Business Processes & Accounting Systems · Week 14

Budgeting — Purposes, Budgetary Control, the Master Budget & Functional Budgets to the Cash Budget

What a budget is, its purposes and functions, steps in budgetary control, types of budgets and master budget components, sales forecasting, and the full LFT chain (sales → production → material usage → material purchases → labour → cash budget), plus limitations.

ITE36221 video · 38 min📄 Budgeting - Session 14.pdf📄 Practice – Budgeting.pdf

▶Lecture videos

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Budgeting

Definitions and functions, then a complete worked example (LFT company, grades A and B, wood and glass) through every functional budget to the cash budget.

00:02Introduction 01:19What a budget is: a quantifiable action plan 03:51Functions of budgets 07:36Types: functional, master and cash budgets 08:24Sales budget 10:10Production budget: the format and its logic 14:37LFT example: sales and production budgets 18:34Material usage budget 20:11Material purchases budget 22:21LFT: material usage (wood and glass)27:26LFT: material purchases 29:21Direct labour budget 30:43LFT: labour budget (Rs 200/hour, 4 and 6 hours)32:05Cash budget 33:00LFT: cash budget 36:08Limitations of budgeting

1What is a budget?

Definitions

Budget: a detailed plan, expressed in quantitative terms, that specifies how an organisation will acquire and use resources during a particular period. In the lecture's words, "a quantifiable action plan for a specified time period" 01:19.
Budgetary control: a system of planning and controlling cost.

Budgets flow from strategic planning. Every enterprise has goals: profitability, growth, public service.
Strategy aims at achieving and maintaining a competitive advantage through critical success factors: the key strengths most responsible for the organisation's success.
A budget is built on past activities: last year's figures plus planned changes 02:29.

Purposes & functions of budgeting 03:51

Purpose	Meaning
Planning	Plan annual operations: what and how much to produce and sell
Facilitating communication & coordination	Departments share information, giving harmony between departments
Allocating resources	Scarce resources go where they're needed
Managing financial & operating performance (control)	Compare progress against the budget; take corrective action
Evaluating performance & providing incentives	Motivates managers towards organisational goals

Steps in budgetary control

Establish budgets

Measure actual performance

Compare actual with budget

Analyse causes of variances & report

2Types of budgets

Budget	What it is
Master budget	A comprehensive set of budgets covering all phases of operations for a period
Operational budgets	How operations will meet demand, using material, labour and overhead
Financial budget	How the organisation will acquire its financial resources
Capital budget	Plan for acquiring (and disposing of) capital assets
Cash budget	Expected cash receipts and disbursements

The lecture groups them as functional budgets → master budget → cash budget 07:36.

Master budget components:

Operational:
sales budget
production budget
direct material budget
direct labour budget
overhead budget
budgeted cost of goods manufactured and sold
selling, general and admin budget (R&D, marketing, customer service)
Financial:
capital budget
cash budget
budgeted income statement
budgeted statement of financial position
budgeted statement of cash flows

Sales budgetProduction budgetMaterial usage → purchasesLabour & overhead budgetsCash budgetBudgeted income statement & balance sheet

Sales forecasting: the starting point

The sales budget drives everything else. The factors are:

past sales levels and trends
general economic trends
economic trends in the industry
other factors expected to affect industry sales
political and legal events
intended pricing policy
planned advertising and promotion
expected actions of competitors
new products planned by the company or others
market research studies

3The functional budgets: formats

Sales budget: Sales units × Selling price = Sales revenue
Production (units) = Budgeted sales + Closing finished goods − Opening finished goods
Material usage = Production units × Material per unit
Material purchases = Usage + Closing raw materials − Opening raw materials (× cost per unit)
Labour budget = Production units × Hours per unit × Rate per hour

Why subtract opening and add closing? Opening inventory is already made, so we don't produce it again. Closing inventory must also be made this period 13:53.

PDF example: quarterly sales & labour budgets (seasonal pattern)

	Q1	Q2	Q3	Q4	Year
Sales units	15,000	5,000	10,000	20,000	50,000
× Rs 12	180,000	60,000	120,000	240,000	600,000
Units produced	14,000	5,500	11,000	19,500	50,000
× 0.2 labour hours	2,800	1,100	2,200	3,900	10,000
× Rs 10 per hour	28,000	11,000	22,000	39,000	100,000

4Full worked example: LFT company

Sales & production budgets 14:37

Data:

	Grade A	Grade B
Expected sales (units)	50,000	10,000
Selling price	Rs 6,000	Rs 8,000
Opening finished goods	1,000	500
Target closing finished goods	11,000	500

Sales budget:

	A	B	Total
Units × price	50,000 × 6,000	10,000 × 8,000
Revenue	300m	80m	380m

Production budget:

	A	B
Sales units	50,000	10,000
Less: opening finished goods	(1,000)	(500)
Add: closing finished goods	11,000	500
Production	60,000	10,000

Material usage & purchases 22:21

Per unit:

wood: 12 boards for both grades, Rs 70 per board
glass: A 6 sq ft, B 8 sq ft, Rs 100 per sq ft

Inventories:

wood: opening 70,000, closing 80,000
glass: opening 60,000, closing 20,000

Usage	Wood (boards)	Glass (sq ft)
Grade A: 60,000 × 12 / × 6	720,000	360,000
Grade B: 10,000 × 12 / × 8	120,000	80,000
Total usage	840,000	440,000
Value (× 70 / × 100)	Rs 58.8m	Rs 44m

Purchases	Wood	Glass
Usage	840,000	440,000
Less: opening	(70,000)	(60,000)
Add: closing	80,000	20,000
Purchase quantity	850,000	400,000
Purchase cost	Rs 59.5m	Rs 40m

Usage and purchases differ because of the inventory adjustments 29:21.

Direct labour budget 30:43

Rs 200 per labour hour. A uses 4 hours and B uses 6 hours per unit.

	A	B	Total
Production	60,000	10,000
Hours	240,000	60,000	300,000
Cost × 200	48m	12m	60m

Cash budget 33:00

Assumptions:

opening cash Rs 3m
all sales are cash sales
material purchases are paid 100% within the year
labour is paid in the year
overheads are paid in cash

	Rs m
Opening balance	3.0
Receipts: cash sales	380.0
Payments: material purchases (59.5 + 40)	(99.5)
Direct labour	(60.0)
Overheads	(55.0)
Total payments	(214.5)
Net surplus (380 − 214.5)	165.5
Closing balance (165.5 + 3)	168.5

Two slips in the video

The question says overheads of Rs 50m, but the solution uses Rs 55m (that's what gives 214.5). With 50m, payments = 209.5, surplus = 170.5, and closing = 173.5.
The video says the closing balance is 186.5m. That's an arithmetic slip: 165.5 + 3 = 168.5m.

Learn the method; check the numbers yourself.

5The cash budget: rules

Closing cash = Opening cash + Cash inflows − Cash outflows

It's prepared weekly or monthly so management can deal with shortages (arrange overdrafts or loans) or surpluses (invest them).
Only actual cash receipts and payments are included.
Depreciation is always excluded: it's not a cash flow.
Credit sales and purchases still outstanding at period end are excluded. Include cash when it's received or paid, e.g. a 30-day credit sale in March is received in April.
The closing balance of period 1 = the opening balance of period 2.

🧪 Try it — Budget chain builder (two products, one material)

Sales units A Price A Opening FG A Closing FG A

Sales units B Price B Opening FG B Closing FG B

Wood/unit A Wood/unit B Rs/board Opening wood Closing wood

Hours/unit A Hours/unit B Rs/hour Other cash payments (glass + overheads) Opening cash

Defaults: "other payments" = glass Rs 40m + overheads Rs 55m, which reproduces the 168.5m closing cash.

6Limitations of budgeting 36:08

Based on estimates and assumptions, so they lack accuracy.
Preparation takes time, cost and management effort.
Lack of flexibility: once fixed, budgets aren't changed for unexpected events (e.g. a COVID lockdown). This can demotivate employees who see the targets as unachievable 37:33.
Budgets can encourage budgetary slack and "spend it or lose it" behaviour.

Exam focus

Expect:

Define a budget and budgetary control.
Give the purposes and functions of budgets.
List the steps in budgetary control.
Name the master budget components.
List sales forecasting factors.
Prepare sales, production, material usage and purchases, labour and cash budgets. Remember the opening and closing stock adjustments. In the cash budget, exclude depreciation and account for credit timing.
Give the limitations.

7Practice questions (course paper)

Q1: Cash budget, January to April 2019

Timing rules:

Customers pay two months after the sale
Suppliers are paid two months after the purchase
Wages are paid the next month
Other expenses are paid one month late
The machine is paid in 5 × 5,000 instalments from January
A dividend of 10,000 is paid in April

	Jan	Feb	Mar	Apr
Opening balance	15,000	18,985	23,795	22,975
Receipts from debtors	30,000 (Nov)	35,000 (Dec)	25,000 (Jan)	30,000 (Feb)
Total available	45,000	53,985	48,795	52,975
Creditors	15,000	20,000	15,000	20,000
Wages	3,200	2,500	3,000	2,400
Manufacturing, admin, selling (previous month)	2,815	2,690	2,820	2,890
Machinery instalment	5,000	5,000	5,000	5,000
Dividend	—	—	—	10,000
Total payments	26,015	30,190	25,820	40,290
Closing balance	18,985	23,795	22,975	12,685

Q2: Receipts from customers (Saman Ltd)

Sales are read as Jan 90,000 · Feb 135,000 · Mar 220,000 · Apr 320,000 (the PDF's table is jumbled), and all sales are assumed to be on credit. Customers pay 25% in the month of sale, 50% the next month and 25% the month after.

	Jan	Feb	Mar	Apr
Jan sales 90,000	22,500	45,000	22,500
Feb sales 135,000		33,750	67,500	33,750
Mar sales 220,000			55,000	110,000
Apr sales 320,000				80,000
Receipts	22,500	78,750	145,000	223,750

Q3: Payments to material suppliers (Saman Ltd)

Materials cost 40% of sales: 36,000 · 54,000 · 88,000 · 128,000, with May at 160,000. Closing stock is half of next month's needs, and suppliers are paid one month later.

	Jan	Feb	Mar	Apr
Materials used	36,000	54,000	88,000	128,000
+ closing stock (½ of next month)	27,000	44,000	64,000	80,000
− opening stock	0	(27,000)	(44,000)	(64,000)
Purchases	63,000	71,000	108,000	144,000
Payment (one month later)	0	63,000	71,000	108,000

8Quick revision sheet

Concept	Remember it as
Budget	Quantified plan for acquiring and using resources over a period
Budgetary control	System of planning and controlling cost
Purposes	Plan · coordinate and communicate · allocate · control · evaluate and motivate
Control steps	Set → measure → compare → analyse variances and report
Master budget	All the budgets together → budgeted income statement and balance sheet
Production	Sales + closing FG − opening FG
Purchases	Usage + closing RM − opening RM
Labour	Production × hours × rate
LFT answers	Sales 380m · production A 60k, B 10k · wood 850k boards = 59.5m · glass 400k = 40m · labour 60m
Cash budget	Opening + receipts − payments; cash items only; no depreciation
Limitations	Estimates · time and cost · inflexible · can demotivate

?Self-check quiz

12 questions on this week. Answer them all, then press Check my answers. Your best and latest scores are saved and shown on the subject page.

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