Budget plans

Budget plans

Budgets are used as a means of achieving planning and control objectives in most businesses and in many non-commercial organizations.

A budget has been defined as: A financial or quantitative statement prepared and approved, prior to a defined period of time, of the policy to be pursued during that period for the purpose of attaining given objectives.

The benefits that derive from budgetary control arise from the ability to coordinate policy, plans and action and to be able to monitor the financial consequences of carrying out the plans.

An engineering company will prepare a number of budgets, each corresponding to a particular functional area. A named manager will normally control each budget although some managers may control several budgets according to the particular management organization employed within the company. In a typical engineering business you will find the following budgets:

• marketing budget
• manufacturing budget
• R&D budget
• administration budget
• capital expenditure budget
• cash budget.

Each of these budgets may be subdivided into further budgets. For example, the manufacturing budget may be subdivided into a budget for direct materials, a budget for direct labour and a budget for factory overheads (heating, lighting and other energy costs).

Each functional manager will forecast his/her own budget; however, there is a need for managers and departments to coordinate their budget activities. For example, the capital expenditure budget may reflect the purchase of major items of capital equipment (such as a fork-lift truck o an overhead crane) that will be shared by several departments.

Stock control

Stock control systems used within a manufacturing company will affect the way purchasing is done. Economic order quantities may be established, which the buyer has to take into account when arranging supplies. Deliveries may have to be phased according to minimum and maximum and re-order stock levels.

The firm's purchasing function (see page 31) will need a clear understanding of the importance of deliveries that enable the company to control its inventory costs, while at the same time ensuring a reliable supply of materials and components for the various production processes.

The company may operate a JIT system. It originated in Japan and it is a way of delivering supplies at the point in time they are required by production. JIT avoids the costs of holding buffer stocks of raw materials and components.

JIT works well when suppliers are dependable and when transport systems are good. The buyer will liaise with the factory on the establishment and operation of the JIT for given products.

There will also be the routine matters of passing invoices for payment of goods or dealing with returns for credit so that accounts department can pay for goods received. Materials purchasing will be subject to budgetary constraints like most other company activities. The purchasing department will be involved, either directly or indirectly in budgets for inventory levels, and in setting up minimum, maximum and re-order levels for stocks. Monthly monitoring of inventory levels will be done by the accounting function and purchasing activities may be responsible for ensuring that stock of components and raw materials stay within agreed levels. Depreciation

Depreciation is the estimate of the cost of a fixed asset consumed during its useful life. If a company buys a car, to be used by a sales representative, for £15,000 it has to charge the cost in some reasonable way to the profit being earned. This process is essential, otherwise the whole cost of running the business cannot be obtained, and profit figures would be overstated. If it is estimated that the car will be worth £6,000 in 3 years time when it is to be sold, then it could be charged to profit at (£15,000 - £6,000)/3 = £3,000 for each year of use.

The way companies accumulate funds with which to replace fixed assets is to charge depreciation as an overhead cost. In the case of our car this recovers £9,000 that together with the sale price of the used car generates a fund of £14,000 towards the purchase of a replacement. It is also possible that the sums so deducted from profit can be invested to offset inflation until the time comes to replace the asset.

Because depreciation is an estimate and is deducted from profit it has the effect of keeping the money available in the business. Many companies use the aggregate depreciation charged as the basis for the fund against which investment appraisal is done.

There are two main methods used to calculate depreciation. We will outline each in turn: