Budgetary Control
Budgetary control is a system whereby the budgets are used as a means of planning and controlling costs.
Budgeting lays down as to what is to be attained and how it is to be attained while control ensures that the objectives are realized and actual results do not deviate from the planned course more than necessary.
Introduction to Budget and Budgetary Control
Budgets are one of the most important aspects of any system – be it domestic life, a corporate house or a nation. At home, we often make yearly, monthly, weekly or even daily budgets that would influence our expenses and savings.
Budget of any organization will tell you about it’s growth and expansion plans.
Definitions of Budget
CIMA has defined 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.”
The main features of budgetary control are:
Establishing budgets for each functional area e.g., sales, production, purchase, etc., the policies and various activities which might be adopted for achieving them.
Recording actual performance of each functional area.
Analyzing the reasons of variances and identifying the persons responsible.
A budget may be expressed in relation to:
Time – Short-term and Long-term Budget; Behavior – Fixed and Flexible Budget; and
Functions – Sales Budget, Production Budget, Cash Budget, etc.
Some of the other features are:
Targets/Objectives
Activities
Plan for each activity
Comparison / ascertain causes
Remedial action
Features of a Budget
A budget is a blueprint for management action. It is a vital tool for carrying out effective short-term planning and control in firms.
The following are the features of a budget:
One Year Duration
Estimation of Business Unit’s Profit Potential
Appraisal of Performance
Monetary Terms
Alteration of Approved Budget Under Specified
Elements of a Budget
Budget is a comprehensive plan of what the enterprise endeavors to achieve.
It provides yardsticks and measures for the purpose of comparison.
Characteristics of a budget
A budget is prepared for a definite future period of time (Budget period).
It is prepared in advance and is based in future plan of action.
It is a statement prepared in monetary value or physical units or both.
It is approved by the management before its implementation.
It is prepared for implementation of policy formulated by the management and achievement of objectives.
The objectives of budgetary control system are usually summarized under five heads:
Planning
Coordination
Control
Optimum employment of capital and
Responsibility accounting
Budgetary Control – Techniques
Establishment of a budget for each activity or section of the organization.
Establishment of budgets for each function like sales, production, purchase, etc.
Measurement of actual performance.
Comparison of actual performance with budgeted performance to find out variations, if any.
Ascertainment of the reasons for such variations and taking suitable remedial action.
Budgets may be classified into 5 types on the basis of:
A. Functions involved.
B. Nature of transactions.
C. Activity levels.
D. Miscellaneous Budgets, and
E. Cash Budget.
Cash budget:
Cash budget represents expected future cash flow of organization over a defined period.
Cash flow includes expected cash receipts, cash payments and resulting cash balance at the end of period.
Note that, cash budget includes only the transactions where actual cash will come in or go out.
So, it will not include credit sales for which cash is not yet received
How is the Cash Budget Prepared?
A cash budget takes shape after the preparation of other budgets like sales, purchases, etc.
These budgets give a clear picture of the cash drivers in the company and by how much.
This budget mainly comprises of three parts: Cash Inflow Forecast
Cash Outflow Forecast Cash Balance Forecast
Importance of Cash Budget
Helpful in Proper Planning
Helpful in Tackling Seasonal Variation
Building Brand Value
Example
Let us look at an example of a cash budget for a period of one month for ABC manufacturing Pvt.Ltd. Its cash balance at the beginning of the budget period is US$ 20000.The cash inflows forecasted over the month are Sales amounting to US$10000, Accounts receivables collections to the tune of US$75000, and a fixed asset sale of US$45000.Hence, the total cash with it over the period will be US$ 150000.
Its cash outflows forecast consists of payments for materials amounting to US$ 25000, labor payments amounting to US$20000, selling expenses of US$10000, printing expenses of US$5000, repairs and maintenance activities of US$10000, and asset purchase of US$30000. Hence, the total outflow forecast amounts to US$ 100000 Therefore, the cash balance at the end of the budgeted period will be US$ 50000 (US$ 150000 – US$100000). We see that the closing balance of cash with the company is more than the opening balance. The management may decide to use the surplus cash for its proposed activities from the financing budget. It may decide to pay dividends in near future to its shareholders. Or it may just sit over it to use it in the future.
Purchase Budgets
A purchases budget report allows business owners to determine how much money and goods are needed to reach desired goals.
This particular budget is used for companies that have products in stock or inventory, as the value of inventory plays a large role in a complete purchases budget.
Calculating Purchase Budget
A purchases budget provides a representation of what the business plans to buy for the inventory and how much inventory it plans to grow or hold over a given period of time.
The budget is created using a simple formula: = The desired ending inventory + the cost of goods sold – the value of the beginning inventory.
This equation gives you the total purchases budget.
Cost of Goods Sold
The cost of goods sold is a collected sum of all products or services offered by the company in terms of the production value.
The sum is a total of products costs plus the means to get it ready for sale.
Some companies even break it down and explain how the cost is divided in terms of planning, production and testing.
Purchases Budget Purpose
A purchases budget is created to keep track of the company’s inventory value and the amount of goods sold.
It also is used to help you keep track of your desired ending inventory value each month.
The purchases budget is often just a partial budget for a business and is often found in a business master budget.
Production Budgets
A budget is a financial plan for a defined period whether monthly, quarterly, or annually. It estimates a wide variety of parameters like sales, revenue, expenditure, etc. and is an essential exercise for every financial organization. The production budget is a plan or estimate of the quantum of products required for production by the organization over a period.
How to Create a Production Budget
A production budget has four components: Beginning Inventory
Sales Forecast Ending Inventory
Production Required in Units of the Product
How to Calculate a Production Budget
In simple equation form,
Production budget = The sales budget or forecast + Planned inventory to be maintained in the end – Inventory in the beginning.
Importance of Production Budget
Basis for Planning of Future Production Process Helps in Taking Key Managerial Decisions
Limitations of Production Budget
Based on Estimates
Time-consuming Process
Example
Let us take an example of company XYZ Pvt.Ltd. that produces computer keyboards. Its monthly sales over the past few months have been 1000 units on average. As a policy, it maintains an ending inventory of 100 units every month The opening inventory stock at the beginning of January month was 50 units. We will make use of the equation for the production budget to find out the optimum quantity the company should produce.
Production Budget= 1000 units (Sales forecast) + 100 units (Desired closing inventory) – 50 units (Inventory at the beginning) = 1050 units
Hence, the company has to produce 1050 units of the keyboard in January to meet its sales forecast and maintain an opening stock of 100 units at the beginning of February.
The production budget for February should be: = 1000 units (Sales forecast) + 100 units (Desired inventory at the end) – 100 units beginning) (Inventory at the beginning) = 1000 units of keyboards.
Flexible Budgets
A flexible budget is a budget or financial plan of estimated cost and revenue for different levels of output. The variation happens due to the change in the volume or level of activity.
A flexible budget adjusts to changes in actual revenue levels. Actual revenues or other activity measures are entered into the flexible budget once an accounting period has been completed, and it generates a budget that is specific to the inputs.
Importance of Flexible budget:
Flexible budgets act as a benchmark by setting expenditure at various levels of activity. And the estimates of expenses developed via a flexible budget helps in comparing the actual cost incurred for that level of activity. Hence any variance identified helps in better planning and controlling. It helps in establishing the variability of cost factors at different levels of activity. Hence it helps in analyzing the cost variances.
It helps in recognition of the operational inefficiencies and error. And thus, better correction and control can happen. It helps to set the prices and quotations for a business contract. Therefore helpful in project acquisition. It helps in assessing the performance of the management and key production personnel. Thus, it increases the efficiency of the employees. Better cost control leads to better profit planning.
How to Prepare a Flexible Budget
There are three ways to prepare a flexible budget:
Tabular method
Graphic method
The Ratio or Formula Method
1)Tabular method
In this method, the budget takes a tablet form, where horizontal columns represent the different levels of activity or capacity. And, the vertical rows represent the budgeted estimates against the different levels of activity or output. The expenses categorized into fixed, variable, and semi-variable costs
2)The Ratio or Formula Method
In this method the following formula is used for calculation: Flexible budget= Fixed cost + (actual unit of activity x variable cost per unit of activity).
Advantages of Flexible Budgeting
Usage in variable cost environment
Performance measurement
Budgeting efficiency
Disadvantages of Flexible Budgeting
Formulation
Closing delay
Revenue comparison
Applicability
Zero-Based Budgeting
Zero based budgeting in management accounting involves preparing the budget from the scratch with a zero- base. It involves re-evaluating every line item of cash flow statement and justifying all the expenditure that is to be incurred by the department. Zero-based budgeting (ZBB) is an approach to making a budget from scratch.
The budget is not based on previous budgets. Instead, the budget starts at zero.
With zero-based budgeting, you need to justify every expense before adding it to the official budget.
The goal of zero-based budgeting is to reduce spending by looking at where costs can be cut.
Zero-based budgeting process
There are a few different steps in zero-based budgeting to keep in mind. The process of zero-based budgeting follows the same basic steps:
Identify business goals
Develop and analyze new ways to achieve goals
Discover new ways to fund business processes
Prioritize fund
Zero Based Budgeting Steps
Identification of a task
Finding ways and means of accomplishing the task
Evaluating these solutions and also
evaluating alternatives of sources of funds
Setting the budgeted numbers and priorities
When to use zero-based budgeting
As a small business owner, you’re busy. You might not have time to make a budget from scratch every few months or even each year. Some companies might benefit from creating a zero- based budget once every few years and using a traditional budget in the meantime.
How can zero-based budgeting help small businesses?
Zero-based budgeting is a great way to improve and manage your small business budget.
It can help you to:
Create your first budget
Save money
Know where money is going
How Zero Based Budgeting is different from Other Methods
To have a clear understanding, it is necessary to understand the key differences between the other methods of budgeting like Activity Based Budgeting etc.
Zero Based Vs. Activity Based Budgeting
Zero Based Vs. Traditional Budgeting
Zero Based Vs. Incremental Budgeting
Zero Based Budgeting Advantages
Accuracy
Efficiency
Reduction in redundant activities
Budget inflation
Coordination and Communication
Zero Based Budgeting Disadvantages
Time-Consuming
High Manpower Requirement
Lack of Expertise