Describe in detail the method used in administering the operating budget or the capital budget for your organization.
In the modern business world, budgeting is the prime objective and a significant activity for every organization’s departments or SBUs like production, marketing and finance etc. Budgeting helps the management to take prompt and correct decisions and set measures for internal control. Budgeting is the pivotal function of the management and it is based to a greater extent on the accounting information provided by the accountant and this information is transformed into a strategy and the management follows up the strategy in the form of a budget. Budget determines whether the company is moving on the right path to achieving the goal. It induces management to think systematically.
Basically budget has four major components.
1. Operating Budget
2. Capital Expenditure Budget
3. Cash Budget
4. Projected financial position.
Operating budget comprises of different segments, which includes, Sales and Promotion Budgets, Material & Purchase Budgets, Manufacturing Overhead Budget, Non-Manufacturing cost Budget and Labor Cost Budget (Hilton 2006).
Starting with sales budget and their working phenomenon and the coordination with other budgets, all of which is disclosed in the flow chart below:
(Shim, Siegel 2005)
When we analyze the workflow of budget we start
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Sales budget (forecasted) focuses on the how many units of a product are sold, how much revenue is generated in terms of dollar, and what is the response of cost of sales in order to generate the revenue. The sales budget commonly grows from a reconciliation of forecasted business conditions; plant capacity proposed selling expenses such as advertising and estimates of sales. Following factors should take into account before making the sales budget (Shim, Siegel 2005).
Prospect of economy & industry.
Past trend analysis of the sales and the competitors sales.
External factors like government rules & regulation to the industry.
Consumer attitudes, needs, dispositions, tastes, and preferences
Production Budget is also an important part of the operating budget. Production budget focuses on the flow of goods from production to sales or the transformation of raw product to finished goods. Production budget focuses on the following factors (Shim, Siegel 2005):
The timing and quantity of sales
Economic order quantity or on inventory levels
Seasonal factors and variations
Check the deviations if any from (Direct Material, Direct Labor, FOH) and take corrective action in order to smoothing the flow of production (Hilton 2006)
Estimate the total quantity of each product to be manufactured during the budget period on the basis of sales forecast and finished goods inventory policy
Specify the finished goods inventory policy of the firm
Material and Purchases budget are those in which material budget figure is free of the direct material as well as indirect material and identifies how much of the quantity is incorporated in the unit. Indirect material is also part of the manufacturing overhead budget. The material budget is used to make evaluations regarding prices, quantities and material purchase (Shim, Siegel 2005). On the other hand, purchase budget shows the type and quantity of each unit purchased, schedule of purchase, reorder level of each item and also the cost of purchases.
When we set the standards for production budget, we can now focus on Labor Cost Budget which emphasizes on labor requirement for each unit of production. We can classify Labor into direct and indirect labor. We primarily focuses on labor rate and labor hours in this particular budget and set the standards in the form of labor rate variance and also in the form of labor efficiency and monitor deviations if any and take corrective measures in order to rectify the problem. Labor cost budget emphasis on the following issues.
· Permanent manpower employed in direct manufacturing activity and their remuneration rates
· Payments likely to arise on account of overtime work
· Temporary manpower that may be needed and their remuneration rates.
Manufacturing overhead budget is the composition of indirect material, indirect labor, depreciation, repair and maintenance, factory rent and all expenses which are related to factory. Manufacturing overhead budget not only focuses on production department but is also relevant to the service department. For this purpose, the expected volume of the work to be done in each department has to be determined in terms of an indicator appropriate to its activity (Shim, Siegel 2005). The Budget services for both departments are stated below:
For production department (Units Produced, direct labor hours, direct machine hours)
For service department (Repair & maintenance, Purchase dept, General factory administration).
Non-Manufacturing Cost Budget focuses on administration, distribution, selling and research and development cost. When making non-manufacturing cost budget, one thing should be kept under consideration that what held in the past may not hold in the current year due to recession in the economy, product life cycle, lack of product innovation, etc are the factors. Following points should be taken into account:
If sales are increasing due to higher sales prices but sales volume is about the same, only a few marketing expenses will increase
When sales volume increases, most marketing expenses increase, but they may not increase in proportion to sales volume
The budgets for non-manufacturing cost are normally related with departments like R&D, Sales, and Marketing, etc. For each non-manufacturing department the individual budgets are set up within the department which will help out in making a strong plan and also in the performance evaluations from the perspective of sales personnel.
The capital expenditure budget is important for long-term projects, i.e. projects whose time horizon is relatively long. For such projects, fixed assets such as plant and equipment are to be acquired. The capital expenditure budget reveals the list of capital projects, with their estimated costs, that can be selected for investment. When we make capital expenditure budget, we should also estimate the total cost and the time horizon of project completion and also evaluate whether the project activities are independent to each other or are mutually exclusive. We only make investments where we consider the project to be feasible for us with respect to rate of return, time value of money, etc. In order to check the feasibility of the project analysts adopt the following estimates for the project acceptance and rejection
Internal rate of Return (IRR)
Pay back period
Net Present Value (NPV)
Helfert, Erich A. (2001). Financial Analysis Tools And Techniques: A Guide For Managers. McGraw-Hill.
Hilton, Ronald W. (2006). Managerial Accounting. McGraw-Hill/Irwin.
Shim, Jae K. & Siegel, Joel G. (2005). Budgeting Basics & Beyond. Wiley