A budget is an integrating and coordinating plan that expresses in financial terms regarding the operations and resources that are part of a company for a given period, in order to achieve the objectives set by senior management.
The main elements of the budget are:
- It is a plan, this means that the budget expresses what the administration will try to do. Integrator. Indicates that it takes into account all the areas and activities of the company. Directed to each of the areas in a way that contributes to the achievement of the global objective. It is indisputable that the plan or budget of a company department is not functional if it is not identified with the total objective of the organization, this process is known as a master budget, made up of the different areas that comprise it. Coordinator. It means that plans for several of the company's departments must be prepared together and in harmony. In monetary terms: it means that it must be expressed in monetary units.Operations: one of the primary objectives of the budget is to determine the income that is intended to be obtained, as well as the expenses that will be produced. This information should be prepared in as much detail as possible. Resources: It is not enough to know the income and expenses of the future, the company must plan the necessary resources to carry out its operation plans, which is achieved with financial planning that includes:
- Cash Budget. Budget of asset additions.
The Master Budget
The master budget is basically made up of two areas that are:
- The operating budget The financial budget
Master Budget Sequence Diagram - What is a Budget
The following video lesson from the teacher Jasbleidy Padilla, from the financial management and treasury training program of the SENA financial services center, will be quite useful since it explains what the master budget consists of and how it is made.
1. The Operation Budget
The master budget is made up of two budgets, the operating budget and the financial budget. The first of these refers properly to the activities of producing, selling and managing the organization, which are the typical activities through which a company carries out its mission of offering products or services to society.
These activities give rise to the budgets of sales, production, purchases, raw material requirements, labor, indirect expenses and operating expenses, costs of sales.
These in turn need to be summarized in a report that allows the administration to know where the efforts will be directed towards the operation of the company, which is achieved through the budgeted Statement of Income.
The sales budget
The organization must determine the behavior of its demand, that is, know what the market is expected to do, at the end of this, it will be able to prepare its own production budget.
This procedure is normally performed in most companies, since they have idle capacity, that is, demand is less than the installed capacity to produce.
There are cases in which companies prepare the production budget as a first step.
There are also public sector companies that first budget their expenses or needs and based on this determine the income that they will have to collect through taxation (taxes, duties, etc.).
To develop the sales budget, the following sequence is recommended:
- Clearly determine the objective that the company wants to achieve with respect to the level of sales in a given period, as well as the strategies that will be developed to achieve it. Carry out a study of the future of demand, supported by certain methods that guarantee the objectivity of the data, such as regression and correlation analysis, industry analysis, economy analysis, etc. Based on the desired data for the future that generated the forecast and on the professional judgment of sales executives, prepare their budget trying to divide it by zones, divisions, lines, etc., in such a way that its execution is facilitated.
Once the sales budget is accepted, it must be communicated to all areas of the organization so that the input budget is planned.
Production budget
Once the sales budget has been determined, the production plan must be drawn up. This is important since the entire requirements plan with respect to the different inputs or resources that will be used in the production process depends on it.
To determine the quantity to be produced of each of the lines that the organization sells, the following variables must be considered:
- Budgeted sales for each line Desired ending inventories for each line type Starting inventory for each line
Production Budget per line
Budgeted sales + Desired ending inventory of Arts. Finished - Initial inventory of Arts. Finished. = Production budget per line
The previous formula assumes that inventories in process have little significant changes. If not, they should be considered within the analysis to determine the production of each line.
Until now, the need to know the inventory levels at the beginning and at the end of the productive period has been raised, however, within this period it is necessary to determine what is the desired policy for each company regarding production.
The most common policies are:
- Stable production and variable inventory. Variable production and stable inventory. Combination of the previous two.
Raw material and purchasing needs budget
Once the production budget has been completed, the needs of the different inputs can be diagnosed.
Under normal conditions, when no shortage of raw material is expected, the quantity should be based on the standard that has been determined for each type of product per product, as well as the quantity budgeted to produce in each line, indicating at the same time the time in which it will be required.
Raw material «A» required = Budgeted production of a line * standard raw material “A”
The raw material requirements budget must be expressed in monetary units once the purchasing department defines the price at which it will be purchased, which constitutes the cost of the budgeted material.
Only direct material is included in this budget, since indirect materials (lubricants, accessories, etc.) are included in the manufacturing indirect cost budget.
Direct labor budget
This budget tries to clearly diagnose the needs of human resources and how to act, according to said diagnosis, to satisfy the requirements of the planned production.
It must allow the determination of the standard in hours of labor for each type of line produced by the company, as well as the quality of labor required, which can detect whether more human resources are needed or whether current are enough.
Once the number of workers required has been calculated, it must be determined what this amount of human resources will cost, that is, translate the budget for direct labor, expressed in standard hours or in number of people and quality, into monetary units, that is, Calculate the cost of labor budget.
Manufacturing Overhead Budget
The budget must be prepared in advance of all the centers of responsibility in the productive area that carry out any indirect productive expenditure. It is important that, when drawing up this budget, the behavior of each of the items of indirect expenses is perfectly detected, so that the variable manufacturing costs are budgeted based on the previously determined production volume and the fixed manufacturing costs are planned within a certain stretch of capacity independent of the budgeted production volume.
When the manufacturing expense budget has been drawn up, the application rate should be calculated in both its variable and its fixed part and choose a basis that is suitable for the indirect manufacturing expense budget structure.
You can synthesize the above using the formula:
Y = a + bx
Where:
- a = fixed manufacturing costs b = variable costs per unit to be produced x = volume of activity.
In the context of developing the master plan, it is very important to use the so-called flexible budget, which consists of budgeting both income and expenses according to different levels of activity, in accordance with the behavior shown by both in terms of a given activity.
Operating expense budget
The purpose of this budget is to plan the expenses incurred by the distribution and administration functions of the company to carry out the activities proper to its nature.
Like indirect production expenses, operating expenses must be separated across all variable and fixed expense items to apply flexible budgeting to these areas, using activity-based costing.
The volume according to which the variable items will change will not be that of production but the one appropriate to its cost-generating function.
2. Financial Budget
The master plan must culminate in the preparation of the budgeted financial statements, which are a reflection of where the administration wants to place the company, as well as each of the areas, according to the objectives that were set to achieve the global situation.
Aside from the annual budgeted financial statements, monthly or quarterly financial reports can be prepared or when deemed appropriate for feedback purposes, allowing corrective actions to be taken as deemed appropriate in each situation.
The financial budget coupled with certain data from the budgeted income statement expresses the budgeted statement of financial position and the budgeted cash flow statement.
The income statement, the statement of financial position and the budgeted cash flow statement indicate the projected situation. With these reports the preparation of the annual plan or master plan of a company is concluded.
