Budgetary control is a type of control in which actual results are compared to budgeted results so that appropriate action can be taken if there are any differences between the two. Let’s see the objectives and process for the preparation of the budgetary control system.
What is Budgetary Control?
A budgetary control system is a set of procedures used to ensure that an organization’s actual revenues and expenditures closely match its financial plan. The budgetary control system typically entails setting personal budget-based goals for managers, as well as a set of rewards that are triggered when the goals are met. Furthermore, budget versus actual reports are routinely distributed to anyone in charge of a line item in the financial statements; they are then expected to take action to correct any unfavorable variances. Furthermore, the business’s results are closely monitored by a budget committee, which provides managers with feedback whenever actual results threaten to fall short of expectations. The budget can even be loaded into purchasing and payables software so that purchases that exceed the budgeted amount are immediately flagged.
Budgetary Control Objectives
An efficient budgeting system is critical to the success of a business organization.
The budgeting system has the following goals, all of which are critical to the overall efficiency and effectiveness of the business organization. These goals are discussed further below.
#1. Planning
Any work that is done on a regular basis requires planning. A well-prepared plan assists the organization in making efficient use of scarce resources, making it easier to meet predetermined targets.
A budget is always prepared for the future period and lays out targets for various aspects such as purchasing, production, sales, manpower planning, and so on. This automatically makes planning easier.
#2. Coordination
Aside from planning, coordinated efforts are required to achieve the predetermined objectives. Budgeting facilitates coordination because budgets cannot be created in isolation.
For example, when developing the production budget, the production manager will need to consult the sales manager for a sales forecast and the purchase manager for raw material availability.
The production budget cannot be created in a vacuum. Similarly, the purchase and sales budgets, as well as other functional budgets such as cash, capital expenditure, manpower planning, and so on, cannot be developed in isolation. As a result, coordination is automatically added.
#3. Control
Planning involves looking ahead, whereas controlling involves looking back.
Budget preparation entails detailed planning for various activities such as purchase, sales, and production, as well as other functions such as marketing, sales promotion, and manpower planning. However, planning alone is insufficient.
There should be a proper control system in place to ensure that the work is progressing as planned.
Budgets serve as the foundation for such control because actual performance can be compared to budgeted performance.
Any difference between the two can be identified and analyzed to determine the causes of the difference so that corrective action can be taken to correct it. Thus, budgeting is extremely beneficial in controlling functions.
The Benefits of Budgetary Control
Budgetary control has evolved into an important tool for organizations to use in order to control costs and maximize profits. Some of the benefits of budgetary control include:
- It defines the enterprise’s goals, plans, and policies. If there is no clear goal, efforts will be wasted in pursuing other goals.
- Budgetary control establishes goals. To meet the deadline, each department is required to work efficiently. As a result, it is an efficient method of monitoring the activities of various departments within a business unit.
- It ensures better coordination between departments.
- If performance falls short of expectations, budgetary control assists management in assigning blame.
- It aids in lowering production costs by eliminating wasteful expenditure.
- Budgetary control promotes efficiency and the economy by instilling cost-consciousness in employees.
- Budgetary control enables centralized control while allowing for decentralized activity.
- Because everything is planned and provided in advance, the business enterprise runs smoothly.
- It informs management of where immediate action is required to solve problems.
Budgetary Control’s Drawbacks or Limitations
Budgetary control has the following limitations:
- It is extremely difficult to prepare accurate budgets in inflationary conditions.
- Budgeting entails large expenditures that small businesses cannot afford.
- Budgets are created for the future, which is inherently uncertain. Conditions may change in the future, causing budgets to be disrupted. As a result, future uncertainties reduce the value of the budgetary control system.
- Budgetary control is only a tool for management. It cannot replace management in decision-making because it is not a management substitute.
- The success of budgetary control is dependent on top management’s support. If top management does not support the initiative, it will fail.
Budgetary Control Process
The stages of budgetary control are as follows.
#1. Creating Budgets
The development of various budgets is the first stage in budgetary control. The budget centers in the organization must be identified, and budgets must be developed for each of them.
Thus, budgets are created for functions such as purchasing, selling, manufacturing, and manpower planning, as well as cash, capital expenditure, machine hours, labor hours, and so on.
Budgets should be created with extreme caution. The factors influencing planning should be thoroughly researched, and budgets should be developed as a result.
#2. Actual Performance Monitoring
A proper system for recording actual performance should be in place. This will make comparing the budget and the actual easier. An efficient accounting and cost accounting system will aid in effectively recording actual performance.
#3. Budgeted and Actual Performance Comparison
The comparison of budgeted and actual performance is one of the most important aspects of budgetary control.
The goal of such a comparison is to determine the difference between the two and provide a foundation for corrective action.
#4. Corrective Action
The essence of budgeting is taking appropriate corrective action based on a comparison of budgeted and actual results.
A budget is always prepared for the future, so there may be a difference between the budgeted and actual results. There is a need to investigate and take appropriate action so that the deviations do not occur again in the future. Responsibilities can be assigned to appropriate individuals so that they can be held accountable for any such deviations.
Budgetary Control Preparation
Budgetary control, as previously described, is extremely useful for planning and control. However, despite these advantages, adequate preparation should be made.
For complete success, a solid foundation must be established, and the following factors are critical.
#1. Budget Committee
A budget committee is required for the successful implementation of the budgetary control system. Budget-related work may be performed by the Chief Accountant himself in small or medium-sized organizations.
Because of the organization’s size, there may not be many issues with implementing the budgetary control system.
However, in large organizations, a budget committee comprised of the chief executive, budget officer, and heads of major departments is required.
The budget committee’s main functions are to prepare budgets and then scrutinize them, establish broad policies regarding budget preparation, approve budgets, suggest revisions, monitor implementation, and recommend action to be taken in a given situation.
#2. Budget Centers
Another important requirement for a sound budgetary control system is the establishment of budget centers. A budget center is a collection of activities or a division of an organization for which a budget can be created.
For example, manpower planning budget, R&D cost budget, production and production cost budget, labor hour budget, and so on. Budget centers should be clearly defined so that preparation is simple.
#3. Budget Timeline
A budget is always prepared ahead of time. This means that the time frame for which a budget is prepared is predetermined.
As a result, a budget can be created for three years, one year, six months, one month, or even one week. The point is that the period for which the budget is prepared should be fixed and predetermined.
In general, functional budgets such as sales, purchases, and production are prepared for a year and then broken down monthly. Budgets for capital expenditure, for example, are typically prepared for a period of one to three years.
Thus, the budget period is determined based on the type of budget, and it must be determined well in advance.
#4. Making an Organizational Chart
An organizational chart that clearly defines the authorities and responsibilities of various executives is required. The organization chart will clearly define the functions that each executive will perform in relation to budget preparation and his relationship with other executives.
The organizational chart may need to be adjusted to ensure that each budget center is overseen by the appropriate member of staff.
#5. Budget Manual
According to ICMA, a budget manual is “a document that sets out the responsibilities of the person engaged in, the routine of and the forms and records required for budgetary control.”
As a result, the budget manual is a schedule, document, or booklet that contains various forms to be used, procedures to be followed, budgeting organization details, and a set of instructions to be followed in the budgeting system.
It also specifies the roles and responsibilities of the various individuals and managers involved in the process.
#6. The principal budget factor or key factor
A key or principal budget factor [also known as constraint] is a factor whose influence must first be assessed in order to prepare functional budgets.
Sales are typically the most important budget factor, but other factors such as production, purchase, and skilled labor may also be important.
For example, if a company has the capacity to produce 30,000 tons per year but the sales forecast indicates that the market can only absorb 20,000 tons, it makes no sense to produce 30,000 tons. As a result, the sale is the most important factor in this case.
On the other hand, if the company can produce 30,000 units and the market can absorb the entire production, this means that sales are not the most important factor; however, if the raw material is in limited supply and only 25,000 units can be produced, the raw material will become the most important factor.
The key factor limits the other functions, so it must be carefully considered in advance. As a result, a continuous assessment of the business situation is required.
In all circumstances, the key factor is the starting point in the budget preparation process.
#7. Maintaining Adequate Accounting Records
The accounting system must be capable of recording and analyzing the transactions.
For the establishment of budgets and finally control through budgets, a chart of accounts or accounts code should be maintained, which may correspond with the budget centers.
Making Budgetary Control More Effective
Budgetary control can be made more effective by ensuring the following:
#1. Establishing appropriate standards
This is critical for budgeting success. Many budgets fail due to a lack of such standards, and some upper-level managers are hesitant to allow subordinates to submit budget plans for fear of lacking a logical basis for reviewing budget requests.
#2. Obtaining top-level management approval
Budget creation and administration must have the full support of top management.
Budgets encourage alert management throughout the organization if top management supports budget making, requires departments and divisions to create and defend their budgets and participates in this review.
#3. User participation in budget preparation
In addition to top management support, concerned managers at lower levels should be involved in its preparation. To ensure success, genuine participation in budget preparation is required.
It may also be worthwhile to give department heads some leeway in changing budgets and shifting funds as long as they meet their overall targets.
#4. Providing managers with information on-budget performance
Managers require ready information about actual and forecast performance under budget by their departments for budgetary control to function properly. Such data should be designed to show them how well they are doing.
Conclusion
Budgeting is the numerical formulation of plans for a specific future period. Budgets can be established for units, departments, divisions, or the entire organization.
A budget is typically one year in length and is expressed in financial terms. Most control systems are built around budgets. They serve as yardsticks for measuring performance and facilitate comparisons across divisions, organizational levels, and time periods.
Budgetary Control FAQs
What are the main objectives of budgetary control?
Objectives of Budgetary Control include Planning, Co-Ordination, Communication, Motivation, Control, and Performance Evaluation.
What is budgetary cycle?
Companies use monthly, quarterly, and/or annual budget cycles to control costs and streamline administrative duties. Budget cycles are also used frequently by government agencies to help them control costs.
