BUDGETING FOR PROFIT PLANNING

A master (comprehensive) budget is a formal statement of management's expectation regarding sales, costs, outputs and
other financial transactions of the firm for the coming period. It consists basically of a pro-forma income statement, a
pro-forma balance sheet and a cash budget.
It serves as a tool for both planning and control purposes. It serves as a tool used for planning during the onset of the
period and it is utilized as a tool for control at the end of the period. The performance of the company is evaluated as to
whether or not the company was able to operate within or exceeds the parameters set by management and identify areas
for improvement in the process.
Budgets help to:
Communicate managements plans throughout the organizations
Force managers to think and plan for future
Allocate resources where it can be utilized most effectively
Discover potential bottlenecks.
Synchronize the activities of the entire organization
Serve as benchmarks for evaluating succeeding performance.
Operating budgets ordinarily cover a one-year period corresponding to the companys fiscal year. Organization may also
divide their budget year into quarters and the quarters into months with operating budgets for each period.
The master budget normally consists of two parts:
1. Operational budget
a. Sales budget
i. Starting point of the master budget
ii. Based from:
1. Statistical forecast based on analysis of business and market conditions
2. Internal estimates from feedback of management and personnel, particularly that from
sales
3. Analysis of factors that may affect future revenue flows and predict the effects of these
factors.
b. Production budget
i. Establish the number of units of finished goods that must be manufactured each period to comply
with projected sales needs and to provide for the desired finished ending inventory.
i.
Although it is set in units of finished goods, the production budget may be used to determine
several items on the budgeted financial statements:
a. Budgeted cost of goods sold
b. Budgeted cost of beginning and finished goods inventory
c. Budgeted cost of goods manufactured
c. Direct material budget
i. Determines the quantity of direct raw materials needed to be purchased in order to meet projected
production
ii. Only addressed DIRECT MATERIAL requirements only.
iii. May also include a schedule of cash disbursement arising from computation of cash payments to
suppliers of raw materials
d. Direct labor budget
i. Determines the number of labor hours and dollars needed to meet production budget.
ii. Only DIRECT labor costs are addressed.
iii. May be affected by overtime costs, supply of labor, and other labor requirements
e. Factory overhead budget
i. Provide a schedule of all manufacturing costs other than direct materials and direct labor.
ii. Requires the development of a predetermined overhead rate for the variable manufacturing
overhead.
iii. Budgeted fixed overhead depends on the total costs expected to be incurred for each type of fixed
overhead costs.
iv. Any non-cash manufacturing overhead costs should be deducted from total manufacturing
overhead to determine the cash disbursement for manufacturing overhead.
f. Ending inventory budget
g. Selling and administrative budget
i. Similar to manufacturing overhead budget as it separates variable and fixed.
ii. Depends on the number of units sold or sales in pesos
iii. Depends on the total costs expected to be incurred for each type of costs
iv. Any non-cash selling and administrative expense should be deducted from total expense to
determine the cash disbursement for selling and administrative expense.
h. Budgeted income statement

2. Financial budget
a. Cash Budget
i. Prepared for purpose of cash planning and control.
ii. Presents expected cash inflow and outflow
iii. Consists of four major sections:
1. Receipts section
2. Disbursement section
3. Cash surplus or deficit section
4. Financing section
b. Budget balance sheet

Steps in budget preparations

1. Prepare sales forecast
2. Determine the production requirements
3. Estimate production costs and operating expenses
4. Determine cash flow and other financial activities
5. Prepare projected financial statements
ZERO BASED BUDGETING
Zero-base budgeting is a planning and budgeting tool that uses cost-benefit analysis of projects and functions to improve
resource allocation in an organization.
Traditional budgeting tends to concentrate on the incremental change from the previous year. It assumes that the previous
years activities are vital and must be continued.
Under zero-base budgeting, however, cost projections are prepared from from the zero level, and must be justified.
Steps in zero based budgeting:
- Describe each organizations activity in a decision package.
- Analyze, evaluate, and rank all these packages in priority on the basis of cost-benefit analysis.
- Allocate resources accordingly.
FLEXIBLE BUDGETING
A budget adjusted for changes in volume.
In the planning stage, a flexible budget is used to compare the effects of various activity levels on costs and
revenues.
In the controlling stage, the flexible budget is used to aid evaluate actual results by comparing actual results with
a flexible budget for the level of activity achieved in the period.
Standard costing naturally complements flexible budgeting.
However, even without standard costing, flexible budgeting can be used based upon actual costs and quantities of
outputs (although lack of input data precludes computation of price and efficiency variances).