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ACCOUNTING DEPARTMENT
BASIC ACCOUNTING WORKS LEVEL II

Learning Guide
Unit of Competence: Develop and Use a Personal Budget
Module Title: Developing and using Personal Budget
LG Code: BUF BAW2 08 0812

TTLM Code: BUF BAW2 M08 1212

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CONTENTS PAGE
INTRODUCTION…………………………………………………………………… 2
LO1………………………………………………………………………… 7
Analyze and discuss budgeting as a financial tool
 different groups
 financial goals
 The Obstacles
LO2 …………………………………………………………………………13
Develop a personal budget
 A spreadsheet
 fixed expenses
 ways to reduce expenses or increase income
 Allocation of surplus funds
LO3 … …………………………………………………………………..… 27
Implement and monitor the personal budget
 The budget is followed according to plan
 budgeted expenses
 Handy hints f
 Ongoing review of the budget

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Introduction

i. Descriptor
This TTLM Consists of unit describes regarding performance outcomes, skills and knowledge
required to develop, implement and monitor a personal savings budget. .

Learning Outcomes:
At the end of this module trainees will be able to:
1 Analyse and discuss budgeting as a financial tool
2. Develop a personal budget
3. Implement and monitor the personal budget

Analyze and discuss budgeting

LO1
as a financial tool

The role of budgeting in the lives of different groups and the importance of
budgeting appropriately to meet expenses is analyzed and discussed and related
to different stages of life The importance of setting financial goals is analyzed
and discussed Obstacles that might prevent financial goals being achieved are
analyzed and discussed with the types of behaviors and skills required for
successful budgeting explored and analyzed
 Budget refers to: a calculation of all projected income and expenditure for period of
time (e.g. on a weekly or monthly basis)
showing all projections versus actual income and expenses for the period and
monitoring variances.

OVER VIEWING
BUDGETING
Information Sheet – 1

Most people associate the word “budget” with the approving, rejecting, or
arguing over various budgets. Tax payers demand that governments plan the

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effective use of their hard earned tax amounts, and budgets not only allow
governments to plan spending, but also allow tax payers to see exactly where
and how their money is being spent.

Most business organizations use budgets to focus attention on company

operations and finances. Budgets highlight potential problems and advantages
early, allowing management to take steps to avoid these problems or use the
advantages wisely. Thus, a budget is a tool that helps managers in both their
planning and control functions.

Budget is a quantitative expression of the money inflows and outflows to

determine whether a financial plan will meet organizational goals. Budgeting is
the process of preparing budgets.

Budgets help mangers with their control function not only by looking for ward
but also by looking back ward. Budgets, of course, deal with what mangers plan
for the future. However, they also can be used to evaluate what happened in the
past. Budgets can be used as a benchmark that allows managers to compare
actual performance with estimated or desired performance.

Recent surveys show just how valuable budgets can be. Study after study has
shown budgets to be the most widely used and highest rated tool for cost
reduction and control. Advocates of budgeting go so far as to claim that the
process of budgeting forces a manager to become a better administrator and puts
planning in the fore font of the manager’s mind.

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Budgetary Control

Budgetary Control is the system of controlling costs through budgets. Budgeting

is thus only a part of the budgetary control. Budgetary Control is defined as “the
establishment of budgets relating to the responsibilities of executives of a policy
and the continuous comparison of the actual with the budgeted results, either to
secure by individual action the objective of the policy or to provide a basis for its
revision”.

The following are some of the characteristics of budgetary control:

 Establish a budget or target of performance for each department or function

of the organization.
 Compare actual performance with the budget.
 Ascertain the reasons for the difference between actual and budgeted
performance
 Take suitable remedial action so that budget performance may be achieved.
Budgetary Control is one of the very important tools of planning and control. It
involves a constant comparison of actual performance with the budgeted goals of
the business. Many business fail because of lack of planning. By planning, many
problems and dangers are anticipated which the business has to face.

Budgetary Control Based on Management Functions

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The objectives of budgetary control may be explained under three heads -

Planning, Co-ordination and Control. These three objectives are so much
interrelated that it is not possible to discuss one with out the other.

1) Planning. A budget provides a detailed plan of action for a business over

a definite period. Detailed plans relating to production, sales, raw material
requirements, labor needs, advertising and sales promotion performances,
research and development activities, capital additions, etc. are drawn up.
By planning, many problems are anticipated long before they arise and
solutions can be sought through careful study. Thus, most business
emergencies can be avoided by planning. In brief, budgeting forces
management to think ahead-to anticipate and prepare for the anticipated
conditions.
2) Co-ordination. Budgeting aids managers in co-coordinating their efforts
so that objectives of the organization as a whole harmonize with the
objective of its parts. Effective planning and organization contributes a lot
in achieving co-ordination. There should be coordination in the budgets of
various departments. For example, budget of sales should be in
coordination with the budget of production. Similarly, production budget
should be prepared in Co-ordination with the purchase budget, and so on.
3) Control. Control is necessary to ensure that plans and objectives as laid
down in the budgets are being achieved. Control, as applied to budgeting,
is a systematized effort to keep management informed of whether planned
performance is being archived or not.
Information Sheet – 2 TYPES OF BUDGETS

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There are several different types of budgets used by business. The most for
ward-looking budget is the strategic plan, which sets the overall goals and
objectives of the organization. Some business analysts will not classify the
strategic plan as an actual budget, though, because it does not deal with a
specific time frame, and it does not produce forecasted financial statements. In
any case, the strategic plan leads to long-range planning, which produces
forecasted financial statements for five to ten-year periods. The financial
statements are estimates of what management would like to see in the company’s
future financial statements. Decisions made during long-range planning include
addition or deletion of product lines, design and location of new plants,
acquisitions of buildings and equipment, and other long-term commitments.
Long-range plans are coordinated with capital budgets, which detail the
planned expenditures for facilities, equipment, new products, and other long-
term investments.

Long-range plans and budgets give the company direction and goals for the
future, while short-term plans and budgets guide day-to-day operations.
Managers who pay attention to only short-term budgets will quickly lose sight of
long-term goals. Similarly, managers who pay attention to only the long-term
budget could wind up mismanaging day-to-day operations. There has to be a
happy medium that allows managers to pay attention to their short-term budgets
while still keeping an eye on long-term plans.

The master budget is an extensive analysis of the first year of the long-range
plan. A master budget Summarizes the planned activities of all sub units of an
organization-sales, production, distributions and finance. The master budget

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quantifies targets for sales, cost-driver activity, purchases, production net

income, cash position, and any other objective that management specifies. It
expresses these amounts in the form of forecasted financial statements and
supporting operating schedules. These supporting schedules provide the
information that is too highly detailed to appear in the actual financial
statements.

Thus, the master budget is a periodic business plan that includes a coordinated
set of detailed operating schedules and financial statements. It includes forecasts
of sales, expenses, cash receipts and disbursements, and balance sheets. Master
budgets (also called pro forma statements, another term for forecasted financial
statements) might consist of 12 monthly budgets for the year or perhaps monthly
budgets for only the first quarter and quarterly budgets for the three remaining
quarters.

Continuous budgets or rolling budgets are a very common form of master

budgets that simply add a month in the future as the month just ended is
dropped. Budgeting thus becomes an ongoing instead of periodic process.
Continuous budgets force managers to always think about the next 12 months,
not just the remaining months in a fixed budgeting cycle.

ADVANTAGES OF BUDGETS

Three major benefits of budgeting are as follows:

1. Budgeting compels managers to think ahead by formalizing their

responsibilities for planning.
2. Budgeting provides definite expectations that are the best framework for
judging subsequent performance.

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3. Budgeting aids managers in coordinating their efforts, so that the

objectives of the organization as a whole match the objectives of its parts.
4. Budgeting helps to motivate employees.
Let’s look more closely at each of these benefits.

FORMALIZATION OF PLANNING

Budgeting forces managers to think ahead-to anticipate and prepare for changing
conditions. The budgeting process makes planning and explicit management
responsibility. Too often, managers operate from day-to-day, extinguishing one
business brush fire after another. They simple have “no time” for any tough-
minded thinking beyond the next day’s problems. Planning takes a back seat to
or is actually obliterated by daily pressures.

The trouble with the day-to-day approach to managing an organization is that

objectives are never crystallized. Managers react to current events rather than
plan for the future. To prepare a budget, a manager should set goals and
objectives, and establish policies to aid their achievement. The objectives are the
destination points, and budgets are the road maps guiding us to those
destinations. Without goals and objectives, company operations lack direction;
problems are not foreseen; and results are difficult to interpret after word.

FRAME WORK FOR JUDGING PERFORMANCE

Budgeted goals and performance are generally a better basis for judging actual
results than is past performance. The news that a company had sales of $ 100
million this year, as compared with $ 80 million the previous year, may or may
not indicate that the company has been effective and has met company
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objectives. Perhaps sales should have been $ 110 million this year. The major
drawback of using historical results for judging current performance is that
inefficiencies may be concealed in the past performance. Changes in economic
conditions, technology, personnel, competition, and so forth also limit the
usefulness of comparisons with the past.

COMMUNICATION AND COORDINATION

Budgets tell employees what is expected of them. A good budget process

communicates both from the top down and from the bottom up. Management
makes clear the goals and objectives of the organization in its budgetary
directives. Employees and lower level managers then inform higher-level
managers how they plan to achieve the goals and objectives.

Budgets also help managers coordinate objectives. For example, a budget forces
purchasing personnel to integrate their plans with production requirements
while production managers use the sales budget and delivery schedule to help
them anticipate and plan for the employees and physical facilities they will need.
Similarly, financial officers use the sales budget, purchasing requirements, and
so forth to anticipate the company’s need for cash. Thus the budgetary process
forces managers to visualize the relationship of their departments’ activities to
other departments and to the company as a whole.

BUDGETING IN GOVERNMENT

In profit-seeking organizations, revenues and expenditures are interrelated;

organizations spend money to earn revenues. In many cases, there is a physical
relationship between the amount of money spent (on things such as raw

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materials) and the amount of revenue. In government organizations, however,

revenues and expenditures are independent.

Governments develop revenue budgets which are estimates of the amount of

money that they will raise or will be allocated. Legislatures approve expenditure
budgets, which provide public servants with the authority to spend government
revenues on specific projects.

Occasionally governments pass laws (often called balanced-budget

requirements) limiting government expenditures to the amount of revenues
raised, but revenues and expenditures are separate. For most governments,
controlling expenditures means ensuring that authorized government spending
has not been exceeded by actual spending rather than assessing whether the
programs on which money was spent accomplished their objectives.

BUDGETARY APPROACHES

Budgetary approaches can be divided in to two:

1. Zero Base Budgeting

2. Incremental Budgeting

1. ZERO BASE BUDGETING

In recent development, Zero base budgeting is considered widely by most

organizations. Zero base budgeting forces each manager to answer the question
why a cost is incurred. It forces managers to start from the scratch (zero bases).
The principal advantage of zero base budgeting is that each type of cost incurred

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in every budget period will be justified. If there is any sort of inefficiency during
the current period, there is no way to continue with that inefficient activity in the
future.

2. INCREMENTAL BUDGETING

In incremental budgeting, previous budgets are considered as a base. The

previous budget figures can be increased or decreased depending on
circumstances, which are determined on the volume of activity the organization
wants to perform. The incremental budgets eases the preparation of budgets
since the budget preparer starts from a budget already prepared and adjusts
those data. However, the incremental budgeting has disadvantages. The greatest
disadvantage is that prior period budgets may include inefficiencies.

Moreover, organizations, in particular government organizations, simply add a

percentage increase to their previous budgets with out considering the fact
whether they usually need or not and by the end of the budget period, they rush
to spend money on unnecessary activities fearing future reduction in budgets.
This is the usual case for most Ethiopian government organizations.

Self Checke

1. “Budgets are primarily a tool used to limit expenditures.” Do you agree?

Explain.
2. How do strategic planning, long-range planning and capital budgeting
differ?
3. Capital budgets are plans for managing long-term debt and common
stock. “Do you agree? Explain.
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4. Why is budgeted performance better than past performance as a basis for

judging actual results?
5. What are the major benefits of budgeting?
6. “Performa statements are those statements prepared in conjunction with
continuous budgets.” Do you agree? Explain?
7. List four characteristics of budgetary control.
8. What are the two budgetary approaches?

Preparing Operating Budget and

Financial Budget for Merchandising
Business
Information Sheet 1. 2

The master budget is a summary of a company’s plans that sets specific targets
for sales, production, distribution, and financing activities. It generally
culminates in a cash budget, a budgeted income statement, and a budgeted
balance sheet. In short, it represents comprehensive expression of management’s
plans for the future and how these plans are to be accomplished.

COMPONENTS OF A MASTER BUDGET

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The terms used to describe specific budget schedules vary from organization to
organization. However, most master budgets have common elements. The usual
master budget for a non-manufacturing company has the following components:

A. Operating budget

1. Sales budget

2. Purchases budget

3. Cost-of-goods-sold budget

4. Operating expense budget

5. Budgeted income statement

B. Financial budget

1. Capital budget

2. Cash budget

3. Budgeted balance sheet

Exhibit 2-1 presents a condensed diagram of the relationships among the various
parts of a master budget for a non-manufacturing company. In addition to these
categories, manufacturing companies that maintain physical product inventories
prepare ending inventory budgets and additional budgets for each type of
resource activity (such as labor, materials, and factory overhead).

The two major parts of a master budget are the operating budget and the
financial budget. The operating budget focuses on the income statement and its
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supporting schedules. Though some times called the profit plan, an operating
budget may show a budgeted loss, or even be used to budget expenses in an
organization or agency with no sales revenues.

In contrast, the financial budget focuses on the effects that the operating budget
and other plans (such as capital budgets and repayments of debt) will have on
cash.

Exhibit 2-1

Preparation of Master Budget for Non-Manufactory Company

Sales Budget

Ending –Inventory
Budget
Purchases Budget

Cost-of-goods-sold –Budget

Operating Budget
Operating expenses Budget

Budgeted Statement of income

Budgeted 15
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In addition to the master budget, there are count less form of special budgets and
related reports. For example, a report might detail goals and objectives for
improvements in quality or customer satisfaction during the budget period.

TASK 2. PREPARING THE MATER BUDGET

Let’s return to Exhibit 2-1 and trace the preparation of the master budget
components. Follow each step carefully. Although the process may seem largely
mechanical, remember that the master- budgeting process generates key
decisions regarding all aspects of the company’s value chain.

Therefore, the first draft of the budget leads to decisions that prompt subsequent
drafts before a final budget is chosen.

Example

To illustrate the budgeting process we will use as an example the Selam

Electronics Company (SEC), a local retailer of a wide variety of kitchen and
dining room items such as coffeemakers, silver ware, and table linens. The
company rents a retail store in a mid sized community near Axum. SEC’s
management prepares a continuous budget to aid financial and operating
decisions. For simplicity in this illustration, the planning horizon is only four
moths, April through July. In the past, sales have increased during this season.
However, the company’s collections have always lagged well behind its sales. As
a result, the company has often found it self pressed to come up with the cash for
purchases, employee wages, and other operating outlays. To help meet this cash

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squeeze, SEC has used short-term loans from local banks, paying them back
when cash comes in. SEC plans to keep on using this system.

Exhibit 2-2 is the closing balance sheet for the fiscal year ending March 31, 1997.
Sales in March were $40,000. Monthly sales are forecasted as follows:

April $50,000

May 80,000

June 60,000

July 50,000

August 40,000

Management expects future sales collections to follow past experience: 60% of

the sales should be in cash and 40% on credit. All credit accounts are collected in
the month following the sales. The $ 16,000 of accounts receivable on March 31
represents credit sales made in March (40% of

$40,000). Uncollectible accounts are negligible and thus ignored. For simplicity’s
sake, we will ignore all local, state, and federal taxes for this illustration

Because deliveries from suppliers and customers demands are uncertain, at the
end of each month, SEC wants to have on hand a basic inventory of items valued
at $ 20,000 plus 80% of the expected cost of goods sold for the following month.
The cost of merchandise sold averages 70% of sales. There fore the inventory on
March 31 is $ 20,000 + 0.8 (0.7 x April sales of $ 50,000) = $ 20,000 + $ 28,000 = $
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48,000. The purchase terms available to SEC are net, 30 days. SEC pays for each
month’s purchases as follows: 50% during that month and 50% during the next
month. Therefore, the accounts payable balance on March 31 is 50% of March’s
purchases, or $33,600 x 0.5 = $ 16,800.

Exhibit 2-2

Selam Electronics Company

Balance sheet March 31, 1997

Asset

Current assets

Cash $10, 000

Accounts receivable, net (0.4 x march

Sales of $40,000) 16,000

Merchandise inventory, $ 20,000 +0.8 (0.7x

April sales of $ 50,000) 48,000

Unexpired insurance 1,800 $75,800

Plant assets

Equipment, fixtures, and others $ 37,000

Accumulated depreciation (12,800) 24,200

Total assets $ 100,000

Liabilities and Owners’ equity

Current liabilities

Accounts payable (0.5 x march

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Purchases of $ 33,600) $16,800

Accrued wages and commissions payable

($ 1,250 + 3,000) 4,250 $ 21,050

Owners’ equity 78,950

Total liabilities and owners’ equity $100,000

SEC pays wages and commissions semimonthly, half a month after they are
earned. They are divided in the two portions: monthly fixed wages of

$ 2,500 and commissions equal to 15% of sales, which we will assume are
uniform through out each month. Therefore, the March 31 balance of accrued
wages and commissions payable is (0.5 x $ 2, 500) + 0.5 (0.15 x $ 40,000) = $ 1,250
+ $ 3000 = $ 4, 250. SEC will pay this $ 4,250 on April 15.

In addition to buying new fixtures for $ 3000 cash in April, SEC’s other monthly
expenses are as follows:

Miscellaneous expenses 5% of sales, paid as incurred

Rent $ 2,000, paid as incurred

Insurance $ 200 expiration per month

Depreciation, including new futures $ 500 per month

The company wants a minimum of $ 10,000 as a cash balance at the end of each
month. To keep this simple, we will assume that SEC can borrow or repay Loans
in multiples of $ 1000. Management plans to borrow no more cash than
necessary and to repay as promptly as possible. Assume that borrowing occurs at

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the beginning and repayment at the end of the months in question. Interest is
paid, under the terms of this credit arrangement, when the related loan is repaid.
The interest rate is 18% per year.

TASK 3. STEPS IN PREPARING THE MASTER BUDGET

The principal steps in preparing the master budget are:

Operating Budget

1. Using the data given, prepare the following detailed schedules for each of
the months of the planning horizon:
a. Sales budget
b. Cash collections from customers
c. Purchases budget
d. Disbursements for purchases
e. Operating expense budget
f. Disbursements for operating expenses
2. Using these schedules, prepare a budgeted income statement for the 4
months ending July 31, 1997 (Exhibit 2-3).
Financial Budget

3. Using the data given and the supporting schedules, prepare the following
forecasted financial statements:
a. Capital budget
b. Cash budget including details of borrowings, repayments, and
interest for each month of the planning horizon (Exhibit 2-4)
c. Budgeted balance sheet as of July 31, 1997 (Exhibit 2-5)

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Organizations with effective budget systems have specific guidelines for the
steps and timing of budget preparation. Although the details differ, the
guidelines invariably include the preceding steps. As we follow these steps to
prepare SEC’S master budget, be sure that you understand the source of each
figure in each schedule and budget.

Step 1: Preparing the Operating Budget

Step 1a: Sales Budget

The sales budget (‘schedule a’ in the following table) is the starting point for
budgeting because inventory levels, purchases, and operating expenses are
geared to the rate of sales activities ( and other cost drivers that are not present in
this example). Accurate sales and cost-driver activity forecasting is essential to
effective budgeting.

March sales are included in ‘schedule a’ because they affect cash collections in
April. Trade the final column in schedule a to the first raw of

Exhibit 2-3. In non profit organizations, forecasts of revenue or some level of

services are also the focal points for budgeting. Examples are patient revenues
and government reimbursement expected by hospitals and donations expected
by churches. If no revenues are generated, as in the case of municipal fire
protection, a desired level of service is predetermined.

Step 1b: Cash Collections from Customers

It is easier to prepare schedule b, cash collections, at the same time as we prepare

the sales budget. Cash collections from customers include the current month’s

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cash sales plus the previous month’s credit sales. We will use total collections in
preparing the cash budget-see Exhibit 2- 4

April-July

March April May June July Total

Schedule a: Sales Budget

Credit sales , 40% $16,000 $ 20,000 $ 32,000 $ 24,000 $20,000

Plus cash sales, 60% 24,000 30,000 48,000 36,000 30,000

Total sales $ 40,000 $50,000 $80,000 $60,000 $50,000 $240,000

Schedule b: Cash collections

Cash sales this month $ 30,000 $48,000 $36,000 $ 30,000

Plus 100% of last month’s

Credit sales 16,000 20,000 32,000 24,000

Total collections $46,000 $68,000 $68,000 $54,000

Step 1c: Purchases Budget

After sales are budgeted, we prepare the purchases budget (schedule c). The
total merchandise needed will be the sum of the desired ending inventory plus
the amount needed to fulfill budgeted sales demand. The total need will be
partially met by the beginning inventory; the remainder must come from
planned purchases. These purchases are computed as follows:

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Budgeted purchases = desired ending + cost of - beginning

Inventory goods sold inventory

Trace the total purchases figure in the final column of schedule C to the second
row of Exhibit 2-3

April-July

March April May June July Total

Schedule c: Purchases Budget

Desired ending inventory $48,000* $ 64,800 $ 53,600 $ 48,000 $42,400

Plus: cost of goods sold 28,000 35,000 56,000 42,000 35,000 $168,000

Total needed $76,000 $99,800 $109,600 $90,000 $77,400

Less: beginning inventory 42,400 48,000 64,800 53,600 48,000

Purchases $33,600 $51,800 $44,800 $36,400 $29,400

Schedule d: disbursements

For purchase

50% of last month’s purchases $ 16,800 $25,900 $22,400 $ 18,200

Plus 50% of this month’s

Purchases 25,900 22,400 18,200 14,700

Disbursements for purchases $42,700 $48,300 $40,600 $32,900

* $ 20,000 + (0.8 x April cost of goods sold) = $ 20,000 + 0.8 ($35,000) = 48,000.

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+ 0.7 x March sales of $ 40,000 = $ 28,000; 0.7 x April sales of $ 50,000 = $ 35,000, and so on.

 $ 20,000 + (0.8 x March cost of goods sold of $ 28,000) = $ 20, 000 + $ 42, 400.

Step 1d: Disbursements for Purchases

Schedule d, disbursements for purchases, is based on the purchases budget. In

our example disbursements include 50% of the current month’s purchases and
50% of the previous month’s purchases. We will use total disbursements in
preparing the cash budget, Exhibit 2-4, for the financial budget.

Step 1e: Operating Expense Budget

The budgeting of operating expenses depends on several factors. Month-to-

month changes in sales volume and other cost-driver activities directly influence
many operating expenses. Examples of expenses driven by sales volume include
sales commissions and many delivery expenses. Other expenses are not
influenced by sales or other cost-driver activity (such as rent, insurance,
depreciation, and salaries) with in appropriate relevant ranges and are regarded
as fixed. Trace the total operating expenses in the final column of schedule e,
which summarizes these expenses, to the budgeted in come statement, Exhibit 2-
3.

April-July
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March April May June July Total

Schedule e: Operating

Expense Budget

Wages (fixed) $2,500 $2500 $2500 $2500 $2500

Commissions (15% of current

Month’s sales) 6000 7500 12000 9000 7500

Total sales wages & Commission 85,00 $10,000 $14,500 $11,500 $10,000 46,000

Miscellaneous expenses

(5% of current sales) 2500 4000 3000 2500 12,000

Rent (fixed) 2000 2000 2000 2000 8000

Insurance (fixed) 200 200 200 200 800

Depreciation (fixed) 500 500 500 500 2000

Total operating expenses 15,200 21,200 17,200 15,200 68,800

Step1 f: Disbursements for Operating Expenses

Disbursements for operating expenses are based on the operating expense

budget. Disbursements include 50% of last month’s and this month’s wages and
commissions, and miscellaneous and rent expenses. We will use the total of these
disbursements in preparing the cash budget,
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April-July

March April May June July Total

Schedule f: Disbursements

For Operating Expense

Wages & Commission

50% of last month’s

Expenses $ 4,250 $5000 $7,250 5,750

50% of this month’s

Expenses 5000 7,250 5,750 5000

Total wages & Commission $9,250 $12,250 $13,000 $10,750

Miscellaneous expenses 2500 4000 3000 2500

Rent 2000 2000 2000 2000

Total disbursements $13,750 $18,250 $18,000 $15,250

Step 2: Preparing the Budgeted Income Statement

Steps 1a through 1f provide enough information to construct a budgeted income

statement from operations (Exhibit 2-3). The income statement will be complete
after addition of the interest expense, which is computed after the cash budget,
has been prepared. Budgeted income from operations is often a benchmark for
judging management performance

Exhibit 2-3

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Selam Electronics Company

Budgeted Income Statement for 4 months ending July 31, 1997

Date Source of Data

Sales $240,000 Schedule a

Cost of goods sold 168,000 Schedule c

Gross margin $ 72,000

Operating expenses:

Wage & commissions $46,000 Schedule e

Rent 8,000 Schedule e

Miscellaneous 12,000 Schedule e

Insurance 800 Schedule e

Depreciation 2,000 68,800 Schedule e

Income from operations $3,200

Interest expense 675 Exhibit 2-4

Net income $2,525

Step 3: Preparation of Financial Budget

The second major part of the master budget is the financial budget, which
consists of the capital budget, cash budget, and ending balance sheet.

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Step 3a: The Capital Budget

Capital budgeting is making of long-term planning decisions for investments.

Plan for the acquisitions of various properties such as buildings, machinery,
equipment, and other long-term investment is referred as the capital budget or
capital expenditure budget. The topic capital budgeting is discussed in more
details in finance course. However, it is important to high light what capital
budget is because it is an important input to develop the cash budget. Each year
or quarter of a year, a provision must be made in the current annual or quarterly
budget for the portion of the long-term plan to be carried out during the budget
period.

In this course, we are interested on the cash budget and the ending balance sheet.
In our illustration, the $3000 purchase of new fixtures would be included in the
capital budget.

Step 3b: Cash Budget

The cash budge is a statement of planned cash receipts and disbursements. The
cash budget is heavily affected by the level of operations summarized in the
budgeted income statement. The cash budget has the following major sections,
where the letter W, X, Y, and Z refers to the lines in Exhibit 2-4 that summarize
the effects of that section:

Exhibit 2- 4

Selam Electronics Company

Cash Budget for 4 months ending July 31, 1997

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April May June July

Beginning cash balance $ 10,000 $10,550 $10,970 $ 10,965

Cash receipts

Collections from customers (Schedule b) 46,000 68,000 68,000 54,000

Total cash available, before financing(W) * $56,000 $78,550 $78,970 $64,965

Cash disbursements

Merchandise (Schedule d) 42,700 48,300 40,600 32,900

Operating expenses (Schedule f) 13,750 18,250 18,000 15,250

Purchase of new fixtures (given) 3,000 -- -- ---

Total disbursements (X) $59,450 $66,550 $58,600 $48,150

Minimum cash balance desired (Y) 10,000 10,000 10,000 10,000

Total cash needed 69,450 $76,550 $68,600 $58,150

Excess (deficiency) of total cash

available over total cash needed

before financing (W-X-Y) $(13,450) $ 2000 $10,370 $6,815

Financing

Borrowing (at beginning of month) $14,000

Repayments (at end of month) __ $(1000) $(9000) $(4000)

Interest (at 18% per year) (30) (405) (240)

Total cash increase (decrease)

from financing (Z) $14,000 $(1,030) $(9,405) $(4,240)

Ending cash balance (W-X+Z) $10,550 $10,970 $10,965 $12,575

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* Letters are keyed to the explanation in the text.

Borrowing and repayment of principal are made in multiples of $1000, at an interest rate of
18% per year.

 Interest computations: 0.18 x $ 1000 x 2/12; 0.18 x $ 9000 x 3/12; 0.18 x $ 4000 x 4/12.

 The total cash available before financing (W) equals the beginning cash
balance plus cash receipts. Cash receipts depend on collections from customers’
accounts receivable and cash sales and on other operating income sources.
Trace total collections from schedule b to Exhibit 2-4.
Cash disbursements (X) for
1. Purchases depend on the credit terms extended by suppliers and the bill-
paying habits of the buyer (disbursements for merchandise from schedule d
should be traced to Exhibit 2-4).

2. Payroll depends on wage, salary and commission terms and on payroll dates,
(wages and commissions from schedule f should be traced to Exhibit 2-4).

3. Some costs and expenses depend on contractual terms for installment

payments, mortgage payments, rents, leases, and miscellaneous items
(miscellaneous and rent from schedule f should be traced to Exhibit 2-4).

4. Other disbursements include outlays for fixed assets, long-term investments,

dividends, and the like (the $3,000 expenditure for new fixtures).

 Management determines the minimum cash balance desired (Y) depending on

the nature of the business and credit arrangements.
 Financing requirements (2) depend on how the total cash available, W in Exhibit
2-4, compares with the total cash needed. Needs include the disbursements, X,
plus the desired ending cash balance, Y. If the total cash available is less than the
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cash needed, borrowing is necessary. Exhibit 2-4 shows that SEC will borrow
$14000 in April to cover the planned deficiency. If there is an excess, loans may be
repaid$1000, $ 9000, and $4000 are repaid in May, June, and July respectively. The
pertinent outlays for interest expenses are usually contained in this section of the
cash budget. Trace the calculated interest expense to Exhibit 2-3, which then will
be complete.
 The ending cash balance is W –X +Y. Financing, Z, has either a positive
(borrowing) or a negative (repayment) effect on the cash balance. The illustrative
cash budget shows the pattern of short-term, “Self-liquidating” financing.
Seasonal peaks often result in heavy drains on cash-for merchandise purchases
and operating expenses-before the sales are made and cash is collected from
customers. The resulting loan is “Self-liquidating” –that is, the borrowed money
is used to acquire merchandise for sale, and the proceeds from sales are used to
repay the loan. The “working capital cycle” moves from cash to inventory to
receivables and back to cash.
Cash budgets help management to avoid having unnecessary idle cash, on the one
hand, and unnecessary cash deficiencies, on the other. A well-managed financing
program keeps cash balances from becoming too large or too small

Step 3c: Budgeted Balance Sheet

The final step in preparing the master budget is to construct the budgeted
balance sheet (Exhibit 2-5) that projects each balance sheet item in accordance
with the business plan as expressed in the previous schedules. Specifically, the
beginning balances at March 31 would be increased or decreased in light of the
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expected cash receipts and cash disbursements in Exhibit 2-4 and in light of the
effects of non-cash items appearing on the income statement in Exhibit 2-3. For
example, unexpired insurance would decrease from its balance of $ 1,800 on
March 31 to $ 1000 on July 31, even though it is a non-cash item.

Exhibit 2-5

Selam Electronics Company

Budgeted Balance sheet July 31, 1997

Assets

Current Assets

Cash (Exhibit 2-4) $12,575

Accounts receivable, net (0.4 x July sales

Of $50,000, schedule a) 20,000

Merchandise inventory (schedule c) 42,400

Unexpired insurance ( $ 1800 - $ 800) 1,000 $75,975

Plant assets

Equipment, fixtures, and other fixtures

($ 37000+$3000) $40,000

Accumulated depreciation ($12,800 + $ 2000

Depreciation expense) (14,800) 25,200

Total assets $101,175

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Liabilities and Owners’ equity

Current liabilities

Accounts payable (0.5xJuly purchases

Of $ 29,400, schedule c) $14,700

Accrued wages & commissions payable

(0.5 x $ 10,000, schedule e) 5,000 $19,700

Owners equity ($ 78,950 + $2, 525 net income) 81,475

Total liabilities and owners’ equity $101,175

When the complete master budget is formulated, management can consider all
the major financial statements as a basis for changing the course of events. For
example, the initial formulation of the financial statements may prompt
management to try new sales strategies to generate more demand. Alternatively,
management may explore the effects of various adjustments in the timing of
receipts and disbursements. The large cash deficiency in April, for example, may
lead to an emphasis on cash sales or an attempt to speed up collection of
accounts receivable. In any event, the first draft of the master budge is rarely the
final draft. As it is reworked, the budgeting process becomes an integral part of
the management process itself-budgeting is planning and communicating.

Develop a personal budget

LO2

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All income and expenses for a six month period are recorded to assist in estimating
expenditure requirements
A spreadsheet for recording all budget information is obtained or developed and
established to record income and expenditure for a relevant period of time
All sources of income and regular fixed expenses and variable expenses for the
specified period are identified and listed in a personal budget using the budget
spreadsheet
Total expenses recorded are subtracted from the total income to determine a surplus
or deficit budget for the specified period
Reasons for a deficit budget are explored if relevant and ways to reduce
expenses or increase income are investigated
Allocation of surplus funds towards saving and meeting identified financial goals is explored

The different groups who may budget may include families

 governments
 individuals:
 single
 married
 elderly
 students
tourists, travelers

Different stages of life may include:

 approaching and during retirement

 buying your first home
 moving out of home
 starting a family
studying.

Financial goals may include: accumulating a set amount of money by a specified

date in the future for the purposes of:
 purchasing assets
 financing holidays, educational expenses, home renovations and other known
future expenses
 establishing a deposit for an investment such as a home or investment property
 aiming to repay existing debts and be debt free
 establishing a regular savings plan
handling income and expenditure responsibly and avoiding financial difficulties.

Obstacles that might prevent financial goals being achieved may include:

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 being unemployed, particularly long term unemployed

 insufficient income to afford items that are beyond the individual's means
 unexpected circumstances such as:
 losing a job
 falling ill
not being able to work.

Behaviours and skills required for successful budgeting may include: controlled
spending
 disciplined approach to money
 organisational skills
record keeping skills

A spreadsheet may

 be simple or complex depending upon the extent of the individual's finances

 have one section for recording all money received as income and another section for
expenses both variable and fixed
have a section to record the difference between income and expenses for the period, this being
the surplus or deficit financial situation for the period.

 Sources of income may include: interest on investments, dividends

 proceeds from sale of assets
 social security benefits, pensions, allowances, child assistance
wages, commission, bonuses, tips.

Self Assessment

1. Differentiate between an operating budget and a financial budget.

2. Why is the sales forecast the starting point for budgeting?

3. Distinguish between operating expenses and disbursements for operating

expenses.

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4. What is the principal objective of a cash budget?

Implement and monitor the personal

budget

LO3

Implement and monitor the personal budget

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The budget is followed according to plan for a period of time

Actual expenses and income for the period during which the budget is
implemented are recorded and compared to budgeted expenses and income with
any differences in budgeted and actual amounts looked at and the budget modified
where necessary
Ways to reduce expenses may include: comparing prices for essential items
 monitoring use of utilities such as electricity, gas and water
 moving back home
 reducing expenditure on discretionary items such as expensive clothing, magazines,
eating out
 share accommodation

Variable expenses may include: car maintenance

 living expenses such as:
 food
 clothing
 medical
 loan repayments if loan is based upon variable interest rates
 miscellaneous expenses such as:
 gifts
 recreation
 entertainment
 fines
 mobile telephone
 mortgage repayments
 utilities such as:
 water
 gas
 electricity
telephone.
 Ways to reduce expenses may include: comparing prices for essential items
 monitoring use of utilities such as electricity, gas and water
 moving back home
 reducing expenditure on discretionary items such as expensive clothing, magazines,
eating out
 share accommodation

Handy hints for managing the personal budget are discussed

Ongoing review of the budget is conducted to ensure it remains relevant and to ensure updates
are incorporated if necessary

Handy hints may include discussing how to avoid getting into financial difficulties
 how to minimise fees and charges imposed by financial institutions
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 how to use credit card debt effectively

 the problems of impulsive buying, particularly when under peer pressure
ways to cut back on spending or change negative spending habits.

Self Assessmen

4. Enter the word or phrase that best completes the following:

1. The financial budget process includes the following budgets:

a. _______________

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b. _______________

c. _______________

2. The master budget process usually begins with the __________ budget.

3. A _________ budget is a plan that is revised monthly or quarterly,

dropping one period adding another.

4. Strategic planning sets the __________________.

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TTLM Development Manual Date:Jan.2017
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