COGS is the cost of direct labor and direct materials that are tied to production. The operating budget also represents the overhead and administrative costs directly tied to producing the goods and services.
However, the operating budget doesn't include items such as capital expenditures and long-term debt. A cash-flow budget helps managers determine the amount of cash being generated by a company during a specific period. The inflows and outflows of cash for a company are important because expenses need to be paid on time from the cash generated.
For example, monitoring the collection of accounts receivables , which is money owed by customers, can help companies forecast the cash due in a particular period.
This process can be challenging if too many customers are past-due. To compensate for this, many businesses create something called an " allowance for doubtful accounts ," which estimates the amount of accounts receivable that are expected to not be collectible. Cash flow budgets help to examine past practices to examine what's working and what's not and make adjustments.
For example, a company could apply for a short-term working capital line of credit from a bank to ensure they cash in the event a client pays late. Also, companies can ask for more flexible options for their accounts payables , which is money owed to suppliers to help with any short-term cash-flow needs.
Once a period has ended, management must compare the forecasts from the static or master budget to the company's performance.
It's at this stage that companies calculate whether the budget came in line with planned expenditures and income. A flexible budget is a budget containing figures based on actual output. The flexible budget is compared to the company's static budget to identify any variances or differences between the forecasted spending and the actual spending. With a flexible budget, budgeted dollar values i. The calculation yields the total variable costs involved in production. The second component of the flexible budget is the fixed costs.
Typically, fixed costs do not differ between static and flexible budgets. Since flexible budgets use the current period's numbers—sales, revenue, and expenses—they can help create forecasts based on multiple scenarios.
Companies can calculate various outcomes based on different outputs, such as sales or units produced. Flexible or variable budgets help managers plan for both low output and high output to help ready themselves regardless of the outcome. As stated earlier, variances can arise between the static budget and the actual results. The two common variances are called the flexible budget variance and sales-volume variance. The flexible budget variance compares the flexible budget to actual results to determine the effects that prices or costs have had on operations.
By comparison, the sales-volume variance compares the flexible budget to the static budget to determine the effect that a company's level of sales activity had on its operations. From these two budgets, a company can develop individual flexible and static budgets for any element of its operations. The variances are classified as either favorable or unfavorable. If the sales-volume variance is unfavorable flexible budget is less than static budget , the company's sales or production with a production volume variance will turn out to be less than anticipated.
If, however, the flexible budget variance was unfavorable, it would be the result of prices or costs. By knowing where the company is falling short or exceeding the mark, managers can evaluate the company's performance more efficiently and use the findings to make any necessary changes.
A flexible budget can help companies account for both variable and fixed expenses, creating a more dynamic process and leading to more accurate forecasts.
For most companies, expenses pop up from time to time. Static budgets typically act as a guideline, meaning they can be changed or adjusted once the variances have been identified via a flexible budget. Understanding the different types of budgeting, managers can gain a wealth of information through the analysis of budget variances leading to better-informed business decisions. Explore Business Business Search.
Explore Blog Reference library Collections Shop. Share: Facebook Twitter Email Print page. A budget is a financial plan for the future concerning the revenues and costs of a business.
However, a budget is about much more than just financial numbers. There are many management uses for budgets. For example, budgets are used to: Control income and expenditure the traditional use Establish priorities and set targets in numerical terms Provide direction and co-ordination, so that business objectives can be turned into practical reality Assign responsibilities to budget holders managers and allocate resources Communicate targets from management to employees Motivate staff Improve efficiency Monitor performance Whilst there are many uses of budgets, there are a set of guiding principles for good budgetary control in a business.
Within a participatory budgeting process, accountants should be compilers or coordinators of the budget, not preparers. They should be on hand during the preparation process to present and explain significant financial data. Accountants are responsible for designing meaningful budget reports.
Also, accountants must continually strive to make the accounting system more responsive to managerial needs. That responsiveness, in turn, increases confidence in the accounting system. Although many companies have used participatory budgeting successfully, it does not always work.
Studies have shown that in many organizations, participation in the budget formulation failed to make employees more motivated to achieve budgeted goals. Participation is not the answer to all the problems of budget preparation.
However, it is one way to achieve better results in organizations that are receptive to the philosophy of participation. Skip to main content. Chapter 7: Budgeting. Search for:. Top management, then, must clearly state long-range goals and broad objectives. These goals and objectives must be communicated throughout the organization. Long-range goals include the expected quality of products or services, growth rates in sales and earnings, and percentage-of-market targets.
Overemphasis on the mechanics of the budgeting process should be avoided. Employees are more likely to strive toward organizational goals if they participate in setting them and in preparing budgets.
Often, employees have significant information that could help in preparing a meaningful budget. Also, employees may be motivated to perform their own functions within budget constraints if they are committed to achieving organizational goals. Communicating results People should be promptly and clearly informed of their progress. Effective communication implies 1 timeliness, 2 reasonable accuracy, and 3 improved understanding.
Managers should effectively communicate results so employees can make any necessary adjustments in their performance. Flexibility If significant basic assumptions underlying the budget change during the year, the planned operating budget should be restated. For control purposes, after the actual level of operations is known, the actual revenues and expenses can be compared to expected performance at that level of operations.
Follow-up Budget follow-up and data feedback are part of the control aspect of budgetary control. Since the budgets are dealing with projections and estimates for future operating results and financial positions, managers must continuously check their budgets and correct them if necessary.
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