Budgeting for Business Financial Planning

Budgeting is commonly used by several business as the tool of future financial planning. The main areas of business for which the budgets are prepared includes the production, labour, trade receivables, and cash and trade receivables in order to offer a detailed future plans for a period of next twelve months (Kaplan and Atkinson 2015). Business are required to plan for the future. Planning is formal in larger companies while for the smaller business planning tends to be less formal. As a general rule, planning for the different time scales requires adopting different approaches. For medium and long term a company would enact wider business objectives while for smaller companies the business objectives are usually discussed by the managers and owners.

Budgets acts as the medium of co-ordinating the entire business functions as a whole. While forming budgets, several aspects namely, purchase of raw materials, sales possibilities, production capacity and labour are balanced and co-ordinated in order to assure that all the activities proceed in agreement with business purposes (Warren and Jones 2018). Co-ordination forms the essential part in the process of planning. The interrelation among the functional budgets is essential as without co-ordination one budget cannot be completed without the reference to numerous other functions.

The report would be assessing the master budgets elements. The report would further address a comparative assessment of top down and bottom up approach in the budgeting procedure. On making the comparative assessments of the top down and the bottom down method the study would further focus on the applicability of the either one methods in the Abilene Oil and Gas Ltd being the selected company for this study.

The entire functional segment in an organization is engaged in the preparation of budgets for a specific division. The master budget forms the sum of all divisional budgets which is prepared by the divisions (Morden 2016). The master budget also consists of the financial planning, cash flow forecast and the budget profit and loss statement and statement of financial position in an organization. The master budget is prepared by the organizations to attain a certain level during a particular period of time. Usually master budget is prepared for one year.

Master budget may be misunderstood as the one big budget for an organization but it is not the case in actual. Rather, master budget represents the summary of the divisional budgets. Master budget is a continuous financial planning. The master budget is normally presented either in the monthly or quarterly format and generally takes into the account an organizations full financial year (Smith 2017). The master budget may also accompany the explanatory tool that would serve as the explanation for the organizations strategic directions and how the master budget would help in meeting particular organizational goals along with management actions required to meet the budget.

Assessing Master Budget Elements

According to Otley (2016) master budget the acts as the tool of central planning which is used by the management team for directing and co-ordinating the activities of the organization and to judge whether the responsibilities centres are functioning effectively. As stated by Lymer (2015) it is necessary for the senior management team to review the number of iterations relating to master budget and introduce modification until a situation is reached where the budget allocates the necessary funds to attain the obvious objectives.

The master budget is held as the most vital tool for planning in an organization. At the time of planning the management at top level discusses the profitability, assets and liability position of the company. Preparation of master budget requires due co-ordination of several budgets which covers the entire parts of a business and makes the master budget appear more accurate.

The master budget elements are given below;

1. Sales budget
2. Direct labour budget

• Manufacturing overhead budgets

1. Production budgets
2. Capital acquisition budgets
3. Cash budgets

• Budgeted financial statements

The sales budget is regarded as the foundation of the master budget. All the requirements relating to staff, administrative costs and purchase are based on sales. Under this budget the first step is to determine the number of units to be sold and price per is obtained. Based on this the sales value is computed (Huikku, Hyvönen and Järvinen 2017). Preparation of the sales budget is based on the certain factors such as estimation of market demand, capacity of production or facility for infrastructure, present supply facility and analysis of industry. The market demand the production capacity is ascertain through the marketing and production division.

The direct labour budget is useful in computing number of labour hours that would be required to manufacture the itemized units in the production budget. A highly complex direct labour budget would not only compute the total number of hours required but would also provide information by breaking the category of labour required (Giuriato, Cepparulo and Barberi 2016). The direct labour budget is helpful in determining the number of employees that would be required to staff the area of manufacturing all through the period of budgeting. This would enable the management to expect the need of hiring along with the schedule of overtime and when it is most likely to layoff. The direct labor budget helps in giving useful information regarding the aggregate level and it is not characteristically used for specific purpose of hiring and requirements relating to layoff.

The manufacturing overhead comprises of information relating to all the cost of manufacturing apart from the cost of direct materials and direct labor. The information provided in the manufacturing overhead budget forms the part of cost of sales line of items in the master budget (Koochakpour and Tarokh 2017). Furthermore, the total costs of all the overhead budget is transformed into per unit overhead distribution that is put into use to obtain the cost of closing finished goods inventory and the same is later incorporated into the budgeted balance sheet. The information that is provided in this budget forms the most vital element for all the departmental budgeting models since it comprises of bigger part of total amount of the organization expenses.

Comparative Assessment of Top-Down and Bottom-Up Approaches

The production budget is helpful in computing the total number of units of a certain product needs to be produced and it is obtained from the combination of sales forecast and planned sum of finished goods inventory to have in hand. The main reason for preparing the production budget is to boost the system of manufacturing as used in the requirements of material planning (Lowe and Tinker 2015). Presentation of production budget is generally done either in the monthly or quarterly format. It may be difficult in creating a comprehensive production budget which incorporates the forecast for each variation in the product that an organization sells. Therefore, it becomes necessary to aggregate the projection data into wider categories of products that are having identical characteristics.

The property, plant and equipment need monthly maintenance and periodical replacement as well. If the targeted amount of sales is higher than the previous period then new there is a need for introducing the new plants and machineries. As a result, careful planning of the capital asset should be done. The capital acquisition budget usually consists of two notional categories (Abor 2017). Namely, the fund  is set apart for meeting the committed business liabilities based on the signing of contracts for earlier years and funds that would be needed to make payment in relation to the new acquisition based on which the contracts are signed during the present year. In most of the situations the delivery period for capital assets usually ranges for over number of years. However, only advance payment which is made throughout the year is associated to pre-defined milestone and stages.

For each of the divisional budgets every organization would require cash. The cash budget assures an organization that all through the financial year a business does not runs out of cash because of inappropriate planning in the preparation of the budget. Based on the production and sales budget, it is ascertained what would be the anticipated cash receipts and the amounts that are anticipated to be paid (Miller-Nobles, Mattison and Matsumura 2016). The receipts and payments of the customer cycle as well as supplier cycle should be determined. While preparing the cash budget the organization makes the decision whether it would require any additional external borrowing or not. At this stage all the administrative expenditure are to be taken into account while preparing the cash budget.

The budgeted financial statements includes the full set of financial reports namely;

1. The income statements
2. Statement of financial position
3. Statement of cash flow  
4. Statement of retained earnings

Applicability of Budgeting Methods to Abilene Oil and Gas Ltd.

The budgeted financial statement is derived from the annual model of business budgeting. They budgeted financial statement is treated as the useful projection of the financial results, financial position and cash flow statement of an organization for several future dates (Lawson et al. 2015). This budget helps in creating new model of budgets where the management can understand the effect of adjusting the model of budgeting in financial reports. The administration team of an organization at the time of preparing the budgeting model brings forward the financial statements which is in accordance with the financial anticipation and what an organization is ultimately capable of doing.

Under the top down method of budgeting, the budgets are created at executive management level and then it passes down to numerous departments. Most often, this budget is not based on any facts or projections but how an organization can afford every operational function (Weygandt, Kimmel and Kieso 2015). The most commonly used method of top down budgeting is the affordable method, percentage sales method, allocation method, return on investment and competitive parity method.

The decision makers are viewed as the main role players as they are responsible in formulating a well-organized order that helps in suiting to the types of current problems (Nazarova et al. 2016). In order to increase the degree of effectiveness the theorists of top down approach have demanded for clear and consistent statement of policy goals as the means of reducing the number of engaged actors with the objective of finding policy makers so that they can guarantee the applications of new statute.  

The top down budgeting approach may face the criticism due to its only emphasis on the formed statute. It disappears the process of discussion that has happened prior to the agreement on one solution and treats the process of implementation as if there are no alternative opinion or not political feature relating to problems solutions that may result in bitterness amid the implementers that have favoured alternative solution (Horngren and Harrison 2015). The top down approach evidently favours the decision makers since they as are the key role players and hardly pays any attention towards the administrative staff that performs the legal act.

The bottom up approach on the other hand is viewed as the build-up approach. At the time of advertisement and promotions, this approach helps in taking into the account the overall objectives of the companies that are necessary in meeting the desired objectives. There are numerous methods related with this approach of budgeting. The most commonly used method of bottom up approach is the objective and task method (Arora 2016). The bottom up approach assigns exactly where the top down budgeting represents its biggest failures by identifying the work of actual implementers. Based on this point of view at the macro-implementation levels the centrally located actors implements government programs that react at the macro level plans, develops and implements their own programs.

In contrary to the top down theorist, the bottom up approach theorists have acknowledged the fact that the implementers at the micro-level think regarding their work and create their own opinion regarding the task they receive and change the given programs so that they can enhance them and adopt them better to the real circumstances (Obi 2015). The theory bottom up theory not only identify this behaviour but also state that the even positive development of the entire project as worker who is associated with the real state of affairs can judge better than the policy makers who  hardly have the identical information as the project worker has.

The top down budgeting approach is more appropriate for the Abilene Oil and Gas Ltd. The main arguments that favours the application of this budgeting approach is that it would help in introducing the financial sustainability considerations towards the forefront of the budgeting procedure (Milojevi?, Andži? and Vladisavljevi? 2018). The application of top down budgeting approach in Abilene Oil and Gas Ltd would help in promoting more informed decision regarding the aggregate expense level for an estimated revenue. Rather than making huge amount of expenses, Abilene Oil and Gas Ltd can aggregate the total expenses that would help in automating the consideration associated to the budget size. Following the automation, Abilene Oil and Gas Ltd can distribute the aggregate expenses among the important segments.

Implementing the top down budgeting would help the Abilene Oil and Gas Ltd in projecting its sales towards wide ranging segments of its products by moving out of narrow categories to much wider line of items (Abilene.com.au 2019). The application of top down method would enable the company in addressing the business factors namely the channel of sales, geographical sales regions, customer categories and even the specific customers which may considerably back the profitability of the company.

The top down approach is very much suitable for the Abilene Oil and Gas Ltd as it would help in forecasting the wider aggregate of GDP and make use of historical data to gain a better understanding of the consumption expenditure (Jaafar, Bakar and Awaludin 2016). Abilene Oil and Gas Ltd can consider the application of top down approach as the means of macroeconomic pointers to project the volume of sales and profitability. The adoption of top down budgeting approach would be more helpful for the Abilene Oil and Gas Ltd as it would help in streamlining the role of finance department to centrally emphasise on monitoring of aggregate expenses.

For Abilene Oil and Gas Ltd it is necessary to formally set a limit on the total expenses at the very early stage of budget preparation. The application of the top down approach would help in establishing limits by binding on the medium term aggregate expense ceilings (Vanderbeck and Mitchell 2015). Even though not obtained directly from the concept of top down approach, a medium term approach towards fiscal policy formulation and budgeting would be important for Abilene Oil and Gas Ltd in assuring the aggregate level of expense limit serve the intended purpose of the company.

The above stated forecasted income statement reflects that the revenue for the Abilene Oil and Gas Ltd is anticipated to rise by 10 per cent while the cost of goods sold is expected to rise by further 8% resulting to a rise in the gross profit by $325,254. With the rise in the expenditure by 2% the company is anticipated to make a loss of $1,356,901 from the actual loss of $1.330.295 (Abilene.com.au 2019). As the company is operating oil and gas industry the recent price slump has resulted in negative profit for the company.

The earnings of the Abilene Oil and Gas Ltd does not reflects the true value of the company however the price earnings ratio for the company represents a useful measure. The company has delivered lower growth in comparison to its peers that are operating in the oil and gas industry but the market appears to be pessimistic on the stock, resulting in probable under valuation (InvestSMART 2019). Abilene Oil and Gas Ltd is the small cap company that is operating in the oil and gas industry that has persevered with the help of increasing oil price slump since the year 2014. The analyst of the energy sector have also made the analysis that entire industry may experience a negative growth in the upcoming year.

To complement the strategic risks of Abilene Oil and Gas Ltd the analysis also provides the budgeted income statement which vividly provides that Abilene Oil and Gas Ltd lags the pack with its sustained negative earnings over the last couple of years. The comparative income statements provides that the outlook for the company appears more uncertain due to the lack of analyst coverage that does not appears to boost the confidence in the price earnings of the company. The lack of growth and transparency of Abilene Oil and Gas Ltd may enable the company to trade cheaper than its peers.

Conclusion: 

On arriving at the conclusion, the analysis evidently provides suggestion that Abilene Oil and Gas Ltd can undertake the top down budgeting approach as this would help the company in streamlining its expenses to overcome its growth lags. The adoption of top down approach would help the company in forming a single line of authority that would facilitate the preparation of budgets for the managements provided that the sectorial revenue are in process with the budgeting requirements. The top down budgeting approach must be adopted by the Abilene Oil and Gas Ltd as this would the company in stabilizing the expenditure and eliminate the risks that is faced by the business for its strategic planning.

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