Chapter 3 Lesson C - Types of Budget
Introduction of the Host
Mrs.Geetha Dasaraty is a commerce graduate with a Masters in Business Administration specialising in finance. Her stint with a Coimbatore based company and later with a consulting firm in Chennai has provided her with a decade of experience in project finance and appraisals, accounting and tax laws. She is a freelance writer and money matters are her forte. She is currently pursuing her final course in Company Secretaryship and is doing a course on Vaishnavism. She has a passion for literature and Carnatic music. She is also a violinist.
About the Class
We bring you an online class titled 'Elementary Finance'. This will
have 12 lessons - one a month. Each lesson is further subdivided into
4 chapters. And we will give you one new chapter every week.
Chapter 3 Lesson C - Types of Budget
In the previous lesson we saw what budget were about. In this lesson
we will get to know the various types of budgets.
Budgets are classified, based on the capacity, coverage, periods
and purpose of the budgets.
Based on capacity
Based on the capacity, budgets are classified as fixed
and flexible budgets.
Fixed Budgets.
A fixed budget is one which will remain unchanged immaterial of the
level of activity. These budgets are prepared for fixed expenses and their
aim is to control cost.
Flexible Budgets.
A flexible budget is designed so as to change with the fluctuations
in output,turnover and other factors, which are variable.
These budgets will change with the change in activity. These budgets
are prepared for various level of activity. While preparing flexible budgets
the expenses are broadly classified as fixed, variable and semi- variable
expenses.
Flexible budgets are prepared under the following circumstances.
- In industries where there are seasonal fluctuations in the production of goods and their sales.
- Industries like ship building etc where the business depends on the orders received.
- Industries where sales depend on the current trends like the fashion business.
- Business which keeps diversifying and keeps introducing change.
- Industries that are related to the general changes in sales.
- A fixed budget is rigid and does not change with the volume of activity achieved, whereas a flexible budget can be changed to suit the level of activity to be achieved. Flexible budget is not rigid.
- A fixed budget is prepared for a particular level of activity and for a particular set of conditions. It is prepared under the premise, that there will be no change in the outside conditions. Flexible budget is prepared for various levels of activities.
- All the costs like variable and fixed are related only to a particular level of activity in the case of fixed budgets, whereas for a flexible budget, variance analysis each cost and its behaviour.
- Fixed budget does not enable price fixation etc, where budgeted and actual figures vary, but a flexible budget enables cost and sales price fixation and enables tender quotations.
- Where there is a difference in two activity levels, comparison of actual and budgeted performance is of no significance, in the case of fixed budgets. While in the case of flexible budgets, the comparisons of actual and budgeted performance is, meaningful.
Functional Budgets & Master Budgets
Functional Budgets
Functional budgets are budgets that relate to the various functions of the business.
Master Budgets
A Master Budget is a consolidated summary of the various functional budgets.
Functional budgets are further grouped as follows:
a) Physical Budget: These are budgets, which provide information about the physical units like sales, production etc. A few examples are Quantity of sales, Quantity of production.
b) Profit Budgets: These are budgets that ascertain the profits.like Sales budget, Profit and Loss Budget.
c) Cost Budgets: These provide information on costs like manufacturing costs, selling costs administration costs.
d) Financial Budgets: These provide information on the financial position of the firm. Examples are cash budget, Capital expenditure Budget.
A few of the functional Budgets are as follows:
Sales Budget: Sales forecast is the startup to budgeting and is crucial for a meaningful budget. Sales budget represents total sales in volume and value for the future period. Anticipation of customers need, impact of new products, selling and promotion strategies, product visibility are vital factors in determining a sales forecast. The purpose of sales budget is to develop a plan with clearly defined objectives towards which the operational effort is to be directed.
Production Budget: The production budget reflects the production for the budget period based on production capacity, sales forecast and stock position. Production budget is normally expressed in units of output. Production budget would indicate the maximum production possible and minimum quantity of stock required.
Selling and Distribution Cost Budget: Selling costs may be defined as costs directly related to selling of products by creating and stimulating demand. Advertising, sales promotion, salesmen salaries, market research, after sales service, collection costs form part of selling costs.
Distribution costs is the costs related to making products available for despatch and ends with the return of empty package. Transport costs, storage, warehousing etc form part of distribution costs. Preparation of selling and distribution costs budget enables the concern to know what is the percentage of selling and distribution to sales price and devise pricing strategies accordingly.
Capital expenditure budget: This is a very important budget as it throws light on the concern's capital outlay and expansion and diversification programme. This budget may not be restricted to a single year and may be prepared to cover a long period of years. While preparing this budget factors such as sales potential for the Increased production, possibility of price reduction, and increased selling and advertising costs are to be considered.
The capital expenditure budget enables the concern to establish a system of priorities, and serves as a tool for controlling expenditure. It also facilitates cost reduction programme particularly when modernisation and renovation is covered by this budget.
Questions on Chapter 3 Lesson B
1.What are the objectives in preparing a budget?
2.What is a budget and how does one go about preparing it?