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Year 12 Accounting. Chapter 17 Budgets. Budgeting. Budgeting is the process of preparing reports that estimate or predict the financial consequences of likely future transactions .
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Year 12 Accounting Chapter 17 Budgets
Budgeting • Budgeting is the process of preparing reports that estimate or predict the financial consequences of likely future transactions. • A small business owner could prepare a budget on just about any area of business performance, ranging from how many sales are made in a month, to how much will be spent on advertising, and how many returns will be made. In this course, we will concentrate on three general-purpose budgets: • The Budgeted Cash Flow Statement, which shows all expected future cash inflows and cash outflows, the actual cash balance at the start of the period, and the expect cash balance at the end of the period.
Budgeting • The Budgeted Profit and Loss Statement, which shows all expected future revenues and expenses, and the expected Gross profit, Adjusted gross profit and Net profit. • Budgeted Balance Sheet, which shows all expected assets, liabilities and owner’s equity at some point in the future. • Budgets or budgeted reports differ from the actual (or historical) reports we have prepared so far in two key ways: • 1 Budgets report future events rather than historical events; they focus on what will happen rather than what has already happened. • 2 As a consequence, budgets use estimates or predictions rather than actual, verifiable data. • In all other ways, budgeted reports are the same as actual reports: they use the same headings, and include the same items.
The importance of budgeted sales • As we have seen in earlier chapters, the accounting reports are interconnected, with transactions reported in one affecting items reported in another, and this is no different for budgets. This means it is essential that the preparation of budgeted reports begin with an accurate estimate of budgeted sales. • First, Sales is the main revenue item in the Budgeted Profit and Loss Statement, and generates significant cash inflows (either as Cash sales or as Receipts from debtors if credit sales are involved). • Second, the level of sales will be crucial in estimating the expenses that vary with the number of units sold (like Cost of sales and Wages), and their corresponding cash outflows. • Third, the level of sales will affect how much stock is purchased, which will in turn effect cash paid to creditors.
The importance of budgeted sales • The Balance Sheet does not report sales directly, but because it uses figures derived from the other two reports, its accuracy is also dependant on an accurate estimate of sales. (At the very least, the expected Bank figure will come straight from the Budgeted Cash Flow Statement, and the expected Net profit or loss will be determined in the Budgeted Profit and Loss Statement). • The purpose of budgeting • Like all accounting reports, budgets have a role in both planning and decision-making. • Budgeting assists planning by predicting what is likely to occur in the future. This allows the owner to prepare for what is likely to occur so that possible problems may be managed, and possible opportunities may be taken. • Budgeting aids decision-making by providing a benchmark or yardstick (a standard) against which actual performance can be measured. This allows the owner to identify areas in which performance is unsatisfactory, so that remedial action can be taken. (This can include the calculation of budgeted ratios and other indicators of performance.)
The Budgeting Process • Budgeting should be a continuous process; budgets should be compared against actual reports to allow problems to be identified, decisions should be made based on that assessment, and then new budgets should be prepared for the next period.
The Budgeting Process • A budget has limited value if it is not used to make decisions to improve business performance in the future. In addition, it makes little sense to develop a budget for one period without preparing another budget for the next period. Under the Going concern principle, businesses are assumed to be continuous, so the budgeting process should be continuous too. • The information presented in the budgeted reports should be based on the historical data, but allowances must be mad efor changes and the effect of new business decisions. • (Obviously, a brand new business will not have any historical data on which to rely – this makes budgeting harder for new businesses, but no less important.)
BUDGETED CASH FLOW STATEMENT • In order to survive, a small business must have sufficient cash to meet its obligations. • These obligations will include making payments to creditors, paying expenses (such as wages, rent, advertising, GST etc.), meeting loan repayments, and providing drawings for the owner. In order to do this, the business must generate sufficient cash inflows, chieflythrough its cash sales and receipts from debtors. The Budgeted Cash Flow Statement attempts to predict all future cash inflows and cash outflows, and thus the estimated cash balance at the end of the budgeted period, to assist the owner in assessing the firm’s ability to meet its obligations over the budget period.
