Budget
The Terminology (CIMA – London) defines a budget as “a plan quantified in monetary terms, prepared and approved prior to a defined period of time, usually showing planned income to be generated and/or expenditure to be incurred during that period and the capital to be employed to attain a given
objective”.
Budgetary Control
Budgetary control is defined as “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 objective of that policy or to provide a basis for its revision.”
From the above definition, the steps for Budgetary Control can be drawn as follows: –
(i) Establishment of Budgets – Budgetary control primarily aims at preparation of various budgets such as sales Budget, production budget, overhead expenses budget, cash budget etc.,
(ii) Responsibilities of executives – The budgetary control system is designed to fix responsibilities on executives through preparation of budgets.
(iii) Policy making – The established policies of the organization are designed as budgets so as to fix responsibility on executives.
(iv) Comparison of actuals with budgets – After establishing the budgets, the actuals are compared with them and any deviations, if any are called variances.
(v) Achieving the desired result – The desired result of the budgetary control system is comparison of actuals with the budgeted results and the causes of variances, if any, are analysed.
(vi) Reporting to Top Management – After the causes of Variances are analysed, the variances and their causes are reported to top management so that the remedial action can be taken.
Prerequisites for the Adoption of Budgetary Control System:
For the successful implementation of a system of budgetary control certain pre-requisites are to be fulfilled. These are enumerated below:
(i) There should be an organization chart laying out in clear terms the responsibilities and duties of each level of executives, and the delegation of authority to the various levels. For complete success, a solid foundation in this regard should be laid at the outset.
(ii) The objectives, plans and policies of the business should be defined in clear cut and unambiguous terms.
(iii) The output level for which budgets are fixed, i.e., the budgeted output, should be stated.
(iv) The principal budget factor which will be the starting point of the preparation of the various budgets should be indicated.
(v) There should be an efficient system of accounting to record and provide data in line with the budgetary control system.
(vi) For the establishment and efficient execution of the plan, a Budget Committee should be set up.
(vii) There should be a proper system of communication and reporting between the various levels of management.
(viii) There should be a charter of programme. This is usually in the form of a budget manual.
(ix) The budgets should primarily be prepared by those who are responsible for performance.
(x) The budgets should be complete, continuous and realistic.
(xi) There should be an assurance from the top management executives of co-operation and acceptance of the budgetary system.
Advantages of Budgetary Control:
- Profit Maximization: Budgetary control aims to maximize profits by efficiently utilizing resources.
- Continuous Monitoring: It provides a technique for continuously monitoring organizational policies and objectives.
- Cost Reduction: Budgetary control helps reduce costs, leading to better fund utilization.
- Coordination: It fosters close coordination among different departments, resulting in smooth organizational functioning.
- Clear Responsibilities: Budgets assign responsibilities to executives, serving as a plan of action and reducing their workload.
- Variance Analysis: It facilitates the analysis of variances, identifying areas of deficiency and enabling remedial actions.
- Management by Exception: Budgetary control allows management to focus on exceptional cases that deviate significantly from the budget.
- Motivating Force: Budgets act as a motivating force for employees to achieve organizational objectives.
- Delegation of Authority: It assists in the delegation of authority and serves as a powerful tool for responsibility accounting.
- Stability: Budgetary control helps stabilize conditions in industries prone to seasonal fluctuations.
- Internal Audit: It provides a suitable basis for internal audit processes.
- Payment by Results: Budgets serve as a foundation for introducing payment by results systems.
- Working Capital Management: It ensures the adequacy of working capital for the organization.
- Performance Analysis: Budgetary control aids in performance analysis and reporting systems.
- Obtaining Bank Credit: Budgets can be used to demonstrate financial stability and secure bank credit.
- Standard Costs: Budgets lay the groundwork for setting standard costs in organizations.
The procedure for implementing budgetary control can be summarized in the following steps:
- Set Objectives: Clearly define the objectives of the organization and establish specific goals that need to be achieved through the budgetary control system.
- Establish Budget Committee: Form a budget committee comprising representatives from different departments to oversee the budgeting process. The committee should include key decision-makers and experts who can contribute to the budget preparation.
- Develop Budget Manual: Create a budget manual that outlines the budgeting process, responsibilities of different individuals or departments, and the timeline for budget preparation, submission, and review.
- Determine Budget Period: Define the time period for which the budget will be prepared. It could be annually, quarterly, or monthly, depending on the organization’s requirements.
- Identify Budget Factors: Identify the key factors that will drive the budget, such as sales volume, production capacity, market conditions, and cost considerations. These factors will serve as the basis for estimating revenues, expenses, and other financial elements.
- Prepare Budgets: Prepare different types of budgets, including sales budget, production budget, overhead budget, cash budget, and capital budget. Each budget should be aligned with the organization’s objectives and cover all relevant aspects of financial planning.
- Communicate and Review: Present the budgets to the budget committee and relevant stakeholders for review and feedback. Incorporate any necessary revisions or adjustments based on their input.
- Allocate Responsibilities: Assign budgetary responsibilities to different individuals or departments. Clearly define their roles in adhering to the budget, monitoring expenses, and reporting variances.
- Monitor Actual Performance: Continuously track and compare actual financial performance against the budgeted figures. Identify any variances and investigate the reasons behind them.
- Analyze Variances: Analyze the variances between actual and budgeted amounts to understand the causes. This analysis will help in identifying areas of improvement, cost-saving opportunities, and corrective actions to be taken.
- Reporting: Prepare periodic reports that summarize the actual financial performance, highlight significant variances, and provide insights into the budget’s effectiveness. Present these reports to the management and relevant stakeholders.
- Take Corrective Actions: Based on the analysis of variances and the recommendations from the budget committee, implement necessary corrective actions to address any deviations from the budget. This may involve adjusting spending, reallocating resources, or revising future budget plans.
- Continuous Improvement: Regularly review and evaluate the effectiveness of the budgetary control system. Identify areas for improvement and implement changes to enhance the accuracy, efficiency, and relevance of the budgeting process.
By following these steps, organizations can effectively implement budgetary control and improve their financial planning, monitoring, and decision-making processes.
The key deliverables of the budgetary control process include:
- Budgets: The primary deliverable of budgetary control is the set of budgets prepared for different departments and areas of the organization. These budgets outline the planned income, expenditure, and capital utilization for a specific period of time.
- Budget Reports: Regular budget reports provide updates on the actual financial performance compared to the budgeted figures. These reports highlight any variances, both positive and negative, and provide insights into the financial health of the organization.
- Variance Analysis: Delivering a comprehensive analysis of variances is crucial in budgetary control. This involves identifying the reasons behind deviations between actual results and budgeted amounts. Variances can be analyzed at different levels, such as sales, expenses, production, or department-wise.
- Performance Evaluation: Budgetary control helps in evaluating the performance of departments and individuals against their budgeted targets. Delivering performance evaluations based on budgetary achievements helps identify areas of strength and improvement.
- Recommendations and Corrective Actions: Based on the analysis of variances and performance evaluations, delivering recommendations and proposing corrective actions is an important aspect of budgetary control. These recommendations can include cost-saving measures, process improvements, or adjustments to future budgets.
- Financial Forecasts: Budgetary control provides valuable insights for financial forecasting. Delivering accurate forecasts based on past performance and budget variances helps in planning future financial goals and making informed decisions.
- Compliance Reports: Budgetary control ensures compliance with financial policies and regulations. Delivering compliance reports demonstrates adherence to established guidelines and helps identify any areas of non-compliance that require attention.
- Communication and Stakeholder Reports: Effective communication is vital in budgetary control. Delivering reports to stakeholders, including management, executives, board members, and investors, helps keep them informed about the organization’s financial performance, budgetary achievements, and future plans.
- Budget Revisions: As part of the budgetary control process, delivering revised budgets based on updated forecasts, changes in business conditions, or management decisions is necessary. These revisions ensure that the budget remains relevant and aligned with the organization’s goals.
- Continuous Improvement Plans: Delivering plans for continuous improvement in the budgetary control process is essential. This involves identifying areas for process optimization, enhancing data accuracy, streamlining reporting mechanisms, and incorporating feedback from stakeholders.
These key deliverables ensure effective financial planning, monitoring, and control within the organization, enabling informed decision-making and improved financial performance.