As earlier noted, budgetary control is a process that involves continuous comparison of the actual results with the budgeted results either to improve performance or to provide a basis for revision of the budget.
Budgetary control is regarded as an important aspect in managing resources in general and cash in particular. In our personal lives, we set a budget to ensure that the competing household interests for our earnings are satisfied whilst not exceeding that earnings capacity. Surely it’s the same for corporations?
Characteristics of Budgetary Control
- Establish a target of performance (set standards)
- Measure actual performance
- Compare actual performance with budget
- Ascertain the reasons for the difference between actual and budgeted performance (Analyse variance)
- Take suitable remedial action so that budgeted performance may be achieved.
Advantages of Budgetary Control
Budgetary control provides the following advantages;
- It pinpoints efficiency or lack of it.
- It shows management where action is needed to remedy the situation.
- It directs capital expenditure in the most profitable direction and project.
- Budgetary control motivates individuals to attain given goals
Limitations Of Budgetary Control System
The budgetary control system suffers from certain limitations and those using the system should be carefully aware of them.
- The budget plan is based on estimates. The strength or weakness of the budgetary control system depends on the accuracy with which estimates are made. While using the system, the fact that the budget is based on estimates must be kept in mind.
- Danger of rigidity. A budget program must be dynamic and continuously deal with the changing business conditions.
- Expensive technique: The installation and operation of a budgetary control system is a costly affair. It may require employing experts if the project is too big.
Essentials Of Effective Budgeting And Budgetary Control
A budgetary control system can be successful only when certain conditions and attitudes exist, absence of which will fail the budget system. Such conditions and attitudes that are essential for effective budgeting include;
- Support of top managers. No control system can be effective unless top management is convinced that the system is important.
- Participation by responsible staff
- Reasonable goals
- Clearly defined organisation
- Continuous budget education
- Adequate accounting system
- Cost of the system should not be more than its benefits.
Budgetary control and responsibility centres;
These enable managers to monitor organisational functions.
A responsibility centre can be defined as any functional unit headed by a manager who is responsible for the activities of that unit.
There are four types of responsibility centres:
- a) Revenue centres
Organisational units in which outputs are measured in monetary terms but are not directly compared to input costs.
- b) Expense centres
Units where inputs are measured in monetary terms but outputs are not.
- c) Profit centres
Where performance is measured by the difference between revenues (outputs) and expenditure (inputs). Inter-departmental sales are often made using “transfer prices”.
- d) Investment centres
Where outputs are compared with the assets employed in producing them, i.e. ROI.
Advantages of budgeting and budgetary control
There are a number of advantages to budgeting and budgetary control:
- Compels management to think about the future, which is probably the most important feature of a budgetary planning and control system. Forces management to look ahead, to set out detailed plans for achieving the targets for each department, operation and (ideally) each manager, to anticipate and give the organisation purpose and direction.
- Promotes coordination and communication.
- Clearly defines areas of responsibility. Requires managers of budget centres to be made responsible for the achievement of budget targets for the operations under their personal control.
- Provides a basis for performance appraisal (variance analysis). A budget is basically a yardstick against which actual performance is measured and assessed. Control is provided by comparisons of actual results against budget plan. Departures from budget can then be investigated and the reasons for the differences can be divided into controllable and non-controllable factors.
- Enables remedial action to be taken as variances emerge.
- Motivates employees by participating in the setting of budgets.
- Improves the allocation of scarce resources.
- Economises management time by using the management by exception principle.
Problems in budgeting
Whilst budgets may be an essential part of any marketing activity they do have a number of disadvantages, particularly in perception terms.
- Budgets can be seen as pressure devices imposed by management, thus resulting in:
- a) bad labour relations
b) inaccurate record-keeping.
- Departmental conflict arises due to:
- a) disputes over resource allocation
b) departments blaming each other if targets are not attained.
- It is difficult to reconcile personal/individual and corporate goals.
- Waste may arise as managers adopt the view, “we had better spend it or we will lose it”. This is often coupled with “empire building” in order to enhance the prestige of a department.
Responsibility versus controlling, i.e. some costs are under the influence of more than one person, e.g. power costs.
- Managers may overestimate costs so that they will not be blamed in the future should they overspend.
Characteristics of a budget
A good budget is characterised by the following:
- Participation: involve as many people as possible in drawing up a budget.
· Comprehensiveness: embrace the whole organisation.
· Standards: base it on established standards of performance.
· Flexibility: allow for changing circumstances.
· Feedback: constantly monitor performance.
· Analysis of costs and revenues: this can be done on the basis of product lines, departments or cost centres.
Budget organisation and administration:
In organising and administering a budget system the following characteristics may apply:
- a) Budget centres: Units responsible for the preparation of budgets. A budget centre may encompass several cost centres.
- b) Budget committee: This may consist of senior members of the organisation, e.g. departmental heads and executives (with the managing director as chairman). Every part of the organisation should be represented on the committee, so there should be a representative from sales, production, marketing and so on. Functions of the budget committee include:
- Coordination of the preparation of budgets, including the issue of a manual
· Issuing of timetables for preparation of budgets
· Provision of information to assist budget preparations
· Comparison of actual results with budget and investigation of variances.
- c) Budget Officer: Controls the budget administration The job involves:
- liaising between the budget committee and managers responsible for budget preparation
· dealing with budgetary control problems
· ensuring that deadlines are met
· educating people about budgetary control.
- d) Budget manual:
This document:
- charts the organisation
· details the budget procedures
· contains account codes for items of expenditure and revenue
· timetables the process
· clearly defines the responsibility of persons involved in the budgeting system.
Budget preparation
Firstly, determine the principal budget factor. This is also known as the key budget factor or limiting budget factor and is the factor which will limit the activities of an undertaking. This limits output, e.g. sales, material or labour.
- a) Sales budget: this involves a realistic sales forecast. This is prepared in units of each product and also in sales value. Methods of sales forecasting include:
- sales force opinions
· market research
· statistical methods (correlation analysis and examination of trends)
· mathematical models.
In using these techniques consider:
- company’s pricing policy
· general economic and political conditions
· changes in the population
· competition
· consumers’ income and tastes
· advertising and other sales promotion techniques
· after sales service
· credit terms offered.
- b) Production budget: expressed in quantitative terms only and is geared to the sales budget. The production manager’s duties include:
- analysis of plant utilisation
· work-in-progress budgets.
If requirements exceed capacity he may:
- subcontract
· plan for overtime
· introduce shift work
· hire or buy additional machinery
· The materials purchases budget’s both quantitative and financial.
- c) Raw materials and purchasing budget:
- The materials usage budget is in quantities.
· The materials purchases budget is both quantitative and financial.
Factors influencing a) and b) include:
- production requirements
· planning stock levels
· storage space
· trends of material prices.
- d) Labour budget: is both quantitative and financial. This is influenced by:
- production requirements
· man-hours available
· grades of labour required
· wage rates (union agreements)
· the need for incentives.
- e) Cash budget: a cash plan for a defined period of time. It summarises monthly receipts and payments. Hence, it highlights monthly surpluses and deficits of actual cash. Its main uses are:
- to maintain control over a firm’s cash requirements, e.g. stock and debtors
- to enable a firm to take precautionary measures and arrange in advance for investment and loan facilities whenever cash surpluses or deficits arises
- to show the feasibility of management’s plans in cash terms
- to illustrate the financial impact of changes in management policy, e.g. change of credit terms offered to customers.
Receipts of cash may come from one of the following:
- cash sales
· payments by debtors
· the sale of fixed assets
· the issue of new shares
· the receipt of interest and dividends from investments.
Payments of cash may be for one or more of the following:
- purchase of stocks
· payments of wages or other expenses
· purchase of capital items
· payment of interest, dividends or taxation.
Steps in preparing a cash budget
- i) Step 1: set out a pro forma cash budget month by month. Below is a suggested layout.
| Month 1 | Month 2 | Month 3 | ||
| $ | $ | $ | ||
| Cash receipts | ||||
| Receipts from debtors | ||||
| Sales of capital items | ||||
| Loans received | ||||
| Proceeds from share issues | ||||
| Any other cash receipts | ||||
| Cash payments | ||||
| Payments to creditors | ||||
| Wages and salaries | ||||
| Loan repayments | ||||
| Capital expenditure | ||||
| Taxation | ||||
| Dividends | ||||
| Any other cash expenditure | ||||
| Receipts less payments | ||||
| Opening cash balance b/f | W | X | Y | |
| Closing cash balance c/f | X | Y | Z | |
- ii) Step 2: sort out cash receipts from debtors
iii) Step 3: other income
- iv) Step 4: sort out cash payments to suppliers
- v) Step 5: establish other cash payments in the month
Figure 4.1 shows the composition of a master budget analysis.
Figure 4.1 Composition of a master budget
| OPERATING BUDGET | FINANCIAL BUDGET |
| consists of:- | consists of |
| Budget P/L acc: get: | Cash budget |
| Production budget | Balance sheet |
| Materials budget | Funds statement |
| Labour budget | |
| Admin. budget | |
| Stocks budget |
- f) Other budgets:
These include budgets for:
- administration
· research and development
· selling and distribution expenses
· capital expenditures
· working capital (debtors and creditors).
The master budget (figure 4.1) illustrates this. Now attempt exercise 4.1.
Budgetary Control In A Non-profit Making Organisation
Control in not-for-profit organizations is particularly difficult because the objectives of the organisation cannot always be expressed in quantitative terms. Control involves assessing whether objectives have been met. If a particular objective cannot be expressed in measurable terms, it must be stated in some way so that an assessment of whether it has been met can be made.
Not-for-profit organistions can therefore compare planned objectives with actual results using either the subjective judgement of a person or group of people or using information which is not directly based on human judgement.
Control in not-for-profit organisations should be concerned with quantity and quality. Quantity is usually easier to measure than quality. For example it is easy to measure the number of trained people in a certain field but not how well they have been trained. The quantity measure can however give some indication of quality.
Inputs can also provide an indication of quality of output. For example, the amount spent on education may provide a clue on the quality of education (other factors constant) if no suitable output measures are available.
Other techniques that can be used for measuring the performance of both not-for-profit and service organisations include management audits and management by objectives.
Management audit – is an investigation of the entire management control system so as to assist management to do a better job by identifying waste and inefficiency and recommending corrective action.
Management By Objectives (MBO) – is the system of control whereby managers are required to state, as specifically as possible, the objectives that they expect to attain during the year. Actual results are then measured against objectives via a periodic performance appraisal interview. Management’s progress is evaluated during the interviews.
The Control cycle
Control is achieved through what is known as the control cycle. The elements of the control cycle include:
- Plans and targets are set for the future – they could be longterm, medium term or short term plans.
- Plans are put into operation: as a consequence, materials and labour are used, and other expenses are incurred.
- Actual results are recorded and analyzed.
- Information about actual results is fed back to the manager concerned, often in form of reports.
- The feedback is used by management to compare actual results with plans or targets.
- By comparing actual and planned results, management can take one of the following decisions depending on how they see the situation:
- They can take control action -by identifying what has gone wrong and then finding out where corrective measures can be taken.
- They can decide to do nothing. This would be the decision when actual results are going better than planned, or when poor results were caused by something which is unlikely to happen again in future.
- They can alter the plan or target. This should be the decision when actual results are different from the plan or target, and there is nothing that management can do to correct the situation.
Basic Financial Accounting 