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Budgeting and Decision Making



The most common method of creating a budget is to simply print out the financial statements, adjust historical expenses for inflationary increases, add some projected revenue adjustments and the instant budget is ready. The management itself will find in serious financial straits action on the instant budget assumptions.

To avoid the problems, the accountant must determine the proper format for budget which interlocks every unit of the budget, ensuring the budgeting process is efficient, factors bottleneck operations into budget and use it as a key to improve the company control system.


• Revenue budget

• Production and Inventory Budget

• Purchasing Budget

• Direct Labour Budget

• Overhead Budget

• Cost of Goods Sold Budget

• Marketing Budget

• General and Administrative Budget

• Staffing Budget

• Facilities Budget

• Research Department

• Capital Budget

• Income and Cash Flow Statement

• Financing Budget


The budget begins in two places, Revenue Budget and Research and Development Budget.

The revenue budget contains the revenue figure that the company believes it can achieve for each upcoming reporting period. These estimates come partially from sales staff for existing product, within their territories. The estimates for the new product which have not yet been released and existing product in new markets will come from a combinations of the sales and marketing staff. The greatest fallacy in any budget is to impose a revenue budget from the top management without any input from the sales staff.

The production budget is largely driven by the sales estimates within the revenue budget and also by inventory level assumption in the inventory budget. Few examples, inventory decisions which affect the production are:

a. New goal may be to reduce the level of finished goods inventory from 10 to 15 turns per year.

b. If there is strong focus on increasing customer’s service then it is necessary to keep finished foods in stock, which requires more production.

Given the input from the inventory budget the production budget is used to the unit quantity of required products that must be manufactured in order to meet revenue targets for each budget period. Other factors that drive the budgeted costs are production batches, setup cost. The expense item included in the production budget should be driven by a set of subsidiary budgets, which are the purchasing, direct labours and overhead budgets.

Thus far we have reviewed the series of budget that descend in turn from the revenue budget and then through the production budget. However there are separate set of budget that are unrelated to production, they are:

a. Sales Department Budget: expenses that are incurred by the sales person to meet the revenue budget.

b. Marketing budget: (closely tied to the revenue budget) Contains all of the funding required to roll out the new product.

c. General and Administrative Budget: Cost of all corporate staff, accounting staff and HR personal.

d. Facilities Budget: Based on the level of utility that is estimated in many of the budgets. It is closely related to the capital budget since expenditure for additional facilities will require more expenses in the maintenance budget.

e. Capital Budget: (Includes input from all areas of the company) The capital budget is of great importance to the calculation of corporate financing requirements since it can involve the expenditure of sums far beyond those that are normally encountered through daily cash flows.

The end results of all budget just described is a set of financial statements that reflects the impact on the company of the incoming budget. At a minimum these stalemates should include the:

a. Income statement

b. Cash Flow Statement: is the best evidence of the fiscal health during the budget period.

c. Balance Sheet is of less importance.

These reports are directly linked to all budgets and any changes to the budget will immediately appear in the financial statement. Apart from above operational and financial ratios should be linked for review by management.

Cash forecast is of exceptional importance for it tells the manager the proposed budget model will be feasible. The assumptions goes into the cash forecast should be based on strict historical fact rather that the wishes of the managers. This structure is practically important in the case of cash receipt and accounts receivable, to spot the changes in credit policy.


Our problem with the traditional budget is that many of the expenses listed in it use directly tied to the revenue level, but actually it’s not so. The issue arises mainly due to semi variable component like sales person, commissions, production supplies and maintenance cost and fixed costs such as salaries, office supplies etc., which there is a huge difference between budgeted and actual revenue levels. A good way to resolve this problem is flexible budget as flex budget.

Flex budget itemizes the different expenses levels depending upon changes in amount of actual expenses. This allows the infinite swings of changes in the budgeted expenses that are directly tied up to the revenue volume and ignores changes to other costs that do not change in accordance to small revenue variations. By accounting step up cost more sophisticated format will also incorporate changes to many additional expenses when larger revenue changes occur. A company will have a tool for comparing actual with budgeted performance at many levels of actuary.


There are several factors which delay’s the budgeting process. One of the predominant among those is input to the budgeting model from all parts of the company, another reason is that the budgeting process is highly iterative, sometimes requires dozens of recalculation and changes in assumptions before the desired results are achieved. The budgeting process must be put in sequential order so that the process can be start again and again until the desired results achieved. To streamline the budgeting process the following practices can be followed.

1. Reduce the number of accounts: reducing the amount of time needed to enter and update data in the budget model.

2. Reduce the number of reporting periods: consolidate the 12 months shown in the typical budget into quarterly information. Then a simple formula can be used to divide the quarterly components into its monthly components

3. Use percentage for variable cost updates: so that the expenses will be automatically updated based on the changes in the revenue.

4. Report on variable in one place: key variables like inflation in wages, tax rates for income, worker’s compensation etc., to reported at one place. So that any changes made in the budget, its impact in key variable can be easily available for reference.

5. Use a budget procedure and time table: there should be a clear time table of events that is carefully adhered to, so that plenty of time is left at the end of the budgeting process for the calculation of multiple iterations of the budget.

In addition to above, the other was to modify the budgeting process to complete budget more quickly:

a. Preload budget line items

b. Itemize the corporate strategy

c. Indentify the maximum amounts of available funding

d. Base expenses change in cost drivers

e. Budget by group of staff position

f. Rank projects

g. Issue a summary level model for senior management

h. Link the budget system to employee role and reward system

By following the above approach, the budget will require much less manual updating; this will allow it to sail through the smaller number of required iterations with much greater speed.


Budget Vs Actual:

There are several methods to enhance the corporate control system by integrating the budget into it. One of the best ways to control the costs is within each department to the purchasing system. By linking, when each purchase order issued it will be tagged against budgeted expenses, once budgeted level is reached flag will be raised and system refuse for further expenses.

As the system won’t flag automatically until the expenses excess its annual budget, budgeted levels must be compared with the actual at regular intervals not too frequent but at correct intervals like once in a quarter.

Evaluating Employees Performance:

Another budgeting control system is evaluating the performance of the employees by comparing actual against the budget. For example for sales staff who can assigned sales quotes that match the budgeted sales levels for their territories and similarly manager of a cost center may receive a favorable review when their total monthly cost stays lower than the average budgeted level. In this manner larger number of employee’s performance can be tied up with the budget for evaluating their appraisal.

Feedback loop of Employees:

Yet another budgeting control system is to use it as a feedback loop to employees. This can be done by using series of reports at the end of each reporting period by comparing the actual against the responsibilities assigned to them. The report must be more specific to each functional heads so that specific person can view only the report which was related to the responsibility assigned to them.


In a traditional budget, the entire budget model is driven by the revenue forecast where there is a lack of clear linkage directly to variable cost and it does not shows the impact of sale projections on the company’s capacity constraint.

By throughput concept by identifying the bottleneck capacity which impacts the budgeted output the company can decide either to increase the capacity to achieve the budgeted revenue or utilize the available bottleneck capacity to the optimum level. This can be decided by linking the contribution to the throughput capacity, so that maximum contribution can be realized.

A link to be created between various operating expenses and throughput impact in the constrained resources by managerial decision cost- cut in any of the operating expenses support throughput generation requires an extremely detailed knowledge of hoe the entire system works together to create throughput.

In many cases where no link between an expense and throughput can be found, management is in cutting expenses. Thus these are considerable difference in how various budget lines to be treated based on their impact in throughput. Any expenses supporting throughput should be cut after detailed review by process analyst while other expenses can cut with much less review


CCI Forum

on 26 August 2013
Published in Others
Views : 3580
Other Articles by - CA.R.Jeyarajan
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