Budgetary control is the process by which budgets are prepared for the future period and are compared with the actual performance for finding out variances, if any. The comparison of budgeted figures with actual figures will help the management to find out variances and take corrective actions without any delay.
ACCORDING TO INSTITUTE OF COST & WORKS ACCOUNTANT, ENGLAND
“The establishment of budgets relating the responsibilities of executives to the requirements of a policy, and the continuous comparison of actual with budgeted results, either to secure by individual action, the objectives of that policy or to provide a firm basis for its revision.”
ACCORDING TO BROWN AND HOWARD
“Budgetary control is a system of controlling costs which includes the preparation of budgets, coordinating the departments and establishing responsibilities, comparing actual performance with the budgeted and acting upon results to achieve maximum profitability.”
ACCORDING TO J BATTY
“Budgetary control is a system which uses budgets as a means of planning and controlling all aspects of producing and / or selling commodities or services.”
ACCORDING TO H.S. WHELDON
“By budgetary control, every items of actual cost is so controlled by vigilant supervision as to make it conform, as nearly as possible, to the predetermined standards. It has resulted in the elimination of waste and excess costs in every suitable instance where budgetary control has been properly instituted.”
CHARACTERISTICS/FEATURES OF BUDGETARY CONTROL
An effective budgeting system is vital to the success of a business firm. Without a fully coordinated budgeting system, management cannot know the direction business is taking. Budgets are prepared with the following objectives and perform following functions:
- Control and performance evaluation.
All business activities are preceded by planning. Planning at the first instance involves in deciding company’s broad aims and objectives. A budget is nothing but deciding the financial objectives of the firm. A budget incorporates expected performance and present managerial targets.
These targets guide the business operations and help in overcoming problems and analyzing the future. Budgeting influences the formulation of all business strategies and subsequently assists business managers in executing such strategies.
It is necessary in an efficient organisation that all people be informed about the objectives, policies, programmes and performances. They should have a clear understanding of the aims and objectives and the part they have to play in goal attainment.
This is made possible through their participation in the budgeting process. Budgets inform each manager of what others have agreed to do. They also inform managers of the resources available to achieve objectives and targets.
Under coordination, all factors of production and all departmental activities are balanced and integrated to achieve the objectives of the organisation. The individual managers, work for their individual interest as well as for the benefit of the organisation as a whole. According to Horngreen, budgets help management to coordinate in the following ways:
(i) Budgets help to search out weaknesses in the organisation structure. The formulation and administration of budgets isolate problems of communication, of fixing responsibility and of working relationship.
(ii) Budgets help to restrain to empire building efforts of executives. Budgets broaden individual thinking by helping to remove unconscious biases on the part of engineers, sales and production officers.
(iii) The existence of the well laid plans is the major step towards achieving coordination. Executives are forced to think of relationships among individual operations and the company as a whole.
Budgeting ensures coordination in the absence of which different departments in an organisation may act in a manner which is beneficial only to their individual departments but not to the firm objectives as a whole.
(D) CONTROL AND PERFORMANCE EVALUATION
Budgets are the basis of performance evaluation as they reflect realistic estimates of acceptable and expected performance. Most managers are interested to know what is expected of them so that they may monitor their own performance.
It is more accurate, reliable and reasonable to measure current performance against a budget rather than against a vague expectation or against results of previous year when conditions might have changed.
TYPES OF BUDGETARY CONTROL
There are various types of budgetary control an organization can implement –
OPERATIONAL BUDGETARY CONTROL
It covers the revenue and operating expenses which are essentials to running day to day business. The actual numbers to a budget are compared monthly in most cases. It helps in achieving control over EBITDA – Earning before interest taxes depreciation and amortization.
CASH FLOW BUDGETARY CONTROL
This is an important budget which keeps control over the working capital requirement and cash management. Cash crunches could be detrimental to everyday functioning, so this is an important aspect.
CAPEX BUDGETARY CONTROL
It covers capital expenditures like buying machinery or constructing a building. Because it involves a huge amount of money, the control here helps in eliminating waste and reducing cost.
OBJECTIVES OF BUDGETARY CONTROL
The following are the objectives of a budgetary control:
Identify the overall aims and objectives of the business and determining targets of performance for each section or department of the business.
RESPONSIBILITIES OF EXECUTIVES
Laying down the responsibilities of each of the executives and other personnel so that everyone knows what is expected of him and how he will be evaluated. Budgetary control is one of the few ways in which an objective assessment of executives and departments is possible.
BASIS FOR COMPARISON AND INVESTIGATION OF VARIATIONS
Providing a basis for the comparison of actual performance with predetermined targets and investigation of variations, if any, between the budgeted targets and the actual. This helps in adopting corrective measures.
BEST USE OF RESOURCES
Ensuring the best use of all available resources to maximise profit or production, subject to the limiting factors. Since proper preparation of budgets requires consideration of all aspects, there is usually good coordination when a system of budgetary control exists.
Planning is an important managerial function. It helps to decide in advance, what to do, how to do it, when to do it and who is to do it. Planning, thus, helps the managers to anticipate eventualities, prepare for contingencies for achieving the ultimate goals. Budget preparation drives the managers to plan ahead.
Managers express their operational plans for anticipated business conditions. Without a formal procedure of budgetary control, many operating managers will not find the time to plan ahead. Thus, budgeting is an important planning device.
The employees of an organisation should know organisational aims, objectives of sub-units (budget centres) and the part that they have to play for their attainment. Budgets effectively communicate this information to employees. Besides, budgets keep different sections of the organisation informed about the contribution of different sub-units in the attainment of overall organisational objectives.
To coordinate is to harmonise all the activities of a company so as to facilitate its working and its success.
Coordination will lead to following results:
- i. Each department will work in harmony with others,
- ii. Each department will know the specific role that it has to play in the accomplishment of overall organisational objectives, and
- iii. The sequential arrangement of activities of different departments is so governed that overlapping of activities and wastage of time and labour is avoided.
A comprehensive system of budgeting helps to coordinate different functional budgets. In other words, a budget will preclude the production department from producing more than the sales department can sell.
If employees have actively participated in budget preparation and if they are convinced that their personal interests are closely associated with the success of organizational plan, budgets provide motivation in the form of goals to be achieved. The budgets will motivate the workers, depends purely on how the workers have been mentally and physically involved with the process of budgeting.
Under the system of budgetary control, budget forecast is thoroughly discussed and reviewed to be finally approved as functional budgets. Thereafter a lot of ‘cuts’ and ‘adjustments’ are made to make functional budgets fit in the organizational objectives.
Then budget formation is followed by a feedback system to pinpoint the extent of variation between actual level of performance and budgeted level of performance. Thus, the inbuilt mechanism of the routine of budgetary control is bound to precipitate to an operational control.
A master budget provides an approved summary of results to be expected from proposed plan of operations. It concerns all functions of organisation and serves as a guide to executives and departmental heads responsible for various departmental objectives.
The main aim of budgetary control is to control the production and other costs with maximum output.
DETERMINATION OF POLICIES
Business policies are determined through budgetary control, which shows the path for the future growth of the organisation.
STEPS OF BUDGETARY CONTROL
There are certain steps which are necessary for the successful implementation budgetary control system.
These are as follows:
- Organisation for Budgetary Control
- Budget Centres
- Budget Mammal
- Budget Officer
- Budget Committee
- Budget Period
- Determination of Key Factor.
1. ORGANIZATION FOR BUDGETARY CONTROL
The proper organization is essential for the successful preparation, maintenance and administration of budgets. A Budgetary Committee is formed, which comprises the departmental heads of various departments. All the functional heads are entrusted with the responsibility of ensuring proper implementation of their respective departmental budgets.
The Chief Executive is the overall in-charge of budgetary system. He constitutes a budget committee for preparing realistic budgets A budget officer is the convener of the budget committee who co-ordinates the budgets of different departments. The managers of different departments are made responsible for their departmental budgets.
2. BUDGET CENTRES
A budget centre is that part of the organization for which the budget is prepared. A budget centre may be a department, section of a department or any other part of the department. The establishment of budget centres is essential for covering all parts of the organization. The budget centres are also necessary for cost control purposes. The appraisal performance of different parts of the organization becomes easy when different centres are established.
3. BUDGET MANUAL
A budget manual is a document which spells out the duties and also the responsibilities of various executives concerned with the budgets. It specifies the relations amongst various functionaries.
4. BUDGET OFFICER
The Chief Executive, who is at the top of the organization, appoints some person as Budget Officer. The budget officer is empowered to scrutinize the budgets prepared by different functional heads and to make changes in them, if the situations so demand. The actual performance of different departments is communicated to the Budget Officer. He determines the deviations in the budgets and the actual performance and takes necessary steps to rectify the deficiencies, if any.
He works as a coordinator among different departments and monitors the relevant information. He also informs the top management about the performance of different departments. The budget officer will be able to carry out his work fully well only if he is conversant with the working of all the departments.
5. BUDGET COMMITTEE
In small-scale concerns the accountant is made responsible for preparation and implementation of budgets. In large-scale concerns a committee known as Budget Committee is formed. The heads of all the important departments are made members of this committee. The Committee is responsible for preparation and execution of budgets. The members of this committee put up the case of their respective departments and help the committee to take collective decisions if necessary. The Budget Officer acts as convener of this committee.
6. BUDGET PERIOD
A budget period is the length of time for which a budget is prepared and employed. The budget period depends upon a number of factors. It may be different for different industries or even it may be different in the same industry or business.
The budget period depends upon the following considerations
- The type of budget i.e., sales budget, production budget, raw materials purchase budget, capital expenditure budget. A capital expenditure budget may be for a longer period i.e. 3 to 5 year’s purchase, sale budgets may be for one year.
- The nature of demand for the products.
- The timings for the availability of the finances.
- The economic situation of the country.
- The length of trade cycles.
All the above-mentioned factors are taken into account while fixing period of budgets
7. DETERMINATION OF KEY FACTOR
The budgets are prepared for all functional areas. These budgets are interdependent and inter-related. A proper co-ordination among different budgets is necessary for making the budgetary control a success. The constraints on some budgets may have an effect on other budgets too. A factor which influences all other budgets is known as Key Factor or Principal Factor.
There may be a limitation on the quantity of goods a concern may sell. In this case, sales will be a key factor and all other budgets will be prepared by keeping in view the amount of goods the concern will be able to sell. The raw material supply may be limited, so production, sales and cash budgets will be decided according to raw materials budget. Similarly, plant capacity may be a key factor if the supply of other factors is easily available.
The key factor may not necessarily remain the same. The raw materials supply may be limited at one time but it may be easily available at another time. The sales may be increased by adding more sales staff, etc. Similarly, other factors may also improve at different times. The key factor also highlights the limitations of the enterprise. This will enable the management to improve the working of those departments where scope for improvement exists.
ADVANTAGES OF BUDGETARY CONTROL
The budgetary control system help in fixing the goals for the organization as whole and concerted efforts are made for its achievements. It enables economies in the enterprise.
Some of the advantages of budgetary control are:
1. MAXIMIZATION OF PROFITS
The budgetary control aims at the maximization of profits of the enterprise. To achieve this aim, a proper planning and co ordination of different functions is undertaken. There is a proper control over various capital and revenue expenditures. The resources are put to the best possible use.
The working of different departments and sectors is properly coordinated. The budgets of different departments have a bearing on one another. The co-ordination of various executives and subordinates is necessary for achieving budgeted targets.
3. SPECIFIC AIMS
The plans, policies and goals are decided by the top management. All efforts are put together to reach the common goal, of the organization. Every department is given a target to be achieved. The efforts are directed towards achieving some specific aims. If there is no definite aim then the efforts will be wasted in pursuing different aims.
4. TOOL FOR MEASURING PERFORMANCE
By providing targets to various departments, budgetary control provides a tool for measuring managerial performance. The budgeted targets are compared to actual results and deviations are determined. The performance of each department is reported to the top management. This system enables the introduction of management by exception.
The planning of expenditure will be systematic and there will be economy in spending. The finances will be put to optimum use. The benefits derived for the concern will ultimately extend to industry and then to national economy. The national resources will be used economically and wastage will be eliminated.
6. DETERMINING WEAKNESSES
The deviations in budgeted and actual performance will enable the determination of weak spots. Efforts are concentrated on those aspects where performance is less than the stipulated.
7. CORRECTIVE ACTION
The management will be able to take corrective measures whenever there is a discrepancy in performance. The deviations will be regularly reported so that necessary action is taken at the earliest. In the absence of a budgetary control system the deviations can be determined only at the end of the financial period.
It creates budget consciousness among the employees. By fixing targets for the employees, they are made conscious of their responsibility. Everybody knows what he is expected to do and he continues with his work uninterrupted.
9. REDUCES COSTS
In the present day competitive world budgetary control has a significant role to play. Every businessman tries to reduce the cost of production for increasing sales. He tries to have those combinations of products where profitability is more.
10. INTRODUCTION OF INCENTIVE SCHEMES
Budgetary control system also enables the introduction of incentive schemes of remuneration. The comparison of budgeted and actual performance will enable the use of such schemes.
11. SHUTTING DOWN OF UNPROFITABLE PRODUCTS AND ACTIVITIES
Budgetary control reveals inefficiencies in products, processes and departments. This is helpful in closing down of loss making divisions to improve the overall profitability.
LIMITATIONS OF BUDGETARY CONTROL
Despite of many good points of budgetary control there are some limitations of this system.
1. UNCERTAIN FUTURE
The budgets are prepared for the future period. Despite best estimates made for the future, the predictions may not always come true. The future is always uncertain and the situation which is presumed to prevail in future may change. The change in future conditions upsets the budgets which have to be prepared on the basis of certain assumptions. The future uncertainties reduce the utility of budgetary control system.
2. BUDGETARY REVISION REQUIRED
Budgets are prepared on the assumptions that certain conditions will prevail. Because of future uncertainties, assumed conditions may not prevail necessitating the revision of budgetary targets. The frequent revision of targets will reduce the value of budgets and revisions involve huge expenditures too.
3. DISCOURAGE EFFICIENT PERSONS
Under budgetary control system the targets are given to every person in the organization. The common tendency of people is to achieve the targets only. There may be some efficient persons who can exceed the targets but they will also feel contented by reaching the targets. So budgets may serve as constraints on managerial initiatives.
4. PROBLEM OF CO-ORDINATION
The success of budgetary control depends upon the co-ordination among different departments. The performance of one department affects the results of other departments. To overcome the problem of coordination a Budgetary Officer is needed. Every concern cannot afford to appoint a Budgetary Officer. The lack of co-ordination among different departments results in poor performance.
5. CONFLICT AMONG DIFFERENT DEPARTMENTS
Budgetary control may lead to conflicts among functional departments. Every departmental head worries for his department goals without thinking of business goal. Every department tries to get maximum allocation of funds and this raises a conflict among different departments.
6. DEPENDS UPON SUPPORT OF TOP MANAGEMENT
Budgetary control system depends upon the support of top management. The management should be enthusiastic for the success of this system and should give full support for it. If at any time there is a lack of support from top management then this system will collapse.
7. CHANGES OF CONDITIONS
Budgets are prepared on the basis of certain prevailing conditions. If the conditions change budgets are also to be revised. Constant changes in budgets may frustrate the employees and the charm in budgeting and implementation may be lost.
ESSENTIAL OF EFFECTIVE BUDGETARY CONTROL
Following are requirements of a good system of budgetary control in the organization:
1. QUICK REPORTING
A good system of budgetary control in the organization requires the establishment of such procedures, which will provide reports on the performance of various operations. The reports should reach the persons concerned with the implementation of budgets without any delay so that quick actions may be taken wherever necessary in the organization.
2. DETAILED ORGANIZATION STRUCTURE
There should be a detailed organization structure with precisely designed authorities, responsibilities and lines of communication so that everybody in the organisation understands the significance of objectives in detail.
3. FREQUENT COMPARISON
There should be frequent comparison between budget estimates and operating results in the organisation. Alford and Beatty are of opinion that careful analysis of both operating results and budget estimates is the essence of budgetary control in the organisation.
4. DEFINITE PLAN
There should be comprehensive planning in the enterprise. All the operations in the organisation should be planned in clear terms. The administration of the budgets should also be properly planned in the organisation. It must be pre-determined who is to be held responsible for the implementation of budget in the organisation.
5. RESPONSIBILITY MATCHED BY THE AUTHORITY
Those assigned with the responsibility to implement the budgets should also be given the necessary authority to achieve the budgeted targets in the organisation. Lack of sufficient authority will make the implementation of budgets ineffective in the organisation.
The purpose of budgetary control is to achieve coordination of various functions of the business in the organisation. Therefore, it is essential that participation up to the lowest level in the enterprise be ensured to make the people committed to the budgets. Everybody in the organisation should understand his role in achieving the budgeted targets.
7. SUPPORT OF THE MANAGEMENT
The top management in the organisation supports a good system of budgetary control. Top management in the organisation should take the preparation of budgets and their implementation seriously in order to achieve the objectives of the enterprise.
Budgets should not be rigid, but flexible enough to allow altering or remodelling in the light of any change in circumstances in the organization. Budgets are a means to an end. They must be flexible to achieve the desired objectives in the organisation. A good system of budgetary control allows sufficient flexibility to the persons concerned with the implementation of budgets in the organisation.
A budgetary control system can prove successful only when certain conditions and attitudes exist, absence of which will negate to a large extent the value of a budget system in any business. Such conditions and attitudes which are essential for effective budgeting are as follows:
9. CONTINUOUS BUDGET EDUCATION
The best way to ensure the active interest of the responsible supervisors is continuous budget education in respect of objectives, potentials & techniques of budgeting. This may be accomplished through written manuals, meetings etc., whereby preparation of budgets, actual results achieved etc., may be discussed.
10. ADEQUATE ACCOUNTING SYSTEM
There is close relationship between budgeting and accounting. For the preparation of budgets, one has to depend on the accounting department for reliable historical data which primarily forms the basis for many estimates. The accounting system should be so designed so as to set up accounts in terms of areas of managerial responsibility. In other words, responsibility accounting is essential for successful budgetary control.
11. CONSTANT VIGILANCE
Reports comparing budget and actual results should be promptly prepared and special attention focused on significant exceptions i.e. figures that are significantly different from those expected.
12. MAXIMUM PROFIT
The ultimate object of realizing the maximum profit should always be kept uppermost.
13. COST OF THE SYSTEM
The budget system should not cost more than it is worth. Since it is not practicable to calculate exactly what a budget system is worth, it only implies a caution against adding expensive refinements unless their value clearly justifies them.
14. INTEGRATION WITH STANDARD COSTING SYSTEM
Where standard costing system is also used, it should be completely integrated with the budget programme, in respect of both budget preparation and variance analysis.
Budgetary control is a very important aspect of an organization’s day to day activities and long-term prospect. When placed carefully, it not only helps in controlling cost but also helps in efficiency improvement. There are other things like standard costing which is also a part of it.
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