Budgetary Control Meaning
Budgetary control is known as setting up a particular budget by management in order to know the variation between actual performance and budgeted performance of the company and it also helps managers in utilizing these budgets so as to monitor and control various costs within the particular accounting period.
It is a process of planning and controlling all the functions of an organization through comparison and analysis of budgeted numbers to actual results. By comparing the budgeted numbers with actual results, it identifies the areas which need improvement and where cost reduction is feasible or budgeted numbers need to be revised.
Budgetary Control Types
There are various types of control an organization can implement –
#1 – Operational Control
It covers the revenue and operating expensesOperating ExpensesOperating expense (OPEX) is the cost incurred in the normal course of business and does not include expenses directly related to product manufacturing or service delivery. Therefore, they are readily available in the income statement and help to determine the net profit., which are essentials to running day to day business. The actual numbers to a budget are compared monthly in most cases. It helps in achieving control over EBITDAEBITDAEBITDA refers to earnings of the business before deducting interest expense, tax expense, depreciation and amortization expenses, and is used to see the actual business earnings and performance-based only from the core operations of the business, as well as to compare the business's performance with that of its competitors. – Earnings before interest taxes depreciation and amortization.
#2 – Cash Flow Control
This is an important budget that keeps control over the working capital requirement and cash managementCash ManagementCash Management refers to the appropriate collection, handling, & disbursement of cash for ensuring financial stability & avoiding insolvency risk. . Cash crunches could be detrimental to everyday functioning, so this is an important aspect.
#3 – Capex Control
It covers capital expendituresCapital ExpendituresCapex or Capital Expenditure is the expense of the company's total purchases of assets during a given period determined by adding the net increase in factory, property, equipment, and depreciation expense during a fiscal year., like buying machinery or constructing a building. Because it involves a huge amount of money, the control here helps in eliminating waste and reducing costs.
How is the Budget Prepared?
The budget is prepared based on previous expenses and takes into consideration any foreseeable expenses which are bound to occur. Nowadays, in a computerized environment where financial statements are prepared in excel sheets. We have the option of selecting the quarterly average or yearly average.
For example – if we want to prepare the budget for July 2019 based on Q2 results, it will look like –
- Here, July Budget Formula = (April + May + June)/3 i.e., Average of April, May and June.
- In the above table, based on April, May, and June actual results, we expect the sales to be $6,250 and net profit to be $383 for July.
Now let’s assume that we got actual results for July and compare it with the July Budget to get the difference –
In this case, the actual sales for July have exceeded the budget by $150. Now, this could be either because the more quantities were sold or the sales price per unit has increased slightly. If the sales price per unit remained constant in July, it means that the sales team has performed better than average and that is the reason sale has increased.
Further analysis will show for which region and which product the sale has increased. The same way the operating cost has gone up by $33, which could be due to an increased cost of any input material, or it could be incidental to extra sales.
Advantages and Disadvantages of Budgetary Control
- An effective tool for performance measurement of departments, individual, and cost centersCost CentersCost center refers to the company's departments that don't contribute directly to the corporate revenue; however, the firm has to incur expenses for keeping such units operative. It comprises research and development, accounting and human resource departments.;
- Identification of areas for reduction and efficiency improvement;
- Increased efficiency and cost reduction results in profit maximization;
- It also helps in introducing and incentive schemes based on performance.
- The reduction in cost is always the primary target.
- Improves coordination between departments as the results and costs are interrelated.
- It provides insight for in-depth analysis and any corrective action.
- Helpful in achieving an organization’s long term goal.
- Budgeted numbers often need revision as future prediction is difficult
- Time-consuming and costly process, need people and resources Budgetary control processes
- This process sometimes requires coordination between various departments is a difficult task
- This process requires approval and support from top senior management
- Always comparing the actual actuals with a budget is detrimental to employees motivation
- Future is unpredictable, so budget always does not guarantee a smooth future for an organization
- Mostly usage past recorded numbers
- Ignores demographics and many other economic factorsEconomic FactorsEconomic factors are external, environmental factors that influence business performance, such as interest rates, inflation, unemployment, and economic growth, among others.
- Government policies and tax reformsTax ReformsTax reform refers to the changes and amendments made in the nation's tax structure or system to fix the loopholes and make it more efficient. It even ensures that there are fewer chances of tax evasion and avoidance by the taxpayers. are not always predictable
- Natural events like rain, monsoon, drought, and other uncontrollable factors affect the actual performance of an organization which cannot be considered for budget
Important Points to Note
- Any foreseeable revenue or expenses not included previously should be included in the budget.
- The control functions should not be of extreme nature to put personnel under pressure if it is, then a change is needed.
- The standards need revision periodically.
- Any change must be informed to all the stakeholders immediately or in advance.
- The change in production, sales, or any function within the organization will impact the control functions.
- The basis of cost allocationBasis Of Cost AllocationCost Allocation is the procedure of recognizing & assigning costs to different cost objects like a product, department, program, customer, etc., as per the cost driver serving as the base for this process. becomes important at micro-level analysis, so if there is a change in the basis of cost allocation, it should be analyzed fully before putting it in place.
Budgetary control is a very important aspect of an organization’s day to day activities and long-term prospects. When placed carefully, it not only helps in controlling cost but also helps in efficiency improvement. There are other things like standard costing, which is also a part of it.
Here we can calculate the cost, efficiency, yield or mix variances, etc. So, it identifies the exact reason behind any variance when we compare the one-period activity to another. Because in today’s cut-throat competition, the organizations are always striving for excellence and best practices, and budgetary control helps in identifying and attaining those policies and practices.
It identifies if there is any issue or chance of improvement with input material procurement, the desired output from the material, any processing issue, or sales team administration. So, to understand the business functions completely and root causes analysisRoot Causes AnalysisRoot cause analysis is a problem-solving technique in which the source of a problem is identified, thereby finding the best possible solutions to it. It is a permanent fix to an issue since it establishes a cause-effect relationship for every adverse situation. of various outcomes, budgetary control is one important tool in the hands of parties associated with the organization.
This has been a guide to what is Budgetary Control and its meaning and definition. Here we discuss various types of Budgetary controls with their advantages and disadvantages. You can learn more about budgeting from the following articles –