Financial Decisions

Read Complete Research Material

FINANCIAL DECISIONS

Managing Financial Resources and Decisions



Managing Financial Resources and Decisions

Introduction

Budgeting is the process by which the goals of an organisation, and the resources to attain those goals, are quantified and communicated. Specifically, budgets are used to plan and control operations and to make long-term investments (Van Stede, 2008, 93). Planning entails coordination, marshaling, and allocating resources, and control involves performance evaluation.

The master budget, portrayed in figure 1 comprises two sets of budgets: (1) operating budgets and (2) financial budgets. Within these two broad categories of operating and financial budgets, there can be an unlimited number and variety of budgets and sub-budgets, depending on the level of detail desired. Operating budgets summarise the expected operating activities - sales, purchases, labor, overhead, and discretionary expenses - culminating in the income statement (Van Stede, 2010, 60).

The income statement is sometimes grouped with financial budgets. Here it is included with operating budgets on the premise that it is a summary display of operating results during the budget period. Financial budgets summarise the investing activities, cash flows, and the pro forma balance sheet. These budgets articulate in that they feed into each other and form part of an interdependent whole. But the impetus clearly flows from operations (Umapathy, 2010, 79).

Discussion

At the centre of budgeting are the projected sales. Forecasting sales is critical because all other budgeted activities depend on it. Organisations develop demand forecasts in different ways. Some use highly sophisticated models and market surveys, while others rely on simple extrapolations of past years' sales. Many use multiple sources of information, including the views of line managers and field sales force (Young, 2009, 82). Forecasts from these separate sources are consolidated into the final sales budget.

The sales forecast is used to develop budgets for operating, investing, and financing activities. For operations, the forecast is used to budget for the acquisition of inputs and for discretionary spending. Operating budgets vary by industry and by company. Manufacturing firms develop a production budget showing the product units to be manufactured, ending inventories for work-in-process and finished goods, direct labour, direct materials, and overhead. A budget for selling and administrative expenses is also prepared (Weitzman, 2010, 57). Merchandising firms, on the other hand, develop budgets for merchandise purchases together with budgets for labor, inventories, and selling and administrative expenses. Service firms develop a set of budgets that show how the demand for their services will be met.

The sales forecast is also used to prepare the financial budgets. The capital budget summarises the investing activities - resources that require medium and long-term advance commitment. The advance commitments insure that capacity is on hand when expected sales materialise (Waller, 2008, 87). But they also entail considerable risk, because, once committed, they cannot be altered easily in the short run. These commitments inject rigidity into the cost structure of the firm, magnifying the impact of small variations in sales on profits - a condition known as the operating leverage effect. (Young 2009 p82)

The cash budget reflects the cash flows associated ...
Related Ads