FAC1502 · Financial Accounting · Study Unit 15
The Art of the Budget
Planning, Control & Variance Analysis
Contents
01
What is a Budget?
A budget is a formal, quantified plan expressed in monetary terms, covering a defined future period — typically one financial year, broken into monthly intervals. It translates strategy into numbers, setting targets for revenue, expenditure, production, and cash before the period begins.
Budgeting is not merely a forecasting exercise. Its real value lies in control: once the period ends, actual results are compared to the budget, variances are investigated, and management can correct course for the next period.
The Four Functions of a Budget
Planning — forces management to think systematically about the future and commit to quantified targets before they spend a cent.
Coordination — aligns the sales, production, and finance functions so that each department’s plans are consistent with the others.
Motivation — clearly defined targets give employees and managers something concrete to work towards.
Control — actual results are compared to budget, variances are identified and investigated, and corrective action is taken.
FAC1502 focuses on fixed budgets and their associated variance analysis. The flexible budget concept is introduced conceptually but the exam calculations centre on static budget comparisons.
02
The Master Budget
The master budget is the consolidated, comprehensive plan for the entire organisation, combining all departmental sub-budgets into a unified whole. It culminates in three financial statements: a budgeted income statement, a budgeted balance sheet, and a cash budget.
The individual sub-budgets feed into one another in a specific sequence — each one depends on the outputs of the one before it. This chain is called the budget cascade.
The limiting factor (also called the principal budget factor) determines where the cascade begins. In most businesses it is sales — but if a factory is at full capacity, production capacity becomes the limiting factor and the production budget must come first, constraining what sales can promise.
03
The Sales Budget
The sales budget is the foundation of the entire master budget. It states the expected units to be sold and the expected selling price per unit for each period, producing a total budgeted revenue figure.
Sales Budget Format
Sales budget = Units budgeted × Budgeted selling price per unit
It is typically broken down by product, region, and month. For FAC1502 purposes, a single product or small product mix over three months is standard.
Worked Illustration
Zara Manufacturing expects to sell 800 units in January, 1 000 in February, and 900 in March at R250 per unit.
| Item | January | February | March | Total |
|---|---|---|---|---|
| Budgeted units | 800 | 1 000 | 900 | 2 700 |
| Selling price per unit | R250 | R250 | R250 | — |
| Budgeted sales revenue | 200 000 | 250 000 | 225 000 | 675 000 |
In questions involving cash collections, the sales budget gives revenue on an accrual basis. The cash budget then requires you to apply a collection pattern (e.g. 60% collected in month of sale, 40% in the following month) to convert revenue into actual cash receipts. Keep these two clearly separate.
04
Production & Purchases Budget
Once sales volumes are known, the production (or purchases, for a trading entity) budget calculates how many units must be made or bought to satisfy both sales demand and desired closing stock levels.
Raw Materials Purchases Budget
For a manufacturing entity, after calculating units to produce, you then calculate raw material requirements:
Closing stock targets are typically expressed as a percentage of the next month’s sales or production. For example, “closing stock should equal 20% of next month’s sales” — so March’s closing stock is based on April’s budgeted sales. If April data is not given, the question will usually state the closing stock figure directly.
05
The Cash Budget
The cash budget is arguably the most important planning tool in the master budget. A business can be profitable yet face a cash crisis if collections are slow or payments bunch up. The cash budget forecasts actual cash inflows and outflows for each month, revealing when shortfalls might occur so management can arrange overdraft facilities or defer expenditure in advance.
Structure of the Cash Budget
Section A — Receipts: Cash collected from customers (applying the collection pattern to credit sales), cash sales, proceeds from asset disposals, loans received.
Section B — Payments: Cash paid to suppliers (applying payment terms), wages and salaries paid, overheads paid, capital expenditure, loan repayments, tax and dividends paid.
Section C — Net movement: Total receipts − Total payments = Net cash inflow or (outflow).
Section D — Closing balance: Opening balance + Net movement = Closing balance. A negative closing balance signals a funding requirement.
Debtors Collection Pattern
Most businesses sell on credit and collect cash with a lag. The question will state the collection pattern. Apply it carefully, month by month:
Example Collection Pattern
60% of sales collected in the month of sale; 35% in the following month; 5% estimated bad debts (never collected).
If January sales = R200 000 and February sales = R250 000, then February cash receipts from debtors = (250 000 × 60%) + (200 000 × 35%) = R150 000 + R70 000 = R220 000.
Creditors Payment Pattern
Similarly, purchases on credit create a payment lag. Apply the payment pattern to the purchases budget to determine cash paid each month:
Example Payment Pattern
50% of purchases paid in month of purchase; 50% paid in the following month.
If January purchases = R80 000 and February purchases = R95 000, then February cash payments to creditors = (95 000 × 50%) + (80 000 × 50%) = R47 500 + R40 000 = R87 500.
Depreciation, amortisation, and other non-cash charges never appear in the cash budget — they do not involve cash. If an overhead total includes depreciation, you must subtract it before including the amount in the cash budget. Always read the question notes carefully for this trap.
06
Budgeted Income Statement
The budgeted income statement assembles the outputs of the sales, production cost, and operating expense budgets to show the expected profitability for the period. It is prepared on an accrual basis — unlike the cash budget.
| Item | R | R |
|---|---|---|
| Sales revenue (from sales budget) | 675 000 | |
| Less: Cost of goods sold | ||
| Opening finished goods inventory | (×××) | |
| Production costs for period | (×××) | |
| Less: Closing finished goods inventory | ××× | |
| Gross profit | ××× | |
| Less: Operating expenses | ||
| Selling expenses | (×××) | |
| Administrative expenses | (×××) | |
| Depreciation | (×××) | |
| Budgeted net profit before tax | ××× |
The budgeted income statement and the cash budget will not show the same profit/cash figure. Profit is accrual-based; cash reflects timing of actual payments. Understanding this difference is a core FAC1502 competency — it loops back directly to Study Unit 14’s cash flow statement logic.
07
Variance Analysis
Once the period ends, actual results are compared to budgeted figures. The difference is a variance. Variance analysis is the control mechanism that makes budgeting worthwhile — without it, the budget is just a document that gathers dust.
Always Label Your Variances
A bare number means nothing. Always write F or A next to every variance figure. An examiner who sees “R12 000” without a label will mark it wrong, even if the number is correct.
Key Variance Calculations
Build your variance statement as a table with four columns: Actual | Budget | Variance | F or A. Calculate each line, then sum the variances at the bottom to reconcile actual net profit to budgeted net profit. The totals must cross-check — the sum of individual variances equals the total profit variance.
Possible Causes of Variances
- 01Sales volume variance — more or fewer units sold than planned. Driven by market conditions, competitor activity, or poor demand forecasting.
- 02Selling price variance — actual price differed from budget. Price reductions to meet competition cause adverse variances; price increases cause favourable ones.
- 03Material cost variance — input prices changed (price variance) or more/less material was used per unit than planned (usage/efficiency variance).
- 04Labour variance — wage rate differed from budget (rate variance) or more/fewer hours worked per unit than planned (efficiency variance).
- 05Overhead variance — fixed overhead overruns are common when activity is lower than planned (under-absorption); efficiency gains at high volumes create favourable variances.
08
Full Worked Example
Kalahari Traders sells a single product. Prepare (a) a three-month cash budget, and (b) a variance statement for March, using the data below.
Given Data
| Month | Budget Units | Actual Units | Selling Price |
|---|---|---|---|
| January | 1 000 | 950 | R200 |
| February | 1 200 | 1 300 | R200 |
| March | 1 100 | 1 050 | R200 |
Additional information:
- 60% of sales collected in month of sale; 40% in following month. No bad debts.
- Cost of goods sold: R120 per unit (variable). No opening/closing stock difference for cash purposes.
- Purchases paid: 50% in month of purchase, 50% next month.
- Fixed overheads: R30 000 per month (includes R5 000 depreciation — not a cash item).
- Opening bank balance 1 January: R15 000.
- Actual March costs: COGS R128 per unit; fixed overheads R33 000 (cash: R28 000).
Step 1 — Budgeted Sales Revenue
Step 2 — Budgeted Purchases (Cash COGS basis)
Step 3 — Cash Budget
| Item | January (R) | February (R) | March (R) |
|---|---|---|---|
| RECEIPTS | |||
| Collections — current month (60%) | 120 000 | 144 000 | 132 000 |
| Collections — prior month (40%) | — | 80 000 | 96 000 |
| Total receipts | 120 000 | 224 000 | 228 000 |
| PAYMENTS | |||
| Purchases — current month (50%) | 60 000 | 72 000 | 66 000 |
| Purchases — prior month (50%) | — | 60 000 | 72 000 |
| Fixed overheads (cash: R30k − R5k depn) | 25 000 | 25 000 | 25 000 |
| Total payments | 85 000 | 157 000 | 163 000 |
| NET POSITION | |||
| Net cash inflow / (outflow) | 35 000 | 67 000 | 65 000 |
| Opening balance | 15 000 | 50 000 | 117 000 |
| Closing balance | 50 000 | 117 000 | 182 000 |
January has no prior-month collections because we assume no outstanding debtors at 31 December. In a real exam, if an opening debtors balance is given, that amount becomes January’s “prior month” receipt. Always check for this.
Step 4 — March Variance Statement
| Item | Budget (R) | Actual (R) | Variance (R) | F / A |
|---|---|---|---|---|
| INCOME | ||||
| Sales revenue | 220 000 | 210 000 | 10 000 | A |
| COSTS | ||||
| Cost of goods sold | 132 000 | 134 400 | 2 400 | A |
| Gross profit | 88 000 | 75 600 | 12 400 | A |
| Fixed overheads | 30 000 | 33 000 | 3 000 | A |
| Net profit | 58 000 | 42 600 | 15 400 | A |
Actual sales: 1 050 × R200 = R210 000 | Actual COGS: 1 050 × R128 = R134 400 | Total adverse variance on net profit: R15 400 (A) — driven by lower volumes (R10 000 A), higher unit cost (R2 400 A), and overhead overrun (R3 000 A).
09
Practice Exercises
Naledi Industries budgets the following sales for the first quarter: April 2 000 units, May 2 500 units, June 2 200 units. Closing finished goods stock should equal 15% of the following month’s sales. Opening stock on 1 April is 250 units. June’s closing stock target should be based on July’s estimated sales of 2 400 units.
Prepare the production budget in units for April, May, and June.
Closing stock targets:
April closing = 15% × 2 500 = 375 | May closing = 15% × 2 200 = 330 | June closing = 15% × 2 400 = 360
| Item | April | May | June |
|---|---|---|---|
| Budgeted sales (units) | 2 000 | 2 500 | 2 200 |
| Add: Desired closing stock | 375 | 330 | 360 |
| Total required | 2 375 | 2 830 | 2 560 |
| Less: Opening stock | (250) | (375) | (330) |
| Units to produce | 2 125 | 2 455 | 2 230 |
Note: Each month’s closing stock becomes the next month’s opening stock.
Msimbi Trading has the following budgeted credit sales: February R180 000, March R210 000, April R195 000. The collection pattern is: 70% in month of sale, 25% in following month, 5% bad debts. There are no opening debtors.
Calculate the cash collected from debtors in March and April.
| Source | March Collections | April Collections |
|---|---|---|
| Current month sales (70%) | 147 000 | 136 500 |
| Prior month sales (25%) | 45 000 | 52 500 |
| Total cash collected | 192 000 | 189 000 |
March: (R210 000 × 70%) + (R180 000 × 25%) = R147 000 + R45 000 = R192 000
April: (R195 000 × 70%) + (R210 000 × 25%) = R136 500 + R52 500 = R189 000
The 5% bad debts are simply never collected — they do not appear anywhere in the cash budget.
The following results were recorded for June:
| Item | Budget (R) | Actual (R) |
|---|---|---|
| Sales revenue | 320 000 | 340 000 |
| Cost of sales | 190 000 | 205 000 |
| Salaries | 45 000 | 45 000 |
| Rent | 18 000 | 18 000 |
| Other overheads | 22 000 | 19 500 |
Prepare a variance statement for June, labelling each variance as Favourable (F) or Adverse (A). Reconcile budgeted net profit to actual net profit.
| Item | Budget (R) | Actual (R) | Variance (R) | F / A |
|---|---|---|---|---|
| Sales revenue | 320 000 | 340 000 | 20 000 | F |
| Cost of sales | 190 000 | 205 000 | 15 000 | A |
| Gross profit | 130 000 | 135 000 | 5 000 | F |
| Salaries | 45 000 | 45 000 | — | — |
| Rent | 18 000 | 18 000 | — | — |
| Other overheads | 22 000 | 19 500 | 2 500 | F |
| Net profit | 45 000 | 52 500 | 7 500 | F |
Reconciliation:
Budgeted net profit R45 000
Add: Favourable sales variance R20 000 (F)
Less: Adverse COGS variance (R15 000) (A)
Add: Favourable overheads R2 500 (F)
──────
Actual net profit R52 500 ✓
Study Unit 15 — Key Takeaways
1. The budget cascade flows from Sales → Production → Materials/Labour/Overhead → Budgeted IS, Cash Budget, Budgeted BS. Each step feeds the next.
2. Production budget formula: Sales + Closing stock − Opening stock = Units to produce.
3. The cash budget uses actual cash timing — apply collection and payment patterns to convert accrual revenue and purchases into cash flows. Exclude depreciation.
4. The budgeted income statement is accrual-based; the cash budget is cash-based. They will show different figures — this is expected and correct.
5. Variance = Actual − Budget for income; Budget − Actual for costs. Always label Favourable (F) or Adverse (A).
6. A reconciliation of budgeted profit to actual profit using variances is a high-mark exam question — practise it until it is automatic.