Preparing a Functional Budget for D Limit


The report is to prepare a functional budget of D Limit organisation for the year to 31 December 1994 including sales budget, production budget, material usage budget and production cost budget. The sales are often considered to be the principal budget factor of an organisation, D limited has to understand the principal budget factor and the sales forecast statistical techniques and the use of microcomputer.

Functional Budgets

Calculation of Budgets (Appendix)

Sensitivity Analysis

Principal Budget Factor

The principal budget factor is a factor which, at any given time, is an overriding planning limitation on the activities of the organisation. The principal budget factor may be production capacity, shortage of labour, materials, finance or, commonly, the level of demand for the goods or services. Because such a constraint will have a pervasive effect on all operational plans and budgets the limiting factor for the planning period must be identified so that the various budgets can be developed having regard to the expected limitation. The factor can and does change - when one constraint is removed some other limitation will occur otherwise there would be no limit to the organisation's activities. (Terry. L, 2003 Pg. 136)

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A vast amount of date is involved in the budgetary planning process and managing this volume of data in a manual system in an onerous and cumbersome task. A computerised budgetary planning system will have the advantages over a manual system, the advantages are that the computers can easily handle the volume of data involved; a computerised system can process the data more rapidly than a manual system and can more accurately than a manual system; computers can quickly and accurately access and manipulate the data in the system. Organisation may use specially designed budgeting software. Alternatively, a well designed spreadsheet model can take account of the entire budget interrelationships described above. (Janet.W 2007 Pg.307)

For many organisations the principal budget factor is sales volume so that the sales budget is the primary budget from which the majority of the other budgets are derived. Before the sales budget can be developed it is necessary to make a sales forecast. A forecast is a prediction or estimate of the events which are likely to occur in the future. The forecast becomes a budget only if management accepts it as the objective. Frequently, consideration of the forecasted sales leads management to make adjustment to their plans so that the agreed sales budget differs from the original sales forecast. (Terry. L, 2003 Pg. 141)

Sales forecasting is a complex and difficult task and involves consideration of numerous factors. Having a regard to the sales forecast and the productive capacity of the organisation the sales budget will be prepared which will be subdivided in several ways. When the sales budget has been drawn up and agreed it becomes the organisation's plan which the sales managers will try to turn into actual sales. (Terry. L, 2003 Pg. 142)


Budgets are the quantitative expression of these plans, stated in either physical or financial terms or both. When used for planning, a budget is a method for translating the goals and strategies of an organisation into operational terms. A budgeting system needs to be communicated clearly to all of the entity's stakeholders. This is particular important in the case of the entity's employees, because they will be required to participate in the budget, and their working conditions will be affected by it. Budgets can also be used in control. Control is the process of setting standards, receiving feedback on actual performance, and taking corrective action whenever actual performance deviates significantly from planned performance. Thus, the budget can be used to compare actual outcomes with planned outcomes, and they can steer operation back on course, if necessary. (Hansen, Mowen and Guan, 2009)

Advantages of Budgeting


Budgeting as a tool for planning allows organizations to prepare for the future and arrange necessary resources. Strategic plans are usually decided on through another technique, trying to match a vision with the capabilities on the long term decision process (Drury, 2001). However, the budget allows a detailed plan for the resources and therefore improves its allocation (Colman, 2005).

Framework of Control

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Colman (2005) suggest that organizations should provide "a road map explaining where the company is, where it wants to go and how it will get there". Through this planning, it as well enables enterprises to establish a framework of control. Almost every industry has been using budgeting as a controlling instrument. As an example, Kimberly Collins of CMO (2005) finds that the transparency of the company's procedures facilitates a better understanding of costs and therefore helps marketer make appropriate decisions.

Coordination and Communication

Budgeting is as well an approach to solve one of the major challenges of a large company: coordination and communication. As Colman (2001) argues, budgeting aids coordination and facilitates control. The various department of an organisation aim for different goals, some of these goals may be antithetical. For examples goals the purchasing manager and the production mangers aim for. On the one hand, the purchasing manager wants to keep stocks low because of the costs. Budgeting compels the managers to communicate and find the best solution (cf. Drury, 2001 p.284).


The motivation of managers as well as employees is crucial for the economic success of an enterprise. Setting targets that are achievable is a major factor in motivating people into putting effort into their actions. Having a road map simplifies the everyday business in a more and more complex economy. And giving people a challenge makes them feel more confident. Confidence is an important step in Maslow's hierarchy of needs.

The budgeting process involves many employees, even in the lower levels, in the planning and the employees. Involvement usually causes identification and association with the employer.

Weaknesses of Budgeting

As already mentioned, budgeting does not only have admirers. Even high ranking CEO's complain about the system. Jack Welch, CEO of General Electric, said that "budget's care the bane of corporate America. It never should have existed." The disapproval for budgeting comes from various reasons. Evidence suggests that there are several disadvantages regarding the budgeting processes applied in business structures.

Out of Date

One of the biggest criticisms of budgeting is that it is not realistic. Bourne (2004) argues that budgets are based on unsupported assumptions. These assumptions can only try to approach the nearest logical development. However, in a fast-paced globalised economy with continuous change in business environment, these assumptions that underpin the budget are already outdated by the time budgets are finalised, as Barret (2005) comments.

According to the third annual Reforecasting Report by ALG Software, the annual budgets of 95 per cent of respondents went off track in 2004 (cf. Barret, 2005). And, as Barret (2005) adds, certainty and reliability are crucial for investment decisions.

Flexibility/ Adaptability

Managing a company with a budgeting system implies strict procedures. An objective of budgeting is to control every move of the company, especially the monetary ones. This does not seem to be a problem if you want to maintain as you are. Despite this fact, Colman (2005) argues that when a company does have to change, to adapt to new situations, traditional budgets can impede the acclimatizing process.

Strategic Gap

Most strategic managers complain about their low influence on the budgeting. Budgets usually originate in financial departments, whereas it is the strategic departments that focus on creating competitive advantage. Babbini (1999) claims that budgets created solely in financial departments fail to generate shareholder value. As BBRT (2005) argues, only internal budget targets matter in the budgeting case.

Incremental Budgeting

Incremental budgeting is a simplistic model that assumes the prior year's expenditures are an adequate base for creating the next budget. Incremental budgeting takes its name from the assumption that each budget line should receive the same increment (usually as a percent) increase or decrease during the next budget cycle. Incremental budgeting seeks to reduce risk and to minimize error; thus it rejects extreme alternatives and untried methods.

Incremental budgeting is a budgeting system that takes the current budgeted allowances for existing activities as the starting point for preparing the next annual budget. This type of approach is therefore mainly concerned with the 'increment' in operations or expenditure which will occur during the budget period because the base is just simply adjusted for changes which are expected to occur during the new budget period. (Iraj.A, Brigid.S, Tania.A, 1998)

Zero-based Budgeting

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The zero-based budgeting process was popularised during the late 1970s when President Jimmy Carter promised to use this approach to budget government spending. Basically, zero-based budgeting is comparable to starting the budgeting process from scratch every year. Hence, this method will require more intensive planning and time. All revenue and expenses are scrutinized more closely in order to create a more accurate budget. The main benefit of zero-based budgeting is that each person involved in the process will integrate all known and expected costs without bias from previous information or data. It also forces employees to work more closely together during the budget process because they must know how each function affects the other functions of the organisation. Also, new ideas and business opportunities may be discovered, as they will given the same weight as last year's ideas. (Nils H.R, 2003)