FMA - Budgeting & Budgetary control

budget (Photo credit: 401(K) 2013)

Budgeting& Budgetary Control

Meaning of Budget:

                     A budget is a plan expressed in quantitative, usually monetary terms, covering a specific period of time, usually one year. In other words, a budget is a systematic plan for the utilization of manpower and material resources.

                     In a business organization a budget represents an estimate of future costs and revenues.

Budgets may be divided into two basic classes;

1.Capital Budgets and 2.Operating Budgets.

                    Capital budgets are directed towards proposed expenditures for new projects and often require special financing.

                     The operating budgets are directed towards achieving short-term operational goals of the organization, for instance, production or profit goals in a business firm. Operating budgets may be sub-divided into various departmental or functional budgets.

Budgeting:

                     Budgeting refers to the process of preparing the budget. It involves a detailed study of business environment clearly grasping the management objectives, the available resources of the enterprise and capacity of the enterprise.

Budgetary control:

                     Budgetary control is the process of preparation of budgets for various activities and comparing the budgeted figures for arriving at deviations if any, which are to be eliminated in future.

                    No system .of planning can be successful without having an effective and efficient system of control. Budgeting is closely connected with control. The exercise of control in the organization with the help of budgets is known as budgetary control.

The process of budgetary control includes

(i) preparation of various budgets

(ii) continuous comparison of actual performance with budgetary performance and

(iii) revision of budgets in the light of changed circumstances.

                    A system of budgetary control should not become rigid. There should be enough scope for flexibility to provide for individual initiative and drive. Budgetary control is an important device for making the organization more efficient on all fronts. It is an important tool for controlling costs and achieving the overall objectives.

Objectives of Budgetary control:

          The following are the objectives of budgetary control.

1. Planning:

     Budgeting ensures effective planning by setting up of budgets.

2. Coordination:

      Budgets are helpful in coordination of business activities .

3. Efficiency and economy:

       Effective budgetary control results in cost control and cost reduction.

4. Increase in profitability:

        Costs are controlled with help of budgets and profits targeted are achieved.

5. Anticipation of future capital expenditure:

         Estimated increases in sales necessitating higher production capacity provides advance for capital expenditure.

6. Control:

        Controlling function is made to be effective as the control is centralized while budgets are prepared and implemented.

7. Deviations:

         Ascertained of deviations is essential to fix responsibility and correct the deviations as far as possible.

Advantages of Budgetary control:

 1. Maximization of profit:

             The Budgetary control aims at the maximization of profits of the enterprise. To achieve this aim, a proper planning and co-ordination of different functions are undertaken.

2. Co-ordination:

             The working of different departments and sectors is properly co-ordinate. Budgets of various functions are interlinked and dependent. Effective implementation of budgets depends upon the co-ordination of various departments.

3. Evaluation of executive performance:

            Goals are set for each department. Actual performance is compared with standards and deviations are reported to the top management for action against unfavorable deviations.

4. Clear cut goals and targets:

             Through the process of budgeting the goals of different department s are set in advance in consultation those in charge  of them.

5. Economy in operations:

            Expenses are properly planned and financial resources are put to optimum use.

6. Revaluation of ineffectiveness:

            Comparison of  actual performance with budgeted performance reveals week spots so that attention is focused on them to improve the performance.

7. Introduce the incentive scheme:

            Incentive schemes can be easily introduce as the predetermined targets act as base to compare the actual performance and determine efficiency.

8. Reduce cost:

            Budgetary control has to play a vital role to reduce the cost and increase the sale.

Limitations of Budgetary control:

 Budgetary control is an effective tool for management control. However it has some limitations while operating it is an technique.

1. Prediction of uncertain future:

            Budgeting is the process forecasting and estimation. Forecasting may not be accurate. Therefore budgets based on inaccurate forecasts and estimates may not be accurate and effective.

2. Changes of condition:

            Budgets are prepared on the basis of certain prevailing conditions. If conditions are change budgets are also to be revised.

3. Complacence:

            Under budgetary control targets are given to every person of the concern. The common tendency of people is to achieve the targets only. So the skillful employees are also worked on that targets only. The budgets are serve as constraints on managerial activities.

4. Difficulty in coordination:

            Effective implementation of budgetary control depends upon proper coordination among various departments. It requires budgetary officer to oversee the integration of various activities to successful implement in the budgets.

5. Conflict among the departments:

            Budgetary control may lead to conflicts among functional departments. Every department heads worries about his department goals without thinking of common goal.

This raises the conflict among different departments. 

Essentials of Budgetary control:

            The following are the essentials requisites for implementing budgetary control successfully

1.Top management support:

            The budgetary control should have continuous support of top management which can be ensure its all round acceptance.

2. Clearly defined organizational structure:

            The authority and responsibilities are to be properly defined to pin-point the responsibility of specific individuals in key positions.

3. Efficient accounting system:

            Efficient accounting system should provide the required information in time.

4. Reporting of deviations:

            Efficient system has to be devised to reduce the differences between budgets and actual performance.

5. Motivation:

            Staffs are to be appraised of budgets and benefits they are going to derive directly and indirectly.

6. Realistic Targets:

            The targets should be realistic so that they are achievable and budgets should not be frustrate the workers by fixing unrealistic targets.

7. Flexibility:

            Budgets are prepared on the basis of certain conditions. If there is a change in conditions budgets also should be adjusted to accommodate the changes.

Classifications of budgets:

(A)   Classification according to time

1.      Long term budgets.

2.      Short term budgets

3.      Current budgets.

(B)   Classification based on functions:

1.      Functional or subsidiary budgets.

2.      Master budgets.

(C ) Classification on the basis of flexibility

             1. Fixed budget

             2. Flexible budget.

(A)  Classification on the basis of time:

1.Long term budgets:

                        The budgets are prepared to depict long term planning of the business. The period of long term budgets varies between 5 to 10 years. The long term planning is done by the top level management. These budgets are useful for those industries where gestation period is long. i.e., electricity., engineering, etc.

            2. Short term budgets:

                        These budgets are generally for 1 or 2 years are in the terms of money.

The customers goods industries like., sugar, cotton, textile, etc use short term budgets.

            3. Current budgets:

                        The period of current budgets is generally for one or two months and weeks. The budgets are relate to the current activities of the business.

(B)   Classification on the basis of functions:

1. Functional budgets:

            The budgets are relate to various functions of the concern. The following are the commonly prepared functional budgets.

a.      Purchase budget

b.      Cash budget

c.       Production budget

d.      Sales budget

e.      Materials budget.

             2.Master budget:

                      This budget is summary of various functional budgets. This functional

Budget is prepared to coordinate the activities of various functional departments.

(C)   Classification on the basis of flexibility:

1. Fixed budget:

           It is prepared for a given level of activity and remains same irrespective of change of activity.

2. Flexible budget:

           It is a budget prepared for various levels of activity by classification of expenditure under fixed, variable, and semi fixed categories.

Some important budgets:

1. Sales Budget:

          A sales budget is an estimate of expected sales during a budget period. A sales budget is known as a backbone of the enterprise. A sales budget is the starting point on which other budgets are also based. The sales budget shows quantity of finished products to be sold and price at which they are to be sold.

2. Production budget:

        This budget is based on the sales budget. It shows the budgeted quantity of output to be produced during the specific period. This budget has to show the output for the period as well as production cost also.

3. Material budget:

         The material budget is concerned with determining the quantity of raw materials required for production. The requirements of raw material are determined product – wise. The rates of consumption of raw materials also determined.

4. Labour Budget:

            Labour budget is also part of production budget. Labour budget is prepared by personnel department. This budget is useful for anticipating labour time required for production. The personnel department is also able to make arrangements for recruitment of workers.

5. Overhead Budget:

            Production overhead budget: It is prepared for with help of production, and labour budgets. It prepared on the basis of past years figures and future changes expected.

            Administration overhead budget: This budget is prepared to estimate the expenditure to be incurred for planning, organizing, directing and controlling functions of the management.

            Selling and distributing overhead budget: This budget is prepared to estimate expenditure to be incurred to sell the product and its distribution.

6. Cash Budget:

            Cash budget is an important budget. It estimates the amount of cash receipts and payments and the balance of cash during the specific period. The objective of cash budget is provide for all cash requirements in time and avoid accumulation of excess cash.

7. Research and development budget:

            This budget is prepared to estimate the research and development expenditure to be incurred during a specific period.

8. Capital Expenditure budget:

            This budget is prepared to estimate the capital expenditure on fixed assets – Building, machinery, plant, furniture, etc., is generally a long term budget.

9. Master budget:

            A comprehensive master budget is prepared for the entire organization, by integrating all the functional budgets of a period. The master budget is an overall for the guidance of the management. This budget is helpful in coordinating activities of functional departments. 

Zero Based Budgeting (ZBB)

          Zero Based Budgeting is the latest technique of budgeting and it has an increased use as a managerial tool. This technique was first used in America in 1962. The former president of America, Jimmy Carter used this technique when he was the Governor of Gorgia for controlling state expenditure.

         ZBB provides a solution towards to failure of traditional budgeting. ZBB as an operating, planning and budgeting process which requires each manager to justify his entire budget request in detail from zero base and shifts the burden of proof to manager.

ZBB involves the following aspects;

1.      Concerned with all requisites of budget.

2.      Evaluation  of existing and newly proposed activities.

3.      Planning the resources, prioritization of different activities and redeployment of resources accordingly.

Process of Zero Base Budgeting: 

1. Specification of decision units:

              A decision unit should be identified in terms of functional responsibility centers or cost centers.

The decision making center may be segment of an organization or a project for which separate budgets are to be prepared  and decisions are made regarding the amount to be spent and quantum and quality of work to be done.

2. Development of Decision packages:

              Formulation of decision packages is a set of documents which identify and describe activities of unit in such a way that management can be evaluate and rank them against others competing for resources and decide whether to approve or disapprove.

3. Prioritization of Activities:

              Another vital step in ZBB is the ranking of proposed alternatives included in decision packages for the same decision packages for various decision units or various decision packages for the same decision unit.

4. Allotment of units:

              The resources of the organization are allocated to various decision units keeping in mind the alternatives selected and approved as a result by ranking  process.

Advantages of ZBB: 

 1. Optimum use of Financial Resources:

              The limited resources of an organization are allotted on the basis of priority of needs of funds, which ensures effective utilization of funds.

2. Weeding out of wastage:

              The funds are allocated at priority and put into best alternative use. This results in inefficiency being removed and wastage being reduced.

3. Participation by all Concerned:

              Management by objective is practiced as all concerned are made to participate in decision making which results in motivation for different levels of managers.

4. Flexibility in Budget:

              The frequent review of performance results in adjustments of budgets for short fall of income.

5. Realistic Targets:

              The budgets are prepared as per importance and essentiality of activity and not on the basis of past occurrence. The budgets are prepared as per conditions prevailing during the current period without considering the past as basis.

Limitations of ZBB:  

 1. Time Consuming:

              ZBB requires more time than the traditional budgeting as there is no basis on which estimates are to be made.

2. Lack of skilled Managerial Personnel:

              It requires skilled managers at all levels of the organization. In practice, skilled managerial personnel may not be available.

3. Limited Application:

              It cannot be directly applied to directly applied to direct materials, direct wages,

And overheads associated with production function.