Different Types of Budgets Essay

Introduction

Budgets are integral parts of planning for business and attaining its perceived objectives. Accordingly business activities involving future planning use the budgetary control process. Different types of budgets to serve business purposes are in vogue, but uses of some budgets that are invariably used by businesses are taken up in detailed manner in this write up.

Sales Budgets

Sales budget is an estimate of expected sales revenue for ensuing financial period. Estimates of sales are budgeted on the basis of variety of factors like earlier period sales, production capacities, existing and expected sales environments, economic factors like trade policies of the Governments, seasonal fluctuations, entity’s capacity to create new markets, financing, advertisements and other marketing plans, and many other factors. As per Hermanson and others (p. 879). “The cornerstone of budgeting process is the sales budget because the usefulness of entire operating budget depends on it.” Some important uses of sales budget are enumerated as under:

• Sales budget is a mother budget as all other estimates of production and/ or trading, marketing, financing including cash flows, and other business activities are based on sales estimations.
• Capital expenditure decisions make use of expected sales revenue in all its techniques like payback method, net present value, and internal rate of return.
• Banks and other financial institutions provide funds to business on basis of budgeted sales revenue.
• Wage structure and other direct production expenses have direct relation to budgeted sales.
• State economic policies are planned as per rise or decline of budgeted sales of various industries as such economic and trade policies help generating demand in the economy.

Production Budget

Production budget is an estimate of item wise production and chalk out timely production plans spreading over the period. Sales budget, availability of production resources and changing manufacturing technique influence production estimates. Uses of production budgets are as under:

1. Production programs as organized in production budget become the basis of calculations of direct material costs, direct labour costs, and production overheads. In others words, material budget, direct labour budget, and factory overhead budgets get inputs from production budgets. Sometimes these budgets become part of a composite production budget.
2. Production budget greatly influence economic ordering quantity (EOQ) of purchases and thus helps in economization of resources at disposal.
3. Production budget provide a number of cost centers that help in costs collections and decision making of absorption of factory overheads under activity based costing (ABC) method of cost absorption.
4. Production budget provides input to assess plant capacity in order to avoid over or under utilization of plant. Such quality control measures enhance marketability of products.
5. Production budget helps in effective utilization of resources bringing down the cost of production to possible extent without affecting quality. Sometime sales estimated are rephrased using inputs from production budgets in order to maximize the profitability.

Cash Budget

Cash budget is an estimation of cash receipts and cash payments over yearly or monthly or even daily basis. Cash budget is important part of working capital assessments that determines the future solvency of the company. The major uses of cash budgets are as under:

1. The basic utility of cash budget as described by Lind Roussel and others (2006, p.281) is that “cash budget indicates whether cash flow will be adequate to meet anticipated payments, such as debt obligations, including replacement and renewals of facilities, unanticipated requirements, payroll, payment for supplies and service, and a prudent investment program.”
2. The estimation of cash receipts and cash payments indicate possible cash shortfall, if any, and thus provide the organization an opportunity to make necessary arrangements.
3. Cash budget provides inputs to compute crucial solvency indicators like current ratio and quick ratio that help the banks and other financial institution in decision making for extending working capital loans to different organizations.
4. Estimation of cash receipts from accounts receivables and cash payments to accounts payables enables the entity to formulate such credit policy that will promote the revenue as well as its customer base.

Capital Expenditure Budget

As per Robert M. Grant (2002, p. 218)³ “the capital expenditure budget grows out of strategic planning system. In setting strategy and performance guidelines, strategic plans also forecast capital expenditure for the strategic planning period.” In other words capital budgets are part of overall strategic planning of the business and thus allocation of resources and capital expenditure are part of project costs. Even capital expenditure budgeting after the start of business is also not a routine affair. The utilities of capital budget are described as under:

• Capital budget being part of strategic planning persuade the entity to decide the exact source of finance. That is whether the company should raise debt capital or equities to meet capital expenditure.
• Capital budgeting normally encourages time value techniques of decision making and thus capital budgets are perpetrators of use of scientific techniques in business decision making.
• Capital budget creates long term resources yielding revenue over a period of time for the entity.

Administrative & Selling and Distribution Overhead Budgets

“Selling and administrative expenses budget lists the operating expense involved in selling the products and in managing the business.” (Shim and Siegel, p.95)⁴ Factory overheads are part of production expenditure budgets, but administrative & selling distribution budget play a distinctive role of decision making in regular and other business transactions. Their utilities cannot be undermined because of following attributes of these budgets:

• These budgets set standards for below the line (i.e. indirect) expenses and thereby persuade businesses to enhance profitability through internal controls to restrict expenditure up to the budgeted amount.
• In intense competitive situations administration & Selling and overhead budgets remove inept inefficiencies in the organizations enabling them to compete at very thin margins, and thus maintaining the presence in the markets.
• Administrative and selling overhead budgets when broken into fixed and variable components of overheads help the entity in making CVP costing analysis in a more effective manner.

Conclusion

Business budgets are inevitable tools for costs planning, allocation and controls. Uses and advantages of different budgets depend upon the objectivity with which those are prepared. As seen above sales budget is a mother budget for most of business budgets; and capital expenditure budget is part of strategic business planning. Accordingly usefulness of each budget must be perceived at the time of planning the budget.

References

Hermanson and others, Accounting Principles, Freeload Press Inc., page 879.

Lind Roussel and others, Management and Leadership for Nurse Administrators, Jones and Bartlett Publishers, 2006, page 281.

Robert M. Grant, Contemporary Strategy Analysis: Concepts, Techniques, Applications, Blackwell Publishing, 2002, page 218.

Shim and Siegel, Complete Budgeting Deskbook, published by CCH Tax and Accounting, 1998, page 95.