategy
for a strong cash cow should be
A. Harvest.- weak cash cow
B. Divest.- dog,question mark
C. Hold.- strong cash cow
D. Build.- star,question mark

A. Harvest:Harvesting involves maximizing short-term cash flow from a product or business unit with
declining growth potential. This strategy is typically applied to Cash Cow products.

Example: Suppose a company has a mature product line in a stable market with little room for further
growth. Instead of investing heavily in marketing or product development, the company might focus
on maximizing profits by reducing costs, increasing prices, or cutting back on marketing expenses.

B. Divest:Divesting involves selling off or discontinuing products or business units that are not
performing well or have limited growth potential. This strategy is often applied to Dogs (low market
share, low growth rate) or Question Marks (low market share, high growth rate).

Example: If a company has a product line that consistently underperforms and doesn't align with its
long-term strategic goals, it may choose to divest that product line by selling it to another company or
shutting it down altogether.

C. Hold:Holding involves maintaining the current position in the market without significant changes in
investment or divestment. This strategy is typically applied to products or business units with stable
market positions and moderate growth rates.

Example: A company may decide to hold onto its Cash Cow products because they continue to
generate significant cash flows with relatively low investment requirements. Rather than divesting or
heavily investing, the company maintains its current level of investment and continues to extract
profits from these products.
D. Build:Building involves investing resources to grow a product or business unit's market share in
high-growth markets. This strategy is typically applied to Stars (high market share, high growth rate)
or Question Marks (low market share, high growth rate) to potentially turn them into future Cash
Cows.

Example: A company might invest heavily in marketing, research, and development to capitalize on a
growing market segment with its Star products. By building market share in these high-growth
markets, the company aims to position these products as future Cash Cows.

CHARACTERISTICS OF SUCCESSFUL STRATEGIC PLANS

ongoing process

integrated throughout the organization

strategy should be made as per current business environment

strategy should be long term in nature

employees at all levels should input into strategy planning process

the strategy should be communicated clearly and often to everyone in the

organization

the success of strategy lies on the execution.

The five process of strategy planning process should done by a team.

Benefits of planning
1. objectives are clearly defined

2. plans are communicated in organization

3. employees are motivated

4. reduced risk

5. improves competitive advantage

6. changes accepted

7. promotes controlling

Limitation of planning
1. time consuming process

2. costly

3. rigidly

4. inaccurate
FORCASTING TECHNIQUES, REGRESSION ANALYSIS

REGRESSION ANALYSIS – it is the statistical technique to create a

mathematical equation used for estimation of relationship between a dependent
variable and one or more independent variable.

It is an impact of one variable over another variable

Dependent variable - response variable- it is a variable that changed because of

independent variable changes.

Independent variable – predictor variable – this variables are independent and

they stand alone. The other variables do not influence them.

Eg; employee salary dependent variable – no of hours worked independend

variable

Sales dependent –advertisement cost independent.

REGRESSION ANALYSIS

1. Simple linear regression 2. Multiple linear regressions

1. Simple linear regression:

It is estimation of relationship between one independent variable and dependent

variable.

y= a + b x

y= dependent(response) variable

a= constant coefficient

b= variable coefficient

x= independent variable

it is a type of time series method

Time series analysis

Use historical data

In this independent variable is time such as no of years, no of months

Blue dots anu trend pattern

Red dot line anu trend

line or regression line

4 TOOLS OF REGRESSION

Coefficient of co-relation (r) or (R)

 It measures the relationship between two variables like x and y.(positive

or negative)

 R is usually expressed by -1 and +1

 R= -1 perfect negative correlation ( 10% ads cost increased that

created 10% decrease in sales)

 R= +1 perfect positive correlation( 10% ads cost increased that

created 10% increase in sales)

 R= 0 no correlation (10% ads cost increased ordecreased no

effect in sales)

 R= close to +1 = +ve strong( positive strong relation)Eg: 0.989

 R= close to -1= -ve strong(negative strong relation) eg: -0.85

 R= closes to 0 = weak relationship

 Eg; -0.01 = -ve weak relation

 o 0.0032=+ve weak relation

Coefficient of determination (r2)

It measures the relationship between two variables in %

T- value or T –statistic - to find the how long the relation is their, greater than
2 means it is long relation

Standard error estimation – to find the error or difference

2.Multiple regression analysis- it is the estimation of relationship between one

dependent variable and one or more independent variable.

It is a type of casual forecasting.

y= a+ b 1 x1+b2x2+b3x3……..

y= predicted value

x 1,x2,x3= independent variable

b1,b2,b3,= variable coefficient

a= constand coefficient

Regression Benefits

 it is an important method for budgeting and cost accounting.

 It is a quantitative method.

 It helps to forecast and find relationship with variables

 It helps the small business to understand the variables that impact success

Limitation

 Validity depends on the range of data.

 It using historical data

 It is a lengthy and complicated procedure

 If the choice of independent variable is inappropriate the result can be misleading

 PROBABILITY
 it is a forecasting method

 probability is the measurement of likelihood that an event will occur

 it is used in forecasting to create expected value

two requirements of probability

1. probability value assigned for each possible outcomes must between 0% to

100%, it can be also stated in decimal values like 0.0 to 1.0.

2. the probability value assigned to all possible outcomes must be sum of 100%

RANDOM VARIABLE it is represented by X

 It is a numerical description of the outcome of an experiment

 Eg- if two coins throw the sample set =(HH,HT,TH,TT)

RANDOM VARIABLE

1.discrete random variable 2.continuous random variables

1. discrete random variable:

If the random variable is a number that can be count that is called discrete random
variable.

It should be whole number like1,2,3,4,……100,210,321

Eg;visitors to a website from 12 noon to 1pm

Sales in a year

2. continuous random variable

If the random variable is infinite number of possible value, it will be in decimal number

Eg; amount of sugar in orange

Rate of return on investment that could be 5.75%

PROBABILITY DISTRIBUTION
It is a table or equation that links the outcome of an experiment.

Discrete random variable can use historical data but continuous random variable
cannot use historical data because it is infinite

For continuous variable use specific interval. It is on a graph called probability density
function

METHODS OF ASSIGNING PROBABLE VALUES

Classical method – it is not used in business, it is used for dies (1/6*100=16.67%)and

coins(1/2*100=50%), it gives equal chance of happening

Relative frequency method- using the historical information the probability is

estimated. Eg; whether there will be rain tomorrow in erumad by using past
information of climate

Subjective method- based on personal judgements and intuitions the probability is

estimated. It is used when neither classical or relative frequency method can be used.

Eg ; a new product will be successful or the profitable

For the above three methods two requirements of probability must be met

Expected value – mean-weighted average()

It means the forecasted value, anticipated, budgeted value.

It is the average of all possible outcomes

Eg: 0 *10% =0

1*40%=.4

2*50%=1

Mean=1.4

Variance = 2= (X-)2

Standard deviation == X-

Eg:

x x- x-2 probability x-2

0 0-1.4=-1.4 1.96 .1 .196
1 1-1.4=-.4 .16 .4
2 2-1.4=.6 .36 .5 .18
Variance 2=.44 square root

Standard deviation = .44 =.66

Learning curves
 Learning curve refers to the concept that the efficiency increases as the amount of
experience a person in give task increases.

 As a result, the time and cost required for performing the task decreased by increasing
the no of performance of task

 Learning curve is used in planning, budgeting, forecasting and also to estimate the
labour cost when bidding a contract.

 The percentage of learning curve indicates how much improvement take place every
time as production level doubled.

 The learning curve percentage must be greater than50% and less than 100% -- reason

If LC = 100% no learning is there and no decrease in time taken for production when
doubling increases

If LC- less than 50% ;The total time take for preparing 2 unit and 1 unit< less than
time taken for preparing 1 unit

If LC=50%;The total time taken for preparing 2 unit and 1 unit = equal to the time
taken for preparing 1 unit

Calculation of learning curve percentage

LC = average time per unit after 2nd unit *100

average time per unit after1st unit production
EG=80/100*100=80%
 Learning rate =100%-80%=20%

production Cumulative Average time Cumulative Incremental Incremental

hourse/total time unit hours unit

Trial run 100 hrs 100 hrs 1 unit 100 hrs 1unit
1st 160 hrs 160/2=80 2 units 60 1unit
doubling
2 doubling 160+96=256hrs 256/4=64 4units 96 2units
3 doubling 51.2*8=409.6 409.6/8=51.2 8units 153.6(409.6- 4units
256)
4 doubling 40.96*16=655.36 51.2*80%=40.96 16units 655.36- 8 units
409.6=245.76

5 doubling 32.768*32=1048.576 40.96*80%=32.768 32 units 1048.576- 16 units

655.36=393.216

TWO LEARNING CURVE MODEL

1.INCREMENTAL UNIT TIME LEARNING MODEL

it is used to estimate the time needed to produce the last unit in quantity of units

2.CUMULATIVE AVERAGE TIME LEAERNING MODEL(cma usa exam)

Time required per unit decreased by a constant rate at each time the cumulative
production quantity doubles.

Cumulative means addition

It is used to calculate 3 things

 Estimate average time per unit for entire quantity produced

  Estimate total time for entire quantity produced

 Estimate total time for a certain block of units

Method-1

Total time= total time required for first unit/batch*(2* LC)n

LC= learning curve percentage in decimal
n= no of doubling of units produced to date
average time per unit =total time
no of units

method 2
average time per unit= average time of 1 unit* LCn
total time=average time per unit*no of units

Benefits of learning curve

 it can be used in development of production and labor budget
when changes such as new products

 it can used for effective evaluation of managers

 it decreases labour cost

 it is used in lifecycle costing and bidding ,it gives more

competitive bidding on projects

 it is helpful in capital budgeting, make or buy decision, cost

volume profit analysis
Limitation

 it is appropriate for labour intensive operation

 learning rate is always a constant percentage

 company cannot accurately forecast the improvement from

learning

 company may or may not realize efficiency from learning

Budgeting concept
Budget is prepared in advance of the period

It is based on forecast and assumption

It is a planning tool

It is a guideline to follow to achieve the company’s planned goals and objectives

Budgeting process is inseparable from planning process

It is also called annual profit plan

Relationship among planning, budgeting, and

performance evaluation
 Planning- involves setting goals, objectives, and
strategies for future, considering both long and short
term perceptive and identifying business
opportunities and risk.

 Budgeting- involves translating management plans to

quantitative terms that is financial terms
  Feedback loop – budget provides feedback to
planning process, allowing revision to plans and
strategies based on quantifies effect. It provides an
alignment between plans, budget and organizational
goals

 Performance evaluation- compares the actual result

with budget to identify the variances, take corrective
action if necessary. It is a control tool, helping the
management to measure the progress towards its
goals and objectives.

 Adaptation- changes in external environment and

significant variances may necessitate revision for
plans, goals, operation, budget, strategies to align
with organisational objectives and addressing
emerging challenges.

 Learning for future plan- lessons learned from

variance Used for future planning process, allowing
organization to adapt changes and improve decision
making for future.

ADVANGES OF BUDGETS
 1. Promote coordination and communication- sales manager should
communicate to production manager about the sales targets

2. Provide framework for measuring performance- budget is like

benchmark, the managers will set low standards so there must be
assessment of industry standard and past performance.

3. Provide motivation to managers and employees- motivates employees

to achieve the goals

4. Promote efficient allocation of organizational resources- allocating

resources as per budget, constraint

Decision under constraint = contribution margin/contrain

5. Provide means for controlling operations- performance analysis

6. Provide means to check on progress- variance

TIME FREMES FOR BUDGET

 Budget is for 1 year - fiscal year of company

 budget period and fiscal year is same it easy for
variance reporting
 variance is a comparison between actual and
planned result
 budget can be prepared in continuous basis that
is called rolling budget or continuous budget
 it always include a 12 months
 eg; in jan 2023 it consists of feb 2023to jan 2024
budget
in feb 2023 it contain of march 2023 to feb
2024budget.

Methods of developing the budget

1.Participative budget- bottom up- lower level to higher level
Negotiation between lower level managers to higher level

Benefits Limitation
1. Good device for communication 1. Budgetary slack- budget targets
that are easily achievable
2. Employee commitment to fulfill 2. Corporate strategic plan into
goals budget make more difficult
bottom up process
3. It is achievable because it is 3. Participative budget are more
developed by employees who time consuming than
are responsible for achieving. authoritative budget.
4. It motivates employees

2. Authoritative budget - top down- top level to lower level. It is

imposed up on lower level

benefits limitation
1. Budgetary slack is not a 1. Employees shows less
problem commitment
2. Achievement of strategic plan 2. Budget cannot be achivable
3. Senior managers have Better 3. Communication is reduced with
control over decision making senior and lower level
managenent
4. More rapidly and greater 4. Morale problems, resentment,
flexibility than participative. and resistence to change
3. Consultative budget– it is the combination of authoritative and
participative budgets. Senior management asks inputs from lower level
managers

No joint decision making or negotiation involved.

Benefit Limitation
1. Final decision is by senior 1. Time required to develop is
management no budgetary more than authoritative budget
slacking
2. Time required to develop is less 2. If the input of employees is not
than participative budget considered no input for future
3. Employees commitment of budget
employees is there because their
input is in the final budget.

Who should participate in the budgeting process

Support of top management is very important for developing and
administrating the budget

Budgeting committee gives guidelines based on strategies and economic

assumptions

Department head prepare initial budget and sent it to senior management

Senior management review initial consolidated and individual budget, then

the budget sent back to departments to revision

After several round of negotiation budget is finalised

So both top and lower level management should participate in budget

preparation process

Steps in budget development process

1. Budget guidelines are set and communicated- it is done by budgeting

committee or senior management.
 2. Initial budgets are prepared by responsibility center managers

3. Negotiation, review and approval

Negotiation is the most time consuming process

Individual budget consolidated into master budget it consists of balance

sheet, income statement, statement of cash flow

Master budget is then kept for approval, after review, doing

negotiations and revision. it is approved by budgeting committee,
senior management, CEO and then submit for the approval BOD

4. REVISION- after adopting the profit plan it should able to adapt

changes, new information about internal and external factors make
revision in profit plan

Revision is done when the changes not controlled by the

responsibility center or by the organisation

5. Reporting on variance- the comparison between actual result and

planed result is called variance analysis.

6. Use of variance reporting – use it for identifying the problem areas

and adjust the problem

Eg; production variance –production manager should check and

investigate the material variance

Inferior material- purchasing manager

Characteristics of successful budgeting process

1. Communication is vital

2. Top-level management attitude towards the budget

3. Process must have the support of all level of management

4. It should be motivating device

5. It should be a planning and coordinating tool that helps in doing the

job better

6. It should not be rigid

 7. It should be flexible

8. Cost management efforts should linked to budget

9. Corporate strategy should linked to budget.

10. Budget complexity and budget cycle time should reduced

11. Significant time lead

Budgetary slacking- it is fraud done by the responsibility managers, when

they are evaluated by the achievement of planed budget, they develop only
easily attainable target in budget

The difference between budgeted amount and managers actually expected

amount

Goal congruence- alignment of individual department goals with

organisation goals

To reduce budgetary slack

1. Budget should use as planning and controlling tool not as performance

evaluation of managers

2. Reward manager as per accuracy of forecast used in budgets

3. use other tools to evaluate the performance of manager like external

benchmarking with the budget

4. Top management should educate lower management about the

importance of accurate budget.

Responsibility centers and controllable cost

 Control is done by responsibility centers, so responsibility center

managers should do budget the cost that they can control.

 Controllable cost(variable and direct cost) is cost that the manager

has the authority to take decision- responsibility center managers
  Non controllable cost (fixed and indirect cost)is controllable by top
level / higher managers eg; salary and bonus, indirect cost- rent,
salary, depreciation- great risk to company

ESTABLISHING STANDARDS
Standard cost are estimated manufacturing cost for direct material, direct
labour, and manufacturing overhead are predetermined and estimated in
budget

Standard cost, estimated cost, planned cost are different terms used for the
standard cost

1. Standard input- quantity of materials, labours of input

2. Standard price- price the company expect to pay for one unit of input

3. Standard cost- cost of producing one unit of output

Standard cost = standard input * standard price

 Standard direct material cost per unit

 Standard direct labour cost per unit

Standard cost are the fundamental element of budget processing.

Manufacturing overheads is by predetermined cost per unit= budgeted

overhead cost/ budgeted activity level

Static budget is a budget prepared using standard cost per unit and
planned level of activity.

Flexible budget is the budget prepared by the standard cost per unit and
the actual level of activity

SETTING STANDARDS

Activity analysis – direct interview, direct study the activity- time

consuming and expensive
 Historical data- not expensive, using past data standards are set, using
past information can result incorporate continuous improvement cannot
gained in the competitive environment

Target costing-cost is based on targeted profit margin.

Strategic decision:- long term planning , kaizen a Japanese word

continuous improvement

Benchmarking- practice of competitor, other firms, division of a

company standards are taken.

Who should set standard-top and lower level or a combination

Authoritative standard setting- top sets and given to down for execution

Benefit Limitation
 Factors affecting the cost get  No motivation
proper consideration
 Managements expectation  Less employee acceptance
reflected in the standard cost
 More effectively the top 
management set the
standards
Participative standard setting- lower level employees are involved in the
standard setting negotiation

Benefit Limitation
 More employee acceptance  Not supporting the firms
strategic goals and
operational objectives
Consultative standard setting- senior management ask the lower level
employees recommendation

Benefits Limitation
Factors affecting standard are More time need than authoritative
considered
Achievement of planned goals and Not accepting by employees if their
objectives input is not included, they felt
Less time required for setting unreasonable.
standards than participative
Accepting by employees
Establishing standard for direct material
1. Quality- of material
2. Quantity per unit of output
3. Price per unit of material

Establishing standard for direct labour

 Based on the nature of manufacturing , type of work, skills of
employees

 Quantity standard of direct labour – no of workers

 Price standard of direct labour or wage per hour

Establishing the manufacturing overhead

standard
Variable moh fixed moh
Indirect material, indirect labour, other indirect
cost they cannot be directly traced from the
product.
Predetermined rate/ standard rate/ overhead rate
per unit = budgeted overhead cost/
Budgeted activity level

CHOOSING BUDGETED OUTPUT OR

ACTIVITY LEVEL;
Supply denominator level concept;
 1. Theoretical or ideal capacity – not achieved in long run- no down time, no
ideal time.

2. Practical capacity or currently attainable

Demand denominator level capacity

1. Normal capacity(average level)- achieved in long run

2. Master budget capacity or expected capacity

BUDGETING METHODOLOGIES
 MASTER BUDGET- it is created using both financial and non-financial
assumptions

 It is the final point (culmination) and goal of budgeting process.

 It express operating and financial plans for full year that is fiscal year.

 It is also called comprehensive budget.

 It is a full set of financial statement such as budgeted income statement,

budgeted balance sheet, and budgeted statement of cash flow

 The projected financial statement is called pro forma financial statement.

 Master budget is not pro forma financial statement,The forecasted financial

statement for a specific purpose ‘what if’

 Pro forma financial statement is not used in variance reporting like master
budget and flexible budget

 Master budget is a static budget- static budget is budget that is prepared for a
planned activity level. Activity level is projected before the period begins

 Activity level= no of units produced, or machine

hour or labour hour.
 Master budget is the result of both operating result and financial
decision

 Operating decision= best use of limited resources

 Financial decision= fund for obtaining the resources the company

needed
 Master budget
Operational budget financial budget

 Operational budgets are used to identify the resources needed for the
planned activity during a budgeted period such as sales, services,
production, purchases, marketing and R&D

 Operating budget is for individual units are compiled into budgeted

income statement.

 Financial budgets are used to identify the fund for budgeted

operation

 Financial budget includes budgeted balance sheet, budgeted

statement of cash flow. Cash budget and capital expenditure budget

 Static budget and flexible budget

 Master budget is a static budget because it uses the budgeted activity

level- volume variance are expected in it

 Flexible budget is a budget that uses variable revenues and cost

planned in master budget and adjust the amount in the actual sales
volume

 Flexible budget are prepared after actual level of activity is known.

 Flexible budget is prepared for actual level of activity using all of

standard variable coat and fixed cost as determined in the beginning
of the year.

 Flexible budget is different from master budget because it focused on

variance that caused by other than differences in volume(other
factors)- that is variances caused by production or administration
problems

 Fixed cost will be always same in the flexible budget

  Flexible cost and standard costing system go togather. One is
meaning less without the other

 The flexible budget can be prepared at the end of the period.

 Benefits  Limitation
 Enables management to focus  If sales decline flexible budget
on variance other than is not useful
differences in volume
  Flexible budgeting needs with
a standard costing. One is
meaning less without the other

 Determining the variances to be investigated

 Magnitude of the variance- if variance is material 80% it should

investigate. If variance is immaterial no investigation.

 The trend of the variance over time – if unfavourable variance

ongoing for several months it should be investigated

 Likelihood that an investigation will eliminate the variance in future

PROJECT BUDGET
 it is a budget for a specific project, time frame as per the project depending on
the length of the project.

 PB is different from static and flexible budget because they cover a distinct time
spam but Project budget have its on time spam

 Eg pb- construction of new building

 A long term project budget for introducing a new product is called life cycle
budget

 Benefits  limitation
 Project budget focuses  Special commitment is need for
management attention on cash project budgets
inflow and outflow from the project
 Project budget forster corporation  Project budget should be integrated
and coordination among various into master budget in the relavent
 responsibility centers that will be period
affected by the project
 Project budget has its own time
span
 Project budget help management
to plan for the level of resources
that will be needed
 Project budget determine in
advance to undertake a project or
not

ACTIVITY BASED BUDGETING – similar to activity based costing

 ABB makes clear relationship between activities performed and output

 ABB is prepared based on the budgeted overhead cost to perform budgeted

activity

 If ABC is used as costing system then the budgeting should be in ABB for
enabling continuous improvement and also to make comparisons between actual
result and budgeted results.

 Benefit  Limitation
 Cost reduction in production and  Time consuming
elimination of wasteful activity
 Helps managers in resource  Costly
allocation
 Defines clear relationship between  Abb should be used in connection
resource consumption cost and with abc
output
 Abb helps in identifying budgetary
slack
 Makes clear relationship between
activities performed and output

ZERO BASED BUDGET

 It is prepared without any reference or use of current periods budget or result of
current period.

 Every planned activity must be justified with cost benefit analysis

 Alternative to reviewing all company activities it can use zero based budgets on a
rotating basis
  Benefits  Limitation
 all activities department plans are  Time consuming
identified and justified
 Justify the activities by prioritizing  costly
them through ranking as per cost
benefit analysis
 Manager must examine every single  High manpower required, lack of
expenditure and activity within the expertise
department  Impossible amount of work to
review all companies activity

INCREMENTAL BUDGET
 It is prepared using current periods budget and actual result. It focus only on the
changes in the coming period so it is cost effective and it requires less time

 Benefits  Limitation
 Managers can operate it in  Based on historical data
Consistent base
 Coordination  No incentives to new ideas
 Simple to operate and easy to under  No incentives to cost reduction
stand  Working will continue in same way
 Budget is stable and changes is  Budgetary slack chances
gradual

Continuous or rolling budget

 Continuous budget is also called as rolling budget

 Eg; one year budget will be prepared at end of every month(12 month plan will
be set)

BUDGETING CYCLE
 Planning

continous
monitorin
improvem
g
ent

investigati
revision
on

 Planning ; managers use past data and future expectation to develop master
budget or annual profit plan

 Monitoring ; actual results are compared with budgeted results regularly,

usually monthly or quarterly

 Investigation ; managerial accounts assist managers in investigating the variance

from the plan and operational changes are made as needed.

 Revision; if external factors arises that affect budgets achievability, the budget
may need to be revised.

 Continuous improvement ; accountants and managers monitors’ market

feedback and external condition throughout the period to plan for the next
budget cycle, making adjustment based on actual results and based on changes
in the business environment.

Development of annual profit plan or master budget

 Involving lower level management is called participative budget or bottom up
budget but the upper management still needs to be involved in planning and
budgeting process. Management needs to set the goals, establish the priorities
and provide the necessary support to make sure the process is completed
correctly

 Master budget-
 Operating budget- it includes the budgeted income statement and all the budgets
that support it.

 Operational budget is budgeted income statement and other budgets feed into it

Operational budgets

Sales budget Budgeted sales revenue = budget units to be sold *

budgeted selling price

Production budget Finished goods units to be produced = sales units

+ending finished goods units =total units required – beginning finished
goods

Direct material usage budget DM needed for production = no of units

produced * per unit DM required

Direct material purchases budget =direct material required +ending

DM inventory= total DM inventory- beginning direct material=DM
purchases budget.
Direct labour usage budget Total direct labour hours required =
expected production *DL per hour
Budgeted direct labour usage = total DL hours required * DL cost per
unit

Manufacturing overhead costs budget Standard rate or

predetermined rate= total budgeted MOHC/allocation base LH or MH
FMOH standard rate = total budgeted FMOHC/BASE LH or MH
VMOH standard rate = total budgeted VOHC/ base MH or LH

Ending inventory budget Ending finished goods budget = production +

beginning finished goods- sales
Ending direct material budget = DM purchases + beginning direct
material – DM used for production

Cost of goods manufacturing budget Budgeted direct material used +

budgeted direct labour used +budgeted manufacturing overheads
applied = budgeted total manufacturing cost +budgeted beginning
work-in- process inventory – ending WIP inventory.

Cost of goods sold budget COGS = BCOGM + beginning finished

goods inventory = budgeted goods available for sale-ending finished
goods inventory
COGS = no of units sold *production cost per unit
Production cost per unit= dm+dl+moh

Non-manufacturing budget
 Budgeted income statement

Budgeted revenue
-budgeted COGS
= budgeted GP
-Budgeted operating expenses
=budgeted operating income
-budgeted non operating loss/gain
=budgeted earnings before interest and tax
-budgeted interest
=budgeted Earnings before tax
-budgeted tax
=budgeted net income

Financial budget
It includes;
1. Capital expenditure budget
2. Cash budget
3. Budgeted income statement
4. Budgeted statement of cash flow
1. Sales budget
 First operating budget to be prepared is always the sales budget because it it is
the driver behind all the budget. Prepared by sales persons. It is the most
difficult budget to produce because it relies upon information and estimation
outside direct control of company.

 Sales budget shows the expected sales in units of each product and each products
expected selling price. It is based on forecasted sales level, short term and long
term objective and production capacity.

 Sales budget is too optimistic (high)- production and inventory is high- chance
for cash shortfall(excess of cash outflow over cash inflow)

 Sales budget is too low- production and inventory is low- sales may lost because
lack of products to sell.

 Development of sales budget incorporate forecasted;

 Sales volume

 Sales mix
  Selling price

 In preparing sales budget the level of credit sales and collection of credit sales
(cash budget) should be considered.

 Budgeted sales revenue = budgeted units to be sold * budgeted selling price

2. production budget – how many units need to be produced

 Production budget incorporates budgeted sales, company’s production capacity
and inventory objectives to determine how many units to be produced.

 Production budget should include any new capital projects planned to begin
production during the period which should be available from sales budget.

 If finished goods inventory should increase – production units should be

increased than planned for sales

 If finished goods inventory should decrease – produce few units than planned for
sales

 Production budget also includes when the units will be produce

 Production budget is used as a foundation for development of 4 budgets

Production budget Foundation for All the 4 budgets feeded into

development of
Direct material usage budget Ending inventory budget
Direct material purchases budget Budgeted cost of goods manufactured
Direct labour usage budget Budgeted cost of goods sold
Manufacturing overhead costs budget
Finished goods units to be produced = sales units +ending finished goods units
=total units required to produce – beginning finished goods

 If Production level changes the direct material and direct labour changes , as
direct labour changes the indirect material and indirect labour changes both
are manufactured overhead.

 Indirect materials are materials used in the manufacturing process but the
cost is not directly traceable from the product. Eg; screws, glues, cleaning
chemicals

 Indirect labours are labours that are not directly traceable to the specific
product or the labours do not have direct contact with the products. Eg;
wages of janitor.

 If production level changes will be needed for other budgets because the
connected with each other
Direct material usage budget-quantity of direct material required
(DM needed for production, DM required for production)
 The number units to be produced taken from production budget is used to
calculate direct material required for calculation

 Direct material usage budget is affected to direct material purchase budget

 DM usage budget also affect new capital projects planned to begin during the
period.

 Efficiency of the employees converts them in to finished products

 Bill of material – it is used in development of DM usage budget. it specifies which

DM should use and how much should use in manufacturing the product. In
which sequence it should use, in what department each process to be completed.

DM needed for production = no of units produced * per unit DM required

Direct material purchase budget

 After completing DM usage budget the purchase department can prepare DM
purchase budget.

 DM purchases budget will also be affected by new capital project that is planned
to begin during the period.

DM needed for production + ending DM inventory= total required material – beginning

DM inventory

Direct labour usage budget

DL usage budget is developed using direct labour standards that is time allowed per
unit of output and coat per hour of direct labour.

Standard cost per hour include wages and other employee benefits that includes health
insurance premium, state unemployment tax, pension, social security, Medicare.

Other employee benefits are shown in employee benefit statement

Total direct labour hours required = expected units production *DL per hour

Budgeted direct labour usage = total DL hours required * DL cost per unit

Manufacturing overhead cost budget

Manufacturing overhead coat is allocated or applied or attached to units produced
during the period as per predetermined rate

COSTING ABSORPTION COSTING VRIABLE COSTING

PRODUCT COST = DM+DL+VMOL+ FMOH = DM+DL+VMOH
PERIOD COST =VARIABLE+FIXED SELLING =FMOH+ VS&A+FS&A
& ADMINISTRATION
Under absorption cost that is approved by GAAP, MOHC is a product cost under
absorption costing

Under traditional method of applying MOHC to units produced, either Machine hour
or labour hour is used as basis for allocation

BTVOC and BTFOC determined

Standard rate or predetermined rate= total budgeted MOHC/allocation base LH or MH

FMOH standard rate = total budgeted FMOHC/BASE LH or MH

VMOH standard rate = total budgeted VOHC/ base MH or LH

Ending inventory budget

 Ending inventory budget consists of both finished goods inventory and direct
material inventory

Ending finished goods budget = production + beginning finished goods- sales

Ending direct material budget = DM purchases + beginning direct material – DM used

for production

Cost of goods manufactured budgets

COGM is cost of completing the manufacturing process of product. For planning
purpose assumption can be made that WIP will not change during the period.
Assuming that Beginning and ending WIP may be same amount

Budgeted direct material used + budgeted direct labour used +budgeted manufacturing
overheads applied = budgeted total manufacturing cost +budgeted beginning work-in-
process inventory – ending WIP inventory.= COGM

Budgeted DM used = beginning DM +DM purchases + transportation- ending DM

inventory – PURCHASES return

COST OF GOODS SOLD BUDGET

After completing budgeted cost of goods manufactured, the next is developing budgeted
cost of goods sold
COGS = BCOGM + beginning finished goods inventory = budgeted goods available for
sale-ending finished goods inventory

COGS = no of units sold *production cost per unit

Production cost per unit= dm+dl+moh

NON-MANUFACTURING BUDGETS
Non-manufacturing budgets are budget for various areas of the company that are not
involved in production. They include,

 Research and development budget

 Selling , marketing, distribution budget - sales supervisor salary, sales

commission, selling expenses( travelling and entertainment),
advertisement and promotional expense, shipping out expense,
telephone and wireless, office supplies, depreciation on furniture and
equipment’s used by sales personnel’s

 Administrative and general budget – salary and wages for management

staff (accounting, legal, IT, HR) travel and entertainment, depreciation
on office furniture and equipment used by management personnel’s,
telephone charges, audit fees, shipping out expenses, office supplies,
insurance.

 Budget for other expenses or source of revenue

The budget should separate the cost into variable and fixed cost because at least in short
term fixed cost cannot change and variable cost can change

BUDGETED INCOME STATEMENT

 After completing various budgets a first draft of budgeted income statement can
be developed and used for evaluating expected net income for the period.

 The evaluation is done using Earning per share, industry average and price
earning ratio.

 Budget income statement becomes a part of the budgeted balance sheet through
it effect on retained earnings in equity section
Budgeted revenue
-budgeted COGS
= budgeted GP
-Budgeted operating expenses
=budgeted operating income
-budgeted non operating loss/gain
=budgeted earnings before interest and tax
-budgeted interest
=budgeted Earnings before tax
-budgeted tax
=budgeted net income

FINANCIAL BUDGET
1. CAPITAL EXPENDITURE BUDGET
Capital expenditure budget is not a part of annual budget development process but it is
very important to develop annual budget.

It is budget for long term capital expenditure such as property, plant and equipment.

Characteristics of capital expenditure budget

It is large and expensive

Required advance planning for financing

Time span is longer than annual budget

So it is prepared for years in advance and reviewed on annual basis

Capital expenditure budget should be included in budgeted process for theyear.

Capital expenditure will affect the budgeted balance sheet as increase in fixed asset,
accounts receivables, inventory and accounts payable

They will affect budgeted income statement as income expected and depreciation on
new equipment

Also affect cash so to budgeted statement of cash flow and cash budget

Budgeted balance sheet Budgeted income statement and statement

of cash flow
It includes investments and financing of Net income and cash flows
capital project
Cash budget- (cash management, cash flow, working capital
budget)
It uses the information from other budget and it is the last budget prepared before
preparing budgeted financial statement

It is very important budget

Cash budget tracks the inflow (,receipt)s and outflow (disbursement) of cash on daily,
weekly, or monthly basis

It is similar but not exact same as budgeted statement of cash flows

Cash budget Budgeted statement of cash flow

Segregated according to receipts and Segregated according to operating,
payments investing, financing cash flows
It is prepared before budgeted financial It is prepared after budgeted financial
statements statements

If cash budget is accurate the company can predict the cash shortfalls and do necessary
things like borrowing loans or selling shares of company. And also for plan for excess
cash.

Preparing cash budget for seasonal business is very important on monthly basis.

Cash budget does not include any noncash items like depreciation, allowance for debt

Beginning cash balance+ cash receipts- cash disbursement= total ending cash balance

Budgeted balance sheet

 It contains all line items in a normal balance sheet.

Budgeted statement of cash flow

 It contains all line items in a normal statement of cash flow.

 Statement of cash flow is much detail and comprehensive than cash budget

 It is segregated as operating, investing, financing activity.

 It is the estimation of all cash receipts and cash payments expected during a time
period.
Master budget financial statement
After completing operating and financial budgets it is compiled into budgeted financial
statement such as budgeted income statement, budgeted balance sheet and budgeted
statement of cash flow.

Master budget is a document that it is summary of operating and financial plans for
period

It helps to find the issues and solve the problem before they are actually develops. eg ;,
long term debt requires company to kept certain standards such as minimum current
ratio in the financial statement this requirements is covenants. If it is not find it can
lead to bankruptcy .

On-going budgetary reporting

After determining and approving the budget it used for comparing actual result and
budgeted result , the difference in it is called variance. Variance reporting is very
important.

If the company is doing better than budget it is a favourable variance.

If the opposite is happening, it is unfavourable variance.

Significant and unexpected variances should be investigated . it is the part of control

loop, by which the activities of company are controlled.

Steps in control loop

 Establish the budget or standard

 Measure the actual performance

 Analyse and compare actual result with budgeted result

 Investigate unexpected variance

 Devise and implement necessary corrective action

 Review and revise standards and budget

Pro forma financial statement – only used internally, (what if)
The term pro forma means some kind of information that is usually financial
statement.

They are financial statements with projected amounts expected if a particular course of
action is followed.

Pro forma financial statements are not same as master budget financial statements

They prepared for a company or for a division that affect the change ,not for every
division

It is prepared after formal budget is adopted. Because an activity is not foreseen before
the adoption of formal budget

It contains pro forma income statement, pro forma statement financial position, pro
forma statement of cash flow

Pro forma is a top level planning that take place with in organisation, as part of
planning process.

Pro forma financial statements used in five general purpose

1. Comparing the anticipated performance with targeted performance of a
company

2. Pro forma financial statement is used for analysing what if the effect of change
on proposed plan.

3. They used to determine in advance the future financing needs of the company

4. They are used to forecast capital requirements for plans in order to select best
plans that maximize shareholders value.

5. Pro forma financial statement determines that the company is following

(compliance with) the covenants on its long term debt .

Sales forecasting
 Future sale will be affected by the events occurring in the future not the events
happened in the past

 Their for the companys sales will depending on future state of domestic and
global economy, future share of market,, growth of market, product line, new
products, marketing efforts,
  An accurate sales forecast is critical.

 The company should forecast its sales by best judgements with future and
historical information not only depend on regression and other forecasting
techniques.

Forecasting future financing needs

 As a result of sales increased company needs additional funds,

 More inventory need for supporting increased sales

 Accounts receivable will increase to sale increased

 For increased sales additional equipment’s is needed it increases assets, for

expected increase in asset can be funded in three ways

1 spontaneous liability increased – as result of assets increased automatically liability

increased, if inventory purchased the accounts payable increased.

2.Fund from profit of additional sales it increases retained earnings. The profit that are
not used for paying dividends increases retained earnings.

3.The fund beyond spontaneous liability and fund from profit of additional sales are
provided through external financing by bank loan and issue of new shares.

Amount of external financing that will be required depending up

on several factors
1. rapid rate of sales growth- sales increases- external fund is needed

2. capital intensity ration= asset that is increased with sales/ sales

If CIR is higher, more asset is needed, greater need of external fund.

If CIR is lower no need of external fund

3. spontaneous liabilities to sales ratio( AP and accrued liability) – if this ratio is high no
need of external fund, if ratio is lower the company needs external funds.

4. net profit margin- if net profit margin is higher

Lower external fund needed. If NPM is low company requires higher amount of
external fund.

5. retention ratio – if net income is not payed as dividends retained earnings of

company is high less external fund. If net income payed as dividend retained earnings
of a company is low it needs higher amount of external fund.
Long term forecasting Multiple years more than one year-FFSM
Medium term forecasting One year- forecasted financial statements.
Short term forecasting 30 days

Forecasted financial statement method

 It is method used for forecasting additional funds needed best for medium and
long term forcasting

 It is most flexible method

 FFSM is used for forecasting future financing needs involves preparation of pro
forma financial statements including income statement, balance sheet, statement
of cash flow

Forecasts are begins with

1. forecasting of sales

2. forecasting of assets- inventory, FA,AR

3. forecasting of spontaneous liability – AP, accrued liability

4. forecasting retained earning from profit

5.forcasting sources of external funds like bank loan and issue of shares(debt and
equity)

The difference between Total asset and liability +equity is the additional fund needed
for future which is a plugged figure on balance sheet.

FFS method forecasts entire pro forma income statement and balance sheet then they
are used for preparing pro forma statement of cash flow.