How Budgets are Constructed

Preparation of budget requires adequate knowledge of prevailing conditions and possible future changes. A sales budget per product is for instance calculated as the product of the unit selling price and the projected number of units sold (Bamber, Braun & Harrison, 2007). Based on past experience or pre-determined criteria such sales could further be divided into cash and credit sections. With regard to cost of goods sold the desired gross profit margin. For a budget of the cost of goods sold the relationship between opening inventory, purchases and ending inventory is used. The beginning inventory is obtained from the previous period’s (month’s, quarter’s, year’s) budgeted balance sheet whereas the ending inventory is the desired amount which can be pegged at a constant value plus a percentage of cost of goods sold (Bamber, Braun & Harrison, 2007). Budgeted purchases can be obtained by reorganizing the equation for calculating the cost of goods sold to make purchases the subject of the formula (Bamber, Braun & Harrison, 2007). Operating expenses values on the other had are calculated with regard to other aspects of the operating budget. For instance while sales expenses such as commission are supposed to fluctuate with the level of sales (variable costs), other expenses, fixed expenses such as rent, remain the same month after month unless a change in these is expected (Bamber, Braun & Harrison, 2007). With this information preparation of a budgeted income statement would follow a similar process as when actual quantities are used for external reporting.

One element of a financial budget is the cash budget. This provides a detailed account of projected changes to the beginning cash balance to lead to the desired end-period amount. Such changes are cash receipts from customers; payments for purchases, operating expenses and capital expenditures in cash; and cash financing (Bamber, Braun & Harrison, 2007). Receipts from customers and operating expenses payments are determined by revenues and expenses thus should not be in excess of such amounts as indicated in the operating budget (Bamber, Braun & Harrison, 2007). The total receipts and payments from the cash budget are further used in constructing the budgeted cash flows statement while for a balance sheet budget asset and liabilities’ projections are made using information from the receipts and payments for expenditures cash budget and operating budget information (Bamber, Braun & Harrison, 2007). Owners’ equity is also calculated by summing the beginning balance with the budgeted net income (Bamber, Braun & Harrison, 2007).

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