Prepare Operational Budgets

Training, Teaching and Learning Materials (TTLM)
Dallol Technology and Business

College
The Ethiopian TVET-System

ACCOUNTS AND BUDGET SERVICELEVEL IV
Learning
Guide
of Competence Prepare Operational Budgets
Module Title Preparing Operational Budgets
LG EIS ABS4 11 0812
Code: EIS ABS4M 11 0812
TTLM
Code:
TTLM Development Manual Date: September ,2017
Compiled by: Business & Finance Department
INTRODUCTION
Welcome to the module “Prepare Operational Budgets”. This
learner’s guide was prepared to help you achieve the required competence in
“Accounts and Budget Support Level IV”. This will be the source of information
for you to acquire knowledge attitude and skills in this particular occupation with
minimum supervision or help from your trainer.
Summary of Learning Outcomes
After completing this learning guide, you should be able to:

Lo1:- . . Prepare the budget
Lo2:- . Set the budget timeframe
Lo3:- Document the budget
How to Use this TTLM
o Read through the Learning Guide carefully. It is divided into sections

that cover all the knowledge, skills and attitude that you need.
o Read Information Sheets and complete the Self-Check at the end of
each section to check your progress
o Read and make sure to Practice the activities in the Operation Sheets.
Ask your trainer to show you the correct way to do things or talk to
more experienced person for guidance.
o When you are ready, ask your trainer for institutional assessment and
provide you with feedback from your performance.

Lo1:- . . Prepare the budget

INFORMATION SHEET
Planning is the basic managerial function. It helps in determining the course of
action to be followed for achieving organizational goals. It is decision in advance,
what to do, when do, how to do and who will do a particular task? Plans are
framed to achieve better results. Control is the process of checking whether the
plans are being adhered to or not, keeping record of progress, comparing it with
the plans and then taking corrective measures for future, if there is any deviation
every business enterprise needs the use of control techniques for surviving in the
highly competitive and changing economic world. There are various control
devices in use. Budgets are the most important tool of profit planning and
control. They also act as instrument of co-ordination.
Meaning of a Budget
A budget is the monetary or/and quantitative expression of business plans and
policies to pursued in the future period of time. The term budgeting is used for
preparing budgets and other procedures for planning, co-ordination and control
of business enterprise. According to I.C.W.A, London “A budget is a financial
and/or quantitative statement prepared prior to a defined period of time, of the
policy to be pursued during that period for the purpose of attaining a given
objective”.
In the words of crown and Howard, “A budget is a per-determined statement of

management policy during a given period which provides a standard for
comparison with the results actually achieved”.

5.2 CLASSIFICATION AND TYPES OF BUDGETS

The budgets are usually classified according to their nature. The following are
the types of budgets which are commonly used. A. Classification according to
time
1. Long-term budgets
2. Short term budgets
3. Current budgets
B. Classification on the basis of functions
1. Operating budgets
2. Financial budgets
3. Master budgets
C. Classification on the basis of flexibility
1. Fixed budget
2. Flexible budget
A. Classification according to time
1. Long term budgets: - The budgets are prepared to depict long term planning
of the business. The period of long term budgets varies between five to ten years.
The long term planning is done by the top level management, it is not generally
known to lower levels of management. Long time budgets are prepared for some
sections of the concern such as capital expenditure, research and development,
long term finances; etc
2. Short term budgets: - These budgets are generally for one or two years and are
in the form of monetary terms.
3. Current budgets: - The period of current budgets is generally of months and
weeks. These budgets relate to the current activities of the business. According to
I.C.W.A London, “current budget is a budget which is established for use over a
short period of time and is related to current conditions”.

B. Classification on the basis of functions

1. Operating budgets:- These budgets relate to the different activates or
operations of a firm. The number of such budgets depends upon the size and
nature of business. The commonly used operating budgets are:-
a. Sales budget
b. production budget
c. production cost budget
d. purchase budge, etc
2. Financial budget:- Financial budgets are concerned with cash receipts and
disbursements, working capital, capital expenditure, financial position and
results of business operations. The commonly used financial budgets are
a. cash budget
b. working capital budget
c. capital expenditure budget
d. income statement budget
e. statement of retained earnings budget
f. budgeted balance sheet or position statement budget
3. Master budget:- various functional budgets are integrated into master budget.
This budget is prepared by the ultimate integration of separate functional
budgets. According to l.C.W.A Londan, “The master budget is the summary
budget incorporating its functional budgets”. Master budget is prepared by the
budget of officer and it remains with the top level management. This budget is
used to co-ordinate the activities of various functional departments and also to
help as control device.

The terms used to describe assorted 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 (and other cost driver budgets as necessary)
2. Purchase budget
3. Cost of goods sold budget
4. Operating expenses budget
5. Budgeted income statement
B. Financial budget
1. Capital budget
2. Cash budget
3. Budgeted balance sheet
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
supporting schedules. Though sometimes called the profit plan, an operating
budget may show a budgeted loss, or even by 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.

Lo2:- . Set the budget timeframe
BASIC STEPS IN PREPARATION OF MASTER BUDGET FOR

MERCHANDISING ENTERPRISE:-
The principal steps in preparing the master budget are
Operating budget
1. using the data, given, prepare the following defiled schedules for each of the
months of the planning horizon.
a. Sales budget
b. Cash collection form customers
c. Purchase budget
d. Disbursements for purchases
f. Disbursements for operating expenses
2. using these schedules, prepare a budgeted income statement financial budget
3. Using the data given and the supporting schedules, prepare the following
forecasted financial statements.
a. cash budget including details of borrowings, repayments, and interest for
each month of the planning horizon
b. budgeted balance sheet as of the end period
You will need schedules 1a, 1c, and 1e to prepare the budgeted income statement
and schedules 1b, 1d and 1f to prepare the cash budget.
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.
Step 1. Preparation of operation budget
You should new be ready to trace the budgeting process.
Step 1a. Sales budget

The sales budget is the starting point for budgeting because inventory levels,
purchases and operating expenses are geared to the rate of sales activities.
Step 1b. Cash collections
It is easiest to prepare schedule b, cash collections, at the same time as preparing
the sales budget. Cash collections include the current month’s cash sales plus the
pervious month’s credit sales. We will use total collections in preparing the cash
budget.
Step 1c. Purchases budget
After sales are budgeted, prepare the purchase 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 form planned
purchases.
The purchases are computed as follows:-
Budgeted purchases = desired ending inventory and cost of goods sold less
beginning inventory
Step 1d. Disbursements for purchases
Schedule d, disbursements for purchase, is based on the purchase budget.
Disbursements include if 50% of the current month’s purchases and if 50% of the
previous month’s purchases. No will use total disbursements in preparing the
cash budget
Step 1.e operating expense budget

The budgeting of operating expenses depends on various factors. Month-to-
month fluctuations in sales volume and other cost drive activity directly

influence many operating expenses. Example of expenses driven by sales volume

include sales commissions and many delivery activities [such as rent, insurance,
depreciation, and salaries] with appropriate relevant rages and are regarded as
fixed.
Trace the total operating expenses in the final column of schedule, which
summarizes these expenses, to the budgeted income statement.
Step1f operating expenses disbursements
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.
Step 2: preparation of budgeted income statement
Step1a through if provide enough information to construct a budgeted income
statement form operations. 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.

Lo3:- Document the budget
Step3: 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.
Step 3a- Cash Budget
The cash budget 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 total cash available before financing equals the beginning cash balance plus
cash receipts. Cash receipts depends on collections from customers’ accounts
receivable and cash sales and n their operating income sources.
CASH DISBURSEMENT FOR
1. Purchases depend on the credit terms expended by suppliers and the bill
paying habits of the buyer
2. Payroll depends on wage, salary and commission terms and on payroll
dates.
3. Some costs and expenses depend on contractual terms for installment
payments, mortgage payments, rents, leases and miscellaneous items.
4. other disbursements include outlays for fixed assets, long term investments,
dividends and the like
Management determines the minimum cash balance desired depending on the
nature of the business and credit arrangements.
Financing requirements depend on how the total cash available compares with
the total cash needed. Needs include the disbursements plus the desired ending

cash balance. If the total cash available is less than the cash needed, borrowing is
necessary to cover the planned deficiency. If there is an excess, loans may be
repaid. The pertinent outlays for interest expenses are usually contained in this
section of the cash budget.
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 3b Budgeted Balance sheet
The final step in preparing the master budget is to construct the budgeted
balance sheet that projects each balance sheet item in accordance with the
business plan as expressed in the previous schedules.
When the complete master budget is formulated, management can consider all
the major financial statements as a basis for changing the course of events:
Illustration
To illustrate the budgeting process we will use as an example the ABC company
as follows:-
Given data
1. The budgeted period:- July-Sep. 20----- (for 3 months)
th
2. The actual balance sheet, June 30 ,20---- is shown below

ABC Company
Balance sheet
th
June 30 , 20------
ASSETS LIABILITY & CAPITAL
Cash 20,000 Account payable 16,000

A/R 12,000 Wages payable 3,000
Inventory 16,000 Commission payable 600
Prepaid insur. 10,000 Owners equity 54,400
Equipment 30,000
n
Acc . Deprecation (14,000) ____
Total 74,000 74,000
2. All sales are made 60% on account and 40% on cash. The credit sales are
entirely collected following the month of sales
3. Purchases are made 60% on account and 40% on cash, The credit purchases
are paid in following month the amount of purchase
4. Payments for wages and commission are made 70% in the month and 30% in
the following month
5. Money can be borrowed at 9% interest, borrowing are made at the begin and
repayments are end of months on FIFO based in multiples of Birr 2000.00.
6. Cost of good sold is estimated at 65% of sales and ending inventory of Birr
40,000.00 is desired at the end of any month.
7. Minimum cash balance of birr 20,000.00 is required at the end of any month.
8. The organization has a plan to purchase a new equipment in the first half of
August for birr 10,000 that will be used expenditure to acquired fixed asset

9. Cost equipment and insurance expire at a rate of 20% on book value per
month
10. Salesmen commission are estimated to be 10% of sales
11. Forecast for wages and sales are as follows:
July August September
Sales 20,000 100,000 18,000
Wages 6,000 4000 4000
Required:-
Prepare a master budget for three months ending Sep. 30,20-----.
Solution
ABC Company
Master Budget
For 3 Months Ending Sep30, 2004
1A. Sales budget July Aug. Sep. Remark
Cash sales, 40% 8000 40,000 7,200

Plus credit sales, 60% 12,000 60,000 10,800
Total sales, 100% 20,000 100,000 18,000 138,000
1B. Collection from sales
Cash sales 40% 8000 40000 7200
Plus collection of A/R, 60% 12000 12000 60000
Total 20000 52000 67200

1C. Purchases budget

C.G.S (65% of sales) 13000 65000 11700 89700
Plus desired ending inventory 40000 40000 40000
Available for sales 53000 105000 51700
Less beginning inventory 16000 40000 40000
Purchased 37000 65000 11700
1D. disbursements for purchase July Aug Sep. Remark
Cash purchase, 40% 14800 26000 4680

Plus payment of A/P, 60% 16000 22200 39000
Total 30800 48200 43680
1.E operating expense budget
Wages 6000 4000 4000
Sales commission (10% of sales) 2000 10000 1800
Insurance (20%) 2000 1600 1280
Depreciation (20%) 3200 4560 3648
Total 13200 20160 10728 44088
1.F Disbursements and operating
Operating expenses
For this month
wages (70%) 4200 2800 2800
Commission (70%) 1400 7000 1260
For last month
Wages (30%) 3000 1800 1200
Commission (30%) 600 600 3000
Total 9200 12200 8260
2. BUDGETED INCOME STATEMENT

ABC COMPANY
FOR CASTLED INCOME STATEMENT
3 MONTHS ENDING SEP 30, 20------
Sales data source of data
Sales 138,000 1A
Less cost of goods sold 89,700 1C
Gross margin 48,300
Less. Operating expenses 44,088 1E
Income from operation 4,212

3A. Cash budget ABC Company cash budget for 3 months ending Sep 30, 20----
July Aug. sep Remark
Beginning cash balance 20000 20000 21600
Add. Cash collection 20000 52000 67200
Total cash available
before financing(W) 40000 72000 88800
Less cash disbursements
Purchase 30800 48200 43680
Expense 9200 12200 8260
Equipment __--____ 10000 _---__
Total cash disbursements (X) 40000 70400 51940
Add minimum cash
balance desired (Y) 20000 20000 20000
Total cash needed 60000 90400 71940
Excess (deficiency) of total cash
Available over total cash needed
Before financing (W-X-Y) (20000) (18400) 16860
Financing
Borrowing (at beginning
of month) 20000 20000 -----_
Repayment of debt (at end
of month) ---- ---- (16000)
Interest (at 9% per year) ---- ---- (360.00)
Total cash increase (decrease)
From financing (Z) 20000 20000 (16360)
Ending cash balance ((W-X) +Z) 20000 21600 20500

Additional
1. interest on the principal paid September 30,20------
Interest = Principal x Rate x Time
16,000 x 9/100 x 3/12 = 360.00
2. loans out standing September 30,20------
nd
2 Loan 20,000
Total 24,000
3. Interest accrued on loans outstanding
4000 x 9/100 x 3/12 = 90.00
20,000 x 9/100 x 2/12 = 300.00
4. Total interest expense (paid and un

paid) 360+390 = 750.00
forecasted capital statement
Beginning capital June 30, 20---- ---------------------------54,400
Operating income statement ------4212.00
Less:- Interest (360+390) 750.00
Net increase in capital 3462.00
Ending capital, September 30, 20---- 57,862.00

3.B Budgeted balance sheet

ABC Company
Budgeted balance sheet
September 30,20----
Current Assets Current liabilities
Cash 20,500 Account payable 7020
Account receivable 10,800 Wage payable 1200
Inventory 40000 Commission payable 540
Insurance 5120 Loans Payable 24000
Equipment 40000 Interest payable 390
(30,000+10,000) Owners’ Equity 57862
Accumulated Dep. (25,408) (54,400+3462)
(14,000+11,408) _________ _____
Total assets 91,012 Total Liab. & Capital 91,012

Review Exercises
Multiple choice
Answer the following selected multiple choice questions
1. The financial budget process
includes a. the cash budget
b. the capital budget
c. the budget statement of cash flows
d. the budgeted balance sheet
e. all of the above
2. The master budget process usually begins with the
a. production budget
b. operating budget
c. financial budget
d. capital budget
e. sales budget
3. The production budget process usually begins with the
a. direct labour budget
b. direct materials budget
c. manufacturing overhead budget
d. sales budget
e. ending inventory budget
4. A continuous ( rolling) budget
a. presents the plan for only one level of activity and does not adjust to
changes in the level of activity
b. presents the plan for a range of activity so the plan can be adjusted for
changes in activity
c. is a plan that is revised monthly or quarterly, dropping one period and

adding another
d. is one of the budget that is part of along range strategic plan, unchanged
unless the strategy of the company changes
e. work best for a company that can reliably forecast its sales revenue and
expenses.
5. Which one of the following management considerations is usually addressed
first in strategic planning?
a. Outsourcing
b. Overall goods of the firm
c. Organizational structure
d. Recent annual begets
e. Being an industry leader
6. The James Company, a wholesaler, budgeted the following sales for the
indicated months
June 2004 July 2004 August 2004
Sales on account 1800,000 1,920,000 2,040,000
Cash sales 240,000 250,000 260,000
Total sales 2,040,000 2,170,000 2,300,000
All merchandise is marked up to sell at its invoice cost plus 25%. Merchandise
inventories at the beginning of each month are at 30% of that month’s projected
cost of goads sold.

Select the best answer for each of the following items from the above given
information
I. The cost of goods sold for the month of June 2004 is anticipated to be
a. 1,632,000
b. 1,428,000
c. 1, 836,000
d. 1,530,000
e. None of these
II. Merchandise purchase for July 2004 are anticipated to be
a. 1,736,000
b. 1, 926,600
c. 1,767,200
d. 1,658,700
e. None of these

Problem 1
Given data:-
1. The budgeted period:- April- July (4 months) 200x
st
2. The actual balance sheet March 31 ,200x is shown below
THE COOKING HUT COMPANY
BALANCE SHEET
ST
MARCH 31 200X
ASSETS LIABILITIES & OWNERS’ EQUITY

Current assets current liabilities
Cash 10,000 Account payable 16,800
Account receivable 16,000 Accrued wages 1850
Inventory 48,000 Commissions 3000 21050
Prepaid insurance 1,800 75,800
Plant assets Owners’ equity 78950
Equ.& Fixtures 37,000
Accu. Depre. 12,800 24200 _____
Total assets 100000 Total liab & Ow. eq. 100000
3. Management expects future sales collections to follows 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.
4. At the end of each month, the company wants to have on hand a basic
inventory of items valued at 20,000 plus 80% of expected cost of goods sold
for the following moths. The cost of merchandise sold averages 70% of
st
sales. Therefore, the inventory on March 31 is $ 20,000 + 0.7 ( 0.8 x April
sales of 50,000) = 20,000 + 28,000 = 48,000
5. The purchase terms available to the company are net, 30 days. The
company pays for each month’s purchases as following. 50% during that
month and 50% during the next month
6. The company pays wages and commissions semi-monthly, half a month
after they are earned. They are divided in to two portions: monthly fixed
wages 2500 and commissions, equal to 15% of sales, which we will assume
are uniform throughout each month.
In addition to buying new fixtures for 3,000 cash in April. The company’s
other monthly expenses are as follows:-
Miscellaneous expenses 5% of sales, paid as incurred
Rent 2,000.00 paid as incurred
Insurance 200 expiration per month
Depreciation, including
new fixtures 500 per month
7. 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 the company can
borrow or repay/owns in multiples of 1000.00 management plans to
borrow no more cash than necessary and to repay as promptly as possible.
Assume that borrowing occurs at 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.
8. The above closing balance sheet shows for the fiscal year just ended. 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
Required:-
Prepare a master budget for four months ending August, 20----.
Review questions
1. What are the major benefits of budgeting?
2. Why is the sales forecast the starting point for budgeting?
3. Differentiate between an operating budget and a financial budget
4. Explain in detail the classification of budgets according to
a. Time
b. Functions and
c. Flexibility
5. Discuss the procedures for preparing the following begets
a. Sales budget
b. Operating budget
c. Master budget


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Training, Teaching and Learning Materials (TTLM)

Dallol Technology and Business

The Ethiopian TVET-System

Summary of Learning Outcomes

After completing this learning guide, you should be able to:

How to Use this TTLM

o Read through the Learning Guide carefully. It is divided into sections

TTLM Development Manual Date: September ,2017

Lo1:- . . Prepare the budget

In the words of crown and Howard, “A budget is a per-determined statement of

TTLM Development Manual Date: September ,2017

5.2 CLASSIFICATION AND TYPES OF BUDGETS

TTLM Development Manual Date: September ,2017

B. Classification on the basis of functions

TTLM Development Manual Date: September ,2017

TTLM Development Manual Date: September ,2017

Lo2:- . Set the budget timeframe

BASIC STEPS IN PREPARATION OF MASTER BUDGET FOR

Step 1a. Sales budget

Step 1.e operating expense budget

TTLM Development Manual Date: September ,2017

influence many operating expenses. Example of expenses driven by sales volume

TTLM Development Manual Date: September ,2017

Lo3:- Document the budget

Step3: Preparation of financial budget

TTLM Development Manual Date: September ,2017

TTLM Development Manual Date: September ,2017

Cash 20,000 Account payable 16,000

TTLM Development Manual Date: September ,2017

Cash sales, 40% 8000 40,000 7,200

TTLM Development Manual Date: September ,2017

1C. Purchases budget

Cash purchase, 40% 14800 26000 4680

TTLM Development Manual Date: September ,2017

TTLM Development Manual Date: September ,2017

TTLM Development Manual Date: September ,2017

4. Total interest expense (paid and un

TTLM Development Manual Date: September ,2017

3.B Budgeted balance sheet

TTLM Development Manual Date: September ,2017

c. is a plan that is revised monthly or quarterly, dropping one period and

TTLM Development Manual Date: September ,2017

TTLM Development Manual Date: September ,2017

ASSETS LIABILITIES & OWNERS’ EQUITY

TTLM Development Manual Date: September ,2017

TTLM Development Manual Date: September ,2017

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