A month-to-month plan projects spending for the year, and a quarter-to-quarter budget assists in preparing financial statements. A three-year budget plan ensures that you manage expenditures over time.
You must adjust the long-term budget based on each yearly budget plan. Small businesses control spending by using their plans as a tool throughout the year. They look at the real monthly levels of income and expenses and compare that to the levels estimated in their annual budget.
One form of budgetary control involves controlling spending by quarter. It is not sufficient to determine if each program area spends according to its budgeted levels. Each manager is responsible to justify why the money should be spent at all and to explain in detail as to what would happen if the proposed activity is not carried out and no money is spent. Thus, each manager or functional head in the organisation, is required to make cost-benefit-analysis of each of the activities or projects under his control and for which he is responsible.
Zero-base Budgeting is more suitably applicable to discretionary cost areas. These costs may have no relation to volume or activity and generally arise as a result of management policies. Where standards are determinable, those costs associated with the inputs should be controlled through the use of standard costing. On the other hand, if output as a function of input cannot be specified. Zero-base Budgeting may be more suitably applied. Thus, service or support- type activities are more suitable for Z.
A decision unit refers to a tangible activity or group of activities for which a single manager has the responsibility for successful performance. Thus, decision unit is a programme or a project or a segment of the organisation for which separate budgets are to be prepared.
Preparation of decision packages is a set of documents which identify and describe activities of the unit in such a way that the management can evaluate and rank them against others competing for resources limited and decide whether to approve or disapprove. The third step involved in Z. Funding involves the allocation of available resources of the organisation to various decision units keeping in mind the alternative which has been selected and approved through ranking process.
ZBB is popular with Not-for-Profit organisations, local authorities and government departments. Manufacturing organisations use ZBB for service and support activities. Decision packages are evaluated using cost benefit analysis.
Step 3 — Decision packages are ranked based on cost benefit analysis. Uneconomical decision packages are excluded. It helps to allocate scarce resources of the organisation in a more efficient and equitable manner. It challenges the status quo and encourages a questioning approach to activities and expenditure.
It requires considerable documentation. Wrong cost benefit analysis may hamper the future growth of the organisation. For example, cutting of present advertisement costs may affect future sales. The real advantages of budgetary control will materialise when budget preparation is followed by a feed-back system. Reporting through well designed performance report is an integral part of budgetary control. A performance report is a document that periodically communicates to achieved, exceeded or not achieved.
A performance report will give the management an insight into the operational inefficiencies. There should be a separate performance report for each budget centre Performance report should be regularly made to the required level of management. For designing a reporting system for an organisation, magnitude and multitude of its activities in relation to organizational structure will form major considerations.
For each company a suitable system should be developed to conform to its requirements. A comparison of actual results with budgeted results is an important facet of control. It is vital for the management to know the underlying causes of significant variations, because causes rather than the results provide the basis for appropriate corrective action.
The variations should not be significant. Both favourable and unfavourable variations should be investigated, if they are significant. It should be noted whether variation was due to special managerial decision in order to improve efficiency or meet certain exigencies.
The maximum attention should be focused towards the variations for which precise underlying causes are not known. These variations are of primary concern to the management and should be carefully investigated.
The final phase is budget follow-up. Budget follow-up is the action taken to see that budgets are properly used and that they cause the initiation of steps for improvement. Thus, it is the control phase of budgeting and utilises the budget performance reports to achieve the results desired, it should be noted that budget follow-up is the most difficult of all areas of budgeting. The operating manager must accept the parts that budget officer has to play.
If budget follow-up work is done properly, it will offer not a threat but still another service to operating managers. Control is the process of ensuring that the activities of an organisation conform to its plans and its objectives are achieved. According to Peter Drucker, controls are different from control.
The former are a means to an and the end is control. The function of control is concerned with satisfying oneself that the actual work proceeds according to that which is budgeted. A control system is a communication network. It monitors activities within the organisation. At the same time, it provides the basis for corrective action. Control ratios are a means of providing information about the extent of deviations of actual performance from the budgeted performance. Deviations may be favourable or unfavourable.
Revisions of budget, as originally established at the start of the budget period, are needed primarily for following two reasons:. Budget revisions should be, as far as possible, a joint effort by the operating managers and the budgeting staff.
A budget is never originally prepared perfectly. Things will be missed and errors will be made. The likelihood of errors will increase with increase in the size of organisation. As the errors are detected during the year, they must be corrected. The major errors that markedly affected the budget plan should be approved by top management. Such revisions are very embarrassing in nature.
The more common and, thus, more troublesome, budgeting problems are those caused by changes in operating conditions. There are unfortunate hard times when a company must revise its income projections downward in the light of developing economic recession. Downward revisions to budgeted costs can be required by many types of changes in operating conditions.
Each revision has to be evaluated and acted upon on its own individual merits and conditions. If a realistic original sales forecast has been made, there should be no need to make upward revision to sales forecast, even though the sales are well above the level originally projected. This is a happy situation and the higher- than-expected income can be identified as the cause of larger than ever expected favourable variance in income.
If favourable income variances are a recurring phenomenon, senior operating management must go deep to get to the reality. A management expects a better original forecasting of sales by its executives. All upward revisions to cost allowances must be approved by higher levels of management.
The procedure to revise the upward cost allowance may be laid down in budget manual. It should be noted that budgets are not handcuffs.
They are not fixed in concrete structure. They are a plan and plan can be changed, as new and better opportunities arise. They should never be allowed to delay the start of progressive action.
For this reason, upward budget cost allowance can be allowed, if laid down procedure has been followed and compelling reasons are existing. It is very necessary to understand the situation. Preparation of budgets, i. Planning deals with futurity of present decisions. Consequently, managers make predictions about the future based on past data and current happening. A forecast is thus, a prerequisite to planning.
Planning is done on the basis of a forecast. Being a prerequisite to planning, a forecast results in planning. Planning, in turn, results in budgeting. Regardless of this inter-relationship, a forecast differs from a budget in the following respects:.
A forecast is only an assessment of probable future events. A budget, on the other hand, is based on the implications of forecast. It relates to planned events. A forecast does not lay down any target in the form of commitment. A budget aims at controlling and shaping them. It may cover all the organisational activities. Alternatively, it may be for a particular function or segment of the business.
A forecast usually covers a specific business function. Being a statement of future events, a forecast is not at all a means of control. Budgeting, however, starts where forecasting ends.
A flexible budget is a budget which is designed to change in accordance with the level of activity attained. It recognises the difference between fixed and variable costs. Semi-variable overheads and segregated into fixed and variable elements.
Only variable costs will undergo change while fixed costs remain unaltered. Flexible Budgeting applies mainly to the production area. A series of budgets are prepared one for each of a number of alternative production levels. ZBB makes significant departure from the traditional budgeting mainly in approach rather than in basic planning and control philosophy.
It requires each manager to re-evaluate all the programmes and activities of his department and justify his entire budget. Each manager has to build up his budget from the grass root. ZBB starts with the assumption that zero will spent on each activity. He has to justify the entire amount of his budget. ZBB forces the managers to constantly evaluate the costs and benefits of all the programmes under his control. CIMA definition.
It has different budgeted costs for different levels of activity. That is, under this method, a series of budgets would be prepared at varying levels of activity, e. The great advantage of flexible budgeting is that variance analysis will enable the management to take appropriate action. It does not provide for any change in expenditure arising out of changes in the level of activity.
It is simple to prepare but reporting to management is less meaningful. It has only a limited application and is ineffective as a tool for cost control. That is, while comparing the actual cost with a fixed budget the difference cannot be properly explained. Traditional budgeting is accounting-oriented. Main stress happens to be on previous level of expenditure. Zero base budgeting makes a decision-oriented approach. It is very rational in nature and requires all programmes, old and new, to compete for scarce resources.
In traditional budgeting, first reference is made to past level of spending and then demand is made for inflation and new programmes. In Zero-base budgeting a decision unit is broken into understandable decision packages, which are ranked according to importance to enable top management to focus attention only on decision packages, which enjoy priority to others.
In traditional budgeting, some managers deliberately inflate their budget requests so that after the cuts they still get what they want. In zero base budgeting, a rational analysis of budget proposals is attempted. The managers, who unnecessarily try to inflate the budget requests, are likely to be caught and exposed. Management accords its approval only to a carefully devised result-oriented package. In traditional budgeting, it is for top management to decide why a particular amount should be spent on a particular decision unit.
In zero base budgeting, this responsibility is shifted from top management to the manager of decision unit. Traditional budgeting makes a routine approach. Zero base budgeting makes a very straightforward approach and immediately spotlights the decision packages enjoying priority over others. The following are the difference between standard costing and budgetary control:. Budgets are compiled for sales, production, expenses, profit, capital expenditure and cash.
Budgets including both income and expenditure. Variance Analysis is only a statistical data. It is a financial measure of target and achievement. It helps to develop at all levels of management the habit of timely, careful and adequate consideration of all factors before reaching important decisions.
It compels all members of management to participate in the establishment of goals of the organisation. It compels different departmental managers to make plans in harmony with the plans of other departments. It forces managers to put down in black and white what is necessary for achieving the desired results. For example, the budget of sales should be in coordination with the budget of production.
Similarly, production budget should be prepared in coordination with the purchase budget, and so on. Are there any devices that are not budgetary controls? There are, of course, many traditional control devices not connected with budgets, although some may be related to, and used with, budgetary controls.
How is flexible budget used for cost control? However, in large size organization, there is a need for a budget committee consisting of the chief executive, budget officer and heads of main departments in the organization.
The main functions of the budget committee are to get the budgets prepared and then scrutinize the same, to lay down broad policies regarding the preparation of budgets, to approve the budgets, to suggest for revision, to monitor the implementation and to recommend the action to be taken in a given situation. The establishment of budget centers is another important pre-requisite of a sound budgetary control system.
A budget center is a group of activities or a section of the organization for which budget can be developed. For example, manpower planning budget, research and development cost budget, production and production cost budget, labor hour budget and so on. A budget is always prepared before a defined period. This means that the period for which a budget is prepared is decided in advance. Thus a budget may be prepared for three years, one year, six months, one month or even for one week.
The point is that the period for which the budget is prepared should be certain and decided in advance. Generally, it can be said that functional budgets like sales, purchase, production, etc. Budgets like capital expenditure are generally prepared for a period from 1 year to 3 years. Thus depending upon the type of budget, the period of the same is decided and it must be decided well in advance.
There should be an organization chart that shows clearly defined authorities and responsibilities of various executives. The organization chart will define clearly the functions to be performed by each executive relating to the budget preparation and his relationship with other executives. The organization chart may have to be adjusted to ensure that each budget center is controlled by an appropriate member of the staff. The budget manual thus is a schedule, document or booklet, which contains different forms to be used, procedures to be followed, budgeting organization details, and set of instructions to be followed in the budgeting system.
It also lists out details of the responsibilities of different persons and the managers involved in the process. A key factor or a principal budget factor [also called constraint] is that factor the extent of whose influence must first be assessed to prepare the functional budgets. Normally sales are the key factor or principal budget factor but other factors like production, purchase, and skilled labor may also be the key factors.
For example, a company has the production capacity to produce 30, tones per annum but if the sales forecast tells that the market can absorb only 20, units, there is no point in producing 30, units. On the other hand, if the company can produce 30, units and the market can absorb the entire production which means that sales are not the key factor but if the raw material is available in limited quantity so that only 25, units can be produced, the raw material will become the key factor.
The key factor puts restrictions on the other functions and hence it must be considered carefully in advance. So continuous assessment of the business situation becomes necessary. In all conditions, the key factor is the starting point in the process of preparation of budgets. A chart of accounts or accounts code should be maintained which may correspond with the budget centers for the establishment of budgets and finally control through budgets. As shown in the table above, budgets facilitate effective control.
By placing financial values on operations, managers can monitor operations effectively and pinpoint problem areas. Second budgets facilitate communication and coordination between departments.
Budgets also help maintain records of organizational performance. Finally, budgets are a natural complement to planning. As managers first plan and then develop control systems, budgets are often a natural next step. On the minus side, some managers apply budgets too rigidly. They fail to understand those budget adjustments are necessary to meet the challenges of changing circumstances.
Moreover, budgets may limit innovation and change. When all available funds are allocated to specific operating budgets, it may be impossible to get additional funds to take advantage of an unexpected opportunity. It is difficult to imagine an organization functioning without proper budgetary provisions.
Despite some drawbacks, budgets generally provide managers with an effective tool for executing the control function. However, due to the changing situation, the budget may require revision during the budget period.
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