Budget and Budgetary Control

3.1Budgeting
Profit is the primary measure of business success. Usually, profits do not just happen. Profits are

managed. Therefore, the profitability the firm fully depends on as to what extent the management

follows proper planning, effective co-ordination and dynamic control. This requires that

management must plan for the future financial and physical requirements for maintaining

productivity and profitability of the firm is generally called 'budgeting'.

Budgeting is a tool of planning and control. Budgeting involves the steps of setting short-term

objectives, specifying programs, and expressing them in the budgets. Budgeting includes sales,

production, distribution and financial aspects of the firm.

3.1.1Budget 

A budget is a comprehensive and coordinated plan, expressed in financial terms, for the

operations and resources of the firm for some specified period in the future. Budget programs are

designed to carry out a variety of functions like, planning activities, implementing plans,

communicating, motivating and authorizing actions. A budget is a written plan for the future. A

complete budget for a firm is often called the master budget. Therefore, a budget is a numerical

plan of action that must be prepared in advance of commencing operations, stating what and how

things are to be done. It covers a definite period of time, usually one year. The budget is

basically forecasted financial statement, which expresses managerial plans that include all phases

of operations such as sales, production, purchasing, manpower and financing.

The main objective of a firm is to make an excess of revenue over expenses to maximize profit.

But it is not a matter of a dream or chance. There is no magic formula for boosting the figure of

profit overnight. Budgeting can increase the chances of making profits within the given

environment.

3.1.2 Objectives of Budget

The main objectives of budgets are as follows:

* To provide a realistic estimate of income and expenses for a period and of the financial

position at the close of the period.

* To provide a coordinated plan of action which is design to achieve the estimates reflected in

the budget.

* To provide a comparison of actual results with those budgeted and an analysis and

interpretation of deviations by areas of responsibility to indicate courses of corrective actions and

to lead to improvement in future plans.

* To provide a guide for management decisions in adjusting plans and objectives if there is an

uncontrollable change in conditions.

* To provide a ready basis for making forecasts during the budget period to guide management

in making day to day decisions.

 Budgetary Control Budgetary control involves the use of budgets and bud-getary reports

throughout the period of budget to co-ordinate, evaluate and control day-to-day operations in

accordance with the goals specified by the budget. Bud-getary control involves a constant

checking and evaluation of actual results compared with the budgeted goals, which should result

in corrective action where indicated. The Institute of Cost and Management Accountants,

London, defines budgetary control as, "The establishment of budgets relating the responsibilities

of execu-tives to the requirements of a policy, and the continuous comparison of actual with

budgeted results, either to secure by individual action the objective of that policy or to provide a

basis for its revision."

The process of budgetary control involves the following steps:

a) Defining and specifying the objectives to be achieved by the business.

b) Preparing business plans in order to ensure that the desired objectives are accomplished.

c) Translating the plans into budgets, and relating the responsibilities of individual executives

and managers to particular sections of the budget.

d) Continuous comparison of actual results with the budget, and the calculation of differences

between the budgeted and actual performance.

e) Investigating major differences in order to establish the causes.

f) Presentation of the information to management in a suitable form, relating the variances to

individual responsibility.

g) Corrective action by the management in order to avoid a repetition of any wastage or over-

expenditure. Alternatively, where it is not possible to achieve the budgeted targets due to change

in circumstances, the revision of the budget.

3.1.2Difference between Budget, Budgeting and Budgetary Control

The difference between budget, budgeting and budgetary control may be stated thus — Budgets

arc the individual objectives of a department, etc. whereas budgeting may be said to be the act of

setting budgets. Budgetary con-trol embraces ail and includes the science of planning the budgets

themselves and utilization of such budgets as an overall management tool for the business

planning and control. Thus, the term budgetary control is wider in meaning and it includes both

budget and budgeting.

3.1.3 Objectives of budgetary control are

a) To Compel Planning. This is the most important feature of budgetary control, because

management is forced to look ahead, set targets, anticipate problems and give the organisation

purpose and direction.

b) To communicate ideas and plans to everyone affected by them. It is necessary

c) To have a formal system to make sure that each per-son is aware of what he is supposed to be

doing.

d) To Co-ordinate the Activities of different departments or sub-units of the organisation. This

concept of co-ordination implies, for example, that the purchasing department should base its

budget on pro-duction requirements, and that the production budget should in turn be based on

sales expectations.

e) To Establish a System of Control by having a plan against which actual results can be

progressively compared.

f) To Motivate Employees to improve their performance.

3.1.4 Requisites of an effective system of Budgetary Control

a) A clearly defined organisational structure, which emphasizes areas of responsibility.

b) Adequate accounting records and procedures, so that measurement of performance may be

relied on.

c) Participation by individuals within the budgeting process.

d) Awareness by management of the uses of the budge-tary control system.

e) Awareness by the top management of the problems of budgetary control, and especially of the

reaction of individuals to budgets.

f) Flexibility, so that plans and objectives may be re-vised.

3.1.5 Advantages of Budgetary Control

The advantages of a budgetary control system are as follows:

a. It defines the objectives of the organisation as a whole, and within this overall framework, it

defines the results which each department should achieve.

b. It reveals the extent by which actual results have exceeded or fallen short of the budget.

c. It indicates, with variances or other measures of performance, the reasons why actual results

differ from those budgeted, and establishes the magnitude of the differences.

d. As a result of reporting on actual performance along with variances and other performance

measures, it provides a basis for guiding executive action to cor-rect adverse trends.

e. It provides a basis for the revision of the current budget, or for the preparation of future

budgets.
f. It provides a system whereby the resources of the organisation are used in the most efficient

way possible.

g. It indicates the efficiency with which the various activities of the organisation have been co-

ordinate.

h. It provides some centralizing control where activities and responsibilities are decentralised.

i. Where the activities of an organisation are subject to seasonal variations, it provides a means of

stabilizing the organization’s activities.

j. It establishes a basis for internal audit by means of regular examination of departmental results.

k. It enables standard costs to be used.

l. It provides a basis for measuring productive efficiency with a view to paying a bonus to

employees.

3.1.6 Disadvantages or Limitations of Budgetary Control

The following are the limitations of budgetary control:

1. It is really difficult to prepare the budgets accurately under inflationary conditions.

2. Budget involves a heavy expenditure which small business concerns cannot afford.

3. Budgets are prepared for the future period which is always uncertain. In future, conditions

may change which will upset the budgets. Thus, future uncertainties minimize the utility of

budgetary control system.

4. Budgetary control is only a management tool. It cannot replace management in decision-

making because it is not a substitute for management.

5. The success of budgetary control depends upon the support of the top management. If there is

lack of support from top management, then this will fail.

Steps in Preparing a Budget Preparing a budget involve the following steps:

a. Establish budget centres (for the purposes of budgetary control)

b. Prepare a clearly defined organisational chart stating the functional responsibilities of each

member of the management team.

c. Prepare a budget manual (specifies in detail the procedures to be followed)

d. Form a budget committee.(for co-ordinating and reviewing the budget programrne)

e. Determine the limiting or key factor

f. Select the budget period. (period of time for which the budget is prepared and employed)

g. Set objectives to be reached by the end of the budget period.

h. Prepare forecasts for the period.

i. Determine enterprise policies (e.g., product range, normal hours of work per week, channels of

distribution, stocks, research and development appropriation, investments).

j. Compute from the forecasts the requirements in terms of the economic quantities needed to

meet the objectives while complying with the policies — and subsequently convert these

quantities into monetary values. This results in an initial provisional budget.

k. Review this initial budget with respect to the planned objectives and amend objectives or

policies or both repeatedly until an acceptable budget emerges.

l. Formally accept the budget which then becomes the master budget and as such is an executive

order.
3.2 Types of budget Functional Budget

A functional budget is a budget which relates to a major function of the business. The usual

functional budgets are:

a. Sales Budget: The budget shows sales in terms of quantity and value, analysed by the

product, by month, by region, by channel of distribution and by salesman.

b. Selling Expenses Budget: The budget includes salesmen's salaries, commission, expenses,

and related administrative costs.

c. Distribution Expenses Budget: The budget is made/up of transportation, freight charges,

stock control, warehousing, wages, expenses, and/elated administrative costs.

d. Marketing Budget: Apart from details of all advertising, promotional activities, public

relations, marketing research, customer service, and so forth, the marketing budget can also

include a summary of the sales, selling expenses and distribution expenses budgets.

e. Research and Development Budget: The budget covers materials, equipment and supplies,

salaries, expenses, and other costs relating to design, development and technical research

projects.

f. Production Budget: The aim of the production function is to supply finished goods of a

specified quality to meet marketing demands. The distribution budget specifies finished goods

stock levels, and this can be related to the sales budget to give detailed production requirements.

Following from this, it is necessary to consider a series of subsidiary budgets:

i. Raw Materials Budget. ; It paying appropriate attention to the desired stock levels.
ii. Labour Budget: It ensuring that the plan will make available at the right times the required

number of employees of suitable skills

iii. Manufacturing Overheads budget: It covering items such as consumable materials and

waste disposal.

g. Manpower Budget: The budget must take an overall view of the organization’s needs of

manpower for all areas of activity — sales, manufacturing, administrative, executive, and so on

— for a period of years. Based on the manpower budget and policies, training expenses budget

and recruitment expenses budget can be formulated.

h. Purchasing Budget: Raw materials, consumable items, office supplies and equipment, and

the whole range of an organization’s requirements, must be considered while preparing this

budget, along with the answers to the questions when, where, at what price, and how often to

buy.

i. Administration Expenses Budget: The budget deals with such expenses as office salaries and

upkeep, depreciation, stationery, management salaries, telephones, postage, etc.

3.3 Financial Budget

The financial budget which summarizes the whole pack-age of budgets is made up of five

individual budgets:

a. Cash Budget

It is concerned with liquidity. It shows the requirements of cash in respect of various

functional budgets as well as anticipated cash receipts.

 b. Budgeted Profit and Loss Account

It is concerned with profitability. It reflects the matching of budgeted revenues during the

period with budgeted costs during the same period.

c. Budgeted Balance Sheet:

It is concerned with the structure of assets and the pattern of liabilities.

d. Budgeted Funds Flow Statement:

It is concerned with the sources of funds and their application in the organization’s

objective-striving endeavours.

e. Capital Budget:

It is concerned with the questions of capacity and strategic direction. It deals with the

evaluation of alternative dispositions of capital funds as well as with the choice of the

best capital structure.

3.3.1 Cash Budget

The cash budget, as its name implies, summarizes the estimated cash receipts and the estimated

cash payments over the budget period. Its object is to ensure a balance between liquidity and

profitability. The cash budget is closely related to the sales forecast, expense budgets, and capital

expenditure budget. The cash budget is concerned with the timing of receipts and payments of

cash (cash basis), whereas the other budgets are concerned with the timing or incurrence of the

transactions themselves (accrual basis).

Purposes of Cash Budget The principal purposes of the cash budget may be out-lined as follows:

a. It indicates the probable cash position as a result of planned operations.

b. It indicates cash excess or shortages.

c. It indicates the need to arrange for short-term borrowing, or the availability of idle cash for

investment.

d. It makes provision for the co-ordination of cash in relation to

i. total working capital,

ii. Sales,

iii. Investment,

iv. Debt

e. It establishes a sound basis for obtaining credit.

f. It establishes a sound basis for current control of the cash position.

Preparation of Flexible Budgets:

There are three methods of preparing a flexible budget:

1. Tabular Method or Multi-Activity Method.

2. Charting Method.

3. Formula Method or Ratio Method.

1. Tabular Method:

According to this method, a flexible budget is prepared for different levels of activity showing

different activity or capacity levels in horizontal columns and budgeted figures against different

activity or capacity levels in the vertical columns.

The expenses are usually recorded under three groups, namely, variable, semi-variable and fixed.

Budgeted figures for any level of activity not specifically covered in the flexible budget can be

obtained by interpolation.

A specimen of a flexible budget may be as follows:

http://www.yourarticlelibrary.com/cost-accounting/flexible-budget/flexible-budget-importance-

and-methods-of-preparation/56044

Charting Method:

Under this method, an estimate of expenses is made for different levels of activity by classifying

the expenses into three categories, namely, variable, semi-variable, and fixed. The estimated

expenses are plotted on a graph paper on Y-axis and level of activity is plotted on X-axis. The

budgeted expenses corresponding to the level of activity attained can then be read out from the

chart and the performance of departmental heads can be assessed.

Formula Method or Ratio Method:

Under this method, a budget is prepared for the expected normal level of activity and variable

cost per unit of activity is ascertained.

Expense budget allowed for a particular level of activity attained will be as follows:

Fixed cost + (Actual units of activity x variable cost per unit of activity)

For example, the overhead expenses budget for a normal level of 80% activity is Rs 90,000.

Assuming that the expenses budget consists of fixed cost Rs 50,000 and variable expenses Rs

40,000, then variable cost per 1% activity is Rs 500 (i.e., Rs 40,000/ 80).

Suppose actual level of activity is 75%, the expense budget allowed will be:

50,000 (fixed) + 75 x Rs 500 (variable) = Rs 87,500.

Understanding Cash Budget

The other name of cash budget is finance budget. This budget is the most important of all the

functional budgets. But, this budget is prepared after the preparation of all other functional

budgets.

The cash budget summarizes the anticipated cash receipts and payments for a specific period.

The cash budget helps the management to makes an arrangement of cash if sufficient amount of

cash is not available at the end of each month. In this way, the company can meet all the

operating expenses and all other commitments. On the other hand, if excess of cash is available

in anytime, the management can take suitable arrangements can take suitable arrangements for

making investment outside the business.

Information required to prepare cash budget

A cash budget is prepared with the help of following information.

1. The amount of budgeted cash sales and credit sales.

2. The time lag between credit sales and collection period.

3. The amount of selling and distribution expenses.

4. The amount of income tax, property tax and sales tax.

5. The amount of budgeted cash purchase and credit purchases.

6. The period of credit allowed by the suppliers.

7. The amount of salaries and wages to be paid.

8. The amount of overhead expenses.

9. Details of capital expenditure.

10. Details of administration expenses and payment of dividend.

Methods of preparing Cash budget

There are three methods of preparing a cash budget. They are briefly explained below:

1. Receipts and Payments Method

Under this method, cash budget is prepared in columnar basis. There are two parts. First part is

receipts and second part is payments. The total receipts are added with opening balance of cash

and deducted the payments to get closing balance of cash. If receipts are more than payments,

there is a surplus of cash at the end of the month and vice versa.

2. Adjusted Profit and Loss Method

This method is also called the cash flow statement. This type of budget is prepared for long

period. It gives more details of incomes and expenses in connection with long term planning.

The profit is considered to be equivalent to cash. Even though, cash receipts and payments are

not into consideration but considers only non-cash transactions to prepare the cash budget under

this method. The profit is adjusted by adding back depreciation, provisions, stock, work in

progress, capital receipts, decrease in debtors, increase in creditors and by deducting dividends,

capital payments, increase in debtors, increase in stock and decrease in creditors. The adjusted

profit is the closing balance of cash.

The following information is necessary to prepare the cash budget under adjusted profit and loss

method.
 1. Expected opening balance.

2. Net profit for the period.

3. Changes in current assets and current liabilities

4. Capital receipts and capital expenditure.

5. Payment of dividend.

3. Balance Sheet Method

This method is very similar to adjusted profit and loss method. Under this method, all the items

of balance sheet are recorded in respective sides except cash. Then, the balance sheet is balanced.

If the liabilities side is heavier than assets side, the balancing figure is cash at bank. Likewise, if

the assets side is heavier than liabilities side, the balancing figure is overdraft.

Questions:

Practical’s: