Generally, the term budget refers to a precise statement which represents a financial estimation of the government’s income and expenditure for a specified period. According to cost accounting, budget is a quantitative statement which is prepared prior to a specified period to function as an estimation of future disbursements and receipts. The whole process of formulating, operating and implementing budgets is known as budgeting. Budget is an estimate of an entity’s economic activities for a specific period in the future. The appropriate authority must write and approve the budget. It should be corrected or modified according to changing circumstances.
A budget helps to measure the business’s performance by comparing budgeted and actual results. It is formulated based on trends and past experiences in the business. Budget is utilized to forecast the business’s operating functions and financial position.
Types of Budgets
Budgets can be classified in the following ways:
Based on Capacity
- Flexible Budget
- Fixed Budget
Based on Time
- Short-term Budget
- Long-term Budget
Based on Expenditure and Receipts
- Capital Budget
- Revenue Budget
Based on Scope
- Functional Budget
- Sales Budget
- Production Budget
- Purchase Budget
- Materials Budget
- Cash Budget
- Master Budget
Each of the types is explained below:
Based on Capacity:
1. Flexible Budget:
The budget changing with changes in the activity level is called a flexible budget. It pinpoints the fixed costs, variable cost and semi-variable cost to exhibit the expected outcomes at dissimilar volumes.
2. Fixed Budget:
The budget prepared for a fixed level of activity, i.e. the budget which remains constant whatever may be the activity level, is known as a fixed budget.
Based on Time:
1. Short-term Budget:
The budget formulated for a period between one to two years is known as a short-term budget. This budget is prepared for short-term projects.
2. Long-term Budget:
The budget formulated for a long period, probably between 3 to 10 years is known as a long-term budget. This budget is prepared for long-term projects.
Based on Expenditure and Receipts:
1. Capital Budget:
This budget considers the business’s estimated expenditure and receipts for a specific period. The process through which a business ascertains and evaluates possible large investments or expenses is called capital budgeting. These investments and expenditures include projects like constructing a new plant or putting the fund in a long-term venture.
2. Revenue Budget:
The budget covering all the revenue expenses and receipts of a specified financial year is known as a revenue budget. It is the sum of money allocated for maintaining and flourishing the business. This budget is necessary for the management and is the outcome of forecasts of expenses, sales revenue and capital expenditures of a business. Revenue budgets assist to properly allocate the resources and thus save the business’s time and effort.
Based on Scope:
1. Functional Budget:
Functional budget is focused on business activities or functions. This budget can be again classified in the following ways:
The sales budget is applied to ascertain the number of probable sales and the anticipated per unit selling price. It is an estimate of the firm’s anticipated total sales and selling expenses. It is called the backbone or the nerve center of the business. It specifies the types, quantities, and prices of the products.
The anticipated total sales volume is broken down product and area wise. The sales manager is responsible for making the sales budget considering the following factors:
- General economic conditions;
- Reports and estimates by salesmen
- Past sales trends and figures
- Orders in hand
- Seasonal fluctuations and
- Government’s control
The production budget is formulated to pinpoint the production for a specific period. It is expressed in terms of the units of anticipated produced outputs. It is made based on the sales budget. It also considers the stock levels needed to be maintained. It helps to determine the production cost.
The production budget’s nature differs from business to business. Practically, the whole budget should be broken down into article wise and month wise considering the estimated demand. The production department is responsible for adjusting its production as per the sales forecast. The production manager prepares it considering the following factors:
- The sales budget
- Availability of power, labor, raw materials, etc.
- Plant capacity
- Inventory policy, etc.
Purchase budget is prepared to estimate the value and quantity of various items to be purchased at various points of time, considering inventory required and the production schedule.
Materials budget is made to estimate the quantities of raw material and direct material needed to produce the finished product.
This budget indicates the cash required by the business in a specific period, considering all the payments and receipts of the business.
There are also other functional budgets apart from the ones explained above, i.e. direct material usage budget, plant utilization budget, production cost budget, factory overhead budget, cost of goods sold budget, administration expenses budget, selling and distribution cost budget, etc.
2. Master Budget:
The Financial officer is responsible for preparing a master budget after the creation of all functional budgets. According to the Institute of Cost and Management Accountants, England, “Master budget is the summary budget incorporating all the functional budgets, which is finally approved, adopted and applied.” Therefore, this budget is made by consolidating functional or departmental budgets. It is a summarized budget reflecting the estimated profit and loss and above all, the financial position applying Budgeted Balance Sheet and Budgeted Profit and Loss Account of the business.
The master budget gives an overall picture of the proposed functions and anticipated outcomes during the period of a budget. The company’s top management must approve it. Practices for preparing this budget may differ from company to company. Generally, a master budget consists of sales, costs-materials, production, factory overhead, labor, profit, major financial ratios and appropriation of profit.
A budget serves as a map for the business’s future economic activities, which are made according to the policies of the various business functions. The main motive of the budget is to optimally utilize the capital and other resources of the business.