Budgets

The budget is helpful to management in making two broad types of decisions:

1. Financing decisions deal with the obtaining of funds for acquisition of resources.
2. Operating decisions are concerned with the acquisition and utilization of scarce resources.

A budget is valuable to any size of organization.

Budgets have several significant advantages when properly used:

1. They compel management to face the task of planning.
2. Budgets aid in translating plans into explicit terms that can be useful as a basis for evaluating actual performance in the future.
3. Budgets also serve to communicate management plans, to coordinate these plans, and to carry them out.

Budgets can be classified in at least two ways:

1. They may be classified as to the length of time covered:
   1. The usual period for planning and control budgets is one year, which can be divided into months or quarters and which can also be kept continuously extended for one year in advance.
   2. Long-term budgets of ten or more years can be used for basic changes in products and manufacturing facilities.
2. The budgeted financial statements, sometimes called pro forma statements, may be classified also as to their general type:
1. Operating budgets, such as the sales, production, and expense budgets, are elements of the budgeted income statement.
2. Financial budgets include the budgeted balance sheet, the budgeted cash flow statement, and the budgets for cash receipts and disbursements.

The final master budget is the product of several preliminary drafts, each of which may lead to decisions that require an additional draft. Two principal levels of exhibits are normally included:

1. Schedules show details for such areas as sales, production, and expenses.
2. Main statements include the income statement, the balance sheet, and summaries of cash receipts and disbursements.

Several basic steps are typically followed in preparing the final budget exhibits:

1. Make the forecast of sales by products in both units and rand amount.
2. Prepare the budget for the number of units to produce that, with beginning inventories, will meet the needs of sales and also bring ending inventories up to the target levels.
3. Construct schedules for material, labour, and overhead costs to support the production activity determined in the preceding step.
4. Prepare the cost-of-goods-sold budget.
5. Prepare the various expense budgets.
6. Construct the budgeted income statement.
7. Make cash budgets that show, in addition to expected cash receipts and disbursements, financing plans involving loans and temporary investments.
8. Prepare a balance sheet that is projected to the end of the budget period.

The forecast of sales volume is usually the keystone of the entire budget structure, but it is often difficult to predict reliable sales figures. Many factors should be considered, such as:

1. Past sales volume,
2. General economic and industry conditions,
3. Market research studies,
4. Pricing policies, and
5. Advertising, competition, and other factors.

Usually, in forecasting sales, it would be wise not to rely entirely upon a single procedure, but to use some suitable combinations of three particular procedures:

1. Individual salesmen and sales managers of the organization combine their predictions after considering such factors as previous sales volumes, economic indicators, and competitive conditions.
2. Predict sales by using a statistical approach such as trend measurements, cycle projections, and correlation analysis.
3. The top executives and administrators of the organization hold a meeting, express their opinions, and arrive at a group judgment as to predicted sales.

Master budgets are helpful foundations for the construction of computer-based simulation models that are often called financial planning models or total models. Such models are mathematical statements of relationships among a company's activities and selected related factors, both internal and external. The models are used not only for preparing and revising budgets, but also for comparing the effects of various decision alternatives (sensitivity analysis). The degree of sophistication of such models ranges from the standard general-purpose simulators, which can be purchased via the web, to the more comprehensive models that must be purpose designed to meet the complex requirements of specific organizations.

As in all information decisions, the selection of computer-based simulation models should be determined by a cost-benefit approach.