A functional budget is actually one which relates to some function of the business, e.g., Production Budget, Sales Budget and Purchase Budget. You can find many types of functional budgets, of which the following are essential:
Types of Budgets
1. Sales Budget.
2. Production Budget.
3. Production Cost Budget.
4. Raw Materials Budget.
5. Purchases Budget.
6. Labor Budget.
7. Production Overhead Budget.
8. Selling and Distribution Cost Budget.
9. Administration Cost Budget
10. Capital Expenditure Budget.
11. Cash Budget.
In most companies, the sales budget is not only the most important but also the most difficult budget to prepare. The importance of this budget arises from
the fact that if the sales figure is incorrect, then practically all other budgets will be affected. The difficulties in the preparation of this budget
arise because it is not easy to estimate consumer demand, particularly when a new produce is introduced. The sates budget is a statement of planned sales
in terms of quantity and value. It forecasts what the company can reasonably expect to sell to its customers during the budget period. The sales budget can
be prepared to show sales classified according to products, salesmen, customers and periods, etc.
The factors to be considered in forecasting sales are the following:
1. Analysis of Past sates to determine trends in the market.
2. Reports by statesmen of various markets of company products.
3. Any changes in companies policies and methods and their effect on sales.
4. Any changes in economic conditions and in business related-conditions and policies.
5. Market research to measure potential demand for company products.
The production budget is actually an estimate of production for that budget period. It is very first drawn up in amounts of each product and when the
leftover budgets have been ready and cost of production calculated, next the quantities of manufacturing cost are translated into cash terms, what in
impact becomes a production cost budget. The production budget is actually the initial step in budgeting production operations. Additionally to production
budget, you can find three other budgets associated with manufacturing activities of an organization. These are labor budget, raw materials budget and
production overhead budget.
The principal considerations involved in budgeting production are:
1. Sales budget. When sales is the principal budget factor, the production budget will be based on the volume of sales forecast by the sales budget.
2. Inventory policy. The management decision regarding quantities needed is stock at all times to meet customer requirements is an important factor.
3. Production capacity. The production capacity of every department needs to be worked out and budget figures must be within these limits.
4. Management policy. Production policy from the management plays a significant role in budgeting production. For instance, management might decide to
purchase a particular component part through outside instead of manufacturing it. This can influence production budget.
Production Cost Budget
This budget shows the estimated cost of production. The production budget (explained above) shows the quantities of production. These quantities of
production are expressed in terms of cost in production cost budget. The cost of production is shown in detail in respect of material cost, labor cost and
factory overhead. Thus Production Cost Budget is based upon Production Budget, Material Cost Budget, labor Cost Budget and Factory Overhead Budget.
Raw Material Budget
This budget exhibits the estimated quantities of most the raw materials and components required for production demanded through the production budget. Raw
material budget serves the following purposes:
1. It assists the purchasing department in planning the purchases.
2. It helps in the preparation of purchase budget.
3. It provides data for raw material control.
It should be noted that raw material budget generally deals with only the direct materials whereas indirect materials and supplies are included in the
overhead cost budget.
Careful planning of purchases offers one of the most significant areas of cost saving in many concerns. The purchase manager should be assigned the direct
responsibility for preparing a detailed of purchases for the budget period and for submitting the plan in the form of a purchase budget.
The purchases budget provides details of the purchases which are planned to be made during the period to meet the needs of the business. It indicates:
1. The quantities of each type of raw material and other items to be purchased;
2. The timing of purchases and
3. The estimated cost of material purchases.
Labor cost is classified into indirect and direct. A few concerns prepare a labor budget that contains both indirect and direct labor, while some include
only direct labor cost and contain indirect labor within the overhead cost budget
The labor budget represents the forecast of labor requirements to meet the demands of the company for the budget period. This budget must be linked with
production budget and production cost budget. The method of preparing the labor budget is like this. The standard direct labor hours of each grade of labor
required for each unit of output and standard wage rate for each grade of labor are ascertained. Multiplication of units of finished goods to be produced
by the labor cost per unit gives the direct labor cost. The indirect labor is normally a fixed amount, so should be easy to calculate in total for the
The labor budget serves the following purposes:
1. To estimate the labor cost of production. h
2. To determine the direct labor required in terms of labor hours and hence the number and grade of workers required to meet the production requirements.
3. To provide the personnel department with personnel requirements so that it may plan recruitment activities.
4. To provide data for determination of cash requirements for payment of wages.
5. To provide data for managerial control of labor cost.
Production Overhead Budget
After budgeting of material and labor cost, the next logical step is to prepare a budget for production overheads. The production overhead budget
represents the forecast of all the production overheads (fixed, variable and semi-variable) to be incurred during the budget period. The fact that
overheads include many dissimilar types of expenses creates considerable problems in:
(a) The Control of production overheads and
(b) Allocation of production overheads to products manufactured.
The production overhead budget involves the preparation of overheads budgets for each department of the factory as it is desirable to have estimates of
manufacturing overheads prepared by those individuals who have the responsibility for incurring them. The budget expenses for each sub-period
During the budget period should be indicated and the classification of expenses should be the same as used by the accounting department. The budgeted
overhead costs of service departments are totaled and apportioned to production departments according to the services received by each such production
department. The budgeted overhead costs of service departments are totaled and apportioned to production departments according to the services received by
each such production department.
Selling and Distribution Cost Budget
This is closely related with the sales budget and represents the forecast of all costs incurred in selling and distributing the company’s products during
the budget period. As a general rule, the sales budget and the setting and distribution cost budgets are prepared simultaneously, since each has a
Definite impact on the other
The sales manager is responsible for setting and distribution cost budget. He prepares this budget with the help of heads of sub-divisions of the sales
department. Some companies prepare a separate advertising budget, particularly when spending on advertising are quite heavy.
Administration Cost Budget
This budget represents forecast of all administration expenses like directors fees, managing director’s salary, office lighting, heating and air
conditioning, etc. Most of these expenses are fixed, so they should not be too difficult to forecast.
Capital Expenditure Budget
This budget symbolizes the expenditure on every fixed assets throughout the budget period. It provides such items as new buildings, land, machinery and
intangible items such as patents, etc.
The capital expenditure budget provides certain characteristic features that distinguish it through other functional budgets. These are:
1. Capital expenditure budget handles items not directly linked to profit and loss account. Expenses associated with capital expenditure for example
repairs, maintenance and depreciation, and so on. are, however, related to this budget and these are a part of overhead budgets.
2. Capital expenditure is frequently planned a number of years in advance, perhaps five to ten years, in which case it is broken down into convenient
periods like years or months. As compared to this, other functional budgets are normally prepared for a shorter period, say, one year.
3. This budget involves huge amount of expenditure that needs leading management approval. The capital expenditure budget is, as a result, subject to some
strict management control.
The objectives of a capital expenditure budget are stated below:
1. To enable the company ‘to establish a system of priorities in expenditure.
2. To correct capacity imbalances.
3. To provide a tool for controlling capital expenditure.
4. To make proper financial provision to meet planned expenditure
5. To provide budgets for depreciation and maintenance cost for inclusion in the departmental expense budgets.
The cash budget is probably the most important and among the last to be prepared. It is actually a detailed estimate of money receipts from all sources and
cash payments for many purposes and the resultant cash balance throughout the budget period. It makes certain how the business has enough cash available to
meet its wants as and when these come up. It is a device for controlling and coordinating the financial side from the business to make sure solvency and
give a basis for financing and planning necessary to cover up any deficiency in cash. Cash budget therefore plays a significant role in the financial
management of any business undertaking.
The principal purposes of cash budget are outlined below:
1. It ensures that sufficient cash is available when required.
2. It indicates cash excesses and shortages so that action may be taken in time to invest any excess cash or to borrow funds to meet any shortages.
3. It establishes a sound basis for credit
4. It shows whether capital expenditure may be financed internally
5. It establishes a sound basis for control of cash position.
Preparation of Cash Budget
There are three methods of preparing cash budget:
1. Receipts and Payments Method.
2. Adjusted Profit and Loss Method and.
3. Balance Sheet Method.
Receipts and Payments Method. This method is usually used for short term cash forecast arid is much more detailed than the other two methods.
The cash budget starts with the opening balance of cash at bank and in hand. To this is going to be added the estimated cash receipts from different
sources and from this can be deducted each estimated payments of cash, whether on capital or revenue account. The resultant figure is actually dosing cash
balance. Cash receipts in many situations comes from cash sales, collections from debtors, loans and interest on investments, miscellaneous sources and
sale of capital assets. When it comes to credit sales, adjustment needs to be made for the time lag between the realisation of cash and point of sale. Cash
payments are created for raw material purchases, out of pocket expenses, direct labor, dividends, capital expenditure projects, and so on. The period of
credit appropriate for the payment concerned has to be taken into account.