Solution 9.1

Distinguish between operating and capital budgets.

Operating budgets are the various budgets that relate to the operating performance of the business and are summarised in the projected profit statement for the period. The operating budgets comprise of a sales budget, cost of sales budget, payroll, operating expenses budgets, and fixed expenses budgets.

Capital budgets relate to the balance sheet and are composed primarily of the capital expenditure budget, and include the stock budget, debtors and creditors budgets.

The master budget brings together all the financial projections from the various operating and capital budgets within an organisation for the period. It embraces the impact of both operating decisions (running the business) and investment and financing decisions (capital budgets) that the business has planned for the next time period (usually 12 months). This is illustrated in the following diagram.

The master budget

What are the main advantages of preparing monthly cash budgets?

The cash budget is primarily concerned with the timings of future cash inflows and outflows and is based on data from the operating and capital budgets. The main advantages associated with preparing monthly cash budgets is that management can foresee significant cash surpluses and cash deficits and thus can plan for such events.

For example if a cash budget discloses a budget period where a cash shortfall is likely then management can plan for this situation and ensure the necessary funds are available for the business to get through this period. If the cash budget highlights possible cash excesses then management can plan to invest these cash surpluses to ensure this asset is working for the business and not lying idle.

Outline the main objectives of budgetary planning

  • To forces management to set and prioritise goals which act as a blueprint for the future.
  • To compels management to plan and focus on the future, thus gaining an advantage by anticipating future business conditions and otherwise unforeseen problems.
  • To provide management with a basis on which to measure subsequent performance.
  • To encourage and promote upward, downward and horizontal communication within the organisation. Thus the budgetary process plays a strong role in the co-ordination of activities and goal congruence. The budget acts as a vehicle through which the activities of the different parts of the organisation can be integrated into an overall plan.
  • To provide a basis for responsibility accounting. Responsibility accounting occurs where managers are identified with their budget centre and are responsible for achieving the budget targets for that centre. Ultimately, responsibility accounting makes managers responsible for the costs, revenues and resources that they actually control. In the context of budgets, responsibility accounting represents the delegation of responsibility to individuals within an organisation.
  • To facilitate control within an organisation by the regular, systematic monitoring and reporting of activities and comparing with the budget.
  • To facilitate better cash and working capital management through the preparation of the master budgets.