Esg Budget Management Final Version

COURSE TITLE: BUDGET MANAGEMENT
ACCOUNTING CONTROL AND AUDITING

LEVEL 3
SEMESTER 1
COURSE CONTENT:
CHAPTER 1 – GENERALITIES ON BUDGETS
CHAPTER 2 - TYPES OF BUDGETS
2.1- SALES BUDGET
2.2 – PRODUCTION BUDGET
2.3-SUPPLY BUDGET
2.4- CASH BUDGET
2.5- INVESTMENT BUDGET
2.6- BUDGET RATIO
OBJECTIVE OF THE COURSE:

▪ Explain why management control is a process
▪ Show that management control is a subject and a management action consisting in a
cycle of operation aiming an accurate result: assessment of enterprise performance.
▪ Budget elaborations
Dr. Forbeneh Jude (Ph.d in Finance) Page 1

CHAPTER 1 – GENERALITIES ON BUDGET
1.1 – MEANING AND DEFINITION OF BUDGET: A budget is defined as the formal
expression of plans, goals, and objectives of management that covers all aspects of operations
for a designated time period. The budget is a tool providing targets and direction. Budgets
provide control over the immediate environment, help to master the financial aspects of the job
and department, and solve problems before they occur. Budgeting, when used effectively, is a
technique resulting in systematic, productive management. Budgeting facilitates control and
communication and also provides motivation to employees.
1.2 - CHARACTERISTICS OF BUDGET
The main characteristics of budget are as follows:
1. A budget is concerned for a definite future period.
2. A budget is a written document.
3. A budget is a detailed plan of all the economic activities of a business.
4. All the departments of a business unit co-operate for the preparation of a budget.
5. Budget is a mean to achieve business and it is not an end in itself.
6. Budget needs to be updated, corrected and controlled every time when circumstances change.
Therefore, it is a continuous process.
7. Budget helps in planning, coordination and control.
8. Different types of budgets are prepared by industries according to business requirements.
9. A budget acts a business barometer.
10. Budget is usually prepared in the light of past experiences.
11. Budget is a constant endeavour of the Management.
1.3- DEFINITION OF KEY CONCEPTS
1.3.1- Budget Manual: A budget manual sets instructions governing the responsibilities of
persons and the procedures, forms and records relating to the preparation and use of budgets. It
is a booklet containing instructions for procedures and time schedules. The main idea behind
the manual is to present complete picture of budget exercise and avoid issue of instructions on
day to day basis. This allows managers to work independently and be ready to act on variations
from budgets.
1.3.2- Budget Controller: The Budget Controller is appointed to coordinate activities of the
Budget Committee. Her duties include –
• Preparation of various budgets and their consolidation into a single master budget.
• Compiling data on actual performance versus budgets, ascertaining causes of deviations
and reporting to executives.
• Reporting such cases to management where revision to budgets necessary.
• Preparation of various documents for successful operation of the budgets.
Budget Controller does not control, but advises executives on their performance against
budgets.
1.3.3- Budget committee: The group of managers that discusses a mutually agreed program to
meet their targets under budgetary control is termed Budget Committee. Its duties and
responsibilities are described in the Budget manual; which include
• Receive, review estimates from members and make recommendations.
• When there is a conflict between departments review & recommend decisions.
• Recommend changes and approval of revisions to budgets.
• Receive, study and analyze periodic reports and budget variations.
1.3.4- Budget period: The budget period is the period for which a budget is prepared and used
which may be sub divided into control periods.
1.3.5- Budget key factor: ‘is factor which will limit the activities of the undertaking and which
is taken into account in preparing budgets.’ It usually is the demand for product or service.
Managers identify the key factor and take a decision to get over the limiting factor to continue
growth of the firm. If that is not possible, the framework of budgets has to be within the limits
of the key factor.
1.3.6- Budget reports: Performance evaluation and reporting of variance is an integral part of
all control systems. Reports need to be followed up until action is taken to avoid further
variances or to revise budget if deficiency is noticed.
1.3.7- The Budget officer: He controls the budget administration on a day to day basis. He will
be responsible to the budget committee and should ensure that its decisions are transmitted to
the appropriate people and relevant data and opinions are presented for its consideration.
1.3.8- Level of activity: It will be necessary to establish the normal level of activity, that is, the
level the company can reasonably be expected to achieve: quantity to produce, quantity to be
sold, etc.
1.4- BUDGETARY PROCESS: The budgetary process involves the following steps:
▪ Definition of objectives: A budget being a plan for the achievement of certain
operational objectives, it is desirable that the same are defined precisely. The objectives
should be written out; the areas of control demarcated; and items of revenue and
expenditure to be covered by the budget stated. This will give a clear understanding of
the plan and its scope to all those who must cooperate to make it a success.

▪ Location of the key (or budget) factor: There is usually one factor (sometimes there
may be more than one) which sets a limit to the total activity. Similarly, lack of demand
may limit production. Such a factor is known as key factor. For proper budgeting, it
must be located and estimated properly.
▪ Appointment of controller: Formulation of a budget usually required whole time
services of a senior executive; he must be assisted in this work by a Budget Committee,
consisting of all the heads of department along with the Managing Director as the
Chairman. The Controller is responsible for coordinating and development of budget
programmes and preparing the manual of instruction, known as Budget manual.
▪ Budget Manual: Effective budgetary planning relies on the provision of adequate
information to the individuals involved in the planning process. Many of these
information needs are contained in the budget manual. A budget manual is a collection
of documents that contains key information for those involved in the planning process.
▪ Budget period: The period covered by a budget is known as budget period. There is no
general rule governing the selection of the budget period. In practice the Budget
Committee determines the length of the budget period suitable for the business.
Normally, a calendar year or a period co-terminus with the financial year is adopted.
The budget period is then sub-divided into shorter periods; it may be months or quarters
or such periods as coincide with period of trading activity.
▪ Standard of activity or output: For preparing budgets for the future, past statistics
cannot be completely relied upon, for the past usually represents a combination of good
and bad factors. Therefore, though results of the past should be studied but these should
only be applied when there is a likelihood of similar conditions repeating in the future.
Also, while setting the targets for the future, it must be remembered that in a progressive
business, the achievement of a year must exceed those of earlier years.
1.5- Budgetary Control: Budgetary control contains two different processes one is the
preparation of the budget and another one is the control of the prepared budget. No system of
planning can be successful without having an effective and efficient system of control.
Budgeting is closely connected with control. The exercise of control in the organisation with
the help of budgets is known as budgetary control.
1.5.1 - The main features of budgetary control are:

• Establishment of budgets for each purpose of the business.
• Revision of budget in view of changes in conditions.

• Comparison of actual performances with the budget on a continuous basis.
• Taking suitable remedial action, wherever necessary.
• Analysis of variations of actual performance from that of the budgeted performance to know
the reasons thereof.
1.5.2 - Objectives of budgetary control: Budgeting is a forward planning. It serves basically
as a tool for management control; it is rather a pivot of any effective scheme of control. The
objectives of budgeting may be summarized as follows:
▪ Planning: Planning has been defined as the design of a desired future position for an
entity and it rests on the belief that the future position can be attained by uninterrupted
management action. Detailed plans relating to production, sales, raw‐ material
requirements, labour needs, capital additions, etc. are drawn out. By planning many
problems estimated long before they arise and solution can be thought of through careful
study. In short, budgeting forces the management to think ahead, to foresee and prepare
for the anticipated conditions. Planning is a constant process since it requires constant
revision with changing conditions.
▪ Co‐ordination: Budgeting plays a significant role in establishing and maintaining
coordination. Budgeting assists managers in coordinating their efforts so that problems
of the business are solved in harmony with the objectives of its divisions. Efficient
planning and business contribute a lot in achieving the targets. Lack of co‐ordination in
an organization is observed when a department head is permitted to enlarge the
department on the specific needs of that department only, although such development
may negatively affect other departments and alter their performances. Thus, co‐
ordination is required at all vertical as well as horizontal levels.
▪ Measurement of Success: Budgets present a useful means of informing managers how
well they are performing in meeting targets they have previously helped to set. In many
companies, there is a practice of rewarding employees on the basis of their accomplished
low budget targets or promotion of a manager is linked to his budget success record.
Success is determined by comparing the past performance with a previous period's
performance.
▪ Motivation: Budget is always considered a useful tool for encouraging managers to
complete things in line with the business objectives. If individuals have intensely
participated in the preparation of budgets, it acts as a strong motivating force to achieve
the goals.

▪ Communication: A budget serves as a means of communicating information within a
firm. The standard budget copies are distributed to all management people that provides
not only sufficient understanding and knowledge of the programmes and guidelines to
be followed but also gives knowledge about the restrictions to be adhered to.
▪ Control: Control is essential to make sure that plans and objectives laid down in the
budget are being achieved. Control, when applied to budgeting, as a systematized effort
is to keep the management informed of whether planned performance is being achieved
or not.
1.5.3 - Limitations of Budgetary control:
▪ It tends to bring about rigidity in operation, which is harmful. As budget estimates are
quantitative expression of all relevant data, there is a tendency to attach some sort of
rigidity to them.
▪ It being expensive is beyond the capacity of small undertakings. The mechanism of
budgeting system is a detailed process involving too much time and costs.
▪ Budgeting cannot take the position of management but it is only an instrument of
management. ‘The budget should be considered not as a master, but as a servant.’ It is
totally a misconception to think that the introduction of budgeting alone is enough to
ensure success and the security of future profits.
▪ It sometimes leads to produce conflicts among the managers as each of them tries to
take credit to achieve the budget targets.
▪ Simple preparation of budget will not ensure its proper implementation. If it is not
implemented properly, it may lower morale.
▪ The installation and function of a budgetary control system is a costly affair as it requires
employing the specialized staff and involves other expenditure which small companies
may find difficult to incur.
1.5.5 - Components of budgetary control system: The policy of a business for a defined
period is represented by the master budget the details of which are given in a number of
individual budgets called functional budgets. These functional budgets are broadly grouped
under the following heads:
▪ Physical budgets: Those budgets which contain information in terms of physical units
about sales, production etc. for example, quantity of sales, quantity of production,
inventories, and manpower budgets are physical budgets.

▪ Cost budgets: Budgets which provides cost information in respect of manufacturing,
selling, administration etc. for example, manufacturing costs, selling costs,
administration cost, and research and development cost budgets are cost budgets.
▪ Profit budgets: A budget which enables in the ascertainment of profit, for example,
sales budget, profit and loss budget, etc.
▪ Financial budgets: A budget which facilitates in ascertaining the financial position of
a firm, for example, cash budgets, capital expenditure budget, budgeted balance sheet
etc.
1.5.6 -Types of control systems: There are two control systems: feedback and feed forward
controls.
▪ Feedback control: actual results are compared with planned outcomes at the end of a
control period. Where the outcome of the comparison is not favourable, it is not possible
to take corrective measures in the same period because it is too late for corrective action.
▪ Feed forward control: Planned outcomes are compared with projected outcomes based
on actual performance so that it is known before the end of a control period whether the
desired outcome will be achieved or not so that any corrective measures can be taken
immediately. Therefore failure to achieve desired planned outcomes will be due to
reasons beyond the control of managers or those responsible.
CHAPTER 2 – TYPES OF BUDGETS

The extent of budgeting activity varies from firm to firm. In a smaller firm there may be a sales
forecast, a production budget, or a cash budget. Larger firms generally prepare a master budget.
Budgets can be classified into different ways from different points of view.

2.1- SALES BUDGET
Sales Budget is an estimate of anticipation of sales in the near future prepared by the responsible
person for the sale of a product by considering the various factors of influence. Sales budget is
usually prepared in terms of quantity and value. The following factors are normally considered
for the preparation of sales budget of a firm:
▪ Last sales figures

▪ Estimates of the salesmen who is frequently operating in the market, known much
greater than anybody in the market
▪ Capacity of the plant and machinery to produce
▪ Funds availability
▪ Availability of raw materials to the tune of demand in the respective time period
▪ Changes in the taste and preferences of the customer or consumer
▪ Changers in the competition structure — Monopoly to Perfect competition
2.1.1- Sales forecast: Sales forecast is the commencement of budgeting and hence sales budget
assumes primary importance. The quantity which can be sold may be the principal budget factor
in many business undertakings. In any case in order to chalk out a realistic budget programme,
there must be an accurate sales forecast.
A – METHOD OF SALES FORECAST: Almost all the techniques used in forecasting sales
are drawn from methods of analysing statistical data:
A.1 – Linear regression by the least square method
According to this technique, the adjustment line is given by the equation y = ax + b.
∑ 𝑋𝑖 𝑌𝑖
Where, a = ∑ 𝑋𝑖2
, Xi = xi - x̅ , Yi = yi - y̅
∑(𝑥𝑖 − x̅)(𝑦𝑖 − 𝑦̅)

a= ∑(𝑥𝑖 − 𝑥)2
b= y̅ − at̅
Example 1 - You are given below the monthly turnovers in thousands of francs from January
to December of the year 2012 in an enterprise:
Months 1 2 3 4 5 6 7 8 9 10 11 12
Turnover 91 94 96 100 106 114 126 130 133 138 142 146
in 00Frs

Work required:
a) Draw a line graph to depict the sales and comment, from your graph, the trend in sales.
b) Determine the trend using the least square method.
c) Assuming that the trend is maintained forecast the turnover of the three first months of
2013.
Solution:
xi yi xi − x̅ yi − y̅ (xi − x̅ ) ( yi − y̅ ) (𝑥𝑖 − 𝑥̅ )2
1 9100 -5.5 -2700 14850 30.25
2 9400 -4.5 -2400 10800 20.25
3 9600 -3.5 -2200 7700 12.25
4 10000 -2.5 -1800 4500 6.25
5 10600 -1.5 -1200 1800 2.25
6 11400 -0.5 -400 200 0.25
7 13600 0.5 800 400 0.25
8 13000 1.5 1200 1800 0.25
9 13300 2.5 1500 3750 6.25
10 13800 3.5 2000 7000 12.25
11 14200 4.5 2400 10800 20.25
12 14600 5.5 2800 15400 30.25
Total = 78 141600 0 0 79000 143
78 1416000
x̅ = = 6.5 , ̅=
Y = 6.5
12 12
79 000
a= 143
= 552 , b = y̅ - ax̅ = 11800 – (552 x 6.5) = 8212
y = 552t + 8212 → The trend (yt ) = 552t + 8212.
t Tt = 552t + 8212
1 8764
2 9316

3 9868
4 10420
5 10972
6 11524
7 12076
8 12658
9 13180
10 13732
11 14284
12 14836
b) Forecasting: T13 = 552 x 13 + 8212 = 15 388, T14 = 552 x 14 + 8212 = 15 940, and
T15 = 552 x 15 + 8212 = 16 492.

A.2- THE COEFFICIENT OF CORRELATION: There is a correlation between two entry
variables (t, y) when the variation of one automatically causes the variation of the other. This
variation can be of the same amplitude or not, instant or moved forward. The coefficient of
correlation which is calculated measures the degree of dependence of the two variables. Given
a time series data with observations (ti, yi), the coefficient of correlation is calculated as follows:
∑(xi− x̅)(yi− y
̅)
r=
√∑(xi− x̅)2 ∑(yi − y
̅)2
• r ranges between -1 and +1 . That is, −1 ≤ 𝑟 ≤ +1.

• r = 1, there is positively strong correlation
• r = -1, there is negatively strong correlation
• r = 0, there is no correlation
A.3- THE METHOD OF MOVING AVERAGES: These are averages calculated by moving
along the values or observations of a time series. Corresponding to the seasons or periodicity
of the data, moving or overlapping averages are calculated in order to bring out a trend. The
aim of this method is to come out with a general trend in case of data with seasonal variation
and also to take into consideration these seasonal variations during the forecast. Hence, the
adjustment is no longer done on the original data but it is done on the moving averages obtained
from the original data.

Given a series of observations (Yt) from t periods. The moving averages on k-points of moving
totals, is the series of observation (Mt) calculated as follows:
• If k is odd, Mt = (Yt−p + Yt−p+1 + … + Yt + Yt+1 + … + Yt+p )/k, with p =

k−1
2
k
• If k is even, Mt= (Yt-p/2 + Yt-p+1 + . . . + Yt+p/2)/k, with p = 2 . In this case, the extreme
values are divided by 2 in order to maintain the equivalence of k whole numbers.
Example 2– The information below is the number of vehicles passing through the Douala-
Yaoundé road within the four past years:
Quarter 2002 2003 2004 2005

1 455 438 513 539
2 578 665 681 685
3 763 820 864 876
4 563 565 605 650
Work required: Calculate the moving averages using five points moving totals.
Solution:
5−1
k = 5 (odd), p = =2
2
M3 = (Y1 + Y2 + Y3 + Y4 + Y5 )/k= (455+ 578 + 763 +563 +438)/5 = 559.4
Year t Y Moving total Moving averages (Tt)

2002 1 455
2 578
3 763 2797 559.4
4 563 3007 601.4
2003 5 438 3249 649.8
6 665 3051 610.2
7 820 3001 600.2
8 565 3244 648.8
2004 9 513 3443 688.6
10 681 3228 645.6

11 864 3202 640.4
12 605 3374 674.8
2005 13 539 3569 713.8
14 685 3355 671
15 876
16 650
A.3- THE MOVING TOTALS: This method accurately combines in case of time series,
seasonal variations and the search for general tendency. After fixing the value of the parameter
n, this method replaces each observation by the total of n last observations. The number of
moving totals depends on the value of n. The total observations of the first year from the first
moving total (the value of the parameter n is the number of observations of the first year). For
example n = 12 if observations are monthly, n = 4 if observations are quarterly. The moving
total totals are determined as in the table below:
Months (n=12) Calculation of the moving total
January Total observations from FebN-1 to JanN
February Total observations from MarN-1 to FebN
March Total observations from AprilN-1 to MarN
April Total observations from MayN-1 to AprilN
........ ………………………………………………………………….
........ ………………………………………………………………….
October Total observations from NovN-1 to OctN
November Total observations from DecN-1 to NovN
December Total observations from JanN to DecN
Term/Quarterly (n =4) Calculation of moving total

1st quarter Total observations from 2nd quarterN-1 to 1st quarterN
2nd quarter Total observations from 3rd quarterN-1 to 2nd quarterN
3rd quarter Total observations from 4th quarterN-1 to 3nd quarterN
4th quarter Total observations from 1st quarterN to 4th quarterN
Example 3 – The monthly statistics of sales in thousands of Francs for the year N-1 are
presented as follows:

Months Jan Feb Mar Apr May Jun Jul Aug Sept Oct Nov Dec
N-1 800 600 200 200 200 400 800 2000 3200 2400 2200 2000
N 1200 400 200 200 400 800 1200 2400 4000 3600 2800 3000
Work required:
1- Established the statistical table of moving totals over 12 months, of the turnover of the
N+1.
2- Determine the trend line of moving totals using the following methods:
a. Least square
b. Extreme points
Solution:
Months Jan Feb Mar Apr May Jun Jul Aug Sept Oct Nov Dec
(n=12)
Moving 15400 15200 15200 15200 15400 15800 16200 16600 17400 18600 19200 20200
totals
N+1
2- Equation of the trend line of moving total

a) Least square methods : y = 446.15x + 13800
b) Extreme points method:
We are going to determine an equation of the line of the form y = ax + b passing through
the points having the following coordinates A (Min value of X, Min value of Y) and B
(Max value of Y, Max value of Y) = A(1, 15400) and B(12, 20200) . We can write:
15400 = 1a + b
20200 = 12a + b
By solving the simultaneous equation above, the equation of the trend line is y = 436.36x
+ 14963.64.
A.4- THE DOUBLE AVERAGE METHOD: Also known as the Mayer’s method, this
method consists of the following:
▪ arrange the data in increasing order of their x-values;

▪ split these data into two equal groups;
▪ in each group calculate ̅
X and ̅
Y (midpoints);
▪ use these points to determine the equation of the regression line y – y1 = m(x – x1),
𝑌 −𝑌
where m = 𝑋2 − 𝑋1
2 1

N.B.:
1. If there are two data with the same x-values, they should be arrange in an increasing order of
their y-values.
2. If the data are odd, after the arrangement the middle data should not be taking into account
for the determination of the equation of the regression (i.e., strike off the middle data).
A.5 – THE EXTREME POINT METHOD: Also called the high and low value method. This
method consists of coming out with a regression line in the form y = ax +b, with the following
consideration:
▪ arrange the data in ascending order of magnitude;

▪ select the lowest and highest value of the data to represent : A(x 1, y1) and B( x2, y2)
respectively. Where, x1 = min value of x, y1 = min value of y, x2 = max value of x and
y2 = max value of y.
▪ establish two simultaneous equations in the form y1 = ax1 + b and y2 = ax2 + b with the
points A and B;
▪ solve the simultaneous equations to obtain a and b; and
▪ replace a and b to obtain the equation of the regression line y = ax + b.
Application :
1- Income of workers and their expenditures on food are summarized in the table below:
Food expenditures (000) 10 8 10 12 10 9 14

Consumers income (000) 200 185 190 230 210 190 250
Required:
▪ Determine the equation of the regression line through the double average method.
▪ Forecast :
➢ full expenditures for consumers earning 260 000F
➢ what may be the income of a consumer who spend 1 500 000F for food?
2 – Considered a discrete data provided to you by a sole proprietor for the financial year 2016.
Employees (X) 5 7 8 10 11 12 13
Profit (Y) 60 80 80 110 100 120 120
Required: Determine the equation of the regression through the extreme point method.

A.6 – SEASONAL COEFFICIENT
In a time series where there are seasonal variations, the calculation of forecasts should take
into account these variations. Seasonal coefficients are used to take into account seasonal
variations in forecasting. Many methods enable to calculate these seasonal coefficients.
a) Simple method called method of periodical averages: The seasonal coefficient of each
period is calculated by applying the following formula:
average observations of the period

general average of the periods
N.B.:
▪ If seasonal coefficients are calculated monthly, the total coefficients should be equal to
12.
▪ If seasonal coefficients are calculated quarterly, the total coefficients should be equal to
4.
b) Method of ratios to the trend: This method enables to determine the equation of the trend
line using the least squares, which is used to determine the adjusted values of the periods
(months or quarters). The seasonal coefficient of a period is determined by applying the
following formula:
average observations of the period

average adjusted values of the corresponding periods
Example 4 - the quarterly sales of the four last months (in thousands of units) of an enterprise
are given in the following table:
Quarters 1st quarter 2nd quarter 3rd quarter 4 quarter Total

N-3 250 406 790 190 1636
N-2 292 464 884 246 1886
N-1 460 550 1132 270 2412
N 316 624 1262 248 2450
Total 1318 2014 4068 954 8384
Work required:
1. Determine the equation of the general trend line using the least squares method.
2. Calculate the seasonal coefficients:

a) By the seasonal average method
b) By the method ratios to the trend
3. Use the answer to the question a and 2(b) to forecast the sales of the year N+1
Solution:
1. Equation of the general trend line: y = 18.83x + 363.95

2. Calculation of seasonal coefficients
a) By the seasonal average method:
Elements 1st quarter 2nd quarter 3rd quarter 4th quarter

Total observations of the 1318 2044 4068 954
quarter
Average observation of the 1318 2044 4068 954
= 329.5 = 511
4
quarter 4 4 4
= 1017 = 238.5
Quarterly average 524 524 524 524
Seasonal coefficient 329.5/524 = 511/524 = 0.98 1017/524 = 238.5/524 =
0.63 1.94 0.45
b) By the method of ratios to the trend
By using the adjustment equation: y = 18.83x + 363.95 the adjusted values of the 1st term of the
year N-3 to the 4th quarter of the year N should be calculated:
1st quarter 2nd quarter 3rd quarter 4th quarter

N-3 382.78 401.61 420.44 439.27
N-2 458.1 476.93 495.76 514.59
N-1 533.42 552.25 571.08 589.91
N 608.74 627.57 646.4 665.23
* 352.78 = (18.83 x 1) + 363.95
➢ Determination of the seasonal coefficients
Quarters Average Average of adjusted value Seasonal coefficients

observations
1st quarter 1318/4 = 329.5 382.78+458.1+533.42+608.14 329.5/495.61 = 0.67
= 495.76
4

2nd quarter 2044/4 = 511 401.61+476.93+552.25+627.57
= 511/514.61 = 0.99
4
514.59
3rd quarter 4068/4 = 1017 420.44+495.76+571.08+646.4 1017/533.42 = 1.91
= 533.42
4
4th quarter 954/4 = 238.5 439.27+514.59+589.91+665.23

= 238.5/552.25 = 0.43
4
552.25
3. Use of the adjustment equation of the line and seasonal coefficients to forecast for the
year N+1 :
Quarters Forecasted sales
1st quarter [(18.83*17) + 363.95] * 0.67 = 458.32
2nd quarter [(18.83*18) + 363.95] * 0.99 = 695.86
3rd quarter [(18.83*19) + 363.95] * 1.91 = 1378.49
4th quarter [(18.83*20) + 363.95] * 0.43 = 318.44
2.1.2- ESTABLISHMENT OF SALES BUDGET
The sales budget is a summary table of forecasted sales in quantities and in values, displayed
per periods (months, weeks, quarters, . . . ) or by geographical regions or by product or family
of product with the possibility of combining the various criteria, for instance per product and
per geographical region and even per period in a single table. In function of the criterium
considered, we can have the following presentations:
A – Display per product and per period:
Period 1 Period 2 Period 3 Period 4 Period 5 Period 6 Totals

Product 1
Product 2
Product 3
Totals
B – Display per product, per region and per period
Region A Region B Total

Period 1 Period 2 Period Period Period 1 Period 2 Period 3 Period 4
3 4
Product 1
Product 2
Product 3
Product 4
Example 5 - The Joint Stock Company TIAM & Bros exclusively sells a product called BIZOU
in bottle. Its market which is in Cameroon and in the CEMAC countries is divided into 03
zones. You are given for the year N the following information:
a – Sales program in number of bottles:
Places Zone A: Zone B: Zone C: Other CEMAC

Periods Cameroon Chad countries
1st quarter N 1 200 300 1 200
2nd Quarter N 1 000 250 1 400
3rd Quarter N 1 150 400 2 000
4th Quarter N 1 500 600 2 000
b- Selling price per bottle for the two first quarters:
- Cameroon : 2 000F tax exclusive

- Chad : 2 200F
- Others : 3 000F
c- Selling expenses:
▪ Cameroon : Fixed : 240 000 F per quarter

Variable: 10% of the turnover tax exclusive
▪ Chad : Fixed per quarter : 300 000F
Variable: 250 F per bottle
▪ Other CEMAC countries: Fixed: 125 000F per country and per quarter
Variable: 260 F per bottle
d- Evolution of the selling price: During the 3rd quarter of the year N an increase of the selling
price is forecasted at 20% for home sales, but a drop of 5% in the other CEMAC countries.

Work required:
1- Graphically represent the evolution of quarterly sales in quantity in the CEMAC zone
during the year N.
2- Present for the year N the sales budget (in term of turnover).
Solution:
1. Graphical representation (in class)

2. Presentation of the sales budget for the year N:
Unit prices from the 3rd quarter:
Zone A: 2000 + (2000 x 20%) = 2400
Zone B: 2200 – (2200 x 5%) = 2090
Zone C: 3000 – (3000 x 5%) = 2850
Solution:

1st 2nd 3rd 4th Totals
Qty Up Amount Qty Up Amount Qty Up Amount Qty Up Amount Qty Amount
Zone A 1200 2000 2400000 1000 2000 2000000 1150 2400 2760000 1500 2400 3600000 4850 10760000
Zone B 300 2200 660000 250 2200 550000 400 2090 836000 600 2090 1254000 1550 3300000
Zone C 1200 3000 3600000 1400 3000 4200000 2000 2850 5700000 2000 2850 5700000 6600 19200000
Totals 2700 6660000 2650 6750000 3550 9296000 4100 10554000 13000 33260000

APPLICATION EXERCISE
Reynolds Pvt. Ltd. manufactures two brands of pen Light & Elite. The sales department of the
company has three departments in different regions of the country. The sales budgets for the
year ending 31st Dec, 2006 Light department I=300,000; department II=562,500; department
III=180,000: Elite–department I=400,000; department II=600,000; department III=20,000.
Sales prices are 3 and 1.20 in all departments. It is estimated that by forced sales promotion the
sales of Elite in department I will increase by 175,000. It is also expected that by increasing
production and arranging extensive advertisement, department III will be enabled to increase
the sale of Elite by 50,000. It is recognized that the estimated sales by department II represent
and unsatisfactory target. It is agreed to increase both estimates by 20%.
Work required - Prepare a sales budget for the year 2006.

2.1.3- SALES OVERHEAD BUDGET OR BUDGET OF DISTRIBUTION EXPENSES
It is one of the important sub functional budgets, prepared by the sales manager who is
responsible for the sales volume of the enterprise to increase through various devices/tools of
sales promotion. The sales overhead can be classified into two categories viz fixed sales
overhead and variable sales overhead.
➢ Fixed sales overhead is the expenses incurred for promoting the sales, which remains
the same or fixed irrespective of the volume of the sales. Example, salaries to sales
department, Salaries to the Administrative Staff and Salary to Salesmen.
➢ Variable sales overhead is the expenses incurred for the promotion of the sales, which
is varying along with the volume of sales of the firm. Example, sales commission,
agents commission, and carriage outward expenses.
As for the sales, a table summarising these charges is presented. We can have the following
presentations:
Periods 1 2 3 ............... ............... Totals
Elements
Fixed expenses
..............................
.............................
Variable expenses
.............................
............................
Totals
Periods 1 2 3 ............... ............... Totals

Elements
Direct expenses
..............................
.............................
Indirect expenses
.............................
............................
Totals

Table of sales expenses of the problem in example 5 above :
Periods 1st 2nd 3rd 4th Annual totals
Elements
Zone A :
Fixed expenses 240 000 240 000 240 000 240 000 960 000
Variable expenses 240 000 200 000 276 000 360 000 1 076 000
Sub-total A 480 000 440 000 440 000 600 000 2 036 000
Zone B :
Fixed expenses 300 000 300 000 300 000 300 000 1 200 000
Variable expenses 75 000 62 500 100 000 150 000 387 500
Sub-total B 375 000 362 000 400 000 450 000 1 587 500
Zone C :
Fixed expenses (*) 500 000 500 000 500 000 500 000 2 000 000
Variable expenses 312 000 364 000 520 000 520 000 1 716 000
Sub-total C 812 000 864 000 1 020 000 1 020 000 3 716 000
General total 1 667 000 1 666 500 1 936 000 2 070 000 7 339 500
(*) 125 000 x 4 = 500 000

Application:
The following expenses were extracted from the books of Swagga and Sons ETS, to prepare
the sales overhead budget for the year 2006:
Advertisement on:
Radio 2000
Television 12 000
Salary to:
Sales administrative staff 20 000
Sales force 15 000
Expenses of the sales department:
Rent of the building 5000
Carriage outward 5% on sales
Agents’ commission 2%
The sales during the period were estimated as follows:
▪ 80 000 including agents’ sales 8 000

▪ 100 000 including agents’ sales
2.2-THE MANUFACTURING OR PRODUCTION BUDGET
The preparation of the production budget is mainly dependent on the sales budget. The
production budget is a statement of goods, how much should be produced. It may be in terms
of quantities, Kilograms in monetary terms and so on. Production budget shows the production
for the budget period based upon:
1. Sales budget,
2. Production capacity of the factory,

3. Planned increase or decrease in finished stocks, and
4. Policy governing outside purchase.
2.2.1- DETERMINATION OF PRODUCTION CAPACITY
Generally, the activities of the industrial enterprises are carried out in workshops. These
workshops function within a certain limit due to the capacity of machines which is also limited.
In fact, the enterprise limits the production of outputs to the capacity of workshops, to the
quantity of inputs available and to the capacity of the market.
2.2.1.1- TECHNIQUES USED TO DETERMINE THE OPTIMAL PRODUCTION OR

PRODUCTION CAPACITY
A - Formulating a linear programme

Forecasting production is to determine in advance the number of product to manufacture taking
into consideration the various constraints which are limiting factors to the production. There
are three main product constraints:
▪ The market constraints: these constraints are related to the maximum number of units
of production that the market is ready to absorb. Also, the market constraint could be in
relation to an order received from customer that should be immediately honoured.
▪ The economic constraints: It is the objective targeted by the firm. It could be:
- The maximisation of sales, contribution margin, profit etc;
- The minimisation of cost.
▪ The technical constraint: It is the constraint derived from the capacity of the
production department taking into consideration the machine and the manpower.

The existence of several constraints (limiting factors) limiting the production leads to the
establishment of the linear programming in other to determine the optimal number of product
to manufacture.
The following steps are used to formulate a linear programme:
▪ Step1 - Choose decision variables: - The decision variables represent quantities that
are, in some sense, controllable inputs to the system being modelled.
▪ Step 2 - Choose an objective function – linear function in variables, which is to be
maximised or minimised.
▪ Step 3 - Formulate constraints – These constraints are expressed as linear inequalities
involving the decision variables;
▪ Step 4 -Choose sign restrictions (constraint of non-negativity)
Example 6 - Suppose an industry is manufacturing two types of products P1 and P2. The profits
per Kg of the two products are 30 FRS and 40FRS respectively. These two products require
processing in three types of machines. The following table shows the available machine hours
per day and the time required on each machine to produce one Kg of P1 and P2. Formulate the
problem in the form of linear programming model.
Profit/kg P1 P2 Total available Machine hours/day
Machine 1 3 2 600
Machine 2 3 5 800
Machine 3 5 6 1100
Solution:
The procedure for linear programming problem formulation is as follows:
Introduce the decision variable as follows:
Let: X = Amount of P1
Y = amount of P2
The product mix problem in the linear programming model is as follows:
Max Z = 30X + 40Y
S.t.:
3X+ 2Y ≤ 600 (Machine 1)
3X+ 5Y ≤ 800 (Machine 2)
5X + 6Y ≤1100 (Machine 3)
X, Y ≥ 0 (Non-negativity)

B - SOLVING LINEAR PROGRAMMES
Solving a linear programme implies the determination of values of the decision variables for
which the value of the objective function is maximised or minimised. The solution to linear
programmed is done using two techniques: - graphical method and Simplex method.
I - GRAPHICAL METHOD
The graphical method is used only when the enterprise envisages producing only two types of
products. That is, a two variable linear programming problem can be easily solved graphically.
The method is simple but the principle of solution depends on the following steps:
Step 1: Draw constraint-lines and determine which side of the line satisfy the inequality.
Each constraint consists of a line, and to draw, one sets the inequality to be the equality. In a
simple approach, we look for the value of y when x = 0, and the value of x when y = 0. We
obtain two points coordinates (x1, y1) and (x2, y2), which are plotted and a straight line is draw
joining them.
Step 2: Deﬁne feasible region. This is done by selecting the region that satisﬁes all the
constraints including the non-negativity constraints.
Step 3: Find the optimum point for which the value of the objective function is maximum or
minimum. Each point within the feasible region constitutes a feasible solution. The coordinate
of each point is substitute into the objective function, and the point with the max or min value
of Z gives the optimum solution.
Example 7: Solve graphically the linear programme below:

Maximize Z = 30x1 + 40x2
Subject to:
3x1+ 2x2 ≤ 600 (1)
2x1+ 5x2 ≤ 800 (2)
5x1 + 6x2 ≤ 1200 (3)
x1, x2 ≥ 0
Step 1 – Transform the inequalities into equations and draw constraint lines in order to
determine the closed-half plane satisfying respective inequalities.
3x1+ 2x2 = 600 (1)

2x1+ 5x2 = 800 (2)

5x1 + 6x2 = 1200 (3)
➢ Table of values:
Equation x1 x2
0 300
1 200 0
0 160
2 400 0
0 200
3 240 0
X2
300 3x1+ 2x2= 600 (line 1)
200
2x1+ 5x2= 800 (line 2)
160
5x1 + 6x2= 1200 (line 3)
200 240 400 X1
Step 2 - Define the feasible region
➢ Three closed half planes and Feasible Region:

• Half plane - A linear inequality in two variables is known as a half plane.
• Boundary - The corresponding equality (line) is called as the boundary of the half
plane.
• Closed half plane – Half plane with its boundary is called as a closed half plane.
In this case we must decide in which side of the line 3x1 + 2x2 = 600, the inequality 3x1+ 2x2≤
600 is satisfied. The easiest way to solve the inequality for x2 is 3x1≤ 600 – 2x2. And for the
fixed x1, the coordinates satisfy this inequality are smaller than the corresponding ordinate on
the line and thus the inequality is satisfied for all the points below the line 1. Similarly, we

have to determine the closed half planes for the inequalities 2x1 + 5x2≤800 and 5x1+ 6x2≤ 1200
(line 2 and line 3 on the graph). Since all the three constraints must be satisfied
simultaneously, we have considered the intersection of these three closed half planes to
represent the feasible region as shown in the figure below:
X2
300 3x1+ 2x2= 600 (line 1)
200
2x1+ 5x2= 800 (line 2)
160
B 5x1 + 6x2= 1200 (line 3)
C
Feasible
region
A D
X1
200 240 400
• Feasible Region: The complete intersection of these three closed half planes is shown
in the above graph as ABCD. The region ABCD is called the feasible region. The
collection of all the feasible solution is known as the feasible region. The feasible region
is a convex polygon. The extreme point of this convex region are A, B, C and D.
• Feasible Solution: Any non-negative value of x1, x2 that is x1 ≥ 0, x2 ≥ 0 is known as a
feasible solution of the linear programming problem if it satisfies all the existing
constraints.
• Optimal point and optimum solution: The coordinate with the maximum value of z
is known as the optimal point. The following table shows the calculation of maximum
value of the objective function:
Coordinates
Extreme point Max Z = 30x1 + 40x2
x1 x2

A (Origin) x1 = 0 x2 =0 0
B x1 = 0 x2 = 160 6400
C (line 1∩ line2) x1 = 127 x2 = 109 8170
D x1 = 200 x2 = 0 6000
The point with the maximum value of Z is C. That is, x1 = 127 and x2 = 109 and Z* = 8170.
N.B: Point C is at the point of intersection of lines 1 and 2. Therefore, the coordinates of point
C are obtained by solving the simultaneous equations:
Line 1: 3x1+ 2x2 = 600 ………………. equation 1
Line 2: 2x1+ 5x2 = 800 ……………......equation 2
II- SIMPLEX METHOD
The linear programming with two variables can be solved graphically. The graphical method
of solving linear programming problem is of limited application in the business problems as the
number of variables is substantially large. If the linear programming problem has larger number
of variables, the suitable method for solving is Simplex method.
➢ SIMPLEX STEPS: The following steps are used for the Simplex approach:
Step 1: Transform the standard form of the LP into canonical form (or equation). The
transformation is done by including surplus, slack and artificial variables into the system.
▪ Artificial Variable: A non-negative variable introduced to provide basic feasible
solution and initiate the simplex procedures. It is introduced for ≥ or = types
inequalities.
▪ Slack Variable: A variable corresponding to a ≤ type constraint is a non-negative
variable introduced to convert the inequalities into equations.
▪ Surplus Variable: A variable corresponding to a ≥ type constraint is a non-negative
variable introduced to convert the constraint into equations.
Step 1 could be summarised as follows:
Type of Coefficient of variables at Coefficient of variables at the objective

inequality the constraints. functions Z.
Max Min

S (coefficient -1) 0 0
≥ A (coefficient +1) -M +M
= A (coefficient +1) -M +M
≤ S (coefficient +1) 0 0
Step 2: Establish the “tableau” of simplex and check if the current basic feasible solution (BFS)
is optimal.
Coefficients of variables from the objective
function (cj).
Basic List of all the variables within the system or Values from the right Ratio
variables programme. hand side of the respective
(xi, Si, Ai) constraints (bj).
Respective coefficients of each variable from the
constraints (aij ).
zj z*
cj - zj
Z* = Optimal value of Z from the table of Simplex.
Note:
1. Zj = ∑ cj aij , where, aij = coefficients of variables of the constraints & cj = coefficients
of variables of the objective function.
➢ Test of the optimality of BFS:
▪ For the case of maximization, the Simplex tableau is optimal, if all the values
of cj-Zj (marginal contribution) are all negative and/or zero. That is, cj-zj ≤ 0. If
the tableau is optimal the algorithm terminates, and the optimal values are read
horizontally from the BV and values from the table of simplex. If the tableau is
not optimal, we move to step 3.
▪ For the case of minimization, the Simplex table is optimal, if all the values of
cj-zj row are all positive and/or zero. That is, cj-zj ≥ 0. If the tableau is optimal
the algorithm terminates, and the optimal values are read horizontally from the
BV and RHS columns. If the table is not optimal, we move to step 3.
Step 3: Determine the entering variable: If the basic feasible solution (BFS) is not optimal
(step 2); we have to change one of the BVs. As a result, one of the non-basic variables (NBVs)
will become a BV (entering), and one of the BVs will become a NBV (leaving).

➢ For the case of maximization, the entering variable will be the one with the highest
positive absolute value along the cj-zj row.
➢ For the case of minimization, the entering variable will be the one with the smallest
negative absolute value along the cj-zj row.
Step 4: Determine the leaving variable: The leaving initial BV will be the one whose ratio has
the smallest value. The value of ratio for each BV is calculated as follows:
Value from RHS (bj )
Coefficient of entering variable(aij )
Step 5: Find a new BFS: now we have a new system of BVs, we have to solve the Simplex
tableau in terms of the new BVs. This is done by the transformation of lines and columns of the
previous table by tracking the entering base variable. Then, we have a new Simplex tableau,
and we go back to Step 2 (that is, performing the test of optimality).
Example 8 - Solve using the Simplex method the following linear programme:
Max Z = 8x1 + 6x2
S.t.:
4x1 + 2x2≤ 60
2x1 + 4x2≤ 48
x1, x2 ≥ 0
Solution:
Max Z = 8x1 + 6x2
S.t.:
4x1 + 2x2+ s1 = 60
2x1 + 4x2 + s2 = 48
x1, x2, s1, s2 ≥ 0
Matrix form:
LHS RHS
x1 x2 s1 s2 bj
4 2 1 0 60
2 4 0 1 48
(From the system, s1 and s2 are basic variables)
Table 1:
cj 8 6 0 0
BV x1 x2 s1 s2 Value Ratio
0 s1 4 2 1 0 60 60/4 = 15

0 s2 2 4 0 1 48 48/2 = 24
zj 0 0 0 0 0
cj-zj 8 6 0 0
Basic feasible solution: x1 = x2 = 0, s1 = 60, s2 = 48 and z*= 0

It is not optimal, since all the values of cj-zj are not negative.
Thus, the variable x1 enters the base, while s1 leaves the base.
Table 2 (1st iteration):
X1 is the pivot line (4) and must enable to obtain the new base derived from the transformation
of line. Since x1 is the entering variable, it must have 1 at the point of intersection of x 1 (row)
and x1(column) and 0 otherwise. The following relations are used to transform the lines and
columns of the new simplex table:
L’1 = ¼ L1
L’2 = L2 + 2 L’1
N.B: Other lines are expressed in relation to the line L’1 to proceed with the transformation:
Cj 8 6 0 0
BV x1 x2 s1 s2 Value Ratio(min)
8 x1 1 1/2 1/4 0 15 15/0.5 =30
0 s2 0 3 -1/2 1 18 18/3 = 6
zj 8 4 2 0 120
cj-zj 0 2 -2 0
Basic feasible solution: x1 = 15, s2 = 18, s1 = x2 = 0 and z*= 120.

This solution is still not optimal, thus, there is a value of cj-zj > 0. As a result, the variable x2
enters the base and s2 leaves the base.
Table 3 (2nd iteration):
X2 is the pivot line (3) and must enable to obtain the new base derived from the transformation
of line.
L’’2 = 1/3 L’2
L’’1 = L’’1 – ½ L’’2
Cj 8 6 0 0
BV x1 x2 s1 s2 Value
8 x1 1 0 1/3 -1/6 12

6 x2 0 1 -1/6 1/3 6
zj 8 6 5/3 2/3 132
cj-zj 0 0 -5/3 -2/3
Given that all the cj-zj≤ 0, the above solution is optimal: x1 = 12, x2 = 6, s1=s2 = 0 and z* = 132.
Application:
1 - An industrial enterprise located in the industrial zone Douala-Bonaberi manufactures two

products P1 and P2. This manufacturing is carried out in three workshops. A market survey
enables to admit that for the coming year the enterprise will sell at most 400 units of P1 and
500 units of P2.
The production department has established the times in hours necessary for the manufacturing
of a unit of each product and in each workshop, the maximal capacity of the manufacturing
workshops, and the variable cost per unit of work as follows:
Product Workshop 1 Workshop 2 Workshop 3

P1 6hrs 6hrs 14hrs
P2 12hrs 2hrs 12hrs
Maximal capacities 6000 hrs 3 000hrs 8 400hrs
The sales realized are 900F per unit of P1 and 1300F per unit of P2. The variable cost per unit
of P1 is 200F and P2 is 200F, and fixed cost is 100F for P1 and 100F for P2.
Work required:
a) Formulate the linear programme of the problem above.

b) Solve the linear programme using :
i) The graphical method.
ii) Simplex method
c) Determine the unused capacity (or bottleneck).
2 – Mr Tem, the technical director in charge of the production, envisages according to the
diversification policy of the enterprise, to produce two new types plumbing tabs for the public.
The first model is called VALDUS and is a tab for the bathing room, while the second model
REGULUS is a wash basing tab. These tabs are produced in three workshops: Mounting-
Assembling-Finishing:
Workshops Model

VALDUS REGULUS Variable cost of
a work in unit
Mounting 1.6 2.25 4 500
Assembling 0.5 2 5 200
Finishing 1 2.25 2 800
For a month, the maximum capacities in work units are 4 000 for the mounting workshop, 2 000
for the assembling workshop and 2 850 for the finishing workshop. Apart from the variable
cost, consideration should be taken as far as the purchase of parts imported from Italy for the
production of tabs is concerned. These parts are purchased at 14 400F for a VALDUS and
26 475F for a REGULUS. The Selling prices are 35 000F for a unit of VALDUS and 72 000F
for a unit of REGULUS.
Work required:
1. Calculate for each model the contribution margin

2. Write the linear program that enables to maximise the contribution margin
3. Determine graphically and by calculation the optimum
4. Verify the answer in question (3) above using Simplex method.
2.2.2- PLANT UTILISATION BUDGET

Plant utilisation budget represents, in terms of working hours, weight or other convenient units
of plant facilities required to carry out the programme laid down in the production budget. The
main purposes of this budget are:
1. To determine the load on each process, cost or groups of machines for the budget period.
2. To indicate the processes or cost centres which are overloaded so that corrective action may
be taken such as: (i) working overtime (ii) sub-contracting (iii) expansion of production facility,
etc.
3. To dovetail the sales production budgets where it is not possible to increase the capacity of
any of the overloaded processes.
4. Where surplus capacity is available in any of the processes, to make effort to boost sales to
utilise the surplus capacity.
2.2.4- DIRECT MATERIAL USAGE BUDGET

This budget takes place only after identifying the number of finished products expected to
produce to the tune of production budget, in meeting the needs and demands of the customers
and consumers during the season. In order to produce to the tune of production budget to meet
the market demands, the raw materials for the production should be maintained sufficient to
supply them without any interruption. The steps involved in the compilation of direct materials
usage budget are as under:
1. The quality standards for each item of material have to be specified. In this connection,
standardisation of size, quality, colour, etc., may be considered.
2. Standard requirement of each item of materials required should also be set.
3. Standard prices for each item of materials should be set after giving consideration to stock
and contracts entered into.
Remarks:
• After setting standards for quality, quantity and prices, the direct materials budget can
be prepared by multiplying each item of material required for the production by the
standard price. If there is any existing stock of raw materials, i.e. opening stock of raw
materials available from years, it should be deducted from the volume of materials
required for production to be ordered and placed. The remaining volume should be the
volume to be ordered for production.
Example 9: The sales manager of the Lord Ltd. reports that next year he anticipates to sell
50,000 units of a particular product. The production manager consults the storekeeper and casts
his figures as follows: Two kinds of raw materials A and B are required for manufacturing the
product. Each unit of the product requires 2 units of A and 3 units of B. The estimated opening
balances at the commencement of the next year are:
Finished product: 10,000 units
Raw Materials A: 12,000 units
Raw Materials B: 15,000 units
The desirable closing balances at the end of the next year are
Finished products: 14,000 units
Raw materials A: 13,000 units
Raw materials B: 16,000 units
Prepare production budget and materials purchase budget for the next year:
Solution:

2.3- THE SUPPLY BUDGET
The problem of supply in enterprises can be defined as a policy enabling to all external
elements necessary to realize the production when and where the enterprise is in need with a
pre-defined level of quality, this by minimizing the global cost. The construction of a supply
budget is done at two levels:
• Programming supplies according to the manufacturing needs of workshops. This is

expressed by a problem of date and quantity. When should we supply and what quantity
should we order?
• Valuing the program which depends on the prices on the market and the ability to
bargain with suppliers, it is a matter of costs and taxes.
2.3.1- Stock management techniques: The management of stock aims at minimizing the
global supplying cost with stocking cost included. The simplest theoretical reasoning is based
on the following quantities: -
▪ The alarm stock: it is the stock level from which an order should be placed. Alarm
stock = safety stock + daily consumption x supplying duration in days.
▪ The safety stock or security stock represents the quantity that will be permanently in
stock to face unforeseen circumstances. Safety stock = usage rate x days of safety, where
usage rate = Annual usage/ Days of safety;

▪ Stock level: Stock level is the level of stock which is maintained by the business concern at all
times. Therefore, the business concern must maintain optimum level of stock to smooth running
of the business process. Different level of stock can be determined based on the volume of the
stock.
▪ Minimum level: A business must maintain minimum level of stock at all times. If the stocks
are less than the minimum level, then the work will stop due to shortage of material. Minimum
Level = Re-order level – Normal consumption × normal (or average) delivery period).
▪ Re-order level (ROL): This is the quantity of stock in the hand that requires to be placed
(made). It is simply a level of inventory at which a replenishment order should be placed. Re-
order level=maximum consumption × maximum re-order period. Re-order period is the
time gap between when an order is placed and when the replenishment is made. It is also called
the gap time or lead time.
▪ Maximum stock level (MSL): It is the stock level which stock is not allowed to go above or
beyond. If the quantity exceeds maximum level limit then it will be overstocking. Maximum
level = Re-order level + Re-order quantity – (minimum consumption x minimum delivery
period). Or, max level = Safety stock + EOQ
▪ Danger level: It is the level below the minimum level. It leads to stoppage of the production
process. Danger level=Average consumption × Maximum re-order period for emergency
purchase.
▪ Lead time or time gap: Lead time is the time normally taken in receiving delivery after placing
orders with suppliers. The time taken in processing the order and then executing it is known as
lead time.
▪ Average stock: - it is the stock that the enterprise should have permanently during the
period.. It is calculated such as :
Minimum stock level + Maximum stock level
❖ Average stock = .
2
Initial Stock +Final Stock
❖ Average stock = 2
Stock at the beginng of period+stock at the end of the period
❖ Average stock =
2
Quantity to order Q
❖ Average stock = 2
= 2
Again, let Q = economic order quantity, A = Annual consumption and N = Optimal number of
command to place during the year. The following relations can be established:
A A Q A
Q = N ; N = Q; A = NQ , Average stock = 2 = 2N.
Example 10- From the following information calculate, (1) Re-order level (2) Maximum level
(3) Minimum level (4) Average level

Normal usage: 100 units per week
Maximum usage: 150 units per week
Minimum usage: 50 units per week
Re-order quantity (ROQ): 500 units
Log in time: 5 to 7 weeks
Solution
(1) Re-order level (ROL) = Maximum consumption × Maximum Re-order period = 150×7=1050 units
(2) Maximum Level = (Re-order level+ Re-order quantity) – (Minimum consumption ×Minimum
delivery period) = 1050 + 500 – (50 × 5) = 1300 units
(3) Minimum Level = Re-order level – (Normal consumption ×Normal delivery period) = 1050 – (100
× 6) = 450 units
Minimum level+Maximum level 1300+450
(4) Average Level = = = 875 units
2 2
2.3.2- ECONOMIC ORDER QUANTITY (EOQ) AND ECONOMIC ORDER NUMBER (EON)
One of the major inventory management problems to be resolved is how much inventory should be
added when inventory is ordered. These problems are called order quantity problems, and the task of
the firm is to determine the optimum or economic order quantity (or economic lot size). Determining an
optimum inventory level involves two types of costs :(a) ordering costs and (b) carrying or possession
costs. The economic order quantity is that inventory level that minimizes the total cost of ordering and
carrying costs. Meanwhile, the economic order number (EON) refers to the number of commands or
order to be placed during the year that minimizes the total cost of ordering and carrying costs.
▪ ORDER COSTS
It represents the amount of indirect and direct expenses linked to the treatment and placing of
commands. For example, they include costs incurred in the following activities: requisitioning, purchase
ordering, transporting, receiving, inspecting and storing. The total ordering cost is proportional to the
number of commands (N) placed during the year.
Consider that, O = the ordering cost per order, which is fixed,
A = Annual consumption, which is EOQ or Q = the economic order quantity, and
𝐴
EON or N = the optimal number of commands to place during the year =𝑄.
The total ordering cost (TOC) is determined as follows:
A
➢ Total order cost (TOC) == Q
∗ O (in terms of order size) . Or,
➢ TOC = O * N (in terms of number of commands or orders)

▪ CARRYING COST
Costs incurred for maintaining a given level of inventory are called carrying or possessing costs. In
other words, it concerns all what has been spent in keeping and conserving stocks by the enterprise.
They include storage, insurance, taxes, deterioration and obsolescence.
Let us assume that carrying cost (or holding cost or possession cost) per unit, c, is constant, and Q is
the order size. Then, average inventory will be:
Order size Q A A
➢ Average inventory = =2 = 2N (since Q = N )
2
Q
➢ Total carrying cost =2 x c (in terms of quantities) or
Ax c
➢ Total carrying cost = 2N
(in terms of commands or order)
▪ TOTAL INVENTORY COST OR TOTAL COST OF STOCK MANAGEMENT
The total inventory cost is the sum of the carrying and ordering cost:
Qxc AxO
➢ Total cost of inventory (TC) = + (in terms of order quantity).
2 Q
Or,
Axc
➢ TC = + N x O (in terms of number of commands)
2N
2.3.2.1- CALCULATION OF ECONOMIC ORDER QUANTITY (EOQ) AND ECONOMIC

ORDER NUMBER (EON)
ECONOMIC ORDER QUANTITY (EOQ): The optimal size of an order for replenishment of inventory
is called economic order quantity. Economic order quantity (EOQ) or optimum order quantity is that
size of the order where total inventory costs (ordering costs + carrying costs) are minimized. Economic
order quantity can be calculated from any of the following two methods:
1. Formula Method: It is also known as ‘square root formula’ or ‘WILSON formula’ as given
A A
below: EOQ or Q = √2AO/C and EON or N = Q =
√2AO/C
Where, A = Annual usage (or consumption) of inventories (units), O = Ordering cost per unit and C =
Carrying (or holding or possession) cost per unit
2. Graphical Method: - The economic order quantity can also be determined with the help of
graph. Under this method, ordering costs, carrying costs and total inventory costs according to
different lot sizes are plotted on the graph. The intersection point at which the inventory carrying
cost and the ordering cost meet, is the economic order quantity. At this point the total cost line
is also minimum. The EOQ occurs at the point Q* where the total cost is minimum. On the
other hand, the EON or N, occurs at the point N* where the total cost is minimum as shown in
the figure below:

Minimum total cost
Qxc AxO
TC = +
2 Q
Cost
Qxc
TCC= 2
AxO
TOC = Q
Q*
Order size Q
Minimum total cost

Axc
TC = 2N + O x N
Cost
TOC= O x N
Ax c
TCC = 2N
N* Number of command N
Example 11 - The annual demanded of FOKOU Ltd is 50 000 bags of cement and the ordering cost
order is 15 000F. The purchase per bag is 5 000F and the carrying cost is 12% of the purchase per
annum. Calculate the EOQ.
Solution:

EOQ = √2AO/C
A = 50 000
O = 15 000
C = 0.12 x 5 000 = 600F
2(50 000)(15000)
EOQ= √
600
Application:
An enterprise consumes per year 48 000 kg of raw materials M. The cost of placing an order
is 6 000F and the possession cost is made up of the financial cost of 5%, depreciation of 2%,
warehouse keeping 2%. The unit purchase price of a kg is 100F.
Calculate:
a) The economic number of order and quantities that will enable to minimize the total
cost.
b) Develop the equation of total cost, and use it to calculate the total cost for 1-12 numbers
of orders.
2.3.3- BUDGETING SUPPLIES
Once the EOQ and EON are known, a schedule of commands and deliveries should be
established in function of consumptions (exists) forecasted. Budgeting can be either by constant
(regular) quantities or by constant periods.
1. Budgeting by constant quantities: The quantity to order (Q) is determined by dividing the
𝐶
annual consumption (C) by the number of commands (N). That is Q = 𝑁 .
This method enables to present a double entry table having at least the following columns:
o Periods
o Exists or consumptions
o Stock with rupture (shortage)
o Entries or deliveries
o Corrected stock
o Commands (date of commands and quantities ordered)

Indeed, this table can be presented as follows:
Periods Consumptions Stock supply or Corrected Commands (orders)

with deliveries or Dates of Quantities
eventual adjusted commands
rupture stock
Work to be done to fill the above table:
• Fill the periods (which are generally months from December N to December N+1)
• Fill the exists or consumptions
• In the column of stock with eventual rupture and on the line corresponding to the first
period (December N), write the initial stock (which is the final stock of the year N that
is December N)
• The other stocks with eventual rupture are determined by applying the following
formula: Stock with eventual ruptures period N = Stock with eventual rupture or
corrected stock period N-1 - Consumptions period N.
• From the forecasted deliveries and considering the replenishment period, the different
dates of commands which enable to fill the column which is reserved for it is
determined.
Example 12– An industrial enterprise uses a raw material for the manufacturing of finished
products. The stock on the 31/12/N was 480 FRS.
Information below are given by the commercial department of the enterprise:
- Possession cost of the average stock is 5F per unit and per month;
- The cost of placing a command is 5 760F;
- The safety cost corresponds to one month of consumption;
- Commands are placed at the beginning of the month and deliveries are received at the
same time;
- The replenish period is one month; and
- The forecasted consumptions for the year N+1 are the following :
Months J F M A M J J A S O N D Total
Consumptions 120 360 420 432 150 540 328 522 688 604 432 204 4800
Work required:

(a) Determine the EOQ and EON
(b) Use the accounting method to determine the elements of the budgets of commands,
deliveries, consumptions and the stocks for the year N+1
(c) Present in a single table the budget of commands, deliveries, consumptions and the stock
for the year N+1.
Solutions:
a) Determination of EOQ as well as EON

EOQ = 960 units
EON = 5 commands
b) Determination of elements of by the accounting method in the following table:
Periods Consumption Stock with eventual Deliveries Corrected Commands

(or exit) rupture (or shortage) stock
Dec N-1 - 480 -
Jan 120 360 -
Feb 360 0 960 960 Beginning of January
Mar 420 540 -
Apr 432 108 960 1068 Beginning of march
May 150 918 -
Jun 540 378 -
Jul 328 50 960 1010 Beginning of June
Aug 522 488 960 1448 Beginning of July
Sep 688 760 -
Oct 604 156 960 1116 Beginning of
September
Nov 432 684 -
Dec 204 480 -
Supplying Budget:
M D J F M A M J J A S O N D
Needs 480 780 852 582 690 868 850 1210 1292 1036 636 x
IS 480 360 960 540 1068 918 378 1010 1448 760
Deliveries 960 960

Stock after 480 1320 960 1500 1068 918 1338 1970 1448 1720 1116 684
deliveries
Consumption 120 360 420 432 150 540 328 522 688 604 432 204
FS 360 960 540 1068 918 378 1010 1448 760 1116 684 480
Safety stock 120 360 420 432 150 540 328 522 688 604 432 204 x
Date of commands 1/1 1/3 1/6 1/7 1/9
Supplying budget:
M J F M A M J J A S O N D
IS 480 360 960 540 1068 918 378 1010 1448 760 1116 684
Consumptions 120 360 420 432 150 540 328 522 688 604 432 204
Commands 01/01 01/03 01/06 01/07 1/9
Qty ordered 960 960 960 960
Date of delivery 01/02 01/04 01/07 01/08 1/10
Qty delivered 960 960 960 960 960
FS with rupture 360 0 540 108 918 378 50 1448 760 156 684 480
Corrected FS 360 960 540 1068 918 378 1010 1448 760 1116 684 480
Budgets of commands, deliveries, exists and stocks for the year N+1:
Month D J F M A M J J A S O N D
commands 960 960 960 960 960 x
Deliveries 960 960 960 960 960
Exists 120 360 420 432 150 540 328 522 688 604 432 204
Stock 480 360 960 540 1068 918 378 1010 1448 760 1116 684 480
2. BUDGETING BY CONSTANT PERIOD
When the gaps among deliveries are constant knowing the number of commands, the date of
the first delivery is determined and from there the other dates of delivery can easily be
determined. The main problem is that of determining the various quantities to order. To
overcome this problem the supply program should be established in such a way that the delivery
should bring up the opening stock at the level of needed consumption. The accounting or the
graphical method is used.
Example 13 - The management of SAMY enterprise thinks that during the year to come, there
will need 24 000 units of raw materials M in the manufacturing process. The stock on the 31/12
of the present year is 2800 units:
- The cost of placing a command is 600;

- The possession rate of stock is 9%;
- The safety stock is one month of consumption;
- Commands are placed and deliveries are done at the beginning of the month;
- The replenish(supplying) duration is one month;
- Budgeting is done by constant periods;
- The unit purchase price is 20F; and
- The forecasted consumptions were presented as follows:
Months J F M A M J J A S O N D Total
Consumption 1000 1800 2180 2160 2280 2700 2640 600 2940 2520 2160 1020 24 000
Work required:
1. Determine the optimal number of commands

2. Use the accounting method then the graphical method to determine the elements of the
supplying budget.
3. Present in a single table the budget of commands, deliveries, consumptions and stocks
for the year to come.
Solution:
1- Calculation of the value of N, N = 6 commands
2- Determination of the elements of the supplying budget:
Periods Cons Stock with Deliveries Corrected Commands

eventual stock
rupture Dates Qty
Dec N-1 - 2800 - - - -

Jan 1000 1800 - - - -
Feb 1800 0 4340 4340 Beginning of Jan 4340
Mar 2180 2160 - - -
Apr 2160 0 4980 4980 Beginning of mar 4980
May 2280 2700 - - -
Jun 2700 0 3240 3240 -
Jul 2640 600 - - Beginning of May 3240
Aug 600 0 5460 5460 Beginning of July 5460

Sep 2940 2520 - - -
Oct 2520 0 3180 3180 Beginning of Sep 3180
Nov 2160 1020 - - Beginning of Nov x
Dec 1020 0 x - -
Budget of commands, deliveries, consumptions and stocks for the year to come:
Month J F M A M J J A S O N D
commands 4340 4980 3240 5460 3180 x
Deliveries 4340 4980 3240 5460 3180 x
Exists 1000 1800 2180 2160 2280 2700 2640 600 2940 2520 2160 1020
Stock 1800 4340 2160 4980 2700 3240 600 5460 2520 3180 1020 x
2.4- CASH OR TREASURY BUDGET
The treasury budget is the summary of all transactions involving the bank and the cash accounts
that is all expenditure and receipts. In the other hand, cash budget is nothing but an estimation
of cash receipts and cash payments for specified period. It is prepared by the head of the
accounts department, i.e. chief accounts officer.
• Cash budget represents the cash requirements of the business during the budget period.
It is the plan of receipts and payments of cash for the budget period, analysed to show
the monthly flow of cash drawn up in such a way that the balance can be forecasted at
regular intervals.
• The cash budget is one of the most important elements of the budgeted balance sheet.
Information from the various operating budgets, such as the sales budget, the direct
materials purchases budget, and the selling and administrative expenses budget, affects
the cash budget.
• In addition, the capital expenditures budget, dividend policies, and plans for equity or
long-term debt financing also affect the cash budget.
Sections of a cash budget : The treasury budget is divided into :
a) The table of encashment or collections. They concern:
▪ Transactions created during the previous periods but having their outcome during the
current year. Ex., collections of customer’s debt;
▪ Or, transactions created during the current periods and having their outcome during the
same period, such as cash sales of goods.

b) Disbursements: They can be related to :
▪ Transactions carried during the previous periods but having their outcome during the
current year. Ex., settlement of suppliers debts.
▪ Or, transactions created during the current period and having their outcome during the
same period, such as cash purchase of goods.
c) The treasury budget properly so called: It takes into consideration the initial balance of
cash, the encashment and the disbursement so as to determine the balance at the end of
each month and the final balance at the end of a given period.
N.B.:
▪ There is a difference between charges and expenditure, revenues and receipt. Any
transaction which is not involving the cash or bank account should not enter in this
budget.
▪ Remember that the cash budget, as its name suggests, deals only in cash/bank
transactions; thus non-cash items, such as depreciation, are never shown. Where cash
discounts are allowed or received, only the actual amount of money expected to be
received or paid is recorded. Similarly, where a business incurs bad debts, only the
amount of money expected to be received from good trade receivables is recorded in
the cash budget.
▪ The main difficulty in the preparation of cash budgets lies in the timing of receipts and
payments –for example, trade receivables may pay two months after date of sale, or
trade payables may be paid by the business one month after date of purchase: it is
important to ensure that such receipts and payments are recorded in the correct month
column.
▪ amount of money expected to be received from good trade receivables is recorded in
the cash budget.

Example 14 – A Company expects to have 37500 cash in hand on 1st April, and requires you
to prepare an estimate of cash position during the three months. April, May and June the
following information is supplied to you:
Month Sales Purchases Wages Factory Office Selling
expenses expenses expenses
Feb 75 000 45 000 9 000 7 500 6 000 4 500
March 84 000 48 000 9 750 8 250 6 000 4 500
April 90 000 52 500 10 500 9 000 6 000 5 250
May 120 000 60 000 13 500 11 250 6 000 6 570

June 135 000 60 000 14 250 14 000 7 000 7 000
Other Information:
▪ Period of credit allowed suppliers 2 months.

▪ 20% of sales for cash and period of credit allowed to customers for credit is one month.
▪ Delay in payment of all expenses: 1 month.
▪ Income tax of 57 500 is due to be paid on June 15th.
▪ The company is to pay dividend to shareholders and bonus to workers of 15 000 and 22
500 respectively in the month of April.
▪ A plant has been ordered to be received and paid in May. It will cost 120 000.
Solution:
Cash budgets of April, May, and June
Particulars April May June
Opening balance 37 500 10 950 -
Sales (i) cash 20% 18 000 24 000 27 000
(ii) credit sales (1 month) 67 200 72 000 96 000
Total receipts (A) 122 700 106 950 123 000
Payments:
Purchase 45 000 48 000 52 500
Wages 10 500 13 500 14 250
Factory expenses 8 250 9 000 11 250
Office expenses 6 000 6 000 6 000
Selling expenses 4 500 5 250 6 570
Income tax - - 57 500
Dividend to shareholders 15 000 - -
Bonus to workers 22 500 - -
Plant cost - 120 000 -
Total payments (B) 111 750 201 750 148 070
Balance c/d (A-B) 10 950 (-) 94 800 (-) 25 070
Bank overdraft - (+) 94 800 (+) 25 070
Example 15- A friend of yours, Mike Anderson, has recently been made redundant from his
job as a sales representative for an arts and crafts company. Mike has decided to set up in
business on his own selling art supplies to shops and art societies. He plans to invest 20,000 of
his savings into the new business. He has a number of good business contacts, and is confident
that his firm will do well. He thinks that some additional finance will be required in the short
term and plans to approach his bank for this.
Mike asks for your assistance in producing a cash statement for his new business for the next
six months. He provides the following information:
• The business, which is to be called ‘Art Supplies’ will commence in January 2021.
• Non-current assets costing 8,000 will be bought in early January. These will be paid for
immediately and are expected to have a five-year life, at the end of which they will be worthless.
• An initial stock (inventory) of goods costing 5,000 will be bought and paid for at the beginning
of January.
• Monthly purchases of goods will then be made at a level sufficient to replace forecast sales
for that month, i.e., the goods he expects to sell in January will be replaced by purchases made
in January, and so on.
• Forecast monthly sales are:
January February March April May June
3,000 6,000 6,000 10,500 10,500 10,500
• The selling price of goods is fixed at the cost price plus 50 per cent; for example, the goods
he expects to sell in January for 3,000 will have cost him 2,000 (two-thirds of the selling price),
i.e., his mark-up is 50%.
• To encourage sales, he will allow two months’ credit to customers; however, only one month’s
credit will be received from suppliers of goods (but the initial goods will be paid for
immediately).
• Operating expenses of the business, including rent of premises, but excluding depreciation of
non-current assets, are estimated at 1,600 per month and are paid for in the month in which they
are incurred.
• Mike intends to draw 1,000 each month in cash from the business.
Work required - You are asked to prepare cash statement for the first six months of the
business.
Solution:

Establishment of cash budget of Mike Anderson
Details Jan Feb Mar Apr May Jun

Receipts:
Capital introduced 20,000 - - - - -
Balance c/f - 4,400 - - - -
Total receivables - - 3,000 6,000 6,000 10,500
Total receipts for month 20,000 4,400 3,000 6,000 6,000 10,500
Payments :
Non-current assets 8,000 - - - - -
Inventory 5,000 - - - - -
Trade payables - 2,000 4,000 4,000 7,000 7,000
Operating expenses 1,600 1,600 1,600 1,600 1,600 1,600
Drawings 1,000 1,000 1,000 1,000 1,000 1,000
Total payments for month 15, 600 4,600 6,600 6,600 9,600 9,600
Balance c/d 4,400 (2 00) (3,600) (600) (3,600) 900
Bank balance (or overdraft) - +200 +3,600 +600 +3,600 -
Application:
The balance sheet of TATA enterprise on the 31/12/2010 is presented as follows (in 00 000F):
Fixed assets 2 330 Capital 2 144
Deposits and advance on fixed assets 31 Financial provision for risk 148
Stocks 1 863 Medium term loans 298
Customers 54 Current account of shareholders 360
Cash 133 Suppliers 828
Short term loan 205
Accrued charges 12
Bank 261
Results 155
For the 1st semester of the year 2011 the forecasts are given as follows: (in 00 000FCFA)
Sales Purchases Salaries Other charges

July 500 200 120 40

August 600 300 130 50
September 800 500 140 50
October 900 400 140 60
November 800 500 150 70
December 500 200 160 70
Other information:
▪ Depreciation are included in “other charges” for 500 000F per month
▪ Customers settle 70% after a month, 20% 30days from the end of month sales, 10%
60days from the end of month.
▪ Purchases are settled 5% cash, 5% 30 days from the end of month of purchase, 10%
60days from the end of month and 80% 90days from the end of month.
▪ Salaries are paid at the end of the month. Social charges represent 50% of the amount
of salaries and are paid the month following that of salaries.
▪ The margin in purchase cost represents 60% of sales. Result is not distributed.
▪ Accrued charges are settled by half in July and August. The amount of customers (of
the balance sheet) is expected by 1/3 every month from July as well as suppliers debts.
▪ For the financial provisions for risk, we can envisaged disbursements of 7 000 000 in
August and 4 800 000FCFA in September.
▪ Medium term debts are settled by 5.2 millions on the 31st December and 5.2 millions on
the 30th June every year.
▪ The short term debt will be settled in three months: 5 millions in July, 5 millions in
August and 10.5 millions in September.
▪ The bank account in liabilities represents for 161 (in 00 000FCFA) an overdraft to be
reimbursed in July. The balance represents a short term debt payable in February.
Work required:
1. Present the treasury budget separately.
2. Present the forecasted balance sheet on the 31/12/2011.
2.5- THE INVESTMENT BUDGET

An investment is an expense incurred by the enterprise so as to improve on the productivity
and whose effects are felts over many years.
a) The cost of the investment: The amount of capital invested should include:
• Investment expenses properly so called accessory expenses (feasibility study expenses,

installation expenses etc . . . )
• The variation of the working capital: When the investment increases the production, the
stocks, the customer’s debts and the supplier’s claims will be modified. Thus, there is
necessity to finance an eventual increase.
b) Cash –flows attributed to the investment
▪ Operating charges = Operating expenditures + depreciation

▪ The cash-flow is therefore = Profit + depreciations
▪ Gross cash-flow = Profit before tax + depreciations
▪ Net cash-flow = Profit after tax + depreciation
N.B – the scrap (or residual) value of the project is considered as the cash-flow of the year N+1.
Example 16– A joint stock company wishing to expand and diversify its activities envisage to
acquire at the beginning of the year a new machine costing 30 000 000F having a life span of
5years, and to be depreciated linearly. The residual value of this asset at the end of the fifth year
is zero. The forecasted production in quantity is presented as follows:
• 1st year = 50 000 units

• 2nd year = 60 000 units
• 3rd year = 70 000 units
• 4th year = 80 000 units
• 5th year = 90 000 units
It is assumed that the entire production will be sold and the unit selling price will be 200 F and
will be constant all over the 5 years. The operating charges relating to this equipment amount
to 150 FCFA per unit sold. The company tax rate is 38.5%. Calculate the yearly cash-flows.
1 2 3 4 5
Turnover 10 000 000 12 000 000 14 000 000 16 000 000 18 000 000
Charges 7 500 000 9 000 000 10 500 000 12 000 000 13 500 000

P before tax 2 500 000 3000 000 3 500 000 4 000 000 4 500 000
Company tax 962 500 1 155 000 1 347 500 1 540 000 1 732 500
Profit after tax 1 537 500 1 845 000 2 152 500 2 460 000 2 767 500
Depreciations 600 000 600 000 600 000 600 000 600 000
Cash-flow 2 137 500 2 445 000 2 752 500 3 060 000 3 367 500
c) CRITERIA OF DECISION
(A) Traditional methods (or Non-discount methods)

(i) Pay-back Period Methods
(iii) Accounts Rate of Return
(B) Modern methods (or Discount methods)
(i) Net Present Value Method
(ii) Internal Rate of Return Method
(iii) Profitability Index Method
1- Pay-back Period: Pay-back period is the time required to recover the initial investment
in a project.
Initial investment
Pay-back period = Annual cash inflows
✓ Accept / Reject criteria: If the actual pay-back period is less than the predetermined
pay-back period, the project would be accepted. If not, it would be rejected.
Example 17- Project cost is 30,000 and the cash inflows are 10,000, the life of the project is5
years. Calculate the pay-back period.
Solution:
Initial investment 30 000
Pay-back period = Annual cash inflows = 10 000 = 3 years
✓ For uneven cash inflows: Normally the projects are not having uniform cash inflows.
In those cases the pay-back period is calculated, cumulative cash inflows will be
calculated and then interpreted.
Example 18- Certain projects require an initial cash outflow of 25000. The cash inflows for 6
years are 5000, 8000, 10000, 12000, 7000 and 3000.
Solution:

Year Cash inflows Cumulative cash
inflows
1 5000 5000
2 8000 13000
3 10000 23000
4 12000 35000
5 7000 42000
6 3000 45000
The above calculation shows that in 3 years 23000 has been recovered 2000, is balance out of
cash outflow. In the 4th year the cash inflow is 12000. It means the pay-back period is three
to four years, calculated as follows
2 000
Pay-back period = 3years + x 12 months
12 00
= 3 years 2 months.
2-Return on capital employed (ROCE) or Accounting rate of return (ARR)
ARR uses accounting information to measure profitability of an investment. Average rate of
return means the average rate of return or profit taken for considering the project evaluation. In
other words, it is the ratio of the average after tax profit divided by the average investment. The
average investment would be equal to half of the original investment if it were depreciated
constantly. Alternatively, it can be found out by dividing the total of the investment’s book
values after depreciation by the life of the project.
Average income
Accounting rate of return (ARR) = Average investment(book value) x 100
EADIT/n
ARR = Io+ In ,
2
where, EADIT = earnings after depreciation, interest and Taxes, Io = Initial investment, In =
Final investment and n = periods.
Initial investment (Io )+Final investment( In )
Average investment =
2
Initial investment−Scrap
Or, average investment = 2
✓ Accept/Reject criteria: If the actual accounting rate of return is more than the
predetermined required rate of return, the project would be accepted. If not it would be
rejected.

Example 19 – A project will cost 40 000. Its stream of earnings before depreciation and tax
(EBDIT) during five years is expected to be 10 000, 12 000, 14,000, 16 000, and 20 000.
Assume a 50% tax rate and depreciation to be linear. Calculate the ARR.
Period
1 2 3 4 5 Average
EBDIT 10 000 12 000 14 000 16 000 20 000 14 400
Depreciation 8 000 8 000 8 000 8 000 8 000 8 000
(-) EBIT 2 000 4 000 6 000 8 000 12 000 6 400
Taxes (50%) 1 000 2 000 3 000 4 000 6 000 3 200
EBIT 1 000 2 000 3 000 4 000 6 000 3 200
Book value of investment
Beginning 40 000 32 000 24 000 16 000 8 000
Ending 32 000 24 000 16 000 8 000 -
Average 36 000 28 000 20 000 12 000 4 000 20 000
3 200
IRR = 20 00 x 100 = 16 per cent
3-Net Present Value (NPV)
Net present value method is one of the modern methods for evaluating the project proposals.
Under this method, all cash inflows and outflow are discounted at a minimum acceptable rate
of return; usually the firm’s cost of capital. Mathematically,
tC
t − Co , where, Ct = Cash inflows of period t, Co = Initial investment outlay, r =
NPV =∑ (1+r)
Cost of capital and t = period .
▪ Accept/Reject criteria:
➢ NPV > 0, project is acceptable, in other words, a positive NPV means the project earns
a rate of return higher than the firm’s cost of capital.
➢ NPV < 0 , project is rejected.
➢ NPV = 0, may be either rejected or accepted.
Example 20 - From the following information, calculate the net present value of the two
projects and suggest which of the two projects should be accepted at discount rate (10%) of the
two.

Project X Project Y
Initial Investment 20 000 30 000
Estimated life 5 years 5 years
Scrap Value 1 000 2 000
The profits before depreciation and after taxation (cash flows) are as follows:
Project 1 2 3 4 5
X 5 000 10 000 10 000 3 000 2 000
Y 20 000 10 000 5 000 3 000 2 000
Solution:
t C
NPV(X)=∑ (1+r)t − Co
5 000 10,000 10,000 3 000 2 000 1 000

= (1+0.10)1 + (1+0.10)2
+ (1+0.10)3
+ (1+0.10)4
+ (1+0.10)5
+ (1+0.10)6
− 20 000
NPV(X) = 4.227
t C
NPV(Y) = ∑ (1+r)t − Co
20 000 10,000 5,000 3 000 2 000 2 000

= (1+0.10)1 + (1+0.10)2
+ (1+0.10)3
+ (1+0.10)4
+ (1+0.10)5
+ (1+0.10)6
− 30 000
NPV(Y) = 4.728
Comment: Project Y should be selected as net present value of project Y is higher.

4- Internal rate of return (IRR)
Internal rate of return is the interest rate that discounts an investment’s future cash flows to the
present so that the present value of cash inflows exactly equals the present value of the cash
outflows i.e., at that interest rate the net present value equals zero.
At a given internal rate of return (k):
t C C
NPV = 0 ↔ ∑ (1+k)t − Co = 0 ↔
∑ t t = Co (It implies that, present value of cash inflows
(1+k)
= initial cost outlay).

To calculate the IRR, we must choose two discount rates:
▪ The lower discount rate (L%) that will give a positive NPV, N L and
▪ The higher discount rate (H%) that will give a negative NPV, N H.
The IRR can be calculated using the trial and error method or the graphical method. The trial
NL
and error method is as follows: IRR = L + x (H − L)%.
NL − NH
N1 I2 −N2 I1
We can use also use the formula: IRR = N1 −N2
, where,
N1 = the NPV at the lower discount rate,

N2 = the NPV at the higher discount rate,
I1 = The lower discount rate, and
I2 = the higher discount rate.
▪ Accept / Reject criteria:
➢ when IRR > cost of capital, we accept the project
➢ when IRR < cost of capital, we reject the project
➢ when IRR = cost of capital, we may either accept the project or reject.
Example 21 – A company undertakes an investment that requires a minimum return of 17%

p.a and the following details are given:
Year 0 1 2 3 4
Cash flow(F) 4 000 1 200 1 410 1 875 1 150
Estimate the IRR at the cost of capital of 14% p.a
Solution:
Year Cash flows DF (14%) PV DF(16%) PV

0 (4000) 1.000 (4000) 1000 (4000)
1 1200 0.877 1,052 0.862 1,034
2 1410 0.769 1,084 0.743 1,048
3 1875 0.675 1,266 0.641 1,202
4 1150 0.592 681 0.552 635
Net present value (NPV) 83 (81)
NL
IRR = L + x (H − L)%
NL − N H
83
IRR = 14% + (16 − 14)% = 14% + (0.5𝑥2%) = 15%
83−−81
N1 I2 −N2 I1 (83)(0.16)−(−81)(0.14) 13.28+11.34

Or, IRR = = = = 15%
N1 −N2 83−−81 164
5- Profitability Index (PI):
PI is the ratio of the present value of cash-inflows, at the required rate of return, to the initial
cash outflow of the investment. The profitability index (PI) is the present value of a project’s
future cash flows divided by the initial investment. It can be expressed as:

PV of cash flows
PI = Initial investment
NPV
=1−
Initial investment
✓ Acceptance/ rejection rule :

➢ accept the project when PI > 1
➢ reject the project when PI < 1
➢ may accept or reject the project when PI = 1
Example 22– The initial cash outlay of a project is 100 000 and it can generate cash inflows of
40 000, 30 000, 50 000, and 20 000 in 4 years respectively. Assume a 10% rate of discount,
calculate the profitability index.
Solution:
40 000 30 000 50 000 20 000
+ + +
(1+0.1)1 (1+0.1)2 (1+0.1)3 (1+0.1)4
PI = = 1.124
100 000
Application:
The Gerhardt Corporation investment had an outlay of €50 million, a present value of future
cash flows of €63.136 million, and an NPV of €13.136 million. What is the profitability index?
d) CHOICE OF INVESTMENT WITH UNCERTAINTY
It is a matter of minimizing risk, when it comes to choosing among many investment projects
with a variability of cash-flows. Here, we attribute respective probability to each cash-flow.
Possible techniques are:
• Standard deviation
• Coefficient of variation
σ(X)
Coefficient of variation (CV) = 𝐸(𝑋), where, σ(X) = standard deviation and E(X) = mathematic
expectation = ∑ni=1 xi pi, xi = possible cash-flow of period i , pi = probability corresponding to

period i and n = number of possible cash-flows
σ(X) = √V(X) and V(X) = ∑ pi xi2 − [E(X)]2
The lower is the coefficient of variation, the less is the risk.
Application exercise: The management of an enterprise hesitates between two investment

projects. The study of cash flows enables to determine the following probability for each of the
two projects:

Project A:
Cash flows 0 40 000 80 000 120 000 160 000 200 000
Probability 0.2 0.3 0.2 0.15 0.1 0.05
Project B:
Cash flows 0 40 000 80 000 120 000 160 000 200 000 240 000 280 000
Probability 0.25 0.32 0.16 0.1 0.08 0.05 0.02 0.01
Work required: what is the best project for the enterprise?
Project A:
E(X)= ∑ni=1 xi pi = 72 000
V(X) = 8 480 000 000 – (72 000)2 = 3 296 000 000
σ(X) = √V(X) = √3 296 000 000 = 57 410.8
57 410.8
CV = = 0.7953
72 000
Project B:
E(Y)= ∑ni=1 xi pi = 71 200
V(Y) = 9 884 000 000 – (71 200)2 = 4 914 560 000
σ(Y) = √V(X) = √4 914 560 000 = 70 103.92
70 103.92
CV = = 0.9846
71 200
Comment: By considering the mathematic expectation, the project A is more advantageous

than the project B. However, by considering the coefficients of variations, we notice that the
coefficient of A is the less, meaning that project A has less risk. It is therefore preferable to
choose the project A.
e) CHOICE OF INVESTMENT WITH UNEQUAL LIFE SPANS
Many methods enable to compare projects having different life spans. These methods include
among others:

• Identical renewal: To appreciate the profitability of projects using this method, we
assume that investments are renewed exactly as far as their amounts and life spans are
concerned in such a way that their total durations should be the same. For instance, for
two projects A and B having respectively 3 years and 9 years as life span, the project A
will be renewed three times so that its duration should be the same as that of project B;
if the life span of the project A is 2 years and that of project B is 3 years, the project A
will be renewed three times and the project B will be renewed two times so that they
should all have a duration of 6 years.
• Residual value of the investment: If the residual value of investments at the end of
different exercises (periods) are known, these values can be used to study the
profitability of the different projects over the life span of the project having the shortage
life span.
• Method of equivalent constant annuities: - In this method the net actual value of each
investment is calculated and the value of equivalent constant annuities which reimburses
the NAV over the life span of the project is calculated.
Example 23 - A company located in Bamenda wants to realize an investment. The management

of this structure contemplates between two projects. Information concerning these projects is
given in the following table:
Project A Project B
Acquisition price of equipments 14 000 000 14 000 000
Forecasted annual net cash flows 5 000 000 3 200 000
Life span 4 years 8 years
Residual value at the end of the life span 0 0
Equipments are depreciated according to the constant system of depreciation and the net
accounting value is considered as the residual value at the end of each year. The actualization
rate is 10%.
Work required: what is the most profitable project?
1- Using the method of identical renewal and by calculating the net actual value
2- By calculating the NAV of each investment after a life span of 4 years
3- Using the method of equivalent constant annuity.
Solution:

1- Method of identical renewal
Project 1:
1− (1.10)−8
NAV = -[14 000 000 + 14 000 000 (1.10)-4] + 5 000 000( )
0.10
= - 23 562 188 + 26 674 630 → NAV = 3 112 442

Project 2:
1− (1.10)−8
NAV = - 14 000 000 + 3 200 000( )
0.10
= - 14 000 000 + 17 071 763 → NAV = 3 071 763

With this method, project 1 is preferable to project 2.
2- Calculation of the NAV over 4 years
Project 1:
1− (1.10)−8
NAV = -14 000 000 + 5 000 000( ) → NAV = 1 849 327
0.10
Project 2: residual value at the end of the 4th year:

14 000 000 x 4
14 000 000 – = 7 000 000
8
1− (1.10)−4
NAV = - 14 000 0000 + 3 200 000( ) + 7 000 000(1.10)-4
0.10
= - 14 000 000 + 10 143 569 + 4 781 094 → NAV = 924 663

With this method, project 1 is still preferable to project 2.
3. Method of equivalent constant annuities
*Calculation of the Net Actual Value (NAV)
Project 1:
1− (1.10)−8
NAV = -14 000 000 + 5 000 000( ) → NAV = 1 849 327
0.10
Project 2:
1− (1.10)−8
-14 000 000 + 3 200 000( ) → NAV = 3 071 763
0.10
*Calculation of equivalent constant annuity of each project:

Project 1:
0.1
Constant annuity = 1 849 327 (1− (1.10)−4 ) = 583 408
Project 2:
0.1
Constant annuity = 3 071 763 (1− (1.10)−8 ) = 575 783
With this method, project 1 is still preferable to project 2.

f– THE LEASE CREDIT

It is financing method which enables the enterprise to acquire equipment without having
necessarily all the means needed, but only by showing it ability of paying regularly rent. The
essential characteristics of this method are the following:
▪ the equipment is chosen by the enterprise, the user;
▪ the equipment is acquired by the lease company who is by then the “landlord”;
▪ the enterprise agrees with the lease company on the amount and the terms of the rent;
and
▪ the duration of the rent is most often the life span of the asset
At the end of the life span of the asset, the enterprise has many options:
▪ either it gives back the depreciated equipment to the lease company, or
▪ it continues using the equipment by paying a lesser rent earlier agreed with the lease
company, or
▪ the enterprise can acquire the equipment at residual value earlier agreed with the lease
company.
Example 24- NONO enterprise is hesitating between two investment projects: to acquire a
delivery van either through lease credit or by taking a medium term loan.
Cost of the investment 6000 000
Depreciation rate 10%
a) Characteristics of the lease-credit:
▪ deposits : 10% of the cost of equipment
▪ annual rent during 5 years: 24%
▪ possibility of acquiring the equipment at the end of the life span: at 15% of the original
value reduced by the deposit which has yielded interest during 5 years at the annual rate
2.5% simple interest.
b) Characteristics of the loan:
▪ Amount: 6 000 000F
▪ Interest: 8.75% (simple interest for simplification)
▪ Reimbursement: single payment at the end of the 5th year.
Work required:
1- Compare over 5 years, by considering the fiscal incidence: the total charges and expenditure
in each of the two hypotheses.
2. Assuming that the enterprise has decided to acquire the equipment at the end of the 5th year,
compare the two financing methods by considering the problem that will occur at the end of the
10th year related to the renewal of the equipment.

Solution:
1 2 3 4 5
Financial charges:
Deposit 600 000
Rent 1 440 000 1 440 000 1 440 000 1 440 000 1 440 000
Purchase 900 000
Reimbursement (750 000)
Total 2 004 000 1 440 000 1 440 000 1 440 000 1 440 000
Accumulated charges 2 004 000 2 880 000 4 320 000 5 760 000 (150 000)
Other charges:
Rent 1 440 000 1 440 000 1 440 000 1 440 000 1 440 000
Interest on deposit (150 000)
Total 1 440 000 1 440 000 1 440 000 1 440 000 1 290 000
Accumulated charges 1 440 000 2 880 000 4 320 000 5 760 000 7 050 000
Fiscal incidence (38.5%) 2 714 250
Borrowing:
1 2 3 4 5
Financial charges:
Interests 525 000 525 000 525 000 525 000 525 000
Reimbursement 6000 000
Total 525 000 525 000 525 000 525 000 6 525 000
Accumulated charges 525 000 1 050 000 1 575 000 2 100 000 8 625 000
Other charges:
Interest 525 000 525 000 525 000 525 000 525 000
Reimbursement 600 000 600 000 600 000 600 000 600 000
Total 1 125 000 1 125 000 1 125 000 1 125 000 1 125 000
Accumulated charges 1 125 000 2 250 000 3 375 000 4 500 000 5 625 000
Fiscal incidence (38.5%) 263 700
The real expenditure is the difference between financial charges and the fiscal economy
realised:
a) Lease-credit : 7 950 000 – 2 714 250 = 5 234 750
b) Loan: 8 625 000 – 2 163 700 = 6 461 300
The first formula seems to be the best as far as expenditures are concerned.

Application:
Kenfack is liable to the company tax at the rate of 38.5% and projects to invest at the beginning
of the year N an amount of 150 000 000F paid cash for the acquisition of an equipment to be
depreciated over 5 years(constant method). The cash flows all realised at the end of the year are
the following:
Year N N+1 N+2 N+3 N+4
Cash flows 50 000 000 50 000 000 70 000 000 70 000 000 60 000 000
a) Say when exactly the capital invested will be recovered.

b) Knowing that the residual value at the end of the 4th year will be nil and that the
actualisation rate is 10%, calculate the net actual value.
c) Calculate the internal rate of return.
2.6 - BUDGET RATIO
These ratios provide information about the performance level, i.e., the extent of deviation of
actual performance from the budgeted performance and whether the actual performance is
favourable or unfavourable. If the ratio is 100% or more, the performance is considered as
favourable and if ratio is less than 100% the performance is considered as unfavourable. The
following ratios are usually used by the management to measure development from budget.
2.6.1- Capacity usage ratio: This relationship between the budgeted number of working hours
and the maximum possible number of working hours in a budget period.
▪ Standard Capacity Employed (or usage) Ratio: This ratio indicates the extent to
which facilities were actually utilized during the budget period. It is equal to =
Budgeted Hours
x 100
Max possible hours in the budgeted period
Actual hours worked
▪ Actual capacity usage ratio = Max possible woreking in a period x 100
Acrual hours worked
▪ Actual usage of budgeted capacity ratio = x 100
Budgeted hours
2.6.2- Calendar ratio: This ratio may be defined as the relationship between the number of
working days in a period and the number of working as in the relative budget period. It is
Available workink days
calculated as follows: Calendar ratio = Budgeted working days x 100
2.6.3-Control ratio: Budget is a part of the planning process. After the various budgets,
including the master budget, have been prepared, you may like to compare actual performance
with the budgeted performance. This can be done by using three important ratios as shown

below: Activity ratio, capacity ratio and efficiency ratio. The above ratios are expressed in terms
of percentages. If the ratio works out to 100 per cent or more, the trend is taken as favourable.
If the ratio is less than 100 per cent, the indication is taken as unfavourable. We shall discuss
these ratios in some details.
a) Activity Ratio: Activity Ratio is a measure of the level of activity attained over a period of
time. This may be defined as the number of standard hours equivalent to work produced
expressed as a percentage of the budget of standard hours. It is obtained by expressing the
number of standard hours equivalent to the work produced as a percentage of the budgeted
Standard hours for actual production
hours. It is calculated as follows: Activity Ratio = x 100
Budgeted hours
b) Capacity Ratio: This ratio indicates whether and to what extent budgeted hours of activity
are actually utilised. It shows the relationship between the actual number of working hours and
the maximum possible number of working hours in a budgeted period. It is calculated as
Actual hours worked
follows: capacity Ratio = x 100
Budgeted hours
2.6.4- Efficiency Ratio: This ratio indicates the degree of efficiency attained in production. It
is obtained by expressing the standard hours equivalent to the work produced as a percentage
of the actual hours spent in producing that work. It is calculated as follows: Efficiency ratio
Standard hours for actual production
= x 100
Actual hours worked in production
It should be noted that: Activity ratio = capacity ratio x efficiency ratio.

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COURSE TITLE: BUDGET MANAGEMENT

ACCOUNTING CONTROL AND AUDITING

OBJECTIVE OF THE COURSE:

Dr. Forbeneh Jude (Ph.d in Finance) Page 1

Dr. Forbeneh Jude (Ph.d in Finance) Page 3

1.5.1 - The main features of budgetary control are:

Dr. Forbeneh Jude (Ph.d in Finance) Page 4

Dr. Forbeneh Jude (Ph.d in Finance) Page 5

Dr. Forbeneh Jude (Ph.d in Finance) Page 6

CHAPTER 2 – TYPES OF BUDGETS

Dr. Forbeneh Jude (Ph.d in Finance) Page 7

▪ Last sales figures

∑(𝑥𝑖 − x̅)(𝑦𝑖 − 𝑦̅)

Dr. Forbeneh Jude (Ph.d in Finance) Page 8

y = 552t + 8212 → The trend (yt ) = 552t + 8212.

Dr. Forbeneh Jude (Ph.d in Finance) Page 9

T15 = 552 x 15 + 8212 = 16 492.

• r ranges between -1 and +1 . That is, −1 ≤ 𝑟 ≤ +1.

Dr. Forbeneh Jude (Ph.d in Finance) Page 10

• If k is odd, Mt = (Yt−p + Yt−p+1 + … + Yt + Yt+1 + … + Yt+p )/k, with p =

values are divided by 2 in order to maintain the equivalence of k whole numbers.

Quarter 2002 2003 2004 2005

M3 = (Y1 + Y2 + Y3 + Y4 + Y5 )/k= (455+ 578 + 763 +563 +438)/5 = 559.4

Year t Y Moving total Moving averages (Tt)

Dr. Forbeneh Jude (Ph.d in Finance) Page 11

Term/Quarterly (n =4) Calculation of moving total

Dr. Forbeneh Jude (Ph.d in Finance) Page 12

2- Equation of the trend line of moving total

▪ arrange the data in increasing order of their x-values;

Dr. Forbeneh Jude (Ph.d in Finance) Page 13

▪ arrange the data in ascending order of magnitude;

Food expenditures (000) 10 8 10 12 10 9 14

Dr. Forbeneh Jude (Ph.d in Finance) Page 14

average observations of the period

average observations of the period

Quarters 1st quarter 2nd quarter 3rd quarter 4 quarter Total

Dr. Forbeneh Jude (Ph.d in Finance) Page 15

1. Equation of the general trend line: y = 18.83x + 363.95

Elements 1st quarter 2nd quarter 3rd quarter 4th quarter

1st quarter 2nd quarter 3rd quarter 4th quarter

➢ Determination of the seasonal coefficients

Quarters Average Average of adjusted value Seasonal coefficients

Dr. Forbeneh Jude (Ph.d in Finance) Page 16

4th quarter 954/4 = 238.5 439.27+514.59+589.91+665.23

2.1.2- ESTABLISHMENT OF SALES BUDGET

A – Display per product and per period:

Period 1 Period 2 Period 3 Period 4 Period 5 Period 6 Totals

B – Display per product, per region and per period

Region A Region B Total

Dr. Forbeneh Jude (Ph.d in Finance) Page 17

a – Sales program in number of bottles:

Places Zone A: Zone B: Zone C: Other CEMAC

- Cameroon : 2 000F tax exclusive

▪ Cameroon : Fixed : 240 000 F per quarter

Dr. Forbeneh Jude (Ph.d in Finance) Page 18

1. Graphical representation (in class)

Unit prices from the 3rd quarter:

Zone A: 2000 + (2000 x 20%) = 2400