There are two ways to create a budget: flexible and fixed budgeting. The fixed budget, which is more detailed and specifies how much money will be used in each department of an organization’s operations, can be described as a plan. When the company has an accurate forecast of future expenses, and has a good understanding of its current costs, this approach works best. As the time progresses, budget must not be altered.
Flexibility is better for adapting to changes in circumstances. This budget allows for some deviation from the plan and includes a safety margin to allow for change. This is a good option for organizations that don’t know what the future will cost or who expect that their expenses may change in time.
A retail store could be an example of a budget that includes safety margin and allows for budgeting for three periods consecutively. The store’s budget for the first period is $100,000 for inventory, $50,000 for rent and $25,000 for salaries. The store has a 10% safety cushion to allow for some flexibility. So inventory costs $110,000; rent $55,000; salaries $27,500. The store can adjust for unexpected expenses, such as increased inventory or salary increases that are not anticipated.
- A statement of cash flows proforma is a document that projects future cash inflows and outflows based on the organization’s budget. The statement of cash flows proforma helps organizations plan and predict their cash positions and makes decisions regarding investments, financing and cash management. The statement of cash flows shows the effect of budgeted transactions on the organization’s cash balance, and it helps the organization to identify potential cash shortfalls before they happen, so it can take action to remedy the situation.
This is an example statement of cash flow for a manufacturing business:
Operating activities generate cash flows:
- Net income: $300,000
- Depreciation: $50,000
- Account Increase: $25,000
- Account receivables decreased by $20,000
- Operating cash: $345,000
Cash flows are a result of investing activities
- Buy property, plants, and equipment at $120,000
- You can use $120,000 of cash to invest in your investments
From financing activities, cash flows: