Budgetary Planning, Control & Cash-Budget Preparation – Managerial Accounting

Introduction to Budgetary Planning and Control

• Budget: quantified $\text{plan of action}$ for a given time period (usually a fiscal year)
  • Expresses projected revenues, expenses, cash flows
  • Functions as:
  • $\text{Definite target}$ for planning
  • $\text{Yard-stick}$ for control
• Personal finance parallel: monthly household budget keeps individuals solvent and out of debt
• Ethical / managerial significance:
  • Promotes responsible stewardship of resources
  • Builds transparency & accountability across the organisation

Key Roles / Multiple Functions of a Budget

• Strategic Planning
  • Aligns day-to-day finances with long-term corporate strategy
• Resource Allocation
  • Distributes money, people, and time to the highest-value projects
• Setting Financial Goals
  • Establishes SMART (Specific, Measurable, Achievable, Relevant, Time-bound) monetary targets
• Performance Measurement
  • Variance analysis: $\text{Variance}=\text{Actual}-\text{Budget}$
• Cost Management
  • Early identification of cost overruns → corrective action
• Profit Planning / Maximisation
  • Forecasts profit $\pi$ and highlights revenue-growth or cost-reduction levers
• Cash-Flow Management
  • Projects $\text{Cash Inflows}$ vs. $\text{Cash Outflows}$ to maintain liquidity
• Decision-Making Support
  • Provides financial feasibility data for new investments
• Communication Tool
  • Cascades financial expectations to all organisational levels
• Motivation
  • Budget targets act as performance incentives for departments / employees

Budgetary Management Infrastructure

• Budget Committee
  • Cross-functional group coordinating preparation & administration
• Budget Manual
  • Compilation of procedures, calendars, forms, authority levels, glossary, etc.

Six Common Approaches to Budgeting

1. Top-Down / Imposed Budgeting
   • Senior management sets targets with little or no lower-level negotiation
2. Bottom-Up / Participative Budgeting
   • Lower-level managers co-create estimates → ownership & richer information
3. Negotiated Budget
   • Iterative compromise between multiple management tiers
4. Traditional / Incremental Budgeting
   • $\text{Next Year Budget}=\text{Current Budget}+\text{Increment}$
   • Easy to prepare but can entrench inefficiencies
5. Rolling (Continuous) Budget
   • Adds a new period (e.g., month or quarter) as the current period lapses, maintaining a constant 12-month horizon
6. Zero-Based Budgeting (ZBB)
   • Every cost must be justified from a $\text{zero base}$; discourages slack & waste

Types of Budgets Prepared

• Functional Budgets
  • Sales, Production, Material Usage, Material Purchase, Labour, Production Cost
• Cash Budget
  • Focus of liquidity planning; compiled after operating & capital budgets
• Master Budget
  • Budgeted Income Statement (P&L)
  • Budgeted Balance Sheet

Cash Budget: Definition & Importance

• Financial budget projecting $\text{Cash Balance}_{\text{end}}$ through explicit inflow/outflow scheduling
• Prepared after:
  • Operating budgets (sales, purchases, wages, S&D, G&A)
  • Capital expenditure budget
• Benefits / Practical Implications
  • Early warning of short-term deficits → arrange overdraft rather than bounce payments
  • Highlights long-term surpluses → plan investments or expansions

Cash-Position Based Managerial Actions

Example 01 – Watson Ltd (Quarterly Cash Budget)

Input Data (core figures):

• Forecast Sales: $\text{Jun}=12\,500,\; Jul=13\,600,\; Aug=17\,000,\; Sep=16\,800$ (Rs.)
• Direct Wages: Rs. $1\,300$ / month (paid immediately)
• Direct Material Purchases: $\text{Jun}=3\,450,\; Jul=3\,780,\; Aug=2\,890,\; Sep=3\,150$
• Overheads:
  • Production: Rs. $3\,200$ / month (1-month credit)
  • S&D + Admin: Rs. $1\,890$ / month (1-month credit)
  • Depreciation components already embedded (non-cash): Rs. $300$ + Rs. $190$
• Additional Capital Outlay: Delivery vehicle purchase Rs. $9\,870$ in August (cash)
• Cash Sales share: $10\%$ immediate; $90\%$ collected one month later
• Creditors: Paid one month after purchase
• Opening Cash (end June): Rs. $1\,235$

Conceptual Solution Outline (no arithmetic shown here):

1. Compute cash receipts each month:
   $\text{Cash Receipts}<em>{t}=0.10\times\text{Sales}</em>{t}+0.90\times\text{Sales}_{t-1}$
2. Compute cash payments:
   • Materials: lag 1 month
   • Wages: current month
   • Overheads (cash portion only): lag 1 month; remove depreciation: $\text{Cash Overhead}=3\,200+1\,890-490$
   • Capital expenditure in August
3. Net Cash Flow = Receipts − Payments
4. Closing Cash = Opening Cash + Net Cash Flow (per month, rolling)

Example 02 – Retail Business (4-Month Cash Budget)

Given

• Opening Cash $=50\,000$
• Sales Forecast Jan–Apr (Rs.): $80\,000;\;75\,000;\;85\,000;\;90\,000$
• Collection Pattern: $70\%$ same month, $20\%$ next month, $10\%$ uncollectible
• Operating Expenses (cash, same month): $30\,000;\;35\,000;\;40\,000;\;45\,000$
• Fixed Monthly Outflows: Loan Repay $5\,000$, Interest $1\,000$, Dividend $2\,000$
• Income Tax: Rs. $15\,000$ due in March
• Capital Expenditure: Rs. $10\,000$ in February
  Computation Framework

1. Cash Collections
   • For January: $0.70\times80\,000=56\,000$
   • For February: $0.70\times75\,000+0.20\times80\,000$, etc.
2. Total Cash Available = Opening Cash + Collections
3. Total Cash Disbursements = Operating Expenses + Loan + Interest + Dividend + Tax + CapEx (as applicable)
4. Ending Cash Balance = Beginning Cash + Net Cash Flow
   Recommendations for Cash-Flow Management

• If projected balances dip near minimum-liquidity thresholds, consider:
  • Negotiating seasonal credit lines with the bank
  • Timing non-urgent CapEx
  • Accelerating collections (early-payment discounts)
  • Stretching payables (without harming supplier relations)
• For sustained surpluses:
  • Invest in higher-yield short-term instruments (e.g., T-bills)
  • Pre-pay high-interest debt to reduce future interest burden

Broader Connections & Real-World Relevance

• Budgeting integrates with:
  • Standard costing & variance analysis (topics likely covered in prior lectures)
  • Capital budgeting (NPV, IRR) for long-term investments
• Practical implications:
  • Credit rating agencies evaluate firms’ budgeting rigour as proxy for governance quality
  • Start-ups employ rolling budgets due to high uncertainty and need for agility
• Ethical dimension:
  • Manipulating budgets to create “budgetary slack” can mislead stakeholders and misallocate capital

Key Formulas & Reminders (Quick Reference)

• Cash Receipts with Mixed Credit Terms:
  $(\text{Receipts}<em>t)=p</em>0\times\text{Sales}<em>t+p</em>1\times\text{Sales}_{t-1}+\dots$
• Variance Analysis:
  $\text{Variance}=\text{Actual}-\text{Budget}$
• Closing Cash Balance:
  $\text{Cash}<em>{\text{close}}=\text{Cash}</em>{\text{open}}+\text{Total Inflows}-\text{Total Outflows}$
• Profit Forecast:
  $\pi=\text{Budgeted Revenue}-\text{Budgeted Cost}$

Study Tips

• Understand the timing differences between recognition of expense/revenue and actual cash movement
• Practice preparing both functional and master budgets before attempting cash budgets
• When given depreciation, remember it is non-cash; adjust cash budgets accordingly
• For exam questions, set up clear schedules: collections, payments, overheads, and a month-by-month cash ledger