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