How does budgetary control compare to other methods of managerial control?

Budgetary control is a system of controlling cost which includes preparation of Budgets coordinating the departments and establishing responsibilities comparing performance with budgeted and acting upon results to achieve the maximum profitable.

The process of budgetary control includes:

• Preparation of various budgets.
• Continuous comparison of actual performance with budgetary performance.
• Revision of budgets in the light of changed circumstances.

A system of budgetary control should not become rigid.

There should be enough scope of flexible individual initiative and drive. Budgetary control is an important device for making the organization an important tool for controlling costs and achieving the overall objectives.

Budgetary control serves 4 control purposes:

1. They help the manager’s co-ordinate resources;
2. They help define the standards needed in all control systems;
3. They provide clear and unambiguous guidelines about the organization’s resources and expectations, and
4. They facilitate performance evaluations of managers and units.

Objectives of Budgetary Control

An effective budgeting system plays a crucial role in the success of a business organization.

The budgeting system has the following objectives, which are of paramount importance in the overall efficiency and effectiveness of the business organization.

These objectives are discussed below.

1. Planning

Planning is necessary for regularly doing any work. A well- prepared plan helps the organization to use the scarce resources efficiently and thus achieving the predetermined targets becomes easy.

A budget is always prepared for the future period and it lays down targets regarding various aspects like purchase, production, sales, manpower planning, etc. This automatically facilitates planning.

1. Coordination

For achieving the predetermined objectives, apart from planning, coordinated efforts are required. Budgeting facilitates coordination in the sense that budgets cannot be developed in isolation.

For example, while developing the production budget, the production manager will have to consult the sales manager for a sales forecast and purchase manager for the availability of the raw material.

The production budget cannot be developed in isolation.

Similarly, the purchase and sales budget, as well as other functional budgets like cash, capital expenditure, manpower planning, etc, cannot be developed without considering other functions. Hence the coordination is automatically facilitated.

1. Control

Planning is looking ahead while controlling is looking back.

The preparation of budgets involves detailed planning about various activities like purchase, sales, production, and other functions like marketing, sales promotion, manpower planning. But planning alone is not sufficient.

There should be a proper system of control which will ensure that the work is progressing as per the plan.

Budgets provide the basis for such controlling in the sense that the actual performance can be compared with the budgeted performance.

Any deviation between the two can be found out and analyzed to ascertain the reasons behind the deviation so that necessary corrective action can be taken to rectify the same. Thus budgeting helps immensely in controlling function.

3 Types of Budgetary Controlling Techniques

Budgetary control is a system for monitoring an organization’s process in monetary terms. Types of budgetary controlling techniques are;

1. Financial Budgets.
2. Operating Budget.
3. Non-Monetary Budgets.

Financial Budgets

Such budgets detail where the organization expects to get its cash for the coming period and how it plans to spend it. Usual sources of cash include sales revenue, the sales of assets, the issuance of stock, and loans.

On the other hand, the common uses of cash are to purchase new assets, pay expenses, repay debts, or pay dividends to shareholders.

Financial budgets may be of the following types:

1. Cash budget

This is simply a forecast of cash receipts and disbursements against which actual cash “experience” is measured

It provides an important control in an enterprise since it breaks down incoming and outgoing cash into monthly, weekly, or even daily periods so that the organization can make sure it can meet its current obligations.

The cash budget also shows the availability of excess cash, thereby making it possible to plan for profit-making investment of surpluses.

1. Capital expenditure budget

This type of financial budget concentrates on major assets such as a new plant, land or machinery. Organizations often acquire such assets by borrowing significant amounts through, say, long-term bonds or securities.

All organizations, large or small, business or non-business, pay close attention to such a budget because of the large investment usually associated with capital expenditure.

1. The balance sheet budget

It forecasts what the organization’s balance sheet will look like if all other budgets are met.

Hence it serves the purpose of overall control to ensure that other budgets mesh properly and yield results that are in the best interests of the organization.

Operating Budgets

This type of budget is an expression of the organization’s planned operations for a particular period. They are usually of the following types:

1. The sales or revenue budget

It focuses on the income the organization expects to receive from normal operations. It is important since it helps the manager understand what the future financial position of the organization will be.

1. The expense budget

It outlines the anticipated expenses of the organization in a specified period. It also points out upcoming expenses so that the manager can better prepare for them.

1. The project budget

It focuses on anticipated differences between sales or revenues and expenses i.e. profit. If the anticipated profit figure is too small, steps may be needed to increase the sales budget or cut the expense budget.

Non-monetary budgets

Budgets of this type are expressed in non-financial sales or revenues and expenses, i.e. profit. If the anticipated profit figure is too small steps may be needed to increase the sales budget or cut the expense budget.

Fixed and variable budgets

Regardless of their purpose, most budgets must account for the three following kinds of costs:

1. Fixed costs

They are the expenses that the organization incurs whether it is in operation or not. Salaries of managers may be an example of such a cost.

1. Variable costs

Such costs vary according to the scope of operations.

The best example may be the raw materials used in production. If $5 worth of material is used per unit. 10 units would cost $50, 20 units would cost $100 and so on.

1. Semi-variable costs

They also vary, but in a less direct fashion. Costs for advertising, repairs, and maintenance, etc. may fall under this category.

All these categories of cost must be accurately accounted for in developing a budget. Fixed costs are usually the easiest to deal with. Variable costs can also be forecast, although with less precision from projected operations.

Semi-variable costs are the most difficult to predict because they are likely to vary, but not in direct relation to operations. For these costs, the manager must often rely on experience and judgment.

Types of Budgets

Budgets can be classified as per the following basis.

1. Based on Area of Operation.
   1. Functional Budgets.
   2. Master Budget.
2. Based on Capacity Utilization.
   1. Fixed Budget.
   2. Flexible Budgets.
3. Based on Time.
   1. Short Term.
   2. Medium Term.
   3. Long Term.
4. Based on Conditions
   1. Basic Budget.
   2. Current Budget.

We have an article explaining the classification and types of budgets in detail which you can check out.

Benefits of Budgetary Control

Budgeting plays an important role in planning and controlling. It helps in directing the scarce resources to the most productive use and thus ensures overall efficiency in the organization.

The benefits derived by an organization from an effective system of budgeting can be summarized as given below.

1. Budgeting facilitates the planning of various activities and ensures that the working of the organization is systematic and smooth.
2. Budgeting is a coordinated exercise and hence combines the ideas of different levels of management in the preparation of the same.
3. Any budget cannot be prepared in isolation and therefore coordination among various departments is facilitated automatically.
4. Budgeting helps planning and controlling income and expenditure to achieve higher profitability and also acts as a guide for various management decisions.
5. Budgeting is an effective means for planning and thus ensures sufficient availability of working capital and other resources.
6. It is extremely necessary to evaluate the actual performance with predetermined parameters. Budgeting ensures that there are well-defined parameters and thus the performance is evaluated against these parameters.
7. As the resources are directed to the most productive use, budgeting helps in reducing the wastages and losses.

Essentials of a Good Budgetary Control System

A good budgetary control system depends upon the following conditions:

1. Support from top management

The effective implementation of the budgetary control system depends upon the attitude and perception of management towards it.

If the top executive takes the budgeting as a mere routine job and does not take any interest in its implementation, it will be a futile exercise.

1. Quantification of organizational goal

The goal of the organization should be clearly expressed and quantified. There should not be any misconception and confusion in the minds of employees regarding goals to be attained.

1. Creation of responsibility center

The entire organization should be divided into sections and sub­section with clear assignment of duties and responsibilities for each of them.

1. The split of organizations’ goals

The goals of each department or responsibility center should be spelled out towards the attainment of the overall goals of the organization. The functional goals should be compatible with the organizational goal.

1. Realistic

The target to be set in the budget should be fairly attainable.

If it is set at a level beyond the capacity of employees, they will lose their interest in its implementation, on the other hand, if it is set at a very low level, it will be meaningless as the job, in any case, will be done.

1. Participation

All the key employees should be made involved in the preparation of the budget. Participation brings in commitment. Commitment enhances the efficiency and productivity of employees.

1. Good accounting system

The accounting system should be designed in such a way that c the actual performance of various responsibility centers can be readily available for comparison with the target.

1. Coverage

To reap the benefit of a budgetary control system it should cover all the areas organization. It should not be partially applied.

1. Creation of environment conducive to budgetary control

A proper environment should be developed in the organization for the successful implementation of budgetary control. The employees should be educated about the utility of the system.

They should be convinced that it is not a tool of pressurization upon them to work more but a way to the prosperity of the organization which will ultimately benefit them.

So seminar, lecture, executive development program, etc. should be held for this purpose.

1. Coordination

Co-ordination is an important requirement” of budgetary control. It brings in common thinking, mutual trust, and confidence amongst various departments.

1. Flexibility

A budget should be amenable to change if the changing situation so warrants.

1. Reporting system

The success of budgetary control depends upon a good reporting system. The actual performance vis-a-vis the target should be continuously reported to the management to enable them to take corrective action in the areas which are not performing well.

Steps of Budgetary Control

Budgetary control has the following stages.

1. Developing Budgets

The first stage in budgetary control is developing various budgets. It will be necessary to identify the budget centers in the organization and budgets will have to develop for each one of them.

Thus budgets are developed for functions like purchase, sale, production, manpower planning as well as for cash, capital expenditure, machine hours, labor hours and so on.

Utmost care should be taken while developing the budgets. The factors affecting the planning should be studied carefully and budgets should be developed after a thorough study of the same.

1. Recording Actual Performance

There should be a proper system of recording the actual performance achieved. This will facilitate the comparison between the budget and the actual. An efficient accounting and cost accounting system will help to record the actual performance effectively.

1. Comparison of Budgeted and Actual Performance

One of the most important aspects of budgetary control is the comparison between the budgeted and the actual performance.

The objective of such a comparison is to find out the deviation between the two and provide the base for taking corrective action.

1. Corrective Action

Taking appropriate corrective action based on the comparison between the budgeted and actual results is the essence of budgeting.

A budget is always prepared for the future and hence there may be a variation between the budgeted results and actual results.

There is a need for investigation of the same and take appropriate action so that the deviations will not repeat in the future. Responsibilities can be fixed on proper persons so that they can be held responsible for any such deviations.

Preparation for Budgetary Control

Budgetary control is extremely useful for planning and control as described above. However, forgetting these benefits, sufficient preparation should be made.

For complete success, a solid foundation should be laid down and given this the following aspects are of crucial importance.

1. Budget Committee

For the successful implementation of the budgetary control system, there is a need for a budget committee. In small or medium-sized organizations, the budget-related work may be carried out by the Chief Accountant himself.

Due to the size of the organization, there may not be too many problems in the implementation of the budgetary control system.

However, in large size organization, there is a need for a budget committee consisting of the chief executive, budget officer and heads of main departments in the organization.

The main functions of the budget committee are to get the budgets prepared and then scrutinize the same, to lay down broad policies regarding the preparation of budgets, to approve the budgets, to suggest for revision, to monitor the implementation and to recommend the action to be taken in a given situation.

1. Budget Centers

The establishment of budget centers is another important pre-requisite of a sound budgetary control system. A budget center is a group of activities or a section of the organization for which budget can be developed.

For example, manpower planning budget, research and development cost budget, production and production cost budget, labor hour budget and so on.

Budget centers should be defined clearly so that preparation becomes easy.

1. Budget Period

A budget is always prepared before a defined period. This means that the period for which a budget is prepared is decided in advance.

Thus a budget may be prepared for three years, one year, six months, one month or even for one week. The point is that the period for which the budget is prepared should be certain and decided in advance.

Generally, it can be said that functional budgets like sales, purchase, production, etc. are prepared for one year and then broken down monthly. Budgets like capital expenditure are generally prepared for a period from 1 year to 3 years.

Thus depending upon the type of budget, the period of the same is decided and it must be decided well in advance.

1. Preparation of an Organization Chart

There should be an organization chart that shows clearly defined authorities and responsibilities of various executives. The organization chart will define clearly the functions to be performed by each executive relating to the budget preparation and his relationship with other executives.

The organization chart may have to be adjusted to ensure that each budget center is controlled by an appropriate member of the staff.

1. Budget Manual

A budget manual is defined by ICMA as ‘a document which sets out the responsibilities of the person engaged in, the routine of and the forms and records required for budgetary control’.

The budget manual thus is a schedule, document or booklet, which contains different forms to be used, procedures to be followed, budgeting organization details, and set of instructions to be followed in the budgeting system.

It also lists out details of the responsibilities of different persons and the managers involved in the process.

1. Principal Budget Factor or Key Factor

A key factor or a principal budget factor [also called constraint] is that factor the extent of whose influence must first be assessed to prepare the functional budgets.

Normally sales are the key factor or principal budget factor but other factors like production, purchase, and skilled labor may also be the key factors.

For example, a company has the production capacity to produce 30,000 tones per annum but if the sales forecast tells that the market can absorb only 20,000 units, there is no point in producing 30,000 units.

Thus the sale is the key factor in this case.

On the other hand, if the company can produce 30,000 units and the market can absorb the entire production which means that sales are not the key factor but if the raw material is available in limited quantity so that only 25,000 units can be produced, the raw material will become the key factor.

The key factor puts restrictions on the other functions and hence it must be considered carefully in advance. So continuous assessment of the business situation becomes necessary.

In all conditions, the key factor is the starting point in the process of preparation of budgets.

1. Establishment of Adequate Accounting Records

The accounting system must be able to record and analyze the transactions involved.

A chart of accounts or accounts code should be maintained which may correspond with the budget centers for the establishment of budgets and finally control through budgets.

Advantages and Disadvantages of Budgeting

Organizations realize many benefits from budgeting including:

1. Budgets communicate management’s plans throughout the organization.
2. Budgets force managers to think about and plan for the future. In the absence of the necessity to prepare a budget, many managers would spend all of their time dealing with daily emergencies.
3. The budgeting process provides a means of allocating resources to those parts of the organization where they can be used most effectively.
4. The budgeting process can uncover potential bottlenecks before they occur.
5. Budgets coordinate the activities of the entire organization by integrating the plans of its various parts. Budgeting helps to ensure that everyone in the organization is pulling in the same direction.
6. Budgets define goals and objectives that can serve as benchmarks for evaluating subsequent performance.

Budgets offer some advantages. They have potential drawbacks as well. Both are summarized below;

StrengthsWeaknesses1.Budgets facilitate effective control.Budgets may be used too rigidly.2.Budgets facilitate coordination and communication.Budgets may be time-consuming.3.Budgets facilitate record keeping.Budgets may limit innovation and change.4.Budgets are a natural complement to planning.However; Budgets hampers development, change, the flexibility of the plan.

As shown in the table above, budgets facilitate effective control. By placing financial values on operations, managers can monitor operations effectively and pinpoint problem areas.

Second budgets facilitate communication and coordination between departments. Budgets also help maintain records of organizational performance.

Finally, budgets are a natural complement to planning. As managers first plan and then develop control systems, budgets are often a natural next step.

On the minus side, some managers apply budgets too rigidly. They fail to understand those budget adjustments are necessary to meet the challenges of changing circumstances.

Also, the art of developing budgets can most often be time-consuming.

Moreover, budgets may limit innovation and change. When all available funds are allocated to specific operating budgets, it may be impossible to get additional funds to take advantage of an unexpected opportunity.

Budgets are an important element of an organization’s control system. It is difficult to imagine an organization functioning without proper budgetary provisions.

Despite some drawbacks, budgets generally provide managers with an effective tool for executing the control function.

Difference between Budget and Budgetary Control

Point of DifferenceBudgetBudgetary ControlNatureBudgeting is the formulation of the plan of the organization.Budgetary control refers to the control of business activities.AimsThe budget sets the target to be achievedBudgetary control aims at attaining that target.DependencyBudget can be set without follow up action i.e., without budgetary control.But budgetary control is not possible without a budget. However budget without the budgetary control will not be of muchAssumption and ActualThe budget is forward-looking. It charts out the course of action to be followed in the future.But budgetary control is concerned with actual performance. Its objective is to make the actual performance confirmContinuity

Budgeting is a one time job done before the budget period.

However, due to the changing situation, the budget may require revision during the budget period.

Implementation of budgetary control involves the measurement of actual performance and comparison of the same with the target to analyze the variance.

The process is continuous and carried out throughout the budget period.

Making Budgetary Control Effective

Budgetary control can be made effective if an organization can ensure the following:

1. Setting appropriate standard

This is key to successful budgeting. Many budgets fail for lack of such standards, and some upper-level managers hesitate to allow subordinates to submit budget plans for fear that they may have no logical basis for reviewing budget requests.

1. Ensuring top-management support

Budget making and administration must receive the whole-hearted support of top ‘management.

If top management supports budget making, requires departments and divisions to make and defend their budgets, and participate in this review, then budgets encourage alert management throughout the organization.

1. Participation by users in budget preparation

Besides the support of top management, the concerned managers at lower levels should also participate in its preparation. Real participation in budget preparation is necessary to ensure success.

It may also prove worthwhile to give department managers a reasonable degree of latitude in changing their budgets and in shifting funds, as long as they meet their total budgets.

1. Providing information to managers about performance under budget

If budgetary control is to work well, managers need ready information about actual and forecast performance under budgets by their departments. Such information must be so designed as to show them how well they are doing.

Conclusion

Budgeting is the formulation of plans for a given future period in numerical terms. Organizations may establish budgets for units, departments, divisions, or the whole organization.

The usual period for a budget is one year and is generally expressed in financial terms. Budgets are the foundation of most control systems.

They provide yardsticks for measuring performance and facilitate comparisons across divisions, between levels in the organization, and from one period to another.

How does Budgetary control system helps in managerial control and decision making?

What does the first step of the budgetary control process involves?

How Budgetary control acts as an instrument of management control?

What are the three advantages of budgetary control?