A Case Study in Budgeting
1. Introduction Doomy Corporation is a rapidly expanding specialist photocopier manufacturer that is in the process of formulating plans for next year.
The companies marketing director has completed his sales budget and has provided The following budgeted sales figures that show the growth expected and will provide the planning basis for other corporate departments. The corporation requires the formulation of a cash budget based on the expected figures above including other information provided. Below is the cash budget for the company for the second quarter a period through April may and June. The importance and various limitations of cash budgeting to the company are given further below. Calculations and explanations 1.
60% of the billings made are collected in the month after the sale and 40% in the second month after the sale. Therefore the accounts records collections for a given month are calculated as: 60/100 * (last months sales) + 40/100 *(the month before the last months sales) 2. The purchase of raw materials equals 50% of sales. Raw materials cost = 50/100 *(sales) 60% of the raw materials are received and paid in the month they are purchased and 40% are paid in the second month of purchase. Months raw materials expenditure= 60/100 *(raw materials cost) + 40/100 * (raw material cost of last month) 3.
80% of creditors are paid one month after receipt of the purchased materials, and the remaining 20% are paid the second month after receipt. Accounts payable= 80/100 *( last months debt) + 20/100 * ( the month before the last months debt) 4. Hourly wages are equal to 20% of the current month’s sales. Hourly wages= 20/100* (months sales) 5. Tax rate is 40%. And the taxable profit for the first quarter is projected to be ?612 000 Tax = 40/100 * 612 000 Discussion: Importance of cash budgeting Cash budgets play a very important role especially to rapid growing companies such as Doomy Corporation.
First it is a very helpful to the company when planning. A cash budget ensures planning for the most efficient use of cash. To Doomy corporation It would point out its cash surplus or deficiency at a given point of time for example when a large customer would have trouble paying its debts or the bank may be unwilling to lend more money to the company. From this the corporation’s management is able to arrange for such a deficiency before it occurs. Or in the case of a surplus it enables planning for its investment in order to ensure it is as profitable as possile.Secondly cash budgets are important to the company for it enables it to forecast its future needs.
A Cash budget is used to forecasts needs of funds in the near or further, the time the funds will be needed and the amount of funds that will be needed. It would therefore enable a corporation such as doodle to plan on how it would raise the funds required through the most profitable resources, especially at the most reasonable terms and costs. Thirdly a cash budget is important in the proper maintenance of an ample cash Balance. To a company or an enterprise the basis of its liquidity is cash. A Cash budget therefore is important in the maintenance of liquidity. It helps in suggesting the most appropriate adequate cash balance for the expected requirements.
It also gives a very fair margin for the contingencies. Therefore companies experiencing rapid growth have to use a cash budget in order to maintain their ample cash balances. A cash budget also plays a very important role that of controlling the cash expenditure of a corporation. A Cash budget usually acts as a controlling device for the company’s expenditure. Various departments in a firm can have their expenses adequately controlled in order to ensure that they are within the budgeted limit. This is really important especially in cases where the bank is likely to refuse to lend the firm more money.
The firm would most likely cut on its cash expenditure to counter such an unforeseen event. A cash budget is also very important especially when it comes to the evaluation of the companies Performance over a given period of time. It usually acts as the standard for evaluating the company’s financial performance. This is very important especially to a company that is growing rapidly like Doomy Company. The company is able to see how the company’s financial position is being affected by the expansion that it is undergoing. Another major importance of a cash budget is to Test the Influence of a proposed Expansion Program.
When a company growing company is planning on making expansions the Cash budget is used to forecast the inflows of this proposed expansion or investment program. It is also used to view the impact of such an expansion on the firms financial position in order to prevent any unnecessary cash deficits in the oncoming future. A cash budget also ensures Sound Dividend Policy. It enables a firm’s management to plan for the cash dividends to share holder thereby making it consistent with the liquid position of that specific firm. To a firm that is experiencing rapid growth it always help if a sound consistent dividend policy is followed in order to protect the firm’s financial position. Finally, cash budgets are an important basis for Long-term Planning and Co-ordination.
By use of cash budgeting the various financial functions such as investment, sales, credit, and working capital are coordinated in a proper manner in a firm. This creates an important basis for long term financial planning and is also very useful when it comes to the study of long term financing especially with respect to timing methods of payment forms of security and probable amount. Long term planning is very important especially to a growing company like Doomy; this is because the growth and expansion is a long term plans fro the company. Benefits and limitations of budgeting system The use of a budgeting system brings about a number of benefits and limitations to any given firm some of which include: 3.2.
1Benefits The use of a budget system usually compels the management to think more about the future, this is probably the most important feature of cash budget. It enables the management to look ahead, and thereby set out a detailed plan in order to achieve the targets set for each department, each operation and even each manager, thereby giving the organization an aim and direction Promotes coordination and communication. A budgeting system also gives a clear definition of areas of responsibility. A manager is made responsible for the achievements of the budgets targets for most all the operations under his control. Thereby ensuring proper financial management and thereby reducing wastage of resources and improving the allocation of scarce resources.Finally a budgeting system provides a basis for performance appraisal which is also known as variance analysis.
A budget is normally just a form of measure against which actual performance is rated and assessed. Financial Control is obtained by comparing the actual results against those in the budget plan. Any deviations from the budget are then investigated and resolved in the process. Limitations Some times the budgeting system can be viewed as pressure devises that the management is trying to impose and it can result in bad labor relations and inaccurate record keeping satisfying the management without actually being true. Some of the departmental l conflicts that arise are because of disputes of resource allocation and the blame game of not achieving the targets set.
Cash budgeting at times may lead to the wastage of resources. Managers are likely to develop an attitude of using all the money that they are allocated to ensure prestige in their departments. Managers are also more likely to overestimate costs to ensure that they do not get blamed in the future when they overspend. Conclusion: In the business world today many companies are experiencing rapid growth and expansion, as such it is very important for them to keep a cash budget in order to ensure better financial planning. This is important in meeting challenges like the effects of unforeseen events like the lack of loans from banks to lend them money to counter their financial deficits.
Though the use of financial budgeting system has its own limitations its benefits out way this limitations showing just how important financial budgeting is to a company.