Question

Maleficent Company Limited is preparing budget based on the information below.

1. Budget sales revenues:

	January	February	March
	$	$	$
Credit sales	550,000	450,000	650,000
Cash sales	65,000	55,000	55,000
Total sales	615,000	505,000	705,000

2. Past experience indicates that customers usually settle their balances as follows:

   • - 60% of a month's credit sales are collected in the month of sale; and

   • - the remaining 40% of a month's credit sales are collected in the following month.

3. All purchases are made on credit, 50% are paid in the month of purchase and 50% will be settled in the month following purchase. Budgeted inventory purchases are:

January $ 550,000

February $460,000

March $575,000

4. Other budgeted cash disbursements:

   1. (i) Purchase of equipment in February for $45,000 in cash;

   2. (ii) Selling and administrative expenses of $28,000 per month; and

   3. (iii) Dividends of $35,000 to be paid in March.

5. The cash balance as at 1 February 2020 was $50,000. It is the company policy to maintain the minimum cash balance at $50,000 at the end of each month. Therefore, the company has a credit arrangement with its bank to borrow at the beginning of any month at 8% annual interest, if necessary. The principal amount together with interest will be repaid when it has enough cash.

Required:

1. (a) Prepare a cash budget for February and March.

2. (b) Budgeting is an important management tool if implemented properly. Identity positive results when budgets are properly used.

3. (c) The CEO of Maleficent Company Limited considers to implement Zero-based budgeting and requires managers of all divisions to examine every cost and budget item in order to create budgets based on perceived needs for the coming period, regardless of what was done in previous years.

   1. (i) How does Zero-based budgeting differ from traditional budgeting?

   2. (ii) What are the possible advantages and disadvantages of adopting Zero-based budgeting approach?

Answer 1

(b) Key Benefits of Budgets (importance of Budgets):

1. Budgeting forces the management to study about the problems relating to the timely implementation. It generates a sense of caution and care among the line managers.

2. It guides the management relating to the planning and formulation of policies.

3. Budgeting provides a means of controlling income and expenditure of a business. It gives a plan for spending.

4. It defines the objectives of an organization in numerical terms for a specific period.

5. Budgeting is used to evaluate the policies and goals of an organization. Moreover, such policies and goals are tested with the help of budgetary control.

6. It involves the management at all levels to participate in the goals setting.

7. Budgeting helps in directing both capital and revenue resources in a profitable way.

8. It helps the management to understand and co-ordinate various functional activities.

9. Budgeting empowers the management to decentralize obligations without losing business control.

10. Responsibility can be easily fixed with the help of budgeting.

ll. It discloses the weaknesses, inefficiencies and deviations in an organization promptly and provides a means to overcome them for the purpose of achieving goals.

12. It standardizes production, equipment and processes.

13. It creates an environment of profit mindedness throughout the organization.

14. An efficient and economy in production control is achieved through budgeting.

15. It provides a basis or yardstick that can be used to measure the performance of department and an individual in an organization.

16. It provides an accurate forecast of customer’s demand.

17. Budgeting encourages competitiveness among employees and provides incentive to those who perform efficiently.

18. It avoids sales of unprofitable and less profitable goods.

19. A systematic and disciplined approach is followed to solve the problems in an organization through budgetary control.

20. Finished goods can be timely delivered.

(c)How to Make a Zero-Based Budget

There are number of steps in building a zero-based budget. Here are some common ones:

• Forecast the organization's revenue or funding levels for the upcoming budgeting period.
• Determine the organization's goals for the coming budget period and beyond. For example, this might be to increase revenues a certain percentage for the company as a whole or for an operating unit in a larger organization.
• Once the top-line objective is determined, work backwards to determine what resources are needed to accomplish that goal. This might entail hiring more people, or perhaps realigning the company's personnel.
• Determine what these resources will cost and if spending this money will help achieve the top-line goal.
• Evaluate all expenses, whether or not they are within the spending parameters needed to achieve the organization's goal, to determine if they make sense.
• If all is good, move forward and implement the budget.
• Go through the same process for the next budgeting period.

A zero-based budget doesn't necessarily mean starting from scratch, that's usually not practical or desirable for an organization. This is more about cost management and aligning expenses with revenues.

(i) Zero-Based Budgeting vs. Traditional Budgeting: Key Differences

Traditional budgeting often assumes that expenses from year-to-year will increase by some percentage. Too often there is not an in-depth review of the expenditures to determine if they are still valid and necessary. Traditional budgeting typically only analyzes proposed new expenditures in depth, with the assumption that any expenditures or budget line items currently in place should remain and receive at least a token increase into the next budget period.

The concept behind zero-based budgeting is to have managers justify what they are spending and to minimize costs. It is not just assumed that because an expense item has been incurred in the past that this cost should occur into perpetuity. The goal of this type of budgeting is to ensure that costs drive value for the organization.

(ii) Advantages and Disadvantages of Zero-Based Budgeting

Like any business financial process, there are both advantages and disadvantages to zero-based budgeting.

Zero-based budgeting can offer a big advantage to business owners who do an annual detailed review of all expenses and to focus on the expenses that support their business goals for inclusion in the next period's budget. This helps senior management ferret out costs that seem to increase by a set amount during each budget cycle.

Zero-based budgeting is a great process to ensure that expenses are not included or increased just because they represent costs or methods of doing business the company has always used.

One disadvantage, while this process might result in lower costs for the organization, management might become too focused on only those areas that directly support top-line growth or offer a tangible payback for the money spent. This might make it more difficult for areas like customer service to get the budgets they need in order to keep the company's customers happy and coming back to purchase other items or services. While an area like customer service doesn't always have a direct correlation to revenues, poor customer service will surely be detrimental to the company's future growth.

Another potential drawback from zero-based budgeting is that it can promote short-term thinking within the organization. This approach often focuses on reducing costs for the next budgeting cycle, but if costs needed to move the business forward on a long-term basis are rejected this can prove detrimental to the company's long-term future.

Zero-based budgeting can also be very resource intensive. Organizations will want to be sure the potential benefits of this approach are worth the commitment in employee and management time.