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Corporate Planning, Budgeting and Control

Corporate Planning, Budgeting and Control

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484



FINANCIAL MANAGEMENT: THEORY AND PRACTICE



INTRODUCTION

This chapter tells us about long range planning and short range planning, performance budgeting, its quantitative

and qualitiative aspects, the steps and strategies involved in it, the various methods of budgeting and so on.



LONG RANGE PLAN (LRP) VS SHORT RANGE PLAN (SRP)

Planning may be broadly classified under two heads:

(i)Long Range Planning (LRP)

(ii)Short-Range Planning (SRP)

Long range plan is also referred to as a perspective plan, visualizing the organization, spread over a period

of five years, ten years, or even twenty years.

A short range plan usually pertains to the organizational activities envisaged to be taken up during the next,

say, twelve months. The Performance Budgeting exercise pertains to the latter category.



PERFORMANCE BUDGETING

Performance Budget is a formal statement of the management plan and policies of its activities during the next

say, twelve months, both in Quantitative and Qualitative terms.



Qualitative vs. Quantitative

The budget proposals, stating that the production would be increased by, say, 20 per cent, as compared to the

last year, or export would go up by say, 15 per cent, may well be said to be the budgeting in quantitative terms.

As against this, the qualitative budgeting would state the determined decision to increase the level of quality

control and customer satisfaction, and/or decrease the incidence of customer complaint, and the like.



STEPS AND STAGES INVOLVED IN THE PERFORMANCE BUDGETING EXERCISE

We will now discuss the various steps and actions taken at different stages of the performance budgeting exercise.



Step 1: Policy Guidelines

The entire budgetary process starts with the formulation of the policy guidelines by the Chief Executive Officer

(CEO), with the aid and advice of the experts in their respective areas, relevant for the business activities of

the organization. These task heads study and scan the various sources of the relevant data and information,

like the government policies, annual budget proposals and plan outlays, Reserve Bank of India credit policies,

both for the busy and slack seasons, Government of India development plans, import and export policies, the

expected industrial and agricultural growth rates, and so on. All these factors taken together may be termed

as the Environmental Scanning.

After considering all the relevant factors, facts and figures, having the bearings on the organization, both

directly and indirectly, a forecast for the demand of the company’s products, as also its expected market share,

is carefully computed. Based upon the estimated market share, the expected quantum of sales of its products are

estimated and the level of production therewith. Then again, depending upon the estimated level of production,

the quantity and value of the various required inputs like the raw materials, direct and indirect labour, and

other overheads are estimated, product-wise and department-wise.

Initially, a Draft Policy Guideline is formulated, which is thoroughly discussed by the Chief Executive

Officers with the top executives and task heads of the organization. These officers, only second-in-command,

are encouraged to give their free and frank opinion and ideas, comments and suggestions, on the draft policy

guideline. Thereafter, a Final Policy Guideline is formulated and circulated down the line, i.e. from the Corporate

Office it goes down to the Zonal Office, and then to the Regional Office, and finally to the various production units.



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The steps and the strategies involved in the formulation and implementation of the performance budget

are quite similar in principle, nature and approach, for manufacturing and service organizations. We shall,

however, discuss in detail the budgetary exercise, pertaining to the manufacturing organizations.

It will augur well if the CEO will bear in mind that the policy guidelines should be brief and to the point, in

clear and concrete terms, so as to command the focused attention of all concerned, for action and implementation,

and achievement of the budgeted levels, both in quantitative and qualitative terms.



Step 2: Draft Budgets

Based upon the policy guidelines, the various departments and units prepare their own draft budgets, and

submit these to their respective controlling authorities who, in turn, compile the figures of all the departments

and sections under their supervision and control.

It is suggested that all the functionaries must be associated in the exercise of the preparation of the draft

budget in such a way that it may be the budget of the unit and not only of the unit head. This will ensure a

feeling of involvement and a sense of belonging to the organization. This way, all the performers, at all levels,

high and low, will feel that it is their own budget, prepared by themselves, and that it has not been thrust nor

imposed upon them. The most productive fall out of such a strategy may be that all of them may join hands

and make concerted efforts to achieve the budgeted levels, all set by themselves.



Step 3: Budget Settlement

On a careful study of the compiled draft budget, the controlling authority will discuss the budget proposals

in regard to the various activities and levels of production, submitted by the departmental heads in the

draft budget proposals, and thereafter the mutually agreed upon estimates may be finally settled. With a

view to ensuring that the budget discussions take place on some fruitful and meaningful lines, it may augur

well if both the sides will do the necessary homework and preparation, and appreciate each other’s points of

view. Besides, the discussion should take place in an atmosphere of mutual trust and confidence, and in an

amicable and friendly atmosphere, so that the juniors may feel free and safe to put forth their points of view,

for a reasonable consideration by the authorities with an open mind. Otherwise, the juniors may well be left

with the feeling that their points of view had not been taken into account, and that the budgeted levels were

just imposed upon them, per force. This will, in fact, set in a very unhealthy trend, whereby the essence and

spirit of the whole budgetary exercise may ultimately turn out to be just a farce formality, a routine ritual,

sans any purpose.



Step 4: Final Budget

After the budget proposals have been discussed and finalized, each unit is required to submit its final budget,

which, in turn, is compiled and sent to the next higher authorities for further compilations. At the end, it

culminates in the consolidated budget of the company as a whole.



Step 5: Corporate Budget

Such consolidated and finally compiled budget is then put up to the Board of Directors, and on its approval, it

becomes the Corporate Budget, also known as the Master Budget.



BUDGETING IN A MANUFACTURING COMPANY

In a manufacturing company, the starting point is obviously the forecast or estimates of sales, as the level

of production and, in turn, the quantum of raw materials and other required inputs are to be determined

accordingly. Therefore, the crucial importance of careful estimation of the levels of sales of different products

can hardly be overemphasized. Once the quantum and value of sales are estimated with near accuracy, further

calculations in terms of percentage of sales becomes quite simple and easy. This method is known as the ‘Per

cent of Sales’ method.



486



FINANCIAL MANAGEMENT: THEORY AND PRACTICE



PER CENT OF SALES METHOD

The per cent of sales method is based on the assumption that the ratio and relationship among the various

elements of costs of sales will remain the same, as these had been so far in the past. That is to say, the historical

data and trends have been presumed to be remaining unchanged (though, in reality, it may not be the case,

more often than not). However, with a view to mitigating the element of error, averages of the past two/three

years are taken into account, so as to make the position more realistic.

By application of this method, a pro forma Profit and Loss Account, as also a pro forma Balance Sheet, is

prepared.

We will now proceed to understand and appreciate the actual methodology adopted in this regard, step by

step, with the help of an illustrative example.

In Table 24.1, the historical data of Snowhite Washing Machines Limited are given for the last two years,

under various relevant heads, under columns 2 and 3. Further, the average percentage of sales ratio [in

terms of the average figures of Colums 2 and 3 of item 1, i.e. (1,560 + 1,665) ÷ 2 = 1,612.50] applicable to the

various items, are also calculated and noted thereagainst in column 4. The basic assumptions and estimate of

the value of sales are given on the basis of which the pro forma Profit and Loss Account has been calculated,

as shown in column 5. But then, as we all know, the appropriation of the net profit (profit after tax), into

dividend paid and retained earnings, is not a mechanical but a major managerial decision. Accordingly, these

two items have not been calculated mechanically, but have, instead, been left as the items pertaining to the

managerial decisions.

TABLE 24.1 Pro forma Profit and Loss Account of Snowhite Washing Machines Limited for the

Year ending 31 March 2010 (based on Per cent of Sales Method)



Particulars











Historical Data for the

years ended 31 March





2008

2009



(1)

1. Net sales

2. Cost of goods sold

3. Gross profit (1 – 2)

4. Selling expenses

5. General and administration Expenses

6.Depreciation

7. Operating profit [3 – (4+5+6)]

8. Non-operating surplus (Deficit)

9. Profit before interest and tax (PBIT) (7+8)

10. Interest on bank borrowings

11. Interest on debentures

12. Profit before tax [9 – (10 + 11)]

13.Tax

14. Profit after tax (12 – 13)

15.Dividends

16. Retained earnings (14 – 15)



(2)

1,560

1,000

560

32

69

97

362

39

40

78

85

238

106

132

78

54



Pro forma Profit and

Loss Account for the year

ending 31st March 2010

(Assuming Sales of 1,800)



Average per

cent of sales



(3)



(4)



(5)



1,665

1,090

575

35

70

104

366

41

407

84

78

245

110

135

82



100.0

64.8

35.2

2.1

4.3

6.2

22.6

2.5

25.1

5.0

5.1

15.0

6.7

8.3



1,800.0

1,166.4

633.6

37.8

77.4

111.6

406.8

45.0

451.8

90.0

91.8

270.0

120.6

149.4



53



CORPORATE PLANNING, BUDGETING AND CONTROL







487



But then, we see that, though the calculation under the Per Cent Sales Method is simple enough, it is too

simplistic and mechanical and, hence, may not be said to be dependable enough for the decision-making process,

because the costs of various items may not necessarily be in the same proportion as had been the case in the

previous years.

Accordingly, yet another method, known as the Budgeted Expenses Method has been propounded, whereby

the various items are estimated purely by way of managerial judgement and decision, taking into account

all the relevant facts and expected developments. But, in that case, this method may obviously call for a

stupendous and tedious, and above all, a very time-consuming task, to be performed by the CEO and the

other top executives.

A Combination Method has, therefore, been evolved, which is a hybrid of the aforesaid two methods.



COMBINATION METHOD

In the combination method, such items, which, by and large, have somewhat uniform and stable relationship

with sales, are computed as per the Per Cent Sales Method. Accordingly, only for the remaining items, the

budgeted expense method may have to be used, whereby the burden of the work involved on the part of the

CEO and the top executives may get reduced to the minimal possible extent.

This system may well be said to be the most practical and pragmatic one, in that it is neither too simplistic

and mechanical (like the Per Cent Sales Method), nor too tedious and time consuming (like the Budget

Expenses Method). For example, while the items like the cost of goods sold, the selling expenses, the interest

on bank borrowings, and so on, may be computed on the basis of the per cent sales method; the other items, like

depreciation and interest payable on debentures, and so on, may be worked out on the basis of the Budgeted

Expenses Method.

An illustrative example of the combination method is given in Table 24.2.

TABLE 24.2 Pro forma Profit and Loss Account of Snowhite Washing Machines Limited, for the

year ending 31 March, 2010 (Based on the Combination Method)

Particulars



(1)



Historical Data for the

years ended 31 March

2008



2009



(2)



(3)



Average

per cent

Sales



Pro forma Profit and

Loss Account for the

year ending 31 March

2010, (Assuming sales

of 1,800)



(4)



(5)



1. Net sales



1,560



1,665



100.0



1,800.0



2. Cost of goods sold



1,000



1,090



64.8



1,166.4



560



575



35.2



633.6



4. Selling expenses



32



35



2.1



37.8



5. General and administration expenses



69



70



Budgeted



73.0



6. Depreciation



97



104



Budgeted



110.5



7. Operating profit [3 – (4 + 5 + 6)]



362



366



*



412.3



8. Non-operating Surplus (Deficit)



39



41



2.5



45.0



401



407



*



457.3



3. Gross profit (1 – 2)



9. Profit before interest and tax (7 + 8)



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FINANCIAL MANAGEMENT: THEORY AND PRACTICE



10. Interest on bank borrowings



78



84



5.0



90.0



11. Interest on debentures



85



78



Budgeted



84.0



12. Profit before tax [9 – (10 + 11)]



238



245



*



283.3



13. Tax



106



110



Budget



117.0



14. Profit after tax (12 – 13)



132



135



*



166.3



15. Dividends



78



82



Budgeted



90.0



16. Retained earnings (14 – 15)



54



53



*



76.3



PRO FORMA BALANCE SHEET

After having understood the mechanism and procedures, step by step, to prepare a pro forma Profit and Loss

Account, we will now proceed to understand and appreciate the procedure of computing a pro forma Balance

Sheet.

The estimated projections of various items may be done in this case, based on the varying principles for

different items. Accordingly, the per cent sales method may well be used for estimating the various assets

except, for the items like ‘investments’ and ‘miscellaneous expenses and losses’, as these may not necessarily

have to be proportionate to the sales. Instead, these are the items to be better decided based on the principle of

the managerial decision and discretion. Similarly, the per cent of sales method can well be used for estimating

the items like the ‘current liabilities and provisions’ as also for the level of ‘bank borrowings’ (both secured and

unsecured) to finance the working capital requirements.

Further, the estimated value of ‘reserves and surplus’ can well be computed by adding the projected amount

of retained earnings (as per the pro forma Profit and Loss Account), and the actual figure of reserves and

surplus of the preceding year. Similarly, the projected value of the ‘equity and preference shares’ can be easily

calculated quite accurately, depending upon the decision already taken by the management in this regard.

Correspondingly, the value of ‘term loan’ and ‘debentures’ can be computed based on the proposed projects,

even at its conceptual or preliminary stage. Thus, the levels of the term loan or debentures, to be incorporated

in the pro forma Balance Sheet, will be equal to the fresh term loans to be raised and debentures to be issued

less, of course, the amount of instalments payable during the next year as also the amount of the current

debentures to be redeemed during the current year.

In the end comes the turn of the ‘Balancing Item’, so as to balance the two sides, of assets and liabilities

of the company, i.e. if the total of the assets side exceeds the total of the liabilities side, the balancing item

will show the amount of the external borrowings required. As against this, if the liabilities happen to exceed

the assets, the balancing item will represent the surplus funds available, which may have to be invested and

utilised gainfully.

Illustrative Example: An illustrative example of the pro forma Balance Sheets (using the example of Snowhite

Washing Machines Limited) as on 31 March, 2008, 2009 and 2010 has been placed at Table 24.3.

As may be observed from Table 24.3, the various items in the pro forma Balance Sheet have been derived

on the lines, indicated in Table 24.4.



*These items are obtained using the accounting identities (i.e., these figures are obtained by adding or subtracting the

items from the respective figures).



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TABLE 24.3  Pro forma Balance Sheet of Snowhite Washing Machines Limited for

31 March, 2008, 2009, and 2010 (Projected)

Particulars



2008



2009



Average of per cent

sales or some other

basis



Projection for

the year ending

31 March 2010

(based on the

budgeted sales of

1,800)



(2)



(3)



(4)



(5)



Net sales

ASSETS



1,560



1,665



100.00



1,800.0



Fixed assets (net)



1,040



1,105



66.5



1,197.0



39



39



No change



39.0



33

260

488

65



37

275

494

72



2.2

16.6

30.4

4.2



39.6

298.8

547.2

75.6



25



25



No change



25.0



1,950



2,047



325

65



325

65



No change

No change



325.0

65.0



325*



378



As per the Proforma

Profit and Loss account



454.3



520

390



520

397



No change

24.4



520.0

439.2



130



155



8.8



158.4



130



146



8.5



153.0



65



61



3.9



70.2



(1)



Investments

Current assets, loans and advances

•  Cash-in-hand and with banks

•  Bills receivable

•  Inventories

•  Prepaid expenses

Miscellaneous expenditures and losses (if any)

Total



Historical Data as on 31 March



2,222.2



LIABILITIES

Share capital

•  Equity shares

•  Preference shares

Reserves and surplus

(325 + 53) and (378 + 76.3)@

Secured loans

•  Debentures

•  Bank borrowings

Unsecured loans

•  Bank borrowings

Current liabilities and provisions

•  Sundry creditors

•  Provisions

Sub-Total



2185.1



External Funds Requirement

  (2,222.2 less 2,185.1) = 37.1

Total



Balancing figure

1,950



2,047



37.1

2,222.2



* Presumed that accumulated resained earnings upto the previous year were at 271. Thus, the retained earnings for this

year (i.e. as on 31.3.2008) will be. 325, i.e., 271 + 54 (retained earnings for this year). [vide Table 24.2].

@ These relative figures appear at colums 3 and 5, respectively, in Table 24.2.



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FINANCIAL MANAGEMENT: THEORY AND PRACTICE



Problem of Circularity

In view of the fact that both the pro forma Profit and Loss Account statement and the pro forma Balance Sheet

are intensely inter-related, the problem of circularity is sure to arise, while preparing the aforesaid two pro

forma financial statements.

This is so because, we cannot prepare the pro forma Balance Sheet unless the figure of the retained earnings

is known as per the pro forma Profit and Loss Account statement. Also, we cannot prepare the pro forma Profit

and Loss Account statement either, unless the amount of external borrowings (and the amount of interest

payable thereon) is known, as from the pro forma Balance Sheet.

TABLE 24.4  Items in the pro forma Balance Sheet

Items



Projections/Estimates based on



Current



assets Per cent of sales method [Proportions based on the average

for the last two years]



Fixed assets



—Do—



Investments



‘No Change’ has been assumed



Miscellaneous expenses and losses



—Do—



Current liabilities and provisions



Per cent of sales method [Proportions based on the average for the

last two years]



Bank borrowings (for meeting the working capital —Do—

requirements)

Equity and preference share capital



‘No Change’ has been presumed.



Reserves and surplus



Computed on the basis of the figures arrived at in the pro forma

Profit and Loss Account



Term loans



‘No Change’ has been assumed



Debenture capital



—Do—



External funds required



This represents the balancing item in the instant illus trative

example.



But then, this problem of circularity can well be circumvented and solved by proper approximations and

allowing for some minor adjustments as, in any case, the whole exercise itself is that of approximation and

estimation, and not of exactness and certainty.



BUDGETING PROCESS IN A MANUFACTURING COMPANY

The operating budget or the performance budget, prepared on the lines of the Pro forma Profit and Loss Account

statement, is the cornerstone of the whole budgetary system and exercise.

The estimates, or budgeting of the various items, are computed on the following lines and steps.



Sales Budget (or Sales Forecast)

As we have seen, while discussing the preparation of the pro forma income statement, the value and volume of

sales is the starting point. The same is the case here too, as the levels of production and, in turn, the quantum

of raw materials and consumable stores and spares, labour, etc. are related and dependent upon the level of the

estimated sales itself. Therefore, it is most crucial and important on the part of the CEO and the top executives,

to make every sincere and rational effort to develop a sales budget, which, in the considered opinion of the top

management, is found to be quite reasonable and achievable. This is of crucial importance, as almost all the

other budget estimates will be arrived at, based upon the volume and value of the sales budget.







CORPORATE PLANNING, BUDGETING AND CONTROL



491



Achievable but Challenging Budget

It may, however, be mentioned here that the level of budgetary estimates should be achievable, and also

challenging. That is to say, it must be neither too low so as to be achieved with the least efforts, nor it should

be too high such that the operating staff may not even make an attempt to achieve and accomplish it.

It must, instead, be such that it can well be achieved but not the easy way. Some serious, sincere and strenuous

efforts may have to be made to make things happen, and the budgeted level achieved and even slightly exceeded.

This concept may well be brought home with the help of an illustrative example.

Supposing Saurabh, as of now, can jump, say, four feet high. If he is given a target of jumping five feet during

the course of one full year, he may achieve this feat quite easily and with great ease and least effort. As against

this, if he is given the goal of jumping ten feet during the course of one year, the chances are that he may not

make even an attempt in this direction, because jumping ten feet within a time frame of one year may seem to

him to be a rather too tall an order, even to merit any effort for achieving it. But then, if he were to be given

the goal of jumping six feet (instead of five feet) during the course of one full year, he will make strenuous and

continuous efforts so as to accomplish the feat. May be, he may end up scaling a height of just five feet ten

inches. But then, such minor shortfall can well be condoned and his sincere efforts and perseverance may well

be appreciated and rewarded.



Estimation of Level of Sales

While formulating and developing the sales budget, the following factors must always be borne in mind:

(i)At the very outset, the position and prospects of the company (national and global) in general, and the

industry in particular, must be carefully studied and assessed.

(ii)Then, as a second step, we should look into the historical data of the company. That is to say, the level of

sales for the last two/three years must be looked into and the trend of the percentage increase/decrease

in the sales must be computed, and the factors responsible for the same must be analyzed and studied,

so as to be able to reasonably forecast the level of sales in the coming year.

(iii)Then comes the turn to study such of the government regulations and control that may affect the industry

directly, and even indirectly.

(iv)Further, as the customer is the king, as our business (sales revenue) depends upon him, the customer’s

(changing) tastes and preferences, attitude and dispositions, must be carefully studied and analyzed,

and a conclusion drawn, so as to position our products accordingly. It will augur well if some market

scanning (somewhat short of the detailed market survey) is undertaken, so as to make our analysis and

decision all the more data based and hence more accurate and reliable.

(v)In the present situation of stiff competition, it becomes imperative for us to undertake the exercise of

studying the extent of competition prevailing, as of now, and even expected to come up in the near future.

The recent phenomena of the stiff competition in the automobile industry (especially in the car segment,

and that too, for the luxury and high value vehicles) due to the opening of this segment to the foreign car

manufacturing companies (like Ford, Hyundai, and so on) has eased out even the Maruti Udyog Limited

(MUL) from the sellers’ market to the buyers’ market. Accordingly, MUL, Premier Motors, Tatas and

such other Indian car manufacturing companies had to pull up their socks and think of some suitable

market strategies, or even consider scaling down the level of their sales, depending upon the loss of their

market share to the several other foreign players in the field.

(vi)In a fiercely-competitive scenario, the importance of formulation and implementation of some suitable

marketing strategies and sales promotion efforts and endeavours can hardly be over-emphasized.

Accordingly, marketing and advertisement expenses may as well have to be estimated and budgeted for.



Production Budget

After estimating the projected level of sales, as per the sales budget, a matching production budget is prepared,

accordingly, with a view to ensuring that the production is planned in an economic manner, commensurate with

the volume of sales. Doing so will augur well for the profitability and prospects of the organization, to produce

only around as much as could be sold off.



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FINANCIAL MANAGEMENT: THEORY AND PRACTICE



Further, while preparing the production budget, the following factors must be kept in view:

(i)Volume of sales and the timings thereof,

(ii)The quantity of inventories of the required raw materials and consumable stores and spares, and, above all,

(iii)The installed (and licensed) capacity of production.

The production of the various items must be planned, commensurate with the volume and timings of the

sales of each item, so as to avoid any uneconomic piling up of the finished goods, and the carrying costs attached

therewith. At the same time, due care must be taken to see to it that we may not lose our customers for want

of the goods in our ready stocks.

But then, at times, it may not be quite economical to have the production plan in strict conformity with the

volume and timings of the sales. For example, in the case of goods, such as fans and coolers, air-conditioners

and refrigerators, heaters and geysers, there may be very low demand for the products in the off season, but

then, it may be quite economical to let the production activity continue, so as to put the fixed assets to their

optimal use.

As against this, in some other cases, like the sugar industry, the production activity has to be completed

well before the onset of the peak summer season, because, due to high temperature, the recovery percentage

of sugar may get adversely affected. But the sale of sugar takes place all the year round.

All things considered, the production plan should be formulated, keeping all the relevant factors in view, so

as to result in the optimal productivity and the financial gains that go therewith.



Preparation of Production Budget

The formulation of a production budget involves the following steps:

(i)At the very outset, the production capacity of the company must be assessed in realistic terms.

(ii)Further, the company’s inventory policy, especially in regard to the finished goods, must be specifically

stated and be known to all the functionaries, concerned with the production activities.

(iii)Besides, the aggregate quantity of each and every item to be produced, during the entire budget period,

must be estimated, based on the twin factors of (a) the estimated volume and pattern of sales as also

(b) the finished goods inventory policy of the company.

(iv)Keeping all these factors in view, a comprehensive production schedule must be prepared for the entire

budget period.



Materials and Purchase Budget

After the production budget has been formulated, the necessary raw materials and consumable stores and

spares will be required to commence the production activity. For this purpose, a materials budget will have

to be prepared. To procure these materials, an estimate of purchases will have to be computed, as also the

purchase schedule.

With these ends in view, the following types of budget will have to be prepared:



Materials Budget: The materials to be used for production activities are broadly classified under the following



two categories:



(i)Direct materials, which comprise such items which can be categorically identified with the manufacturing

of a specific product. For example, the iron and steel strips, which are used exclusively for manufacturing

cupboards and steel trunks.

(ii)Indirect Materials: Manufacturing Overheads Budget: Indirect materials, however, are such materials

which cannot be identified exclusively with any single product. For example, the salary of the foreman,

who supervises the manufacturing activities of steel cupboards and trunks as also of various other items

like, plastic moulded chairs and tables, wooden sofa sets and dining tables, and so on. Accordingly, the

estimates of these two materials must be computed in two distinct budgets.

The ‘materials budget’ generally pertains to the direct materials. This budget must show not only the quantity

of the materials planned to be purchased, but preferably their purchase price, too. Also, the indirect materials and

supplies have to be budgeted for, separately. Such estimates are known as ‘Manufacturing Overheads Budget’.



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Purchase Budget: The purchase budget must, inter alia, contain the following:

(i)Quantities required

(ii)Purchase schedule

(iii)Estimated purchase price

All these three data must be prepared individually for each item of the raw materials and supplies to be

purchased. While computing the purchase budget, the following facts and figures must be carefully considered:

(i)The quantities of each item of the raw materials planned to be purchased, as per the materials budget.

(ii)The re-order level of each item of the raw materials, taking into account the relative factors like, the

leadtime, safety stock, anticipated scarcity, expected price change (both increase and decrease), risk of

obsolescence, government restrictions, and so on.

(iii)Economic Order Qualities (EOQ), as also the Optimal Order Quantities (OOQ), (where bulk purchase

discount is available), for each item of raw materials, separately.

These budgets must also contain the following data:

(i)The level of raw materials at various points in time, during the budget period; and

(ii)The estimated cost of raw materials to be consumed in the production process.

These two budgets are respectively known as:

(a)Materials inventory budget

(b)Cost of raw materials used budget



Labour Cost Budget

Labour cost is broadly classified under two heads:

(i)Direct labour cost

(ii)Indirect labour cost

Direct labour cost comprises the payment of wages to such labours who are engaged in the manufacturing

activities directly.

Indirect labour costs, however, represent such labour costs which are not involved directly in the manufacturing

activities. For example, salaries paid to the supervisory staff, storekeepers, maintenance workers, and so on.

The labour cost budget usually takes into account the cost of direct labour alone, and the cost of indirect

labour is taken into account in the manufacturing overheads budget.



How to prepare the Labour Cost Budget?

The labour cost budget can be prepared on the following lines:

(i)(a) First, compute the standard direct labour hour, required of each unit of production.



(b) Multiply this [at (a)] by the average rate per hour.



(c) The resultant figure will represent the estimated labour cost per unit of production.



(d) Now, multiply this figure [at (c)] by the number of units of finished goods budgeted to be produced.



(e) The resultant figure will represent the labour cost budget.

(ii)Alternatively, the labour cost may well be estimated on the basis of its relationship with the material

cost, or such other measures and parameters.

(iii)In the cases where the aforementioned approaches may not be used, the labour cost budget can be

prepared on the basis of the following data:

(a) The permanent labour force directly employed in the manufacturing activities, and the rate of their

wages, plus



(b) The estimated amount that may become payable to these permanent labour by way of overtime, plus



(c) The temporary/casual labour that may be required, from time to time, and the rate of wages payable

to them.

The aggregate figure of items (a), (b), and (c) will constitute the labour cost budget.



494



FINANCIAL MANAGEMENT: THEORY AND PRACTICE



Manufacturing Overheads Budget

The factory cost, other than the direct material cost and the direct labour cost, constitute the manufacturing

overheads. These comprise such costs that cannot be identified with, or allocated to, any particular product or job.

For example:

(i)Indirect materials

(ii)Indirect labour

(iii)Miscellaneous items of factory expenses, like depreciation, utilities, supplies, repairs, maintenance,

insurance, rent, taxes, and so on



How to Prepare the Manufacturing Overhead Budget?

For the purpose of preparing the manufacturing overheads budget, the expenditure budget of all the departments

in the factory, both the production and services departments, must be computed and added up together. Further,

the volume of work of each department must be estimated appropriately, on the basis of the relevant measures

of the activity.

Such measures of activities, relating to some of the departments, are given as follows:

(i)For Production Department:



(a) Units of production



(b) Direct labour hours



(c) Direct machine hours

(ii)For Services Department



(a) Repair and maintenance, in terms of direct repair hour, or in terms of number of machines, which

are required to be maintained



(b) For purchase department, in terms of total value of purchases (in terms of rupees), or in terms of

number of purchase orders required to be placed



(c) For general factory administration, in terms of the number of employees in the plant, or in terms of

the total direct labour hours

Based on the levels of activity of each department, computed on some suitable measures, as discussed above,

the departmental budgets are prepared.

These budgets are required to be prepared, in terms of both the (a) variable cost and the (b) fixed cost. While

the variable cost components are prepared in relation to the planned level of activity, the fixed cost components

are estimated independently, by way of managerial decision and discretion.



Non-Manufacturing Cost Budget

The components of non-manufacturing cost budget are:

(i)Selling and distribution expenses

(ii)General administration

(iii)Research and Development (R&D)

(iv)Financing



How is the Non-Manufacturing Cost Budget Prepared?

This budget is also prepared on similar lines, as in the case of computing the overhead cost budget. This, too,

must be prepared in two segments, viz. in terms of fixed cost and variable cost. The variable cost in this budget

must be computed on the basis of some relevant and meaningful indicators/index of activities. The fixed cost

component should be computed, based on the managerial decision and discretion.



Division of Annual Budget

The year-end budget figures must be divided into quarterly and also monthly levels of performance, taking into

account the various relevant factors, like the peak-season and off-season, and such other factors, instead of just

mechanically dividing the annual level into equal and uniform monthly and quarterly levels.



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Corporate Planning, Budgeting and Control

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