BUDGET AND BUDGETORY
CONTROL
1.
Meaning of a Budget
2.
Importance or functions or objectives of a budget
3.
Essentials of a Budget
4.
Types of Budgets:
1. Based on Capacity or flexibility or level of activity
a) Fixed Budget
b) Flexible Budget
2. Function wise
a) Sales Budget
b) Production Budget
c) Materials Usage Budget
d) Material Purchase Budget
e) Direct Labour Budget
f) Factory overheads Budget
g) Office and Administrative overheads Budget
h) Selling and Distribution overheads Budget
i) Research and Development Budget
j) Capital Expenditure Budget
Cash Budget
3. Period wise:
a) Short Term Budgets
b) Long Term Budgets
c) Current Budgets
4. Master Budget
5. On the basis of level of participation
a) Top-down approach
b) Bottom-up approach
5.
Zero Base Budgeting
6.
Performance Budgets
7.
Budget Ratios
Meaning:
Before
understanding budgets, let us give a thought to the need of planning. As a
manager or a person of general reasoning, leading a common life, all of us come
across situations where we think before acting. This means we are concerned
with the unfavorable outcome. Outcome can be favorable provided we select a
matching course of action. If we have not pre-planned this matching or requisite
course of action, two things will follow:
(i)
Our resources will be consumed or lost (more than what should have been)
(ii)
Desired result will not accrue.
Budget reduces above risk and allows a manager to act in a planned and controlled manner. (Compare this with a person indulging with unknowns of life with out any preparation and you will realize his precarious condition)
Thus, a budget is
a species of plan. It looks into future. It provides with a future course of
action. Only distinguishing thing is budgets are quantified plans i.e. They are
expressed in terms of money or they deal with financial aspects. Secondly it
corresponds to or relates to a precise period or time frame.
Note: All budgets are plans but all plans are not budgets.
However,
this is not a very strict boundary line and more often than not, this line is
blurred or stretched or trespassed as per the need of real life situations.
To assess
the need, process and significance of a budget, one can imagine real life
common scenarios like a housewife managing her house affairs by drawing a
monthly budget. Children asking parents for an excursion trip after completion
of their examinations and parents replying, “oh…umm lets see, next month we are
already into a very tight spot with the budget as we have to spent with the
renovation of the house and which cannot be postponed further”.
In
commercial world the need is even more grave as the stakes in terms of precious
resources are very high. Any wrong move can lead to irreparable losses and more
likely extinction. We have seen misadventures in case of Kingfisher Airlines,
RCom etc.
Definition
of budget:
A
budget is a plan
of action for a future
period clearly laying down financial
constraints to be observed and financial targets
to be achieved. It simply means a financial plan
expressed in terms of money. The budget pertaining to any of the activities
of business is always forward looking.
The term
‘budget’ has been derived from the French word, “bougette”, which means a
leather bag into which funds are appropriated to meet the anticipated expenses.
This gives an idea that how much funds one has to do various expenses OR What
expenses can be done with the available funds. With the passage of time
and growth in business magnitudes, budget has acquired much wider scope.
The CIMA
Official Terminology defines a budget as “A quantitative
statement, for a defined period of time, which may include planned revenues,
expenses, assets, liabilities and cash flows.”
Another
way of thinking about budgets is that what are the organisational objectives.
Next step is to enlist the functions and activities required to be performed
for achieving those objectives. Obviously these functions and activities will
demand use or consumption of resources i.e. funds. Thus budget sets out the targets
or performances to be achieved in quantitative or financial terms on one
hand and availability of funds for use i.e. level of expenses to be incurred
for supporting those performances on the other, of course, with reference to a
definite period.
Note:
Budget can be in quantitative terms also and need not be expressed in terms of
money only. For example a sales budget can simply state the number of passenger
cars to be sold in next quarter.
Budgeting and Budgetary control:
Budgeting
simply means preparing budgets. It is a process of preparation, implementation
and the
operation
of budget. Being a plan of action, a budget guides every manager in the
decision making
process.
In the
words of Rowland Harr, “Budgeting is the process of building budgets”.
Budgetary
control is a system of using budgets for planning and controlling costs. The
official terminology of CIMA defines the term ‘budgetary control, as “the establishment of
budgets relating to the responsibilities of executives to the requirement of a
policy, and the continuous comparison of actual with budgetary result, either
to secure by individual action the objectives of that policy or to provide a
basis for its revision.”
Thus,
when plans are embodied in a budget and the same is used as the basis for
regulating operations, we have budgetary control. As such budgetary control
starts with budgeting and ends with control.
Features of Budget:
(i)
It has a definite time frame
(ii)
It is prepared for the period about to come in
future
(iii)
A budget is principally about financial or
quantitative items or variables.
A budget has to be in sync
Objectives of Budget and Budgetary control:
The following points reveal the objectives of Budget and
budgetary control: –
(i)
To safeguard the capital of the enterprise.
(ii)
To aid the planning of annual operations
(iii)
To coordinate the activities of the various
parts of the organization
(iv)
To communicate plans to the various
responsibility centre managers
(v)
To motivate managers to strive to achieve the
organizational goals.
(vi)
To control activities
(vii)
To eliminates the wastes of all kinds
(viii)
To provide a yard stick against which actual
results can be compared
(ix)
To evaluate the performance of managers.
(x)
To reduce the uncertainties and guide about the
road ahead
Meaning of Estimate, forecast and Budget:
An estimate is predetermination of future events either on
the basis of simple guess work or following scientific principles.
Forecast is an assessment of probable future events. Budget
is based on the implications of a forecast and related to planned events. To
establish a realistic budget, it is necessary to forecast a wide range of
factors like sales volume, sales prices, availability of raw material or labour, wage rate, the
cost of overheads, inflation, even government policies, technological changes etc.
Limitations of
Budgeting:
(i)
Budgeting is only a tool and not substitute of
management
(ii)
Budgeting is heavily dependent on forecasting and
can mislead if forecasts fail.
(iii)
It is costly and time consuming.
(iv)
Tends to kill flexibility and innovation…gives
birth to complacency and rigidity.
(v)
Requires continuous monitoring.
Steps involved in
Budgetary Control:
The following steps may be considered necessary for a
comprehensive budgetary control Programme: –
(i)
Laying down organizational goals or objectives
(ii)
Formulating the necessary plans to ensure that
the desired objectives are achieved.
(iii)
Translating plans into budget
(iv)
Relating the responsibilities of executives to
the requirements of a policy.
(v)
Recording and reporting actual performance
(vi)
Continuous comparison of actual with budgeted
results
(vii)
Ascertainment of deviations, if any
(viii)
Focusing attention on significant deviations
(ix)
Investigation into deviations to establish
causes
(x)
Presentation of information to management,
relating the variations to individual responsibility.
(xi)
Taking corrective action to prevent recurrence
of variations.
(xii)
Provide a basis for revision of budgets.
Essentials of a Budgetary Control system:
Successful implementation of a budgetary control system
depends up on the following essentials.
(i)
Support by top management: The wholehearted
support of all managerial persons is very necessary for the success of a
budgetary control system.
(ii)
Formal organization: The existence of a formal
and sound organizational structure is of an
absolute necessity for an effective
system of budgetary control.
(iii)
Budget centers: For budgetary control purposes,
the entire organization will be split into a
number of
departments, area or functions, known as ‘centres’, and budgets will be
prepared for
each such centers
(iv)
Clear cut objectives and reasonably attainable goals:
– If goals are too high to be attained, the purpose of budgeting is defeated.
On the other hand, if the goals are so low that they can be attained very
easily, there will be no incentive to special effort.
(v)
Participative budgeting: Every executive
responsible for the implementation of budgets should be given an opportunity to
take part in the preparation of budgets.
(vi)
Budget committee: The work of preparing a budget
manual should be entrusted to a Budget committee. The work of scrutinizing the
budgets as well as approving of the same should be the work of this committee.
(vii)
Comprehensive budgeting: Budgeting should not be
partial, it should cover all the Functions.
(viii)
Adequate accounting system: There should be an
adequate accounting system for the
(ix)
successful budgetary control system, because
those who are involved in the preparation of estimates depend heavily on the
accounting department.
(x)
Periodic reporting: – There should be a prompt
and timely communication and reporting system for the effective implementation
of a budgetary control system.
Budget manual:
CIMA England, defines a budget manual as “ a document ,
schedule or booklets which sets out; inter alia, the responsibilities of the
persons engaged in the routine of and the forms and records required for
budgetary control”. In other words, it is a written document which guides the executives
in preparing various budgets.
Budget period: This may be defined as the period for which a
budget is prepared and employed. The budget period will depend on the type of
business and the control aspects. There is no general rule governing the selection
of the budget period.
Budget Factor:
Budget factor is also known as 'Key Factor' or 'Limiting Factor'. Budget factor is either based on the forecasts or known or available conditions which have the effect of putting restraint or limiting the level of activity. These may be outside factors like a very common factor is demand of the product or service. If demand is high, sales can also be budgeted at a high level and vice versa. Another example of outside factor is government regulations like restriction on number of admissions that can be made in MBBS during an academic year by Medical Council of India.
Internal factors are availability of raw material, skilled labour, machines etc.
Thus, budget factor puts limits to budgeted activity levels and forces preparation of realistic budgets.
Budget Factor:
Budget factor is also known as 'Key Factor' or 'Limiting Factor'. Budget factor is either based on the forecasts or known or available conditions which have the effect of putting restraint or limiting the level of activity. These may be outside factors like a very common factor is demand of the product or service. If demand is high, sales can also be budgeted at a high level and vice versa. Another example of outside factor is government regulations like restriction on number of admissions that can be made in MBBS during an academic year by Medical Council of India.
Internal factors are availability of raw material, skilled labour, machines etc.
Thus, budget factor puts limits to budgeted activity levels and forces preparation of realistic budgets.
Classification of
Budget
(I)
Classification according to time factor
(II) Classification
according to flexibility factor
(III) Classification
according to function.
I. Classification according to time factor: – On this basis, budgets can be of three types:
(i) Long term budget – for a period of 5 to 10 years
(ii) Short term budgets – Usually for a period of one to two
years
(iii) Current budgets – Usually covers a period of one month
or so,
II Classification according to flexibility: It includes
(i) Flexible budgets and
(ii) Fixed budgets
Flexible budgets: It is a dynamic budget. It gives different
budgeted cost for different levels of activity. It is prepared after making an
intelligent classification of all expenses between fixed, semi variable and
variable because the usefulness of such a budget depends up on the accuracy with
which the expenses can be classified.
Steps in preparing
flexible budgets:
(i)
Identifying the relevant range of activity
(ii)
Classify cost according to variability
(iii)
Determine variable cost
(iv)
Determine fixed cost
(v)
Determine semi variable cost
(vi)
Prepare the budget for selected levels of
activity
III. Classification according to function: It includes (i) functional
budgets and (ii) master budgets:
Functional budgets are those which are prepared by
heads of functional departments for their respective departments and are
subsidiary to the master budget.
Functional budget may be Operating budgets or financial
budget.
Operating budgets are those budgets which relate to the different
activities or operations of a firm. These are the primary budgets.
Financial budgets are those which incorporate financial
decisions of an organization. They show in detail the inflow and outflow of
cash and the overall financial position.
Master budget contains the summary of all functional
budgets. It summarizes sales, production, purchase, labour, finance budgets
etc. It is considered as the overall budget of the organization.
Different types of functional budgets:
1.
Sales
budget: It is forecast of total sales expressed in quantities and money. It
is prepared by the sales manager. While preparing sales budget we have to
consider the past sales data, market conditions, general trade and business
conditions etc.
2.
Production
budget: It is the forecast of the quantity of production for the budget
period. It is usually expressed in physical quantity.
3.
Material
budget: It shows the estimated quantities as well as cost of raw material
required for the production of different product during the budget period.
4.
Purchase
budget: It shows the quantity of different type of materials to be
purchased during the budget period taking into consideration the level of
activity and the inventory levels.
5.
Cash
budget: It is prepared only after all the other functional budgets are
prepared. It is also known as financial budget. It is a statement showing
estimated cash inflows and cash outflows over the budgeted period.
Cash budget is prepared on the basis of the cash
forecast. The cash forecast is an estimate showing the availability or
otherwise of adequate amount of cash in a future period for meeting the
operating expenses and all other commitments. It summarizes the anticipated
cash receipts and cash payments for the budget period.
There are three methods
for preparing the cash budget. They are:
(i)
The
receipts and payment method
(ii)
Adjusted
Profit and Loss method: Under this method, profit is adjusted by adding
back
depreciation, provisions, stock and work in progress, capital
receipts, decrease in debtors, increase
in creditors etc. Similarly, dividends, capital payments, increase in
debtors, increase in stock and
decrease in creditors are deducted. The adjusted profit will
be the estimated cash available. Under this method, the following information
becomes necessary:
(a)Expected opening balance
(b) Net profit for the period
(c) Changes in current asset and current liabilities
(d) Capital receipts and capital expenditure
(e) Payment of dividend
(iii)
Balance
sheet method: Under this method, a budgeted balance sheet is prepared for
the
budgeted period, showing all assets and liabilities except cash. The
two sides of the balance sheet are then balanced. The balance then represents
cash at bank or overdraft, depending upon whether the assets total is more than
that of the liabilities total or the latter is more than that of the former.
Advantages of Cash
budget:
(i)
It helps to ascertain the shortage of cash
(ii)
It helps to identify excess of cash, so that the
surplus cash can be invested for a short period
(iii)
It helps to ensure sufficient cash is available
when required.
Recent trends in
budgeting:
1. Zero Base
Budgeting (ZBB): According to the official CIMA terminology, zero base budgeting
is, “a
method of budgeting which requires each cost element to be specifically justified,
as though the activities to which the budget relates were being undertaken for
the first time. Without approval, the budget allowance is zero”. Under
ZBB the programmes and activities get evaluated and ranked from zero base as if
these were launched for first time. In this technique of budgeting the unwanted
projects and activities get dropped and wanted and desirable activities and
projects get included in the budget.
Features:
(i)
It starts from zero
(ii)
All activities are identified in appropriate
decision packages
(iii)
All programmes are considered totally afresh
(iv)
A detailed cost benefit analysis of each
programme is undertaken
(v)
There is an officer responsible for each
decision packages
(vi)
Priorities are established, and decision
packages are ranked
Advantages of ZBB
(i)
It considers every time alternative ways of
performing the same job. It helps the management to get a critical appraisal of
its activities.
(ii)
It is helpful to the management in making
optimum allocation of scarce resources
(iii)
ZBB is particularly useful for service
departments and Governments
(iv)
It ensures active participation of managers in
the budgeting process.
(v)
It promote high level of motivation at the level
of unit managers
(vi)
It focuses on output in relation to value for
money.
(vii)
It makes managers cost conscious and helps them
in identifying priorities in the overall interest of the organization.
Difference between
Traditional budgeting and ZBB
Traditional budgeting
|
Zero Base Budgeting
|
Begins with previous year’s budget
|
Begins with zero base i.e. from scratch
|
Focuses on money
|
Focuses on goals and objectives
|
Produces a single level of expenditure for an activity
|
Produces alternative level of expenditure and desired result
|
Resources are allocated not on the basis of cost benefit analysis
|
Resources are allocated on the basis of cost benefit analysis
|
Prepared annually
|
Prepared once in every five years
|
Less costly and time saving
|
Costly and requires more time
|
2. Activity based
budgeting: The CIMA official terminology defines activity-based budgeting as,”
a method of budgeting based on an
activity frame work and utilizing cost driver data in the budget setting and
variance feedback processes.” In the case of traditional budgeting, budgets
are established on the basis of budget centers. In the case of activity-based budgeting,
however, the budget centres are activity based cost pools or cost centres in
relation to which budgets are prepared. Separate cost pools are established for
each type of activity.
3. Performance
budgeting: – To understand this, let us think like this: Suppose you are given an objective to earn a rate of return of 25% on the investment or capital employed and lets say the time frame is 1 year. This translates that you have to earn Rs.25,00,000/- on an investment of Rs.1,00,00,000/- if used or employed for 1 year. For this suppose you chose to run a business of say manufacturing and selling helmets. Now you will have to plan various functions like Sales, purchase, Stores, office and administrative works, selling and distribution functions you will have to undertake. After this, diffrent programme and activities under each function have to be chalked out. Here as the targets are well quantified i.e. you have to earn Rs.25 Lacs of net profit, you have to set the target for each function and activity in clear terms to be achieved. This leads to answer of question as to what resources have to be used in order to achieve such targets. This leads to a setup where each constituent knows what he has to perform in order to achieve the target. In other words you can monitor and tune your level of activity and thus performance to meet the performance level budgeted.
Performance oriented budgets are established in such a manner that each item of expenditure related to a specific responsibility centre is closely linked with the performance of that centre. The following matters will be specified very clearly in such budgeting:
Performance oriented budgets are established in such a manner that each item of expenditure related to a specific responsibility centre is closely linked with the performance of that centre. The following matters will be specified very clearly in such budgeting:
(vii)
Objectives of the organization and for which
funds are requested
(viii)
Cost of activities proposed for the achievement
of these objectives
(ix)
Quantitative measures to measure the performance
(x)
Quantum of work to be performed under each
activity.
Advantages of
performance budgeting:
(i)
It improves budget formulation process
(ii)
It enhances accountability of the executives
(iii)
It facilitates more effective performance audit
(iv)
It presents clearly the purpose and objectives
for which funds are required
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