Capital Budgeting

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Capital Budgeting

Category : Articles


In Every organization be it in manufacturing or service sector need a guideline or plan so that it will be used to achieve such organization??™s goal. A well organized plan that allocates resources, (income and expenditure) in an organization within a specified period of time and helps in co-coordinating activities e.g. cash budget.
According to the Chartered Institute of Management Accountants (CIMA) a budget is a plan expressed in money, prepared and approved prior to budget period which may show income, expenditure and capital. They also define budgetary as the establishment of budgets relating the responsibilities of executives to the requirements of policy and the continuous comparison of actual with budgeted results either to secure by individual action the objective of that policy or to provide basis for revision.
Budgetary control may be seen as the method of comparing actual company performance against the budget, the difference or variances from the actual performance and the budget will then be the main focus of the organization. The budgetary control has to do with decision making because any variance in the budget must be acted upon

* COMMUNICATION OF OBJECTIES: in any business or organization there must be some objectives contained in the organization??™s strategic plan, a change in policy should be brought to the notice of those of those accountable to the budget preparation by the top managers because such awareness by the budget committee will help in adjusting the budget. Changes in organizations policies may include expansion or withdrawal of certain activities etcetera.
* IDENTIFING OF COMPANY??™S LIMITING FACTORS: This criterion is sometimes regarded as the most crucial of all the criteria because every business entity must have its limiting factors that may delay progress in its activities. The most well known limiting factor in companies is sales volume because the level of certainty with regards to sales of all manufactured products is not known to the manufacturer, such limiting factor and other must be identified and addressed in the budgetary control system if it is to be effective.
* PREPARATION OF FUNCTIONAL BUDGET: Some examples of functional budgets are; production budget, sales budget, cash budget etc. any of the functional budget that serve as a limitation in a company such budget become the most Important in that year??™s budgetary process. These kinds of budget are departmental in nature they influence actions of the functional managers.
* COORDINATION OF INITIAL BUDGET: at this stage the higher management will require their subordinates (lower management) to prepare a budget and present to them, the budget preparer must always be there to defend the budget so as to ensure more accurate budget that will fit the organizations target. Such budgets are also prepared in accordance with the guidelines issued by the top management
* PREPARATION OF FINAL BUDGET: it is the function of the management accountant to prepare this budget. This is a comprehensive budget that encompasses information for subsidiary budget; it also contains forecasted statement of financial position (balance sheet), comprehensive statement of income (profit and loss account) and cash flow statement.
* FINAL ACCEPTANCE OF THE BUDGET: when all budget processes has been approved including the master. The budget will go through some channels that are responsible for the budget. It is now the responsibility of each departmental manager to see that they concerned budget is been followed according to plan
* IMPLEMENTATION OF BUDGET: Each budget centre or department at this stage is to organize the operational plan for activities under its care. E.g. labor allocation, machine scheduling and sales mix or what is known as operational plan.
* FEEDBACK AND REVIEW: This stage is meant to complete the budgeting process, an organization or business may not know its progress based on the budget without any review, that is why the actual activities for each budget centre should be evaluated with the forecasted or budgeted figures and a report should be made on the variance in other to make up for the variance.

RECEIPTS | | | | | | | | |
Cash received for sales | | 30000 | 30000 | 30000 | 30000 | | 40000 | 40000 |
Capital | | 125000 | ??” | ??” | ??” | | ??” | ??” |
Sales of vehicle | | ??” | ??” | ??” | 5000 | | ??” | ??” |
| | 155000 | 30000 | 30000 | 35000 | | 40000 | 40000 |
PAYMENTS | | | | | | | | |
Cash paid for purchases | | 25000 | 35000 | 30000 | 30000 | | 35000 | 35000 |
Salaries | | 12000 | 12000 | 12000 | 12000 | | 12000 | 12000 |
Rental | | 6000 | 6000 | 6000 | 6000 | | 6000 | 6000 |
Advertising | | ??” | 15000 | ??” | ??” | | 15000 | ??” |
Commissions (5%) | | 1500 | 1500 | 1500 | 1500 | | 2000 | 2000 |
Motor vehicle | | ??” | ??” | ??” | 40000 | | ??” | ??” |
| | 44500 | 69500 | 49500 | 89500 | | 70000 | 55000 |
Net Receipts/Payment | | 110500 | -39500 | -19500 | -54500 | | -30000 | -15000 |
Opening Balance | | -50000 | 60500 | 21000 | -1500 | | – 53000 | -83000 |
Closing Balance | | 60500 | 21000 | 1500 | -53000 | | -83000 | -98000 |
| | | | | | |

When surplus cash are available in the business it is more profitable to re-invest the surplus in other available portfolios that can yield extra money to the organization. For these investments to yield a good returns there are several factors to be considered such as;
* Risk: It is commomly known that ??? the higher ther risk the higher the returns???, when one wishes to take a high risk investment, consideration should be given to the value of the money when invested and value at the expected returns because there are other factors that will ensure the instability of investment. It is important to know the security and safety of your investments al least let the initail be gotten back. Oxford company has to also keep in mind that while investing the surplus cash there some kind of risk associated with it especially when it has to do with dealings in stocks.
* Market risk; this kind of risk is also known as systematic risk, it is unavoidable and affects the economy as a whole. Examples of market risk are interest rate, economic recession, inflation etc
* Specific risk; this kind of risk also known as unsystematic risk, it has to do with risk that is associated with a particular investment and it can be reduced by diversifying invesments. Accoding to Markowitz H (1952) shows that looking at the risk and benefits of particular investment is not enough but diversification of investments can be beneficiary to the investor.

From the above gragh it can be said that the expected return for a risk factor of 1 is 4.5%
And also the expected returns for risk factor of 1.7 is 6.5%. Risk Free Rate=2%
* Liquidity: Simply means how the funds invested can be changed in to cash without much difficulty. Cash which is used to solve unexpected emergencies must be invested where it can be gotten when needed, according to this factor it will be wrong for Oxford limited to put there money in investments that when the money is needed it will be difficult of impossible to convert such investments into cash. A good example of investments that can be done are in the marketable securities and short term investments.
* Maturity: The time investments take to materailize. Every investment has different time of maturity whether shorterm, medium term or long term however it is left for the business to choose the appropraite maturity period that they returns from they investments will be gotten back because the longer the maturity period the higher profit and shorter period will yield low profit.
* Returns: The rate of returns of an investment solely depends on the other factors like risk, liquidity and maturity. Once the prefered level of risk, maturity and liquidity have been decided, the rate of returns is left for the market to dictate.
Every investment should be carefully choosen based on the there risk and returns because every investments carries different level of return.

Credit control is an integral part of a business. With effective credit control system which ensures that all the debt are fully recovered and on time will create steady flow of cash within the organization throughout the financial year and also a bad debt recovery will drive the organization into financial loss. The following are steps that an organization can effectively use to ensure a good credit control system.
* Create a detailed credit control system: This procedure helps the organization to have full knowledge of their creditors by asking them to provide some basic information like;
a) Business Name
b) Registration Numbers (limited company)
c) The amount of credit needed
d) Bank and account details
e) Payment arrangements / Trade reference
This information??™s are important because at the time of default by the creditor the above information??™s can be used to trace and contact him.
* Credit Check Your Customers: It is important to know how credits worthy customers are before you can agree a credit transaction with them. This step ensures a thorough check of the creditors past borrowings and repayment. This can be done from their bank account details or by using a credit reference agency and also with other suppliers to have the assurance that your money will be back at the exact time stated. Failures to credit check your customers thoroughly may lead to bad debt.
* Conditions: Before an agreement is reached on rendering a service or goods on credit, it is important that oxford limited should ensure that all their terms are going to be adhered to and it has to be written because verbal agreement may not be effective especially in the court of law. In such cases the company may not be able to reclaim their debt because of lack of evidence. The following are conditions and terms that should be agreed upon:
a) Price of product or service
b) Delivery arrangements
c) Terms of payment: which should be agreed by both parties according to court standards
d) Collection of interest on late payments

* Sending invoice: when is comes to sending invoice to customers it is important that they invoice be delivered alongside the goods to avoid delay in payment, and they invoice should be well addressed and delivered to the concern customer. As a precautionary motive oxford limited should also remind their customer about invoices that are due in order to chase payment.
* Effective Credit Control supervisor: the appointment of a credit control supervisor should be on the basis of his/her credibility, who will keep all records of credit effectively, follow up debts and also keep record of all telephone calls and letters with regard to legal actions. The company can also hire a credit consultant from time to time to check whether there is room for improvements.
* Late Payment: oxford limited should always have a routine check on your creditors to know those that are late in paying their debts, and then circulate a list containing their names to workers so as to prevent them from granting them more debts and finally let the creditor know the consequences of paying late.

Before making any decision there are factors that oxford limited need to put into consideration based on the goals of the company. Some of the factor that may affect credit control decision making in oxford limited are as follow;
* Rivalry. In making decision concerning credit control system the company has to consider the level of competition within the industry. If oxford limited is having a very tight competitors there are tendencies that the company may have a mild credit control policies in order to attract customers.
* Terms within the industry. For oxford limited if their competitors within the industry offer more lenient and longer terms the must also do the same if they are to remain competitive within the industry
* Economic conditions. In periods of economic problems like economic crisis when the economy may be facing a number of problem and slow business transactions, the only way to enhance sales revenue is to implement a less stiff credit control policies.
* In period when the demand for a company??™s products or services is less the only way to attract new customers and to hold the existing customer may be to introduce less harsh credit control measures. Also in times when the company is experiencing loss and high bad debt, stiff credit control measures may be implemented to reduce bad debt and loss.
* Profit margin. If a company has a high profit margin it may be carried away by the profit thereby leading the company to taking higher credit risk but companies with less profit margin tend to take less credit risk.

Overdraft is a situation where a bank account holder (usually current account) is allowed by the bank to overdraw his/her account??™ this kind of finance serves as short-term source of finance to businesses. The bank usually charge interest on the extra money taken mostly based on the amount that was used. The following are the advantages and disadvantages that oxford limited will have by using overdraft.
* Flexibility: Overdraft is always available when needed and usually cost nothing apart from the interest being charged on it. It gives the business an opportunity to make vital payments while pursuing other business payments.
* Cash Flow: Overdraft has given the business a life line of ensuring that there is steady flow of cash throughout the financial year because overdrafts are easy to get so a business cannot suffer from lack of cash at any time.
* Fast: The availability of overdraft has given most business organization a backup plan to hold on to in times of financial crisis within the organization.

* Cost: Overdrafts come with interest considering the amount of money that is taken; most times overdrafts are higher in rates when compared to loans. The overdraft becomes expensive when the stated period of payment is overdue, which makes provision for extra charges.
* Re- collection: The bank sometimes re-collects the whole overdraft at any time. This usually happens when the business has failed in previous payments or terms and conditions where breached after the transaction, and in other cases the bank might decide to change it banking policies. This stands as a great threat to the business because there is no much guarantee.
* Security: Overdrafts are sometimes insured against business assets, which might endanger the business when payments become a problem at the end of the day.

As a conclusion, it is important for oxford limited to keep track of the progress of the budgeting system by comparing actual levels being achieved against the budgeted levels, thereby using the difference to make decisions that may affect the company??™s future. Weighing budgets success against actual levels of output can sometimes be destructive to businesses, thus long term goals are suppose to be done within the budget period.
It will be advisable to oxford limited to try using zero base budgeting system where it will be assumed that the existence of resources is absent and recognising only alternatives. I e the available resources has to be accountable based on the comparisons with the alternatives

Atrill, P. and Mclaney, E (1994) Management Accounting: an active learning approach. Google [online]. Available at: (Accessed: 10 March 2011)
Drury, C. (2008) Management and Cost Accounting 7th ed. Derby: Pat Bond
Markowitz H (1952) ??™Portfolio Selection??™ Journal of Finance
Thukaram, M. E (2003) new age Management Accounting google [online]. Available at (Accessed: 12 March 20111)Hhhhh uhgfdyr (Accessed: 10 March 20011)

Atrill, P. and Mclaney, E (1994) Management Accounting: an active learning approach. Google [online]. Available at: (Accessed: 10 March 2011)
Drury, C. (2008) Management and Cost Accounting 7th ed. Derby: Pat Bond
Markowitz H (1952) ??™Portfolio Selection??™ Journal of Finance
Thukaram, M. E (2003) new age Management Accounting google [online]. Available at (Accessed: 12 March 20111) (Accessed: 24 February 20011) (Accessed: 24 February 2011) (Accessed: 24 February 2011)
Hhhhh uhgfdyr (Accessed: 6 March 2011) (Accessed: 10 March 20011) (Accessed: 12 March 2011)