Budget is an operational plan, for a definite period usually a year.
It is expressed in financial terms and based on the expected income and expenditure.
Purposes of Budgeting:
•Mechanism for translating fiscal objectives into projected monthly spending pattern.
•Enhances fiscal planning and decision making.
•Clearly recognizes controllable and uncontrollable cost areas.
•Offers a useful format for communicating fiscal objectives.
•Allows feedback of utilization of budget.
• Helps to identify problem areas and facilitates effective solution.
• Provides means for measuring and recording financial success with objectives of organization.
Characteristics of budgeting
1.Should be flexible.
2.Should be synthesis of past ,present and future.
3.Should be product of joint venture and cooperation of executive/department head at different level of management.
4.Should be in the form of statistical standard laid down in the specific numerical terms.
5.Should have support of top management throughout the period of its planning and implementation
Importance of budgeting
1.Needed for planning future course of action and control over all activities in the organization.
2.Facilitates coordinating operation of various departments and sectors.
3.Helps to weigh values and make decision when necessary.
Principles of Budget
1.Should provide sound financial management by focusing on requirement of the organisation
2.Should focus on the objectives and policies of the organization.
3.Should ensure the most effective use of financial and non financial resources.
4.Programme activities should be planned in advance.
5.Requires consistent delegation for framing and executive budget.
6.Should include coordinating efforts of various departments establishing a frame of reference for managerial decision and evaluate managerial performance.
Cost Analysis - Short-run Cost Function
•TOTAL COST TC = FC + VC
•FIXED COST - stays constant no matter what level of output
•VARIABLE COST - vary with the level of output
•Marginal cost = the extra or additional cost of producing 1 extra unit of output
•Average cost (unit costs) – concept that enables a firm to dicern whether or not it is making a profit (compared with price or average revenue)
AC can be broken down into two components – AFC and AVC
Average Fixed Cost
•since total fixed cost is a constant, dividing it by an increasing output gives a steadily falling
Average Variable Cost
•VC divided by output
Connection between AC and MC
•if MC is below AC, AC must be falling (the last unit produced costs less than the average of all the earlier units produced č AC including the last unit must be less than the old AC) ,
•if MC is above AC, AC must be rising (the last unit costs more than the average of the earlier units, the AC including the last unit must be higher than the old AC),
•if MC is just equal to AC čthe last unit costs exactly the same as the average cost of all earlier units (the AC curve is flat).
Short-run cost curves
The link between production and costs
•the shape of cost curves is affected strictly by the shape of production function, which reflects the form of returns čthe U-shaped cost curves are grounded in the law of diminishing returns
•the essence of the link between costs and production is simple – for each level of output, firms must choose the least costly combination of inputs
The Long-Run Cost Curve
•the long-run cost curves depends on production function also – therefore, depends on the returns to scale
•the long-run average cost (LAC) curve is called „envelope curve“, because it wraps around the outside of all the short-run curves
•LMC can be derived from the LAC – also goes through the minimum point of the LAC and has a gentler slope than the short-run SMC at the minimum point
The Least-cost Rule
- whatever the level of output, the firm should strive to produce that output at the lowest possible cost and thereby have the maximum amount of revenue left over for profits
MPL/ w = MPK/r
- technological optimum = the level of output with the lowest average cost
Other cost concepts
•difference between economic and accounting approach to cost
•OPPORTUNITY COST (implicit cost) = implicit return to labor supplied by the owner of a firm