20.10 Interest coverage

= Operating profit Interest expense = R500 000 R120 000 = 4,17 times

5.3.2 The debt to assets ratio indicates that 40% of Mestle Wholesalers assets come from borrowed funds.

The debt to equity ratio indicates that the creditors supply Mestle Wholesalers with 66,67 cents for every Rand supplied by the owners.

Mestle Wholesalers earned its interest obligations 4,17 times over in 20.10; or one could say that profit before interest and tax was 4,17 times as large as interest.

TOPIC 7

BUDGETS

LEARNING OUTCOMES Students should be able to:

distinguish between the concepts budgets and budgetary control.

explain the purposes of budgeting.

discuss the advantages of budgets and budgetary control.

prepare a sales budget, purchases or production budget, cost of sales budget, expenses budget, budgeted income statement, cash budget and budgeted balance sheet.

CONTENTS

1. Introduction

2. Concepts of budgets and budgetary control 3. Purposes of budgeting

4. Advantages of budgets and budgetary control 5. Preparation of budgets

6. Self-assessment activities

READING Recommended reading

► Correia, C., Langfield-Smith, K., Thorne, H. and Wilton, R.W. (2008) Management Accounting: Information for managing and creating value. 1st Edition. Berkshire: McGraw-Hill Education. pp. 416-432

► Marshall, D.H., Mcmanus W.W. and Viele D.F. (2007) Accounting: What the numbers mean. 7th Edition. New York: McGraw-Hill. Pp.533-546

► Meredith, G. and Williams, B. (2005) Managing finance: Essential Skills for Managers. 1st Edition. North Ryde: McDraw-Hill. pp.194-206

► _{Niemand, A.A., Meyer, L., Botes, V.L. and van Vuuren, S.J. (2004) Fundamentals of} Cost and Management Accounting. 5th Edition. Durban: LexisNexis Butterworths. pp. 528-549

1. INTRODUCTION

Planning is an integral element of management. It involves creating a path for

achieving the enterprise’s goals and objectives. Proper planning and effective control of costs are important if an enterprise wishes to maximize profit. Budgets and

budgetary control are important management tools that assist management in planning and cost control.

2. CONCEPTS OF BUDGETS AND BUDGETARY CONTROL

Niemand et al. (2004:528) make a distinction between the concepts of budgets and budgetary control.

2.1 Budgets

A budget may be described as a plan expressed in financial terms. It is the path that must be followed from the present time to the future. A budget must reveal the plans to achieve the objective of the enterprise for a given period.

2.2 Budgetary control

As indicated above a budget is the path that an enterprise must follow to achieve its objective. Budgetary control, on the other hand, includes measures put into place to monitor any deviations from the path and to ensure that the objective is realised within the budgeted period. This can be achieved by regularly comparing actual results with the budgeted targets. Budgetary control must ensure that deviations from the plan are analysed and if necessary remedial measures are put in place to remedy or prevent problems that may occur.

3. PURPOSES OF BUDGETING

According to Correia (2008:416) the budgeting process can serve five primary purposes:

■ _{Planning: The most important purpose of a budget is to put a plan of action into} quantifiable terms. The budgeting process makes it mandatory for individuals within an enterprise to plan.

■ _{Facilitating communication and co-ordination: There must be good communication} and coordination between all managers for a business to plan operations effectively.

The budgeting process provides a formal mechanism to enable this to occur.

■ _{Allocating resources: Usually the resources of an enterprise are limited and budgets} provide one way of allocating resources among competing uses.

■ _{Controlling profit and operations: Budgets serve as benchmarks against which} actual financial results at all levels of the enterprise may be compared to.

■ _{Evaluating performance and providing incentives: The comparison of actual results} with budgeted amounts also assists managers to evaluate the performance of

individuals, departments, divisions, or the entire enterprise. As budgets are used to evaluate performance, they may also be used to provide incentives for individuals to perform well.

4. ADVANTAGES OF BUDGETS AND BUDGETARY CONTROL

■ _{They act as means to achieving the objectives of the enterprise.} ■ _{Manufacturing costs can be carefully planned and controlled.} ■ _{Budgetary control facilitates the delegation of authority.}

■ _{Budgets can motivate managers and employees to better performance.} ■ _{Budgets can provide a basis for a system of control of employees.}

■ _{Budgets promote forward thinking and the identification of possible problems.}

THINK POINT 1!

Whilst budgeting is an invaluable tool in financial planning, what do you think are some possible disadvantages of budgets?

5. PREPARATION OF BUDGETS

The main budget called the master budget is developed from the operating budget and the financial budget. The operating budget consists of the sales budget,

purchases or production budget, cost of sales or cost of production budget, operating expense budget, and budgeted income statement. The financial budget consists of the cash budget and budgeted balance sheet.

Figure 7-1

Sales Budget

Purchases or Production Budget

Cost of Sales or Cost of Production Budget Operating Expense Budget Budgeted Income Statement Cash Budget

Budgeted Balance Sheet

Meredith and Williams (2005:201) outline the following steps in the budget process: