Batch 13 B Roll No 93
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Budgeting
* INTRODUCTION
* TYPES
* METHODS
Capital Budgeting
Working Capital Management
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INTRODUCTION:
For effective running of a business, management must
know:
• where it intends to go i.e. organizational objectives
• how it intends to accomplish its objective i.e. plans
• whether individual plans fit in the overall
organizational objective. i.e. coordination
• whether operations conform to the plan of
operations relating to that period i.e. control
“Budgetary control is the device that a company
uses for all these purposes.”
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WHAT IS A BUDGET?
“ A plan expressed in money. It is
prepared and approved prior to the
budget period and may show income,
expenditure and the capital to be
employed. May be drawn up showing
incremental effects on former
budgeted or actual figures, or be
compiled by Zero-based budgeting.”
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WHAT IS BUDGETARY CONTROL?
Budgetary control is the use of the comprehensive system of
budgeting to aid management in carrying out its functions like
planning, coordination and control.
This system involves:
Division of organization on functional basis into different
sections known as a budget centre.
Preparation of separate budgets for each “budget centre”.
Consolidation of all functional budgets to present overall
organizational objectives during the forthcoming budget period.
Comparison of actual level of performance against budgets.
Reporting the variances with proper analysis to provide basis
for future course of action.
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CLASSIFICATION OF BUDGETS
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1. SALES BUDGET:
Sales budget is the most important budget based on which all the
other budgets are built up. This budget is a forecast of quantities
and values of sales to be achieved in a budget period.
2. PRODUCTION BUDGET:
Production budget involves planning the level of production which
in turn involves the answer to the following questions:
a. What is to be produced?
b. When is it to be produced?
c. How is it to be produced?
d. Where is it to be produced?
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3. COST OF PRODUCTION BUDGET:
This budget is an estimate of cost of output planned for a
budget period and may be classified into –
• Material Cost Budget
• Labour Cost Budget
• Overhead Cost Budget
4. PURCHASE BUDGET:
This budget provides information about the materials to be
acquired from the market during the budget period.
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5. PERSONNEL BUDGET:
This budget gives an estimate of the requirements of
direct labour essential to meet the production target.
This budget may be classified into –
a. Labour requirement budget
b. Labour recruitment budget
6. RESEARCH AND DEVELOPMENT BUDGET:
This budget provides an estimate of expenditure to be
incurred on R & D during the budget period.
A R&D budget is prepared taking into consideration the
research projects in hand and new R & D projects to be
taken up.
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7. CAPITAL EXPENDITURE BUDGET:
This is an important budget providing for acquisition of
assets necessitated by the following factors:
a. Replacement of existing assets.
b. Purchase of additional assets to meet increased production
c. Installation of improved type of machinery to reduce
costs.
8. CASH BUDGET:
This budget gives an estimate of the anticipated receipts and
payments of cash during the budget period.
Cash budget makes the provision for minimum cash
balance to be maintained at all times.
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9. MASTER BUDGET:
CIMA defines this budget as “ The summary budget incorporating
its component functional budget and which is finally approved,
adopted and employed”.
Thus master budget is a summary of all functional budgets in
capsule form available in one report.
10. FIXED BUDGET:
This is defined as a budget which is designed to remain
unchanged irrespective of the volume of output or turnover
attained.
This budget will, therefore, be useful only when the actual level of
activity corresponds to the budgeted level of activity.
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11. FLEXIBLE BUDGET:
CIMA defines this budget as one “ which, by recognising the
difference in behaviour between fixed and variable costs in
relation to fluctuations in output, turnover or other variable
factors such as number of employees, is designed to change
appropriately with such fluctuations”.
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13. ZERO BASE BUDGETING:
The zero base budgeting is not based on the incremental
approach and previous figures are not adopted as the base.
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14. RESPONSIBILITY ACCOUNTING:
Responsibility accounting fixes responsibility for cost control
purposes by establishing responsibility centres namely –
a. Cost centre
b. Profit centre
c. Investment centre
Principles of responsibility accounting are as follows:
1. Fixation of targets for each responsibility centre
2. Actual performance is compared with the target
3. The variances therein are analyzed so as to fix the
responsibility of centres.
4. Taking corrective action.
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CONCLUSION:
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CAPITAL BUDGETING
DECISION INVOLVES
THREE STEPS
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1. ESTIMATION OF CASH FLOWS
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The cash flows may be grouped into relevant and
Traditional or Time-adjusted or
Non-discounting Discounted cash flows
I . PAYBACK PERIOD:
# The payback period is defined as “the number of
years required for the proposal’s cumulative cash inflows to be
equal to its cash outflows.”
# The payback period is the length of time required
to recover the initial cost of the project.
# The payback period may be suitable if the firm
has limited funds available and has no ability or willingness to
raise additional funds.
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II . ACCOUNTING RATE OF RETURN (OR) AVERAGE
RATE OF RETURN
(ARR)
# The ARR may be defined as “the annualized net
income earned on the average funds invested in a project.”
# The annual returns of a project are expressed as a
percentage of the net investment in the project.
COMPUTATION OF ARR:
These are based upon the fact that the cash flows occurring at
different point of time are not having same economic worth.
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II. PROFITABILITY INDEX METHOD:
This technique is a variant of the NPV technique and is also
known as BENEFIT - COST RATIO or PRESENT VALUE INDEX.
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III. INTERNAL RATE OF RETURN (IRR) METHOD:
The IRR of a proposal is defined as the discount rate which
produces a zero NPV, i.e., the IRR is the discount rate which will
equate the present value of cash inflows with the present value of
cash outflows.
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CONCEPTS:
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PURPOSE:
The NWC is necessary because the cash outflows and inflows do not
coincide.
The purpose of NWC is to measure the liquidity of the firm.
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INSTRUMENTS OF SHORT TERM
FINANCING
ǿ Trade Credit
ǿ Bill Discounting
ǿ Inter Corporate Deposits
ǿ Public deposits
ǿ Commercial papers
ǿ Factoring
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APPROACHES TO DETERMINE
FINANCING MIX
1. Hedging approach
2. Conservative approach
3. Trade off between the above
mentioned two approaches.
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HEDGING APPROACH
(MATCHING APPROACH)
This is the process of matching maturities of debt
with the maturities of financial needs.
According to Hedging approach, the permanent
portion of funds required should be financed with
long term funds and the seasonal portion with
short term funds.
Under this approach working capital = 0 since CA
are not financed by long term funds (CA = CL).
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CONSERVATIVE FINANCING APPROACH:
This is a strategy by which the firm finances all funds
requirement, with long term funds and uses short term
funds for emergencies or unexpected outflows.
TRADE OFF BETWEEN HEDGING AND
CONSERVATIVE APPROACHES:
One possible trade off could be equal to the average of the
minimum and maximum monthly requirements of funds
during the given period of time. This level of requirement
of funds may be financed through long run sources and
for any additional financing need, short term funds may be
used.
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FACTORS DETERMINING AMOUNT OF WORKING CAPITAL
Inventory Receivable
conversion conversion
period period
Payables Cash
period Conversion
period
Operating cycle 39
The ‘length of the operating cycle’ is the most
widely used method to determine working capital need.
The longer the production cycle, the larger is the
working capital need or vice versa.
Manufacturing and trading enterprises require fairly
large amount of working capital to support their
production and sales activity. Service enterprises like
hotels, restaurants etc., need less working capital.
During boom conditions need for working capital is
more.
Growth industries and firms need more working
capital.
Working capital requirement are to be determined
on the basis of cash cost i.e excluding depreciation.
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