Budgeting and Forecasting |Is it Same or Different?

Budgeting and Forecasting – Is it Same or Different?  Budgeting and forecasting is the process of determining an organization‘s long term as well as short term financial goals in detail. It is a method to allocating organisation’s resources to in-line with the strategic intent of the business.

The main purpose of the Budgeting and forecasting process is to support the enterprise strategy through planned initiatives, budgeted resource allocation extent to which changes in the environment are impacting the capacity of the business to meet objectives.

In this article, we discuss the following –

What is Budgeting?


Budget is a detailed statement of an enterprise financial activity which includes Revenue, Expenses, Investment and Cash Flow for a particular time period (often a year).

While preparing budget for large companies, the budget statement may comprise of input from the company’s various functional departments and profit centers (Business units). It is a time consuming process.

Generally budgets are static and prepare for the company’s financial year. However, some organizations use a continuous budget, adjusted during the year based on changing business conditions. While this can add accuracy, it also requires closer attention and may not necessarily yield a better outcome.

For example: A enterprise provide $ 75 million for interest (@10% pa) cost in its budget. But during the year suddenly The Central Bank of the country increases interest rate instigating the banks to increase their landing interest too. Which shall result into higher interest cost to the company and hence the company needs to reinstate it’s budget according to the new projected interest cost.

Preparation of Budgets


The process of preparing and using budgets will differ from organization to organization. However, there are number of key requirements in preparation of budget planning and control process.

Budgeting - key requirements

Co-Ordination: 

In the process of preparation of budget, various factors like production capacity, sales possibilities and procurement of material, labour etc. are balanced and co-ordinates so that all the activities proceeds according to the objective. In short the production department shall inform the capacity to produce the units of goods in the given period of time and estimate the required quantity of raw material and labour for that. Whereas the sales team also project the expected units to be sold in the same time frame.

Taking their inputs into the budget, the finance team shall estimate requirement of funds and budget the interest cost and incorporate the same into the budget. Hence the co-ordination between all the internal departments are must for accuracy in budget.

Participative Budgeting

A budgeting system in which all budget committee members are given the opportunity to apply their own budget in practice. A budget preparation process is a joint exercise to arrive at some logical conclusion which can help the organisation to grow.

The Budget Manual

A budget manual is a collection of documents that contains all key information for those involved in planning process. The following are major information that contain in Budget manual:

  • Budgetary planning and control process including a statement of budget objective and desired results.
  • Organisation Chart.
  • Timetable for the preparation of budget.
  • Information about key assumptions to be taken by management while preparing budget. For example Interest rate, Inflation and exchange rate etc.

Identification of key factor:

The key budget factor is the factor that that limits the activities of functional budget of the organisation. Generally sales  factor is the key  budget factor . So sales budget must be prepare first then all other budget should be linked to it. Once the sales numbers are finalise, everything else can be backward calculated such as material, labour and salary costs.

Types of Budget


Based on the organisation structure, culture and activities budgets can be classified in  following categories;

Budgeting types

#1 – Functional Budget

Functional budget is prepared on each activity level of the enterprise. Targets for each unit i.e profit center, cost center or administration set in the budget and profit or loss forecasted. This activity requires coordination between activities and a consolidated effect of all activities shown as budget and forecast. The management’s approach to set target for each activity of the enterprise approach is called “Functional Budget”.

In a manufacturing organization, generally followings are the part of functional budget;

  • Sales Budget
  • Production Budget
  • Production cost Budget
    • Material
    • Labor
    • Other factory overheads (plant) Budget
  • Overhead Budget
    • Manufacturing overhead
    • Selling and Distribution overhead
  • Research and Development Budget
  • Financial Budget
    • Capital Expenditure Budget
    • Cash Budget

#2 – Master Budget

As named “Master Budget” is the consolidation of all the functional budget and also includes full profit and loss along with balance sheet. A budgeted cash flow add the advantage to the management to understand the future cash inflow, outflow requirements.

The master budget is prepared by budget committee on the basis of functional budgets. Hence a well coordinated functional budget could help a lot to the master budget.

#3 – Basic Budget

Basic budget prepared while keeping in the mind that there will be low variations in every item of the Income and Expenditures of the organization. This kind of budget is prepared in the industries where the business growth is same since last many years and the management is not expecting any increase or decrease in the business in the short period of time. Hence we can say that this budget can be suitable for standard situation or conditions. The current conditions are totally ignored while preparing this kind of budget and assumption is taken that everything shall be same as before.

#4 – Current Budget

A current budget is prepared for some specific project such as new IT system adoption, new infrastructure etc. In this kind of budget an amount allotted to the activity first and according to that the activity shall perform. The periodicity of this kind of budget is normally very short and changes in that short term budget is even possible. A company which decided to adopt new IT infrastructure shall first prepare the amount of money they are going to spent on the new IT system and prepare budget accordingly.

#5 – Long Term Budget

Long term budget are define as budget which are prepare for a period more than one year. This budget helps organization or entity in business forecasting and future planning. Infrastructure development budget, Research & Development budgets and capital expenditure budgets are some examples of long term budget.

#6 – Short Term Budget:

Short term budgets are defined as budget which are prepare for a period less than one year. This budget is very crucial for management for their day to day operations and control purposes. A new start-up company usually prepares this kind of budget to keep track on their income and expenditures.

#7 – Fixed Budget:

Fixed budget is a budget which remains static or unchanged irrespective of the level or volume of activities. It is a budget which is prepared for a specific planned activity or output level and is not altered to the level of activities achieved when the actual and budgeted cost are compared.

Fixed budget can be prepared for a short time period when the actual output is not supposed to differ from the budgeted output. However, a fixed budget may be revised if business conditions undergoing a basic change. In practice fixed budgets is rarely used because actual output is often major different from budgeted output. It cannot be used as tool of cost control

#8 – Flexible Budget:

The Chartered Institute of Management Accountants, (UK) defines flexible budget as a “Budget which by recognizing different cost behavior patterns, is designed to change as change as volume of output change. “ Flexible budget is prepared in a manner that budgeted cost can be calculated at any level of activity / output. It is also known as Variable Budget, dynamic budget, expense control budget etc. For example Variable cost of material is determined at output level of 7,000 / 10,000 / 15,000 units @ Rs. 15, 12 and 10 p.u. respectively.

Flexible budget is required to be prepared in the following cases:
  • (i)  Where the level of output / activities during the year varies due to the seasonal nature of the industry or to variation in demand.
  • (ii)  If the business is new and it is difficult to forecast demand.
  • (iii) Where the entity is facing shortage of a factor of production such as labour, material etc.
Features of flexible features:
  • It includes various levels of activity.
  • Due to flexibility it is easy to modify with change in production level.
  • It provides a logical comparison of budget allowance with actual cost.
Method of preparing flexible budget:
  • (i) Tabular Method
  • (ii) Formula or ratio method
  • (iii) Graphic Method

Budgeting Example


Following information is received from NSA ltd for the year ended on 31st Mar 2016.

  • Semi Variable Expenses (50% Capacity)

                                                                                                              $ million

Repairs and Maintenance                                                                                            5.00

Indirect labour                                                                                                               8.50

Selling and distribution exp                                                                                         4.30

Administrative exp                                                                                                        2.50

  • Variable Expenses (At 50% capacity)

Material                                                                                                                               25.80

Labour                                                                                                                                  22.70

Other Exp                                                                                                                            08.20

  • Fixed Expenses

Wages and Salaries                                                                                                         12.50

Rent, rates and taxes                                                                                                       8.50

Depreciation                                                                                                                     5.50

Sundry Admin. Exp.                                                                                                         7.50

Assuming that fixed expense remain constant for all levels of production, semi variable expenses remain constant between 65% and 85% of capacity, increase by 10% between 85% to 100%

  • Sales at various levels:

                                                                                                                                             $ million

50% Capacity                                                                                                                      120.00

75% Capacity                                                                                                                       180.00

90% Capacity                                                                                                                      216.00

100 Capacity                                                                                                                        240.00

Prepare flexible budget and budgeted profit at 75%, 90% and 100% of capacity.

Solution:


Flexible Budget
Amount (in $ million)
50% 75% 90% 100%
Sales A 120.00 180.00 216.00 240.00
Variable Expenses B
Material 25.80 38.70 46.44 51.60
Labour 22.70 34.05 40.86 45.40
Other Exp 8.20 12.30 14.76 16.40
Semi Variable expenses C
Repairs and Maintenance 5.00 5.00 5.50 5.50
Indirect labour 8.50 8.50 9.35 9.35
Selling and distribution exp 4.30 4.30 4.73 4.73
Administrative exp 2.50 2.50 2.75 2.75
Fixed Expense D
Wages and Salaries 12.50 12.50 12.50 12.50
Rent Rates and Taxes 8.50 8.50 8.50 8.50
Depreciation 5.50 5.50 5.50 5.50
Sundry Admin. Exp 7.50 7.50 7.50 7.50
Total (B+C+D) 111.00 139.35 158.39 169.73
Profit 9.00 40.65 57.61 70.27

What is Forecasting?


A forecast is an assessment of possible future events. At initial planning stage it is compulsory to prepare to forecasts for possible actions for the business in future. Forecasts are prepared for sales, production, cost, procurement of material, and financial need of the business. Forecast have some flexibility whereas budget having a fixed target.

Generally budgeting and forecasting used interchangeable or understood as same activity (budgeting includes forecasting). However there is a thin line in between them.  A forecast is a projection of what will happen during the budgeting period at an organization level; generally include significant incomes and expenditures. A forecast may be for long term or short term period or using the top down or bottom up approach.

A long-term forecast will provide valuable output to the management for their strategic business plan whereas short term forecast generally done for operational and day to day business needs.

Budgeting vs Forecasting


The following point’s distinction can be noted between forecasting vs budgeting:

Sr.No. Forecasting Budgeting
1 Forecast is only estimate of what is likely to happen. It is a statement of probable events which are likely to happen under and anticipated conditions during a specified period of time. Budget is policy and program to be followed in a future period under pre mentioned situation.
2 Forecast to some extent are flexible. Budget having definite target and cannot be flexible.
3 Forecasts, being statement of future events. A budget is tool of control.
4 Forecasts have wider scope, since it can be made in those activities and events also where budget cannot interfere. Ex. Weather forecasting, market forecasting etc Budgets have limited scope. It can be made only for a specific activity or dept wise or at enterprise level. Ex sales budget, production budget etc.
5 Forecasting is a preliminary step for budgeting It begins when forecasting ends. Forecasts are converted into budgets.

In the corporate world, budget and forecast prepared at the same time and with the same inputs received from business and cost units of the enterprises. Though purpose and approach is the same in both the statement, the use may differ.

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