Budget preparation: formula sheet

Key formulas

Purpose of budgets (memory aid)

Planning, Coordination, Communication, Motivation, Control, Authorisation, Evaluation

Use this list to answer any 'why do organisations budget' question. Pick the purposes the question points to.

Budget process order

Communicate guidelines → identify principal budget factor → prepare that budget first → prepare other budgets → negotiate and coordinate → prepare master budget → approve → review

The principal budget factor budget is always prepared first. The master budget (budgeted income statement, statement of financial position and cash budget) comes last.

Budget versus forecast

Budget = plan management commits to; Forecast = prediction of what is likely to happen

A budget is a target and a basis for control. A forecast is an estimate and does not commit resources.

Sales revenue

Sales revenue = budgeted sales units × selling price per unit

If the price changes during the year, calculate each period separately.

Production budget (units)

Production = Sales + Closing finished goods − Opening finished goods

Works in units. This is the core formula for this topic.

Opening inventory link

Opening inventory of a period = Closing inventory of the previous period

Use this to find opening figures for later periods.

Closing inventory as a policy

Closing inventory = stated % × next period's budgeted sales

Common wording: 'inventory equal to 20% of next month's sales'.

Production with wastage

Units to start = good output required ÷ (1 − wastage % of input)

Only if the question states a loss on production. Check whether the loss is a % of input or of good output.

Usage for good output

Units to produce × material per unit

Use the production budget figure, not the sales figure.

Usage with normal wastage (loss as % of input)

Input required = Good output requirement ÷ (1 − wastage % of input)

If the wastage is stated as % of input, divide. If stated as % of good output, multiply by (1 + %).

Purchases quantity

Purchases = Usage + Closing inventory − Opening inventory

All three must be in the same units.

Purchases cost

Purchases quantity × price per unit

Use the expected purchase price.

Production needed (link to sales)

Production = Sales + Closing finished goods − Opening finished goods

Use this first if only sales are given.

Standard hours required

Units to produce × standard hours per unit

Use units of production, not units sold. Production comes from the production budget.

Hours of active work at given efficiency

Standard hours required ÷ efficiency %

At 80% efficiency, divide by 0.80. Lower efficiency means more hours.

Hours to be paid with idle time

Hours worked ÷ (1 − idle time %)

Use when idle time is a percentage of total paid hours. If idle time is a percentage of hours worked, multiply by (1 + idle %) instead. Read the wording.

Direct labour cost

Hours paid × rate per hour

Add overtime premium separately on the overtime hours only.

Overtime premium cost

Overtime hours × premium per hour

Premium is the extra above the basic rate, for example 0.5 × basic rate if time-and-a-half.

Closing cash balance

Opening cash + Receipts − Payments = Closing cash

Closing cash for one month becomes opening cash for the next. A negative figure is an overdraft.

Cash from credit sales

Cash received in a month = Sales of the earlier month(s) × % collected in that lag, adjusted for any discount

If 60% pay in the month after sale, then May cash from this group = April sales × 60%.

Cash paid to suppliers

Cash paid = Purchases of the month(s) before × credit terms

Use purchases, not production cost or sales. Take any settlement discount into account.

Cash overheads

Cash overheads = Total overheads − Depreciation (and other non-cash items)

Also apply any payment lag, such as paid one month in arrears.

Closing receivables

Closing receivables = Credit sales not yet collected at the period end

This feeds the budgeted statement of financial position.

Closing payables

Closing payables = Credit purchases not yet paid at the period end

Check the credit terms to find which months are unpaid.

Budgeted closing retained earnings

Opening retained earnings + Budgeted profit − Dividends = Closing retained earnings

Use this to complete the equity section of the master budget.

Contribution per unit

Selling price per unit − variable cost per unit

Use variable costs only. Ignore fixed costs when ranking products.

Contribution per unit of limiting factor

Contribution per unit ÷ units of scarce resource used per unit

Rank products highest to lowest on this figure when one resource is scarce.

Flexed variable cost

Budgeted variable cost per unit × actual activity level

Equivalent to budgeted variable cost ÷ budgeted activity × actual activity.

Flexed fixed cost

Budgeted fixed cost (unchanged)

Fixed costs are not flexed within the relevant range. Stepped costs need care.

Flexed budget variance

Flexed budget figure − actual figure (for costs: favourable if actual is lower)

For revenue, favourable if actual is higher than flexed budget.

Incremental budget

New budget = Last period's figure × (1 + expected change %)

Apply to each cost line separately. Adjust for volume and price changes.

Rolling budget

Budget horizon stays constant: drop the period just ended, add a new period at the end

For example, a 12-month rolling budget updated each quarter always shows the next 12 months.

ZBB ranking rule

Fund decision packages in order of ranked benefit until the available resources are used up

Packages below the cut-off are not funded.

Activity-based budget cost

Budgeted activity cost = Budgeted activity level (driver volume) × Cost per unit of driver

Cost pools are linked to drivers such as number of set-ups or orders.

Quick revision

• Production units = sales units + closing inventory − opening inventory.
• Materials purchases = materials needed for production + closing materials inventory − opening materials inventory.
• Allow for wastage first: input required = good output ÷ (1 − wastage rate), where wastage is a share of input.
• Labour hours paid = hours worked + idle time; allow for idle time when costing labour.
• Cash budgets include only cash flows; exclude depreciation and other non-cash items.
• Credit sales are received in later periods, so time receipts by the credit terms given.
• The master budget comprises the budgeted income statement, statement of financial position and cash budget.
• Flexing: keep fixed costs unchanged and adjust variable costs to the new activity level.
• The limiting factor is the scarce resource; with one limiting factor, rank products by contribution per unit of that factor.
• Zero-based budgeting starts from nothing and justifies every item; incremental budgeting adjusts last period's figures.
• A rolling budget is updated regularly by adding a new period as one expires.
• Participative budgeting can improve motivation and commitment, but can take longer and allow budgetary slack.

Common mistakes

• Assuming the principal budget factor is always sales demand. Fix: Read the scenario. If labour, materials or capacity is scarcer than demand, that is the principal budget factor.
• Treating a budget and a forecast as the same thing. Fix: Remember that a budget is a plan and a target that management commits to. A forecast is only a prediction.
• Adding opening inventory and subtracting closing inventory. Fix: Think of the cupboard. Higher closing inventory means you must make more. So add closing, subtract opening.
• Using this month's sales to work out closing inventory when the policy refers to next month's sales. Fix: Underline 'next month' in the question. Write out sales for one extra period before you start.
• Using sales units instead of production units for usage Fix: Always work out production first. Materials are used to make goods, not to sell them.
• Adding opening inventory and deducting closing inventory Fix: Remember: closing inventory must be bought, opening inventory is already there. Purchases = usage + closing − opening.
• Multiplying by efficiency instead of dividing. Fix: Lower efficiency means more hours. Divide by 0.80. Check that your answer is larger than the standard hours.
• Using sales units instead of production units. Fix: Always calculate production first: sales + closing inventory − opening inventory.
• Including depreciation as a cash payment Fix: Deduct depreciation from total overheads before putting overheads in the cash budget.
• Using sales or purchases in the wrong month Fix: Write the lag beside each line, such as 'sales of previous month', before calculating.

Exam tips

• Learn the exact roles of the budget committee, budget manual and budget officer. Questions often ask you to match each one.
• When a question says 'first budget to be prepared', look for the limiting factor before choosing sales.
• Match purposes to verbs in the stem: inform, coordinate, compare, motivate. Avoid choosing 'control' by habit.
• In multiple response questions, count the options you must select and do not choose more than asked.
• Treat forecast versus budget as a likely one-mark question and answer it quickly using plan versus prediction.
• In objective test questions, the trap answer is usually the result of reversing the signs. Work out which way the answer should move before you calculate.
• Read whether the figure asked for is units or money. Production budgets are in units.
• If inventory is stated as a percentage of next period's sales, check for the extra period's sales figure, often tucked in at the end of the question.