A budget is the monetary or/and quantitative expansion of business plans and policies to be pursued in the future period of time. The term budgeting is used for preparing budgets and other procedures for planning, co-ordination and control of business enterprise. So a budget is a pre- determined statement of management policy during a given period which provides a standard for comparison with the results actually achieved.
Types of Budgets
Budgets are classified according to their nature and purpose. Some of their types are given as follows:
- Sales Budget: A sales budget is an estimate of expected sales during a budget period. A sales budget is known as a nerve centre or backbone of the enterprise. The degree of accuracy with which sales are estimated will determine the practicability of operating budgets. A sales budget is the starting point on which other budgets are also based.”
A sales budget lays down potential sales figures in value as well as in quantity. It lays down a comprehensive plan and programme for sales department. The sales manager is made responsible for preparing sales budget. He uses all possible information available from internal and external sources. The following factors are taken into account while preparing sales budget:
(a) Past sales figures (b) Availability of raw materials.
(c) Availability of finances (b) Assessment and reports by salesmen
(e) Seasonal fluctuations (f) Plant capacity.
- Selling and Distribution Cost Budget: Selling and distribution cost budget forecasts the cost of selling and distributing the products. This budget depends upon the sales budget. These expenses will vary with the expected sales figures during the period. These expenses may be estimates per unit of sales or some percentage on sales, etc. The persons incharge of sales and distribution should sit together to prepare this budget.
- Production Budget: The production budget is prepared in relation to the sales budget. Whatever is to be sold should be produced in time so that it is delivered to the customer. It is a forecast of the production for the budget period. Production budget is prepared for the number of units to be produced and also for the cost to be incurred on materials, labour and factory overheads Two impotant considerations involved in the preparation of production budget are:
(a) What is to be produced?
(b) When is it to be produced?
The preparation of production budget involves the following stages:
(i) Consideration of plant capacity
(ii) Production planning
(ii) Stock quantity to be held
(iv) Sales budget figures.
- Cost of Production Budget: The production budget determines the number of units to be produced. When these units are converted into monetary terms, it becomes a cost of production budget. The cost of production budget is the total amount to be spent on producing the units stipulated in the production budget. The physical units are broken into elements, i.e, material, quantity, labour, time and manufacturing overheads. The material cost, labour cost and overheads required for manufacturing are totalled together to make it a cost of production budget.
- Materials Budget: The materials budget is concerned with determining the quantity of raw materials required for production. The programme for purchasing raw materials is adjusted according to the production budget. The materials are purchased as per the requirements of production department. The requirements of materials are determined productwise. The rate of consumption of raw materials is also determined. The number of units to be produced multiplied by the rate of consumption (raw materials required for producing one unit) will give the figure of materials required. The stocks of materials required in hand at any time are added to the materials required for production. The opening stock of materials is deducted from the figures determined as above. In this way, the requirements of materials in units will be determined. The units of materials required multiplied by the rate per unit of raw materials will give us a figure of material cost. The raw materials budget will serve the following purposes:
(i) The Purchase Department will be able to plan the purchase of raw materials at different times.
(ii) It will enable the fixation of minimum stock level, maximum stock level and re-ordering level.
(iii) The raw materials purchase budget will be determined.
(iv) The budgeted cost of raw materials will be determined.
- Direct Labour Budget: The labour required for production may be classified into direct and indirect labour. The labour required for manufacturing the product is known as direct labour. The labour which cannot be specific with production is called indirect labour. Though two budgets may be prepared for direct and indirect labour but from costing point of view only direct labour budget is prepared because indirect labour is made a part of manufacturing overheads.
The labour content of each item is determined in terms of grades of workers required as per production budget. The labour time needed for each job, process and operation is determined with the help of time and motion study. The rates of pay including all allowances are multiplied by labour time for calculating labour cost. If labour incentive schemes are in operation then labour rates should be suitably increased. If piece-rate system for paying wages is in operation then labour cost will be calculated by multiplying budgeted units by the labour rate per unit.
Labour budget is useful for anticipating labour time required for production. It also helps in determining the finances required for labour. The personnel department is also able to make arrangements for recruitment of workers, etc.
- Manufacturing Overhead Cost Budget: The manufacturing overheads cost is that part of works cost which arises from indirect labour, indirect materials, overheads and other factory expenses Manufacturing cost is excluded from direct materials and direct labour. A manufacturing overheads cost may be classified into fixed cost, variable cost and semi-variable cost. The fixed works overheads cost remains constant irrespective of output and it is estimated on the basis of past experience. The variable works overheads cost is determined per unit of cost and it is calculated by multiplying the rate per unit by the budgeted output.
The semi-variable cost increases with the increase in output. But the rate per unit decreases with the increase in input. While budgeting manufacturing overheads cost, management must consider the level of activity to be attained in future so that the expenses are estimated accurately.
8. Cash Budget: A cash budget is an estimate of cash receipts and disbursements during a future period of time. It precedes various other budgets like materials budget, labour budget, overheads cost budget, capital expenditure budget and research and development budget. It is an analysis of flow of cash in a business over a future short or long period of time. It is a forecast of expected cash intake and outlay.
The cash receipts from various sources are anticipated. The estimated cash collections from sales, debts, bills receivables, interests, dividends and other incomes and sales of investments and other assets will be taken into account. The amounts to be spent on purchase of materials, payments to creditors and meeting various other revenue and capital expenditure needs should be considered.
Cash forecasts will include all possible sources from which cash will be received and the channels in which payments are to be made so that a consolidated cash position is determined. The cash budget should be co-ordinated with other activities of the business. The functional budgets may be adjusted according to the cash budget. The available funds should be fruitfully used and the concern should not suffer for want of funds.
ZERO-BASE BUDGETING (ZBB)
Zero-base budgeting is the latest technique of budgeting and it has an increased use as managerial tool. This technique was first used in America in 1962. The former President of America, Jimmy Carter used this technique when he was the Governor of Georgia for controlling state expenditure.
As the name suggests it is starting from a ‘scratch’. The normal technique of budgeting is to use previous year’s Cost Levels as a base for preparing this year’s budget. This method carries previous year’s inefficiencies to the present year because we take last year as a guide and decide “what is to be done this year when this much was the performance of the last year. In zero-base budgeting every year is taken as new year and previous year is not taken as a base. The budget for this year will have to be justified according to present situation.
Zero is taken as a base and likely future activities are decided according to the present situations. In the words of Peter A. Pyher, “A planning and budgeting process which requires each manager to justify his entire budget request in detail from scratch (hence zero-base) and shifts the burden of proof to each manager to justify why he should spend money at all. The approach requires that all activities be analysed in decision packages’ which are evaluated by systematic analysis and ranked in order of importance.”
In zero-base budgeting a manager is to justify why he wants to spend. The preference of spending on various activities will depend upon their justification and priority for spending will be drawn. It will have to be proved that an activity is essential and the amounts asked for are really reasonable taking into account the volume of activity.