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Topic 5 - Budgeting

This unit is divided into the following topics:

1. Why Budgets Matter

2. How and Why Managers Use Budgets

3. Operating Budgets

4. Financial Budgets

5. Flexible Budgets

6. How Budgets are used to Evaluate Goals

• In day-to-day conversations, budgets are associated with financial constraints.

• Expressions like:

• “this purchase is beyond my budget”

• “I just love that item, but my budget does not allow me to buy that”

• “I don’t have a budget for that”.

• However, if we take a step back & drill deeper, we recognize that both personally & organizationally, the budget or budgeting is an important exercise to ensure that our resources are being spent wisely, & unplanned expenditure is minimized.

• In this unit, we look at several aspects of budgets and budgeting, and how organizations can use budgeting tools to ensure optimization of resources.

• Key word in Topic 5 is budgets

• Budgets fit in Controlling aspect of POLC Model

1: Why Budgets Matter?

• By way of a simple introduction a budget is a spending

plan.

• It helps you balance your expenses with your income

(see exhibit below) over a future period of time.

• If you spend(expenses) more than you make(income),

you will have a problem and slowly sink deeper into debt every year.

• Therefore, budgeting is the process of creating a plan to spend your money. A budget allows you to determine

in advance whether you will have enough money to do

the things you need to or like to do.

• If you don't have enough money to do everything you would like to do, then you can use this planning process

to prioritize your spending and focus your money on the

things that are most important to you.

Similarly, at organizational level, budgets are important and matter for a

variety of reasons:

1. Budgets help keep track of organizational income and expenditures.

2.Performance evaluation becomes easy as there is a set target or goal to

achieve in the budget for a pre-determined period.

3.Budgets help forecasting and planning.

4.Management can question any deviation from the set goals.

5. Helps identify and take corrective action in a timely manner in cases of

under-achievement, or excessive expenditure.

6. Ascertains if money is being spent/invested wisely.

•There are two types of controls organizations use to measure progress: financial and non-financial.

•Budgets help measure the financial progress of an

organization.

•Though not emphasized enough, the non-financial controls of an organization are important in contributing

in so many ways towards the overall success of the

organization.

•A look at the examples of non-financial controls in next slide will help underscore their importance to the growth of the organization.

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2: How and Why Managers Use Budgets

• As the organization puts it strategy and strategic plan together, the budget is an important component in taking the organization from where they are to where they want to be.

• A budget deals with projected revenues, expenses, financing options etc.

• A budget is a helpful tool for key internal stakeholders of the organization to monitor and evaluate the organizations financial performance.

• When discussing budgets, managers use the term master budget.

• The master budget is the collection of many budgets (sales, labour,

manufacturing, materials, administration etc.).

• Each budget contributes and feeds into the overall performance of the

organization.

• While there are many budgets that feed into the master budget, the

master budget has two major categories: the financial budget and the

operating budget.

• Figure 7.6 from section 7.1 of the readings, depicts how the different

budgets connect to the operating and financing budgets of the

organization.

• For further details on financial and operating budgets read section 7.1.

• Video – Master Budget, Capital Expenditure

• Video – the Art of Start up Finance

• The many budgets of an

Organization

Budgets – ow they all fit in…..

• Video: ow the aster udget and other budgets fit in…

Two Approaches to preparing budgets

• Complete reading for topic 5

• Reading: Principles of Accounting – Chapter 7

https://openstax.org/books/principles-managerial-

accounting/pages/7-why-it-matters

3. Operating Budget

What Is an Operating Budget?

• An operating budget is a detailed projection of what a company expects its revenue and expenses will be over a period of time.

• Companies usually formulate an operating budget near the end of the year to show expected activity during the following year.

How Is an Operating Budget Used?

• An operating budget helps organizations set and achieve business goals.

Each month or quarter, managers can compare actual results to the

operating budget and analyze the outcome, asking such questions as:

• Are sales more or less than projected?

• Were there unexpected expenses?

• Do figures for the rest of the year need to be adjusted?

• Analyzing the results can help companies adapt to changing conditions,

update their actions and strategies if necessary, and achieve better

performance.

Operating Budget Details

4. Financial Budgets

5. Flexible Budgets

• A flexible budget is a budget that adjusts to the activity or volume levels

of a company.

• Unlike a static budget, which does not change from the amounts

established when the budget was created, a flexible budget continuously

"flexes" with a business's variations in costs

• E.g – A flexible budget may allot 25% of a company's revenue to salary as

opposed to allotting $100,000 to salary in a given year. This accounts for

any changes in both the company's revenue and staff that may occur

throughout the year.

Video: Flexible Budget

Key Differences Between Fixed and Flexible Budget

1. fi ed budget is a budget that doesn’t change due to any change in

activity level or output level. A flexible budget is a budget that changes as

per the activity level or production of units.

2. he fi ed budget is static and doesn’t change at all. On the other hand, a

flexible budget is adjustable as per the necessity of the business.

3. A fixed budget is always fixed. That means it is the same for any activity

level. A flexible budget, on the other hand, is semi-variable. One part of it

is fixed, and another changed as per the activity level.

4. The fixed budget is very simplistic. A flexible budget is pretty complicated.

5. The fixed budget takes comparatively little time to prepare. On the

other hand, a flexible budget takes a lot more time.

6. fi ed budget is estimated on the past data and management’s

anticipation regarding future events. On the other hand, a flexible budget

is estimated based on realistic situations.

7. fi ed budget isn’t advantageous to medium and large enterprises but

only suitable for micro-organizations. A flexible budget is suitable for all

kinds of organizations – from micro to large

6. How Budgets are used to evaluate goals • If used wisely, a budget is a useful assessment tool to evaluate an organi ation’s

progress towards its goals and objective…….

• Provides management needed information to adjust production, shipping, inventory,

• Build better communication channels (both inside the business organization and with

suppliers and customers)

• Better customer service

• Makes it possible for management to weigh the costs of specific products & services

against the actual profits earned for the particular products & services.

• Complete reading for topic 5

• Reading: Principles of Accounting – Chapter 7

https://openstax.org/books/principles-managerial-

accounting/pages/7-why-it-matters

Infographics - Examples