You are on page 1of 10

Budjetry control There are two types of control, namely budgetary and financial.

This chapter concentrates on budgetary control only. This is because financial control was covered in detail in chapters one and two. Budgetary control is defined by the Institute of Cost and Management Accountants (CIMA) as: "The establishment of budgets relating the responsibilities of executives 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".

Chapter objectives
This chapter is intended to provide: An indication and explanation of the importance of budgetary control in marketing as a key marketing control technique An overview of the advantages and disadvantages of budgeting An introduction to the methods for preparing budgets An appreciation of the uses of budgets.

Structure of the chapter

Of all business activities, budgeting is one of the most important and, therefore, requires detailed attention. The chapter looks at the concept of responsibility centres, and the advantages and disadvantages of budgetary control. It then goes on to look at the detail of budget construction and the use to which budgets can be put. Like all management tools, the chapter highlights the need for detailed information, if the technique is to be used to its fullest advantage.

Budgetary control methods

a) Budget: A formal statement of the financial resources set aside for carrying out specific activities in a given period of time. It helps to co-ordinate the activities of the organisation. An example would be an advertising budget or sales force budget. b) Budgetary control:

A control technique whereby actual results are compared with budgets. Any differences (variances) are made the responsibility of key individuals who can either exercise control action or revise the original budgets. Budgetary control and responsibility centres; These enable managers to monitor organisational functions. A responsibility centre can be defined as any functional unit headed by a manager who is responsible for the activities of that unit. There are four types of responsibility centres: a) Revenue centres Organisational units in which outputs are measured in monetary terms but are not directly compared to input costs. b) Expense centres Units where inputs are measured in monetary terms but outputs are not. c) Profit centres Where performance is measured by the difference between revenues (outputs) and expenditure (inputs). Inter-departmental sales are often made using "transfer prices". d) Investment centres Where outputs are compared with the assets employed in producing them, i.e. ROI. Advantages of budgeting and budgetary control There are a number of advantages to budgeting and budgetary control: Compels management to think about the future, which is probably the most important feature of a budgetary planning and control system. Forces management to look ahead, to set out detailed plans for achieving the targets for each department, operation and (ideally) each manager, to anticipate and give the organisation purpose and direction. Promotes coordination and communication. Clearly defines areas of responsibility. Requires managers of budget centres to be made responsible for the achievement of budget targets for the operations under their personal control.

Provides a basis for performance appraisal (variance analysis). A budget is basically a yardstick against which actual performance is measured and assessed. Control is provided by comparisons of actual results against budget plan. Departures from budget can then be investigated and the reasons for the differences can be divided into controllable and noncontrollable factors. Enables remedial action to be taken as variances emerge. Motivates employees by participating in the setting of budgets. Improves the allocation of scarce resources. Economises management time by using the management by exception principle. Problems in budgeting Whilst budgets may be an essential part of any marketing activity they do have a number of disadvantages, particularly in perception terms. Budgets can be seen as pressure devices imposed by management, thus resulting in: a) bad labour relations b) inaccurate record-keeping. Departmental conflict arises due to: a) disputes over resource allocation b) departments blaming each other if targets are not attained. It is difficult to reconcile personal/individual and corporate goals. Waste may arise as managers adopt the view, "we had better spend it or we will lose it". This is often coupled with "empire building" in order to enhance the prestige of a department. Responsibility versus controlling, i.e. some costs are under the influence of more than one person, e.g. power costs. Managers may overestimate costs so that they will not be blamed in the future should they overspend. Characteristics of a budget A good budget is characterised by the following: Participation: involve as many people as possible in drawing up a budget. Comprehensiveness: embrace the whole organisation.

Standards: base it on established standards of performance. Flexibility: allow for changing circumstances. Feedback: constantly monitor performance. Analysis of costs and revenues: this can be done on the basis of product lines, departments or cost centres. Budget organisation and administration: In organising and administering a budget system the following characteristics may apply: a) Budget centres: Units responsible for the preparation of budgets. A budget centre may encompass several cost centres. b) Budget committee: This may consist of senior members of the organisation, e.g. departmental heads and executives (with the managing director as chairman). Every part of the organisation should be represented on the committee, so there should be a representative from sales, production, marketing and so on. Functions of the budget committee include: Coordination of the preparation of budgets, including the issue of a manual Issuing of timetables for preparation of budgets Provision of information to assist budget preparations Comparison of actual results with budget and investigation of variances. c) Budget Officer: Controls the budget administration The job involves: liaising between the budget committee and managers responsible for budget preparation dealing with budgetary control problems ensuring that deadlines are met educating people about budgetary control.

A budget is an account of the estimated revenue and estimated expenditure within a fiscal year. There are three types of budgets:

Surplus budget deficit budget balanced budgetchange

What is a flexible budget?

A flexible budget is a budget that adjusts or flexes for changes in the volume of activity. The flexible budget is more sophisticated and useful than a static budget, which remains at one amount regardless of the volume of activity. Assume that a manufacturer determines that its cost of electricity and supplies for the factory are approximately $10 per machine hour (MH). It also knows that the factory supervision, depreciation, and other fixed costs are approximately $40,000 per month. Typically, the production equipment operates between 4,000 and 7,000 hours per month. Based on this information, the flexible budget for each month would be $40,000 + $10 per MH. Now lets illustrate the flexible budget by using some data. If the production equipment is required to operate for 5,000 hours during January, the flexible budget for January will be $90,000 ($40,000 fixed + $10 x 5,000 MH). If the equipment is required to operate in February for 6,300 hours, then the flexible budget for February will be $103,000 ($40,000 fixed + $10 x 6,300 MH). If March requires only 4,100 machine hours, the flexible budget for March will be $81,000 ($40,000 fixed + $10 x 4,100 MH). If the plant manager is required to use more machine hours, it is logical to increase the plant managers budget for the additional cost of electricity and supplies. The managers budget should also decrease when the need to operate the equipment is reduced. In short, the flexible budget provides a better opportunity for planning and controlling than does a static budget.

Fixed budget
A fixed budget is a financial plan that does not change through the budget period, irrespective of any changes from the plan in actual activity levels experienced. Since most companies experience substantial variations from their expected activity levels over the period encompassed by a budget, the amounts in the budget are likely to diverge from actual results. The only situations in which a fixed budget is likely to track close to actual results are when:

Costs are largely fixed, so that expenses do not change as revenues fluctuate The industry is not subject to much change, so that revenues are reasonably predictable The company is in a monopoly situation, where customers must accept its pricing

Most companies use fixed budgets, which means that they routinely deal with large variations between actual and budgeted results. This also tends to cause a lack of reliance by employees on the budget, and in the variances derived from it. A good way to mitigate the disadvantages of a fixed budget are to combine it with continuous budgeting, where you add a new budget period onto the end of the budget as soon as the most recent budget period has been concluded. By doing so, you gradually incorporate the actual results of the most recent period into the budget.

Master Budget:
Learning Objective of the Article:

1. Define and explain the term "master budget".

2. What are the parts / components of master budget? 3. What are its advantages and disadvantages? Give example of master budget.

Definition and Explanation:

The master budget is a summary of company's plans that sets specific targets for sales, production, distribution and financing activities. It generally culminates in a cash budget, abudgeted income statement, and a budgeted balance sheet. In short, this budget represents a comprehensive expression of management's plans for future and how these plans are to be accomplished. It usually consists of a number of separate but interdependent budgets. One budget may be necessary before the other can be initiated. More one budget estimate effects other budget estimates because the figures of one budget is usually used in the preparation of other budget. This is the reason why these budgets are called interdependent budgets.

Parts | Components and Preparation of a Master Budget:

Following are the major components or parts of master budget. Click on a budget link for detailed study.

1. Sales Budget 2. Production Budget 3. Material Budgeting | Direct Materials Budget 4. Labor Budget 5. Manufacturing Overhead Budget 6. Ending Finished Goods Inventory Budget 7. Cash Budget 8. Selling and Administrative Expense Budget 9. Purchases Budget for a Merchandising Firm 10. Budgeted Income Statement 11. Budgeted Balance Sheet

Sales Budget

Budgeted Income Statement Ending Inventory Budget

Production Budget

Direct Labor Budget

Overhead Budget

Direct Materials Budget

Selling and Admn. Budget

Cash Budget

Budgeted BalanceSheet

Advantages and Disadvantages of a Master Budget:

Some advantages of a master budget are that it can give an idea of where a company wants to go and what it has to do in order to get there. It will also allow the company to realistically project future cash flows which in turn would help in getting certain types of financing. Some disadvantages of a master budget include the time involved in producing such a budget. This is primarily the reason a smaller company may not make a master budget if the company has a very small managerial staff.

Another way to mitigate the effects of a fixed budget is to shorten the period covered by it. For example, the budget may only encompass a three-month period, after which management formulates another budget that lasts for an additional three months. The fixed budget is not effective for evaluating the performance of cost centers. For example, a cost center manager may be given a large fixed budget, and will make expenditures below the budget and be rewarded for doing so, even though a much larger overall decline in company revenues should have mandated a much larger expense reduction. The same problem arises if revenues are much higher than expected - the managers of cost centers have to spend more than the amounts indicated in the baseline fixed budget, and so appear to have unfavorable variances, even though they are simply doing what is needed to keep up with customer demand.

The reverse of a fixed budget is a flexible budget, where the budget is designed to change in response to variations in activity levels. There tend to be much smaller variances from the budget when a flexible budget is used, since the model tracks much closer to actual results. Similar Terms A fixed budget is also known as a static budget.

Zero-based budgeting
From Wikipedia, the free encyclopedia

This article needs additional citations for verification.

Please help improve this article by adding reliable references. Unsourced material may be challenged and removed. (August 2008)

Zero-based budgeting is a technique of planning and decision-making which reverses the working process of traditional budgeting. In traditional incremental budgeting, departmental managers justify only increases over the previous year budget and what has been already spent is automatically sanctioned. By contrast, in zero-based budgeting, every department function is reviewed comprehensively and all expenditures must be approved, rather than only increases.[1] No reference is made to the previous level of expenditure. Zero-based budgeting requires the budget request be justified in complete detail by each division manager starting from the zero-base. The zero-base is indifferent to whether the total budget is increasing or decreasing. The term "zero-based budgeting" is sometimes used in personal finance to describe "zerosum budgeting", the practice of budgeting every dollar of income received, and then adjusting some part of the budget downward for every other part that needs to be adjusted upward. Zero based budgeting also refers to the identification of a task or tasks and then funding resources to complete the task independent of current resourcing.

1 Advantage of zero-based budgeting 2 Disadvantages of zerobased budgeting

3 Incremental budgeting 4 See also 5 References


of zero-based budgeting

1. 2. 3. 4. 5. 6. 7. 8. 9. goals. 10.

Efficient allocation of resources, as it is based on needs and benefits. Drives managers to find cost effective ways to improve operations. Detects inflated budgets. Useful for service departments where the output is difficult to identify. Increases staff motivation by providing greater initiative and responsibility in Increases communication and coordination within the organization. Identifies and eliminates wasteful and obsolete operations. Identifies opportunities for outsourcing. Forces cost centers to identify their mission and their relationship to overall It helps in identifying areas of wasteful expenditure and, if desired, it can also


be used for suggesting alternative courses of action.


of zero-based budgeting

1. 2. 3.

Difficult to define decision units and decision packages, as it is timeForced to justify every detail related to expenditure. The R&D department is Necessary to train managers. Zero-based budgeting must be clearly

consuming and exhaustive. threatened whereas the production department benefits. understood by managers at various levels to be successfully implemented. Difficult to administer and communicate the budgeting because more managers are involved in the process. 4. In a large organization, the volume of forms may be so large that no one person could read it all. Compressing the information down to a usable size might remove critically important details. 5. Honesty of the managers must be reliable and uniform. Any manager that exaggerates skews the results.