Budgetary control: meaning, steps to install it, advantages and limitations

Meaning of budgetary control

A budget is a quantitative plan, in money and physical terms, prepared in advance for a defined period, to achieve given objectives. Budgetary control is the system of using budgets to plan and control the activities of a business: budgets are prepared for every function, responsibility for each budget is fixed on an executive, actual results are recorded and compared with the budget continuously, and the differences are analysed so that corrective action can be taken or the plans revised. It thus combines planning, coordination and control.

Steps in installing budgetary control

1. Define objectives, policies and planning assumptions. Top management states the goals the budgets must serve, profit, market share, growth, and the policies and assumptions behind them, such as expected prices, wage rates, plant capacity and the production programme.
2. Organisation chart and responsibility. The organisation structure is set out, showing the authority and responsibility of each executive, so that each budget has an owner.
3. Budget centres. Departments and functions for which budgets will be prepared and controlled are identified.
4. Budget committee and budget officer. A committee of functional heads under the chief executive, with a budget officer as coordinator, guides the process and approves budgets.
5. Budget manual. A written manual sets out the procedures, forms, timetable, duties of each executive and the accounting codes to be used.
6. Budget period. The period is fixed: usually a year, divided into months or quarters for control.
7. Key factor (principal budget factor). The factor that limits activity, usually sales demand, sometimes materials, labour or plant capacity, is identified, and its budget prepared first.
8. Functional budgets. Sales, production, materials, purchases, labour, overheads, selling and administration, cash and capital expenditure budgets are prepared and coordinated.
9. Master budget. The functional budgets are combined into a master budget, a budgeted income statement and balance sheet, and approved by the board. The approved budgets are then sent to every responsible manager, so that each knows the targets for his or her centre.
10. Accounting and reporting system. Actual results are recorded under the same heads as the budget.
11. Comparison and variance analysis. Periodic reports compare actual with budget (using flexible budgets where activity differs) and identify variances and their causes.
12. Corrective action and revision. Responsible executives act on adverse variances; budgets are revised when conditions change materially.

In a manufacturing concern the sales budget usually comes first, and the production budget follows from it (budgeted sales plus desired closing stock less opening stock). The production budget in turn gives the materials, labour and factory overhead budgets, and these, with the selling, administration and capital budgets, give the cash budget. All the budgets must be coordinated: a production plan that the purchasing department cannot supply, or that the cash budget cannot finance, has to be revised before the master budget is approved.

Essentials of a successful system

1. Full support of top management, and participation of the executives who must achieve the budgets.
2. Clear organisation with well-defined authority and responsibility.
3. Realistic targets, neither too easy nor impossible.
4. A sound accounting system that records actual results under the same heads as the budget, promptly.
5. Flexibility: flexible budgets for varying activity, and revision when conditions change.
6. Prompt reporting of variances to the person responsible, followed by action.
7. Education of staff about the purpose of budgeting, so that budgets are seen as aids, not as pressure devices.

Advantages

1. Forces management to plan ahead and set clear objectives.
2. Coordinates the work of all departments towards common goals.
3. Provides standards against which performance is measured and controlled.
4. Fixes responsibility on individual executives.
5. Promotes economy and efficient use of resources, and checks waste.
6. Helps in planning cash and finance, avoiding shortages and idle funds.
7. Management by exception: attention is focused on significant variances.
8. Motivates staff through participation and clear targets.
9. Provides a basis for incentive schemes and performance appraisal.
10. Helps in policy formulation and in obtaining finance.

Limitations

1. Budgets rest on estimates and forecasts, which may prove wrong.
2. Conditions change; budgets may become outdated unless revised.
3. Installation and operation are costly and time-consuming, especially for small firms.
4. Budgets may become rigid; managers may follow them mechanically or resist necessary changes.
5. It cannot replace management judgment; it is only a tool.
6. It may cause conflict and pressure, and managers may pad budgets to make targets easy.
7. Success depends on the support of top management and the cooperation of staff.
8. Budgets set for departments may make managers protect their own budget rather than the interest of the whole firm.

Conclusion

For a manufacturing concern, where materials, labour, plant capacity and cash must all be planned together, these advantages are especially important, and most of the limitations can be reduced by flexible budgets, participation and regular review. Budgetary control, carefully installed and flexibly operated, is one of the most effective tools for planning and controlling a manufacturing business, though its usefulness depends on realistic estimates, regular revision and the commitment of people.