Question

Explain the main objectives of preparing budgets and critically evaluate the statement: “The sales budget is the foundation of all other budgets? (300 words)

Management Accounting

Answer 1

Objective of Preparing Budgets

1. Proper allocation of available resources
A budget helps the preparer to assess all the available resources for the upcoming period. When availability of resources is known, only then an efficient allocation can be made.

2. Cash flow management
A budget can play a very important role in helping the management manage the cash flows. Without cash flows a company's survival becomes difficult. A budget can help utilize excess cash or can help cope up with deficiency.

3. Performance evaluation
After a year is done and dusted, how can you evaluate the performance? It can easily be done by making comparisons with the budgets and see where improvements are needed.

Imagine different budgets - Production budget, Raw Material budget, Labor budget, Overhead budget, etc.
Now, to know the overhead budget, you need to know the Labor hours since most overhead is based on labor hours. To know the labor hours, you need to know the labor budget. To prepare the labor budget, you need to know the goods to be produced. Same is the case with Raw Materials budget. But, how do you determine the number of units to be produced? Only and only a sales budget can help.

So this implies that, in order to create other budgets, first and foremost, a revenue budget is to be prepared. A Revenue Budget lays the foundation to all other budgets. Only after preparing the revenue budgets, other budgets can be prepared becasue without knowing the quantity to be sold, no production budget can be thought of.