Budget as an Instrument of Control

• Formulation and Administration of Budgets

• Budgeting – The Human Dimension
• Types of Budgets
• Zero-based Budgeting

Reading: Chapter IV of Text Book

 Budgets and Budgeting
• Budgets are business plans that are stated in quantitative terms
and are usually based on estimations
– Quantitative Statement for a defined time period, which could
include Planned Revenues, Expenses, Assets, Liabilities & Cash Flows
– Budgets aid an organization in successful execution of strategies
– Uncertainties in business environment / wrong estimation, could
cause deviations between actuals and plans
– Budgeting, as a control tool, provides an Action Plan for firm to
ensure least deviations
• Budgeting refers to process of designing, implementing, and
operating budgets
• All managers should participate in budgeting process to ensure
consistency in overall adherence to corporate goals
 Importance of Budgets
• Budgets provide an overview of organization and its operations
• Useful in resource allocation, such that processes which are expected
to give highest returns, are given priority
• Budgets are also used as forecast tools and make organization better
prepared to adapt to changes in environment
• Budget preparation requires participation of managers from different
functions/ departments
– Helps in integrating tactical & operational strategies of departments
with corporate strategy of organization
• Budget is a tool to verify progress of various activities undertaken to
achieve planned objectives (Verification is done by comparing actuals
against standards set earlier)
• Budgets can be used to evaluate performance of operations of
organization, and performance of employees against set standards
– Promote division of labor and process of specialization
– Help in delegation of authority and allocation of responsibility and
accountability to more people in an organization
 Steps in Budget Formulation and Administration
• Creating a budget department or appointing a budget controller
• Developing guidelines for budget preparation
• Developing budget proposals at department/business unit level
• Developing budget for entire organization
• Determining budget period and key budget factors
• Benchmarking the budget
• Budget review and approval by Top Management
• Monitoring progress and revising budget if necessary
• Rolling Budgets/Forecasts
 Budgeting – Human Dimension

• Participative Budgeting
• Degree of Budget Goal Difficulty
• Budgetary Slack
• Culture and Budgeting
• Budgets and Compensation
• National cultures also influence how budgets are prepared
• Participative budgeting not usually employed in cultures that rate
high on power distance, uncertainty avoidance, or masculinity
• Budgeting is an internal process and hence lack of cultural
similarities will pose a problem in budget being communicated
across subsidiaries of organization
 Making Budgets Effective

• Be prepared to learn
• Learn from the errors
• Establish a flexible budget
• Keep track of the cash flow
• Be conservative
• Provide a buffer
• Use budgets as controls
 Preparation of Financial Budget
• Capital Budget
• Cash Budget
• Budgeted Balance Sheet
Types of Budgets
Components of Master Budget
 Benefits of master budgets
• To guide Performance
– Helps employees track how each of their business unit objectives,
when achieved, contribute to objectives of organization
– Budget is used as base, for acquiring & using resources, that are
needed to achieve objectives of organization

• To integrate and organize

– Master budget is a compilation of budgets from different
departments
– Helps in better integration of all organizational functions
– Master budgets serve as planning tools as well as control tools

• To effect continuous improvement:

– Planning activity helps organizations to look for alternative ways in
which they can enhance value to customers and minimize costs
– Helps in continuous improvement
 Zero-Based Budgeting (ZBB)
• In ZBB, base is taken as zero and budget is devised as if for a new
venture
• ZBB is followed by private organizations, defense forces, and
certain state governments in India

ZBB Process
• Responsibility centers are called decision units, process &
activities involved in each decision unit are called decision
packages

Key Steps in ZBB Process

• Decision unit identification
• Decision package development
• Evaluation and grading of decision packages
• Resource allocation
 Benefits of ZBB
• ZBB assumes next year’s budget to be zero: Forces managers to
carry out Cost-Benefit analysis, of individual activities of their
respective decision units
• ZBB is designed to evaluate whole spectrum of functional
activity, to identify areas that are inefficient and of little value
• ZBB helps in devising a more realistic budget, as resources are
allocated, depending on ranking of decision packages
– Helps in curbing redundant expenditure
• As ZBB involves creation of decision units and decision
packages, it gives a clearer picture of organization’s working
– Helps in integrating planning and budgeting control processes
• ZBB fosters better communication and participation between
different functions of organization
– Helps in creating a flexible budget
• ZBB helps in performance evaluation of subordinates, aids top
management in advanced planning & goal setting
 Issues in Implementing ZBB
• As ZBB involves identification of decision units, Manager of
every decision unit will try to portray his/her own unit as most
important, and get higher budgets approved for it
– ZBB can result in creation of budgetary slack

• In ZBB, contributions are evaluated and ranked, but these

contributions are often intangible, and hence ranking, and in
turn ZBB, is rendered ineffective

• ZBB involves a lot of documentation and hence turns out to be a

slow process. It is also expensive to implement