Budgeting is one of the most important parts of financial management. Budgeting allows the management to identify the areas where the company will be making expenses along with identifying cash inflows. Thus it helps the management to analyze the difference between the expenses and revenues and therefore by comparing these two, budget can provide estimated profits that the firm would make. Budgeting therefore helps the management of the firm to make decisions, to analyze the future cash inflows and outflows and thus make decisions accordingly (Besley, & Brigham, 2007).
This report has been divided into three parts. The first part of the report defines about the budget, and its benefits. This part of the report also discusses about the benefits of budget and the importance of including budget in a business plan along with the process of preparing budgets. Top down approach and bottom up are the two approaches of preparing budgets and these approaches have also been discussed. In addition to this, zero based budgeting and incremental budgeting have also been discussed. Budgets can impact the behavior of the individuals that are involved with the budget and this has been discussed. In addition to this, the techniques that could be applied to reduce the impact have also been discussed. Moreover, production budget, sales budget and cash budget have also been discussed along with their respective advantages and disadvantages.
The second section of the report prepares the budget of Winslow Limited. Then the third section of the report uses the budget and shows the changes that have occurred in the cash flows of the company during the year. Moreover, it has also been discussed that how the information presented in the financial reports of the company can help the company to make better decisions.
A Budget is an action plan to accomplish the target, viewed in financial values and terms to be achieved at a specific time period and in specific conditions. Budget is a financial document which shows the expected income and expenses of the company. It is a set of interlinked schemes and plans which describe projected future operations of the organization. Budget also reflects estimated or intended earnings and expenditures of the organization. Putting it in simple words, budget is the set criterion to measure the actual performance of the company with its standards (Weygandt, Kieso, & Kell, 1996).
Benefits of budget
The most essential component of budget is the responsible money management and understanding and estimating how much money to spend and where to utilize is the first step towards achieving financial independence. Another important benefit of budget is to provide an estimated future earnings and expenses and its importance increases manifold when the organization makes decision according to the budgets. Moreover, it provides a set of standards with which the organization compares its actual performance and a good manager always tries to stick to budget (Friedlob, & Plewa, 1996).
Importance of including a budget in a business plan
Startup Companies normally use budgets to plan for future business expansion and growth. Budget provides a roadmap to the organization and management. Moreover, it shows the amount of capital the firm needs to have (Gitman, 2003). The Budgeting also helps organization to analyze potential growth opportunities considering the cash the company can have. Also company can analyze Capital on hand at different times and then make quick decision for increasing the Business operations. This capital can also be utilized at the time of slow Economic times such as safety net for paying the normal expenses of the business. Therefore budget offers a lot for new businesses when they are preparing their business plans (Hilton, 2010).
In developing a business plan, the Budgets assist in forecasting the future cash flows. Budgets normally allow the startup Businesses to set up a financial roadmap for Business activities. Several organizations review last year budgets to evaluate that how well they have performed as per the guidelines and why the budget variances have occurred. Not every budget variances might reflect negative business condition. If the Budget variances occur due to unforeseen expansion in sales revenue, the companies may require raising the Budget values for potential sales rise. Thus the management needs to consider such aspects as well (Hilton, 2010).
Process of preparing budgets
In order to prepare the budgets, initially the variable and fixed costs need to be determined. After that the level of targeted profit to be achieved will be set and the values will be used in determining the sales level to be achieved. After calculating the sales level, the selling price, variable costs and the fixed costs needs to be assessed. It needs to remember that altering the selling prices and variable costs will develop the most impacts as it will also amend the volume.
Budget preparation sometimes proves complex and hectic job because it involves a number of issues to be considered. Budget is used to estimate the future earnings and expenses of the company, so there is no space left for whims and wishes of an individual. Typically budget formation starts by the approval of strategic planning by senior management and then these agreed strategic plans are converted into strategic directions, which includes sales budget, production budget including direct labor budget, manufacturing overhead budget, sales and administrative budget and fixed assets budget (Weygandt, Kieso, & Kell, 1996). All these plans are the part of master budget which includes budgeted income statement, budgeted balance sheet and cash forecast. To make budget more real and representing the actual estimated figures, its future estimations are derived considering company’s past performance, its standing in the market and major macroeconomic indicators like inflation, GDP per capita and GDP growth rate of a country. There are two approaches of preparing budgets; top down and bottom up approaches.
Top down budgeting approach and bottom up budgeting approach
The top down budgeting approach is the one in which the top management decides the budget and the team in the lower management is responsible for accomplishing the tasks and targets presented in the budget. On the other hand, the bottom up approach is lower management has a greater contributor and they are empowered in preparing the budget (Weygandt, Kieso, & Kell, 1996)..
Zero based budgeting and incremental budgeting
If the budgets are prepared without any pre-authroized source or from zero then this method is calleda s the zero based budgeting. When the budgets are prepared suing the past data like sales of the previous year, expenses incurred in the last year etc then such a method is called incremental budgeting (Kaplan, and Atkinson, 1998). Incremental budgeting is the traditional method of budget preparation where it is prepared using previous budget or the actual performances are used as the basis for preparing the budgets with some incremental amounts added or reduced for new fiscal periods (Weygandt, Kieso, & Kell, 1996)..
Behavioural impact the production of budgets
Budget can influence the behavior of the human resource of the company. Budgets are not only prepared to give a guideline to the managers but these are also used to analyze the performance of the mangers. Therefore it influences the behavior of the individual.
Some of the major factors that could affect the behavior of the individual are:
- If the targets are set too high, then it could lead to higher stress level of employees.
- If the budget targets are set too low, then it may not create a challenge and may not motivate the individuals.
- Focusing too much on financial goals, may not necessarily lead to long term success (Raghunandan, Ramgulam, Raghunandan-Mohammed, 2012).
How any negative behavioral impact can be minimized
It is important for the management to use budget but it is not a good way to strictly focus on the budgets. There can be different errors and issues that may emerge and the impact of such issues and errors are not considered while preparing the budget. Thus, this also signifies that the management should not only use the budgets to compare the performance but use other performance management tools as well (Raghunandan, Ramgulam, Raghunandan-Mohammed, 2012). Moreover, humans are not machines and they may have a higher motivation level on one day and lower motivation on the other day, thus these are other important aspects that need to be considered. Therefore to reduce the negative behavioral impact of the budget the management should appreciate and reward those that meet the budgets but should not punish those that have not been able to achieve their goals but try to work with them and identify areas and issues that they have faced so that they can achieve these goals in the long term (Raghunandan, Ramgulam, Raghunandan-Mohammed, 2012).
Preparing the budgets
Production budget shows the number of units produced by the company. Production budget also shows the labor, material cost along with other fixed or variable costs (Khan, 1993). The advantage of production budget is that it shows an estimated figure of the number of units that would be produced along with their costs. So the management can make their decisions accordingly. However the disadvantage of production budget is that, the company determines well before the period the number of units produced. As there can be changes in the supply and demand in the market and therefore the company should consider such aspects that are ignored by production budget (Kaplan, and Atkinson, 1998).
Production budget of the company is prepared on a monthly basis and the production budgets are as follows:
Production budget for the month of July, 2011
Production budget for the month of August, 2011
Production budget for the month of September, 2011
Production budget for the month of October, 2011
Production budget for the month of November, 2011
Production budget for the month of December, 2011
Sales budget shows the sales that the company is expected to make. Sales budget shows the revenue that the company would receive. The advantage of sales budget is that it shows the company expected sales that would occur during the period and thus the management can set their targets accordingly. However the disadvantage of sales budget is that it ignores the demand and supply of the market along with unexpected situations that could occur and thus sales target may not be achieved (Kaplan, and Atkinson, 1998).
Sales budget of the company are prepared on a monthly basis. Sales budget of the company are as follows:
Sales budget for the month of July, 2011
Sales budget for the month of August, 2011
Sales budget for the month of September, 2011
Sales budget for the month of October, 2011
Sales budget for the month of November, 2011
Sales budget for the month of December, 2011
Cash budget shows the expected cash inflows and inflows. The cash budget of the company is helpful for the management to identify the cash on hand at different times and thus make decisions accordingly. However the cash budget shows an estimated figure and may vary (Kaplan, and Atkinson, 1998).
How budget can be helpful in decision making
The budgets prepared can be very helpful in making different decisions. James can use these budgets in order to predict the cash inflows and outflows of the company. These budgets can help the company in formulating targets and then performance can be evaluated accordingly. In making decisions, the management needs to evaluate the performances of the employees and managers based on these targets (Johnson, Scholes, and Whittington, 2008). In addition to this, these budgets can be helpful in increasing the motivation level of employees and setting targets to each department or employee. Also in the long run, it can be helpful in identifying whether the company has sufficient capital to make investment in the years to come (Bodie, Kane, and Marcus, 2004).. In addition to this, the budgets are used to forecast the sales as well as the expenses.
Statement of Cash flow and comment on why the profit earned by a business differs to cash received
Cash flow statement is an important financial statement as it presents all the cash inflows and cash outflows throughout the period. The profits made by the company are different from the cash that has been received and therefore this signifies the importance of cash flow statement. Cash flow statement shows all the cash that the company has received and paid during the period including cash that has been received for operations, investment and financing activities (McLaney, 2009). On the other hand, profits of the company shows the sales of the company including both cash sales and credit sales and the expenses and costs that have incurred irrespective of the fact that whether they have been paid or not. Thus profit shows the accounting profits during the time period whereas the cash flows shows the net cash inflows and outflows that the company has during the period. Therefore cash flow and profits earned by the company may differ (Ross, Westerfield, and Jordan, 2009).
Reasons for changes in the bank balance
The bank balance of the company has changed from last year to this year and the main reason for the changes is the cash flows of the company. The company has incurred expenses however some of these expenses have not been paid. Similarly, company has earned revenues however some of these revenues have not been received and therefore this has resulted a change in the bank statement of the company. Moreover, the company has purchased assets and paid liabilities as well as some liabilities have increased thus all these have influenced the cash flow and the bank statement.
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