Chapter 7: Budgeting and Budgetary Control
A budget is a quantitative plan for the future expressed in financial terms. Budgetary control is the system of using budgets to plan, coordinate, and control business activities. This chapter covers types of budgets, the budgeting process, flexible budgets, and the master budget — essential tools for business planning in Nepal.
7.1 Definition and Objectives
Budget: A quantitative expression of a plan of action for a future period, typically expressed in monetary terms. It translates strategic plans into operational targets.
Budgetary Control: The process of preparing budgets, comparing actual results with budgeted figures, analyzing variances, and taking corrective action.
Objectives of Budgeting
| Objective | How Budgets Achieve It |
|---|---|
| Planning | Forces management to think ahead; quantifies goals |
| Coordination | Ensures all departments work toward common goals |
| Communication | Communicates expectations to all levels |
| Motivation | Targets motivate performance; participation increases commitment |
| Control | Provides benchmark for measuring actual performance |
| Performance Evaluation | Variances identify areas needing attention |
7.2 Types of Budgets
| Classification | Types | Description |
|---|---|---|
| By Function | Sales Budget | Expected sales in units and value (starting point for most budgets) |
| Production Budget | Units to produce = Sales + Desired closing stock - Opening stock | |
| Cash Budget | Expected cash receipts and payments; identifies surplus/deficit | |
| By Flexibility | Fixed Budget | Set for one activity level; doesn't change with actual volume |
| Flexible Budget | Adjusts for actual activity level; better for variance analysis | |
| By Time | Short-term (Operating) | Usually 1 year, broken into months/quarters |
| Long-term (Capital) | 3-5 years; strategic investments | |
| By Approach | Zero-Based Budget | Every item justified from zero each period (not incremental) |
7.3 Master Budget Components
The master budget is the comprehensive plan combining all individual budgets into a complete financial picture.
| Budget | Key Formula/Content |
|---|---|
| Sales Budget | Expected units × Selling price = Total sales revenue |
| Production Budget | Sales units + Closing stock - Opening stock = Production units |
| Material Purchase Budget | Production need + Closing material stock - Opening stock = Purchases |
| Labor Budget | Production units × Labor hours/unit × Rate/hour |
| Manufacturing OH Budget | Variable OH + Fixed OH = Total manufacturing overhead |
| Cash Budget | Opening balance + Receipts - Payments = Closing balance |
| Budgeted Income Statement | Revenue - COGS - Expenses = Budgeted profit |
| Budgeted Balance Sheet | Pro-forma balance sheet based on budget data |
7.4 Cash Budget Example
| Particulars | Jan | Feb | Mar |
|---|---|---|---|
| Opening Balance | 50,000 | 35,000 | 60,000 |
| Receipts: | |||
| Cash Sales | 1,00,000 | 1,20,000 | 1,50,000 |
| Collection from Debtors | 80,000 | 90,000 | 1,00,000 |
| Total Available | 2,30,000 | 2,45,000 | 3,10,000 |
| Payments: | |||
| Material Purchases | 80,000 | 70,000 | 90,000 |
| Wages | 60,000 | 65,000 | 70,000 |
| Overheads | 40,000 | 35,000 | 45,000 |
| Capital Expenditure | 15,000 | 15,000 | — |
| Total Payments | 1,95,000 | 1,85,000 | 2,05,000 |
| Closing Balance | 35,000 | 60,000 | 1,05,000 |
7.5 Flexible Budget
A flexible budget adjusts for actual activity level, making variance analysis meaningful. It separates variable costs (which change with volume) from fixed costs (which don't).
| Item | Fixed Budget (1,000 units) | Flexible Budget (900 units) | Actual (900 units) | Variance |
|---|---|---|---|---|
| Sales | 5,00,000 | 4,50,000 | 4,40,000 | (10,000) U |
| Variable Costs | 3,00,000 | 2,70,000 | 2,80,000 | (10,000) U |
| Contribution | 2,00,000 | 1,80,000 | 1,60,000 | (20,000) U |
| Fixed Costs | 1,00,000 | 1,00,000 | 1,05,000 | (5,000) U |
| Profit | 1,00,000 | 80,000 | 55,000 | (25,000) U |
7.6 Production Budget — Complete Worked Example
Nepal Furniture Company — Quarterly Production Budget
Policy: Closing finished goods stock = 20% of next quarter's sales. Opening stock Q1 = 400 units. Q5 expected sales = 2,200 units.
| Item | Q1 | Q2 | Q3 | Q4 | Total |
|---|---|---|---|---|---|
| Budgeted Sales (units) | 2,000 | 2,500 | 3,000 | 2,800 | 10,300 |
| Add: Desired Closing Stock (20% of next Q sales) | 500 | 600 | 560 | 440 | 440 |
| Total Required | 2,500 | 3,100 | 3,560 | 3,240 | 10,740 |
| Less: Opening Stock | (400) | (500) | (600) | (560) | (400) |
| Production Required | 2,100 | 2,600 | 2,960 | 2,680 | 10,340 |
Note: Production (10,340) > Sales (10,300) by 40 units because closing stock Q4 (440) > opening stock Q1 (400).
7.7 Material Purchase Budget — Linked Example
Each unit requires 3 kg of wood @ NPR 200/kg. Material closing stock policy = 10% of next quarter's production need. Opening material Q1 = 630 kg.
| Item | Q1 | Q2 | Q3 | Q4 |
|---|---|---|---|---|
| Production (units) | 2,100 | 2,600 | 2,960 | 2,680 |
| Material needed (×3 kg) | 6,300 | 7,800 | 8,880 | 8,040 |
| Add: Desired closing material (10% of next Q) | 780 | 888 | 804 | 700* |
| Total material needed | 7,080 | 8,688 | 9,684 | 8,740 |
| Less: Opening material | (630) | (780) | (888) | (804) |
| Material to purchase (kg) | 6,450 | 7,908 | 8,796 | 7,936 |
| Purchase cost @ NPR 200/kg | 12,90,000 | 15,81,600 | 17,59,200 | 15,87,200 |
*Q4 closing material estimated based on Q5 production estimate
7.8 Cash Budget — Comprehensive Example with Collections
Nepal Trading Co. — Cash Budget April-June
Sales: March=NPR 8L, April=10L, May=12L, June=15L. Collection pattern: 60% in month of sale, 30% next month, 10% two months later. All material purchased on 1-month credit.
| Receipts | April | May | June |
|---|---|---|---|
| From April sales (10L×60%) | 6,00,000 | 3,00,000 | 1,00,000 |
| From March sales (8L) | 2,40,000 | 80,000 | — |
| From May sales (12L) | — | 7,20,000 | 3,60,000 |
| From June sales (15L) | — | — | 9,00,000 |
| From Feb sales (assume 6L) | 60,000 | — | — |
| Total Collections | 9,00,000 | 11,00,000 | 13,60,000 |
| Payments | April | May | June |
|---|---|---|---|
| Material purchases (1-month credit) | 4,00,000 | 5,00,000 | 6,00,000 |
| Wages and salaries | 2,00,000 | 2,00,000 | 2,50,000 |
| Rent | 50,000 | 50,000 | 50,000 |
| Utilities and overheads | 30,000 | 35,000 | 40,000 |
| Tax payment | — | 1,00,000 | — |
| Equipment purchase | — | — | 3,00,000 |
| Total Payments | 6,80,000 | 8,85,000 | 11,40,000 |
| Cash Summary | April | May | June |
|---|---|---|---|
| Opening Balance | 2,00,000 | 4,20,000 | 6,35,000 |
| Add: Collections | 9,00,000 | 11,00,000 | 13,60,000 |
| Less: Payments | (6,80,000) | (8,85,000) | (11,40,000) |
| Closing Balance | 4,20,000 | 6,35,000 | 8,55,000 |
Analysis: Cash position improves each month. No borrowing needed (minimum balance maintained). June shows strong position despite equipment purchase, thanks to growing collections from rising sales.
7.9 Zero-Based Budgeting (ZBB) — Detailed
| Aspect | Traditional (Incremental) Budget | Zero-Based Budget |
|---|---|---|
| Starting Point | Last year's budget + adjustment | Zero — every item justified from scratch |
| Justification | Only new/incremental amounts justified | Every rupee must be justified |
| Focus | Maintaining existing programs | Evaluating all activities; eliminating waste |
| Time Required | Less — builds on existing base | More — requires complete analysis |
| Advantage | Faster, simpler, stable | Eliminates inefficiency, aligns with strategy |
| Disadvantage | Perpetuates waste, encourages "use it or lose it" | Very time-consuming, may create anxiety |
| Nepal Use | Most Nepali organizations (government budgets) | Some progressive companies, donor-funded projects |
Practice Questions
Short Answer:
1. Define budget and budgetary control.
2. What are the objectives of budgeting?
3. Distinguish fixed budget from flexible budget.
4. What is zero-based budgeting?
5. List components of a master budget in sequence.
Long Answer:
6. Prepare a production budget and material purchase budget from: Expected sales Q1=2,000, Q2=2,500, Q3=3,000, Q4=2,800. Closing stock = 20% of next quarter's sales. Opening stock = 400 units. Material per unit = 3 kg at NPR 50/kg. Material closing stock = 10% of next quarter's needs. (15 marks)
7. Prepare a cash budget for April-June from given receipts and payments data. (15 marks)
8. Explain the budgeting process from sales forecast to master budget. Discuss challenges faced by Nepali businesses in budgeting. (15 marks)
9. Prepare a flexible budget for 80%, 90%, and 100% capacity given: VC per unit = NPR 40, FC = NPR 2,00,000, SP = NPR 100, 100% capacity = 10,000 units. (15 marks)
10. "Budgets are useful only if they are flexible." Discuss with reference to fixed vs flexible budgets and variance analysis. (15 marks)
Exam Tips: ✓ Cash budget preparation is very common ✓ Production budget formula: Sales + Closing - Opening ✓ Know the sequential relationship between budgets ✓ Flexible budget uses actual volume with budgeted rates ✓ Mark variances as F (Favorable) or U (Unfavorable)