PRINCIPLES OF FINANCE

LECTURE 2
BUDGETING/FINANCIAL PLANNING, ANALYSIS &
CONTROL

GERONIMO ANDREW A. RIVERA, CPA, CIA

 Budgeting

Budget – is a plan, expressed in

quantitative terms, on how to acquire
and use the resources of an entity during
a certain future period of time
 Functions of Budgeting – Planning and Control

Planning – starts from the development of ideas,

setting of goals, selection of strategies,
programs and procedures in attaining such
goals, up to the preparation of the formal
budget
 Functions of Budgeting – Planning and Control

Control – involves the comparison of actual

results of operations with the budgeted figures
“This control phase enables managers to learn
from their mistakes and gain experience in
improving operational efficiency and
effectiveness”
 Uses/Advantages of Budgeting

 Compels periodic planning

 Enhances coordination, cooperation and
communication
 Forces quantifications of plans and proposals
 Provides a framework for performance evaluation
 Enables members of the organization to be aware
of business costs
 Satisfies some legal and contractual requirements
 Directs the firm’s activities toward the
achievement of organizational goals
 Limitations of Budgeting

 Since budgeting means planning for the future, the

plan itself as well as the figures therein are merely
estimates requiring a certain amount of judgment.
 To be successful, a budgetary system requires the
cooperation and participation of all the members of
the organization – should any member fail to
coordinate and cooperate with each other, the
entire budgetary system will fail
 Limitations of Budgeting

Some managers think that budgets restrict their



movements and limit their decision making power.

Some are even afraid that such budgets may be used
against them if they fail to work in accordance with the
plans contained in the budget
The development and installation of a good budgetary


system may be time consuming and too costly for some

organizations, such that benefits that can be derived
from budgeting may be outweighed by its costs.
 Organization for Budgeting

The organization and installation of a budgetary system

for a firm are greatly influenced or affected by such
firm’s organizational structure.
For multi-segmental organizations, all managers are held
responsible for the preparation and implementation of
the budget for their respective sections.
The final responsibility for such budgets and the
consolidated budget for the organization as a whole
rests with the executive management
 The Budget Committee

Usually composed of the sales manager, the production manager,

the chief engineer, the treasurer and the controller

Principal function:
 Formulate and decide on general policies relating to the firm’s

budgetary system
 Request, review and revise if necessary individual budget

estimates from the different segments of the organization

 Approve budgets and subsequent revisions therein

 Receive, evaluate and analyze budget reports

 Recommend necessary actions to improve operational efficiency

and effectiveness
 Budgeting Principles

 Budget Development
 Adequate and clearly defined guidance should be
provided to all responsible persons in the organization so
that they may work on the same assumptions
 All individuals concerned should be encouraged to
participate and cooperate in the budgeting process
 Eliminate the feeling of anxiety and defensiveness among
the participants in the course of preparing the budget
 Budget development should be structured such that there
is a reasonably great chance of attaining the objectives
 Budgeting Principles

 Budget Implementation
 Reward system must be established to motivate all persons
concerned to work toward the attainment of goals
 In implementing the budget, giving rewards for good
performance, rather than punishment for bad results should be
emphasized. This will enable all members of the organization
to have a positive attitude toward the entire budgetary system
 A performance reporting system should be provided to get
immediate feedback on the result of operation of each
individual or organizational concerned. This is necessary for
purposes of monitoring, controlling and evaluating performance
 The Master Budget

Represents the overall plan of the organization for a given budget

period. It consists of all the individual budgets for each segment of
the organization aggregated or consolidated into one overall budget
for the entire firm
The exact composition of the master budget depends on the type and
size of the organization
Generally composed of two major parts - operating budget and
financial budget
The operating budget is the budgeted income statement. The financial
budget includes the budgeted balance sheet, budgeted statement of
changes in financial position, capital expenditures budget and all
other budgets required in financial management
Master Budget – Graphic Illustration
Master Budget
 Operating Budget

Operating Budget – no other than the budgeted

or projected income statement. It contains the
projected revenues, costs and expenses, as
well as the forecast net income figure for a
certain budget period
Operating Budget
 Sales Forecast

Sales Forecast – serves as the starting point in the

preparation of the master budget plan. All the other
budgets in the entire master plan depend upon it,
directly or indirectly
Factors considered in making sales forecast:
 The company’s past sales volume

 Economic and political conditions

 Conditions in the industry in which the company

belongs
 Competition
 Sales Forecast

Factors considered in making sales forecast:

 Market research studies

 Pricing policies of the firm as well as those of the

competitors
 Government control and regulations affecting the company

 The company’s own sales force and its planned advertising

and promotional activities

 The company’s productive capacity and other limitations

affecting production
 Change in demand for the product due to seasonal variations
 Sales Forecasting Procedure

Two basic approaches:

 Statistical Approach – involves the study of general

business and market conditions with the use of trends

and correlation analyses
Trend Analysis Example – Assume that the company had the
following sales for the past three years:
 2016 – 1,500 units; 2017 – 1,800 units; 2018 – 2,160 units

Using trend analysis, it may be observed that the sales increased

by 20% for each year. Assuming that the general market and
business conditions indicate that the trend will continue for the
year 2019, the sales forecast for such year may be placed at 2,592
(2,160 x 120%)
 Sales Forecasting Procedure

Two basic approaches:

Correlation Analysis – a change in one number is forecasted
in terms of a change in another number, if an identifiable
association or relationship exists between those two
numbers
Example: J&J is a leading manufacturer of baby powder. Its
management observes that its sales volume in the past changed
directly with the change in birth rates. For the coming year, the
National Census and Statistics Office predicts that the birth rate
will go up by 10%. In this case, if J&J’s sales for the current
year is 1,000, its sales forecast for next year will be set at 1,100
considering the predicted change in birth rate
 Sales Forecasting Procedure

Two basic approaches:

 Internal Estimate Approach – require the

participation of all personnel concerned in the

budgeting process
Sales Staff Procedure – involves mostly the sales personnel.
Sales estimates originate from the salesmen/account executives
Group Executive Judgment – the formal sales budget is
developed based on the sales forecast prepared by the group
composed normally of top company officers engaged in
production, sales, finance, purchasing, credit and collection and
other segments of administration
 Sales Budget

Sales Budget – shows the sales volume, expressed in pesos

and/or physical units that the company expects to
generate in the coming budget period. Its format may
show sales classified by:
 Product lines
 Periods – months, quarters, years
 Sales areas or territories
 Sales outlets
 Branches, divisions and other business segments
 Types of customers
 Salesmen
 Inventory Levels Budget

Inventory Levels Budget – after preparing the sales

budget, the projected inventory levels at the
beginning and end of the budget period should be
determined to complete the data needed for the
preparation of the production budget. This is
because the budgeted production usually covers not
only the sales requirements but also a satisfactory
level of inventory that the company desires to keep
in stock
 Production Budget

Production Budget – the production budget shows the

number of units that the company plans to produce
(production quantity budget) and the costs that it
expects to incur for such production. It is composed
of the materials budget, direct labor budget and
manufacturing overhead budget
 Cost of Goods Sold Budget

Cost of Goods Sold Budget – for manufacturing firms,

the cost of goods sold shows the production cost of
the budgeted sales. It is different from the
production cost budget since the latter covers not
only the sales but also the inventory requirements for
a budget period
 Operating Budget

Budgeted Gross Income – is computed by subtracting the

budgeted cost of goods sold from the budgeted sales
Budgeted Operating Expenses – includes the amount of
selling and administrative expenses that the company
expects to incur during the budget period
Budgeted Income Statement – after completing all the
preceding budgets, the budgeted income statement may be
prepared, showing the budgeted net income for the period.
This income statement should include expected non-
operating income and expenses such as dividends and
interest, as well as projected income taxes
Financial Budget
 Financial Budget

Financial Budgets – usually composed of the capital

expenditure budget, cash budget, budgeted balance
sheet, and the budgeted statement of changes in
financial position
Capital Expenditure Budget – contains planned acquisitions
of major items like plant and equipment. This budget
involves some of the most critical budgeting decisions in
an organization because capital expenditure projects
usually require larger cash outlays and cover longer time
periods as compared with operating expenditures
 Financial Budget

Cash Budget – shows the expected cash balance at the

beginning of the budget period, the projected cash receipts,
and disbursement during the period, and the expected ending
cash balance
Budgeted Balance Sheet – or budgeted statement of financial
position, shows the projected balances of all the assets, liability
and capital accounts at the end of the budget period
Budgeted Statement of Changes in Financial Position – it is
prepared from the data in the budgeted income statement and
the changes between the projected balance sheet at the
beginning of the budget period and the budgeted balance sheet
at the end of the same period
Budget Review Process
Budget Review Process
Budget Manual
Budget Revision
Progressive/Continuous Budgeting
Zero-Base Budgeting
Sales Budget-Illustrative Example
Sales Budget-Illustrative Example
Sales Budget-Illustrative Example
Finished Goods Ending Inventory Budget-
Illustrative Example
Production Budget-Illustrative Example
Production Budget-Illustrative Example
Cost of Goods Sold Budget-Illustrative Example
Cost of Goods Sold Budget-Illustrative Example
Operating Expenses Budget-Illustrative Example
Operating Expenses Budget-Illustrative Example
Capital Expenditure Budget-Illustrative Example
Cash Budget-Illustrative Example
Cash Budget-Illustrative Example
Cash Budget-Illustrative Example
Budgeted Balance Sheet-Illustrative Example
Budgeted Statement of Changes in Financial
Position-Illustrative Example
 END

QUESTION AND ANSWER