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What is a Budget?

ICMA defines budget as:

A budget is a quantitative statement, for a defined period
of time, which may include planned revenues, expenses,
assets, liabilities and cash flows. A budget provides a focus
for the organizations, aids in the co-ordination of activities
and facilitates control.
Classification of Budgets
According to time According to function According to flexibility

Long term
Sales Budget Fixed Budget

Short term Production

Flexible Budget
budget Budget

Cost of Production

R&D Budget

Cash Budget

Classification of Budget according to Time
Short Term Budget Long Term Budget
May cover periods of three to twelve A systematic and formalized process
months depending upon nature of for directing & controlling operations
business for period extending beyond one year
Should be long enough to allow It evaluates future implications
completion of a season or all aspects associated with present decisions
of a business
Market trends, change in
The period should coincide with demographics, national income, etc.
financial accounting period to play important role in preparing long
facilitate evaluation of performance term budget
e.g. A budget allocated to It proves useful in forecasting and
manufacturing of lots for spring- evaluation of an organization over
summer season, Fashion Retailing, etc. period of time
e.g. A father planning money
requirement for his childs future
Examples on short term and long term
Short Term budget:
A student allocating his/her pocket money to his monthly expenses
like food, clothing, rent, leisure activities, stationaries, etc.
Long Term budget:
A father planning future of his children:
College expenses
Child 1 (current age 8); $20,000/year beginning in 10 years
Child 2 (current age 3); $24,000/year beginning in 15 years
New car purchase - $30,000 in two years ($4,000 upfront +
$400/month for seven years)
Classification of Budget according to Function
Sales Budget

The most important budget, all other budgets are contingent upon
Production budget, selling and distribution, etc. are affected by sales
Quarter 1 Quarter 2 Quarter 3 Quarter 4 Yearly
Sales units 120 130 150 165 565
Price per unit 20 22 25 27
Total Sales 2400 2860 3750 4455 13465

Sales forecasting:
Developing a sales budget requires forecasting future sales, which depends upon three
main factors:
1. Information concerning past performance
2. Information about present conditions within industry and sales territory and
3. Data concerning the industry and general business conditions
Classification of Budget according to Function
Production Budget
It is stated in physical units
It specifies the number of units of each product that must be
produced to satisfy the sales forecast
The number of units to be produced can be formulated using:

Units to Produce = Budgeted sales + Desired closing inventory

of finished goods Beginning inventory of finished goods

Budgeted sales = 70,000,
Desired closing finished goods inventory = 20,000
Beginning finished goods inventory = 40,000
Units to be produced = (70,000 + 20,000 40,000) = 50,000
Classification of Budget according to Function
Production Cost Budget
It summarizes the materials budget, labor budget and the factory
overhead budget
It is made up of three budgets:
Factory overhead
Direct Materials budget:
It specifies the cost of direct materials used and cost of the direct materials
It helps in developing purchasing and delivery schedule
Helps to meet production targets
Direct Labor Budget:
It estimates the labor, in number and grades, to enable production budget
to be achieved
It must disclose: grade of labor along with cost (wages) and period of
Factory Overhead Budget:
Prepared on basis of chart of accounts which reflects different expense
accounts and details of cost center or departments
Example on Production Cost budget

Material Usage
Product A Product B Total
50,000 80,000
Direct materials
Product A X 5
Product B X 8
Direct materials
2,50,000 4,80,000
usage (kg)
Cost per kg Rs. 1 Rs. 1.50
Cost of Direct
Rs. 2,50,000 Rs. 7,20,000 Rs. 9,70,000
materials used
Classification of Budget according to Function
Research and Development Budget

A tool for planning and controlling research and development costs

Helps in coordination with companys other plans and projects
Helps allocation of funds for R&D by coordinating companys
immediate and long-term plans
Helps in planning staff and equipment requirements for R&D
Classification of Budget according to Function
Cash Budget
It contains details of cash inflows and cash outflows for the budget period of
some other specific period.
It indicates effect on cash positions of seasonal requirements, unusual
receipts and slowness in collecting receivables
Indicates availability of cash
Shows availability of excess funds for short term investments
Helps in planning bond redemptions, income tax installments and
payments to employees
Period of Cash budget
1. Operational: May be prepared monthly, weekly even daily to meet requirements
2. Short range: Prepared annually and is in correspondence with annual profit plan.
Indicates cash inflows and outflows as generated by annual profit plan
3. Long range: Does not disclose detailed estimates of revenue and expenses.
It is prepared according to:
The timing of the capital expenditure projects
The timing of long range profit plan
Classification of Budget according to Function
Master Budget
It is summary or total budget package for a business firm
It can be called end product of budget making process
IT reveals the top managements goals of revenues, expenses, net
income, cash inflows and financial positions
Takes the macro view of business and coordinates with
production, raw materials, manpower and other resources with
production targets
It cuts across divisional boundaries to coordinate firms diverse
The operating budgets constitute the building block used to
complete the master budget
Classification of Budget according to Function
Fixed Budget

Fixed budget is designed to remain unchanged irrespective of the

level of the activity actually attained
It is based on single level of activity
It compares data from actual operations with single level of
activity reflected in budget
Fixed budget is good for performance measurement, if output can
be estimated within close limits
Classification of Budget according to Function
Flexible Budget
It is prepared for a range, for more than one level of activity
It is a set of alternative budgets to different levels of activity
Flexible budget is prepared considering that a business is dynamic, ever
changing and never static
Important features of flexible budget:
It covers a range of activity
It is easy to change with variation in production levels
It facilitates performance measurement and evaluation
Advantages of Flexible budgeting:
1. Accurate budgeting: Output factor is considered while preparation, since cost of goods may
fluctuate time to time
2. Coordination: Production is planned in relation to expected sales, materials and labor are
acquired to meet expected production requirements
3. Control tool: Comparison between the budgeted costs and actual costs form basis for
analyzing cost variances and fixing responsibility for same. This motivates managers to feel
themselves motivated in controlling costs for which they are responsible.
Zero Base Budgeting (ZBB)
Zero base budgeting is method of budgeting where by all the activities are
re-valuated each time budget is formulated.
It involves starting from zero
In ZBB, each departments functions are reviewed completely
ZBB rejects incremental nature of traditional budgeting, instead states
that expenditure of each program must start from base zero with each new
budget being compiled as if the programs were being launched for first
Advantages of ZBB:
It identifies and eliminates wastage and obsolete operations
Develops questioning attitude
Leads to staff involvement which may lead to improved motivation
Increases communication and coordination within organization
Disadvantages of ZBB:
Cost involved in preparing a vast number of decision packages in large firm are very high
Time consuming and large amount of paperwork is involved
Managers may oppose new ideas and changes
Zero Base Budgeting (ZBB)
Steps followed in application of ZBB:

1. Decision packages are prepared so that management can:

Evaluate and rank it against other activities and
Decide to approve of disapprove it

2. Each decision package is justified that it promotes the goals of

3. If justifies, then the cost of minimum efforts needed to sustain is
4. Alternatives for each package are considered
5. Incremental decision package are also justified and costed to
describe benefits of additional work that would be done
6. Managers rank their decision packages in order of priority for
resource allocation
7. Resources are allocated to the decision package.
Thank You