Budgeting and Estimation

DR. GOURI KALAGOND

Budget
“A budget is defined as a comprehensive and coordinated plan, expressed in financial terms, for
the operations and resources of an enterprise for some specified period in the future.”
-J. M. Fremgen
• Plan
• Operations and Resources
• Financial Terms
• Specified Future Period
• Comprehensiveness
• Coordination
 Budget as management control techniques
• Explicit Statement of Expectations
• Communication
• Coordination
• Expectations as a framework for judging performance
Budget Process
A master budget consists of three types of budgets:
• Operating budgets- Sales, Production, Purchase, Direct Labour, Manufacturing Expenses,
Administrative & Selling Expenses
• Financial budgets- Budgeted Income Statement, Budgeted Statement of Retained Earnings,
Budgeted Balance Sheet, Cash Budget
• Special decision budget
Other Classifications:
• Fixed/Static budget & Flexible/Variable budget
• Optimistic budget & Pessimistic budget
Cash Budget
The objective of the cash budget is to ascertain whether, at any time, there is likely to be an
excess or shortage of cash.
Cash budget is divided into two broad categories:
• Operating Cash Flows
• Financial Cash Flows
Operating Cash Flow Items
CASH INFLOWS/RECEIPTS CASH OUTFLOWS/DISBURSEMENTS

Cash Sales/Fees Purchase of raw materials

Collection of debtors/account receivables Payments to creditors/account payables
Disposal of fixed assets Wages & Salaries
Factory expenses
Administrative expenses
Selling expenses
Purchase of fixed assets
Financial Cash Flow Items
CASH INFLOWS/RECEIPTS CASH OUTFLOWS/PAYMENTS

Loans/Borrowings Interest paid

Issue of shares and securities Redemption of loan
Sale of securities Dividend paid
Interest received Buyback of shares
Dividend received Purchase of shares
Refund of tax Tax payments
Cash Flow Analysis
Cash flow analysis is basically preparation of cash flow statement which involves analyzing from
where the cash is got in and to where the cash is gone out. (Where Got Where Gone Statement)
Cash flow statement is a statement which indicates sources of cash inflows and transactions of
cash outflows of a firm during an accounting period.
The transactions which generate cash inflows are known as sources of cash and transactions
which cause cash outflows are knows as application/uses of cash.
Preparation of Cash Flow Statement as per AS-3
Cash flow statement deals with the provision of information about the historical changes in cash
and cash equivalents of an enterprise which classifies the cash flows during the period among
• Operating activities
• Investing activities
• Financing activities
Operating Activities
Cash receipts from the sale of goods or rendering of services
Cash receipts from royalties, fees, commissions, and other revenues
Cash payments to suppliers for goods and services
Cash payments to and on behalf of employees
Cash payments or refunds of income taxes unless they can be specifically identified with
financing and investing activities
Investing activities
Cash payments to acquire fixed assets
Cash receipts from disposal of fixed assets
Cash payments to acquire financial securities of other enterprises
Cash receipts from disposal of financial securities of other enterprises
Cash advances and loans made to third parties
Cash receipts from the repayment of advances and loans made to third parties
Dividend/interest received
Financing Activities
Cash proceeds from issue of shares
Cash proceeds from issue of debentures, bonds and other borrowings
Buy-back of shares
Cash repayment of amounts borrowed
Redemption of preference shares
Dividend/interest paid
Financial Analysis & Interpretation
“Analysis means methodical classification of the data given in the financial statements into a
simplified form”.

“Interpretation means explaining the meaning and significance of the data to the
management”.
 Ratio Analysis
The term Ratio refers to the numerical or quantitative relationship between two figures.
It is obtained by dividing the former by the later.
A Ratio is only a comparison of numerator with the denominator(N/D).
TYPES OF RATIOS
• Liquidity Ratios
• Solvency Ratios
• Activity or Turnover Ratios
• Profitability Ratios
Liquidity Ratios
Liquidity ratios are the ratios which measure short term solvency or financial position of a firm.
• Current Ratio
• Quick Ratio
Current ratio:
Defined as the relationship between current assets & current liabilities.

Current ratio= Current Assets

Current Liabilities

Current assets include cash in hand , cash at bank , Debtors , Bills Receivable , stock , prepaid
expenses, short term investments.
Current liabilities include creditors , Bills payable, O/S expenses, tax payable, Bank O/D , short
term loans, Income received in advance.
Quick Ratio:

It is the ratio of quick or liquid assets to current liabilities.

Liquid(Quick) Ratio = Quick assets

Quick liabilities

Quick Assets = C.A – stock – prepaid expenses

C.L – Bank O/D
Solvency Ratios
The term solvency refers to the ability of a concern to meet its long
term obligations.
• Debt Equity Ratio
• Proprietary Ratio
Debt Equity Ratio:
It measures the relationship between long term debts and equity.

Debt Equity Ratio= Long term debts

Shareholder’s funds
Long term debt = Debentures + Long term loans
Shareholder’s funds = Equity share capital + Preference share capital + Reserves &

Surplus
Proprietary Ratio:
It expresses relationship of proprietors (share holder funds) to total assets.

Proprietary Ratio = Shareholder’s funds

Total assets
Activity or Turnover Ratios
Activity Ratios or Turnover Ratios refer to such ratios which measure the level of
activities or the operating efficiency of an enterprises.
• Inventory or stock turnover ratio
• Debtors turnover ratio
• Creditors turnover ratio
Stock Turnover Ratio:
Stock turnover ratio is the ratio which indicates the number of times the stock is turned over during a year.
Stock turnover ratio = Cost of goods sold(COGS)
Average stock
COGS = Opening stock + Purchases + Direct Expenses – Closing stock
COGS = sales – Gross profit
Average stock = Opening stock + Closing stock
2
Debtors Turnover Ratio:
It is the ratio which indicates the relationship between debtors & credit sales. It is also called as accounts receivables
turnover ratio. It is the ratio which indicates the number of times the debts are collected in a year.
Debtors turnover ratio = Net credit sales
Average Debtors
Credit sales = Total sales–Cash sales–Sales returns
Average Debtors= Opening(Debtors+B/R)+Closing(Debtors+B/R)
2
Average collection Period = No. of months/days in a year
DTR
Creditors Turnover Ratio:
Creditors turnover ratio indicates the relationship between creditors and credit
purchases. It indicates the speed with which the creditors are turned over in relation
to credit purchases.
Creditors turnover ratio = Net credit purchases
Average creditors
Net Credit Purchases = Total purchases – Cash purchases – Purchase returns
Average Creditors = Opening(Creditors+B/P)+Closing(Creditors+B/P)
2
Average Payment Period = No. of months/days in a year
CTR
Profitability Ratios:

Profitability ratios are the ratios which measure the earning capacity of the business,
as the outcome of utilization of resources employed in the business. These ratios will
be expressed in terms of percentages.

• Gross profit ratio

• Net profit ratio
• Operating profit ratio
Gross profit ratio :
It calculates the relation between gross profit and sales.

Gross Profit Ratio = Gross Profit * 100

Net Sales
Gross Profit = Sales – COGS
Net profit ratio :
It is the ratio of net profit to sales.

Net profit ratio = Net profit * 100

Sales
Operating ratio:
It is computed to analyse the cost of operations in relation to sales.

Operating ratio = Operating cost * 100

Net sales
Operating Cost = COGS + Administrative Expenses + Selling & Distribution Expenses
Operating profit ratio = 100 – Operating ratio
Return on Investment
Return on Investments (ROI) can be computed by relating the profits of a firm to its investments.
• Return on Assets (ROA)
• Return on Capital Employed (ROCE)
• Return on Shareholder’s Equity
Return on Assets:
Relationship between net profits and assets.
ROA = Net profit after taxes * 100
Average total assets
Return on Capital Employed:
Relationship between net profits and capital employed.
ROCA = Net profit after taxes * 100
Capital employed
Capital employed = Shareholder’s fund + long term debt
Return on Shareholder’s Equity:
Relationship between net profits and shareholder’s funds.
Return on Shareholder’s equity = Net profit after taxes * 100
Total shareholder’s fund