Budgetary control is a concept of financial accounting that helps oversee an organization’s payments and receipts.
It provides a greater tool to plan, monitor, and control financial activities within an organization.
The concept of budgetary control can be linked with liquidity and cash flow management. However, the concept of budgetary control is not limited to cash flow management, it extends to include profitability, capital management, financial management, and all other aspects of business management.
What is the Concept of Budgetary Control?
The concept of budgetary control is based on comparing budgeted and actual amounts. The budgeted amounts are forecasted based on the current market and business conditions.
That’s the operations planning stage that needs to be set in line with the market research and expectation.
Although, the budget needs to be challenging it must be realistic and designed to increase the efficiency of the managers.
A good budget needs to be comprehensive, easy to understand, in line with the organization’s motives, and free from unrealistic assumptions.
The budget preparation can be top to bottom or bottom to top. The top-to-bottom does not include input from the lower employees in the hierarchy.
The bottom-to-up approach to setting a budget involves operational staff in setting the budget.
At the end of the period, an actual amount is compared with the estimated or budgeted figures to come up with the variance.
The obtained variance needs to be analyzed if that’s controllable or not. The variance might be favorable or adverse depending on the situation that helps to decide the performance of the managers.
What are the Objectives of Budgetary Control?
The objective of budgetary control is to measure performance, control financial and operational activities, establish responsibilities, and closely monitor the different managerial aspects.
Further, If budgets are prepared and monitored effectively, it helps to improve the profitability and liquidity structure of the business.
Let’s understand how budgetary controls help the business achieve organizational objectives.
1) Performance measurement
The comparison of budgeted and actual financial figures generates variance. The variances can be negative or positive.
If the variance is positive it’s good news for the managers as their performance exceeds expectations.
On the contrary, if a variance is negative the reasons need to be investigated for the lower performance of the manager.
Further, the business needs to consider if performance was severely affected by the external market conditions or if it was negligence by the manager.
The volume of variance indicates the intensity of the variation. If an adverse variation is not material, the cost of action might be more than its benefits.
2) Control of financial and operational activities
The budget system pre-actively sets the direction for managers responsible for making decisions. They have targets in their mind from the start of the period and the capability to direct their energy toward achieving periodic targets/goals.
The budget mechanism further allows the managers to decide the company’s risk exposure. For instance, if the target increases sales exponentially, it’s logical to look for acquisitions and mergers.
In addition, managers with expense budgets are expected to have more skepticism before approval.
3) Establishment of responsibilities
In the world of accounting, there is a concept of responsibility centers. These responsibility centers have their revenue and expenses.
Setting a budget helps set the target of revenue and expenses for the specific responsibility center.
The setting of a budget for the responsibility center helps to easily identify its performance and contribution to the overall profit/loss for the company.
The combination of budgetary controls and responsibility accounting increases an organization’s transparency and culture of enhanced efficiency.
4) Close monitoring of managerial aspects
The budget is of prime importance in the management of the company. It brings collaboration between different departments that sit at the table and decide what needs to be done with how much resources.
Effective implementation of the budget process makes managers think about activities that will take place throughout the organization.
The budget helps to think about all the managerial aspects including the purchase of inventory, cost of inventory holding, cost of production, production losses, forecasted sales, forecasted expenses, required threshold of inventory, expected sales, cost of sales, related administrative and operational expenses, etc.
It makes managers think about different managerial aspects that help them to improve their efficiency and organizational profits.
Types of budget
Various budget types have been developed to cover different financial statements and managerial information areas.
These types of budgets include sales, production, fixed assets, purchase, capital, labor, expense, cash, etc.
All these budgets are merged into one budget sheet called a Master budget.
1) Sales budget
The sales budget contains forecasted revenue over a specific period. The formation of an appropriate sales budget requires an estimation of the number of units and sales price.
The expectation of the sales price and the number of units is developed based on market research, trend analysis, and seasonal variations.
2) Production budget
The production budget contains a plan regarding the production of units at a specific time. The formation of a production budget depends on the expected sales and level of holding required by the company.
3) Fixed assets purchase budget
The fixed assets purchase budget contains the expected purchase that the business needs to make in the period under consideration.
For instance, a business may need some additional machinery to meet the demands set in the production budget. Capital budget
The capital budget contains all the expected changes in the company’s capital. For instance, the company may need to issue shares to get funds for purchases planned in the fixed assets budget.
4) Expense budget
The expense budget contains all the expected expenses for the period under consideration. The expense budget provides a sound tool to control expenses and an easy basis for approval.
5) Labour budget
The labor budget provides a comprehensive base to predict labor charges. It needs to consider the labor hours required and the rate per hour.
The labor budget formation depends on the production budget as figures from the production budget are used in the labor budget.
6) Cash budget
The cash budget contains the expected movement of in and out of the cash for a business. The formation of a cash budget requires a strong understanding of operations management.
Business managers are interested in the cash budget to ensure they do not have to face liquidity issues.
These different types of budget help in the identification of areas that need to be improved. For instance, if there is adverse variance in the sales it suggests the company enhance marketing efforts.
If all the negative areas with massive adverse variance are considered and improved, it definitely helps to improve the company’s financial performance.
Advantages
Planning and monitoring the budget requires the consumption of energy. However, there are massive advantages to applying principles of the budget.
These advantages include but are not limited to ease in goal setting, setting targets, improved departmental coordination, enhanced responsibility accounting, enhanced centralized control, and identification of financial areas that need to be improved.
If the business succeeds in improving specific areas, it gets to improve the performance of the business.
Limitations
The concept of budgeting is based on estimates that might not be always accurate. There may be a gap in expectations or goals, leading to demotivation if targets are not achieved.
Another side of budgeting is difficulty coordinating and collaborating between different company departments.
Hence, the activity of budgetary control may be costly and time-consuming.
Sometimes, there may be significant changes in the external environment of the business that have severe impacts on performance.
If changes in the external environment are not considered the use of budget may be full of problems instead of enhancement in the business efficiency.
