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. Fixed budgets are best when an organization is clear about its expenses and can accurately forecast future costs. As the time progresses, budget cannot be modified.
Flexible budgets are more flexible and can be adjusted to change. A flexible budget is one that permits some variation from the initial plan while still allowing for a certain amount of flexibility. When the company is uncertain about future expenses or anticipates changes in its costs over time, this approach works best.
Retail stores are an example of how budgeting can be done for three consecutive periods, with safety margin included to allow for flexibility. The store’s budget for the first period is $100,000 for inventory, $50,000 for rent and $25,000 for salaries. For flexibility reasons, the inventory budget is $110,000. Rent is $55,000, and wages are $27,000. This gives the store the flexibility to adapt to any unexpected costs such as extra inventory requirements or raises in salary during budgeting.
- A statement of cash flows proforma is a document that projects future cash inflows and outflows based on the organization’s budget. This document helps an organization plan for and forecast its cash situation and make financial and investment decisions. 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.
Here’s an example of a statement on cash flows of a manufacturing company:
Operating activities generate cash flows:
- Net income: $300,000
- Depreciation: $50,000
- Increase in Accounts Due: $25,000
- Account receivables decreased by $20,000
- Operating cash: $345,000
Cash flow from investments:
- Buy property, plants, and equipment at $120,000
- Spend $120,000 to invest in cash
The financing of activities generates cash flows.