Budgeted Income Statement Meaning
The Budgeted Income statement, also known as Pro Forma Income Statement, presents the forecasted financial performance of the entity for future years of operations. It assists the management in setting the financial target for future years, designing and implementing new strategies to achieve the set financial goals and also to track the actual periodic performance with the forecasted numbers.
Format of Budgeted Income Statement
How to Prepare?
The Budgeted Income statement can be prepared quarterly or yearly. However, it is advisable to prepare the current year financial projections at quarterly intervals to monitor the actual performance as compared to budgeted numbers at the end of every quarter. It is merely the combination of Sales/Revenue Budget, Cost of Goods Sold Budget, Operating expense budget and cash budget.
For example, ABC Inc. is in the business of manufacturing and selling LED monitors. During the year the company sold 100000 units of LED monitors. The company also generated income from interest on bank deposits. Here, the income generated from the sale of the LED monitor will be considered the operating revenue as it is the core business activity of the entity, and interest income on deposit will be regarded as non-operating income.
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The total operating revenues are derived from the sales budget.
- The cost of goods sold is derived from the Cost of goods sold budget. The cost of goods sold comprises all the expenses directly related to manufacturing or procurement of goods such as material cost, labour cost, factory overheads, and direct expenses.
- The value of operating expenses is calculated with the help of the Operating Expense Budget. Operating Expense includes office administration expenses such as rent, insurance, salaries, and selling and marketing expenses.
- Similar to Non-operating income, Non-operating expenses are the expenses that are not related to the operating activity of the business. Examples of such expenses are litigation claim payments, business restructuring expenses, a loss incurred on the sale of assets, etc.
- Earnings before Interest and Taxes (EBIT) is the total profit of the entity before deducting interest expenses and statutory taxes.
- The amount of statutory taxes can be calculated at the current corporate tax rates.
- The value of interest expenses can be derived from the cash budget. A cash budget is the projection of future cash inflows and outflows.
Advantages
- It helps in planning and coordinating the activities of the various departments and functions as the budgeted income statement is the combination of sales, cost and expense budgets.
- Provide a long term vision about the investing and financing decision of the entity to the management.
- Play a vital role in the designing, implementation, and execution of various financial strategies to accomplish target projections.
- Provide constant vigilance on the financial performance of the entity by comparing the actual reported data with forecasted data.
- Serves the base for the investors willing to invest their money in the entity
Limitations
- Based on Assumptions – The budgeted income statement is prepared using various assumptions and estimates. Generally, these assumptions are based on historical trends, and market scenarios prevailing at the time of projecting the statement. Inaccurate assumptions and estimates can lead to significant variation between actual data and forecasted data. Also, negligence of the effect of changes in economic conditions and policies can create a question on the accuracy of the forecasted data.
- Time-Consuming – Forecasting isn’t a one day job, and the preparation of budgeted income statement requires a lot of time as well as managerial expertise to forecast the underlying assumptions accurately.
- Execution generally does not occur automatically – Although the budgeted income statement provides a basis for financial planning and setting departmental and functional goals, the success of it to a large extent depends on effective execution at all levels. If the departments do not perform to match their financial targets and co-ordinates well with other departments, it won’t be easy to realise the forecasted performance.
- Inflexibility – The budgeted Income statement can be viewed as inflexible as it is a combination of information from various other budgets and incorporating any change requires the change in supporting budgets (such as sales budget, cost budget, cash budget, operating expense budget as well).
Conclusion
The budgeted Income statement is a resourceful tool for management to project the financial performance and profitability of the entity. It sets the vision into numbers and serves as the basis of the implementation of various strategies at all levels in the entity. With the exercise of managerial expertise and due care in making assumptions and estimates, it can reduce the possibilities of inaccuracies and can be utilised in planning the future investing and financing decisions effectively.
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