Budgetary control in an organisation: an in-depth analysis

What is Budgetary Control:

Budgetary control is a system for establishing the best estimate budget for each function of an organisation by management in terms of expenditure and revenue. The purpose is to know the variance between actual and budgeted results with an objective to control various costs within a particular period. The budget enables the evaluation of an organisation’s financial efficiency and planning.

The shape and structure of budgetary control system, to a great extent, is determined by the size and nature of an organisation for both long term and short term in different periodicity such as monthly, quarterly, half-yearly, annually and over a wide range of years which may include future estimates.

In a big organisation, a viable budgetary control system can be organized on the following lines:

1. Organisational Structure: An organisational structure defines the functional responsibilities of every member of the management and ensures that each one is aware of his role in the organisation and his relationship with other participants.
2. Establishing Budget Centres: A Budget Centre of an organisation may be a department or section of the organisation and these should be related to cost centres. A cost centre is a section or department or a business unit where cost is incurred which may be indirectly contributing towards revenue generation of the organisation. The department heads of the organisation should work as a responsibility centre responsible for achieving the budgeted target hence be involved in the process of budgeting. For instance, the production manager should be consulted for the preparation of the production budget and he should be responsible to achieve the budgeted targets.
3. Establishment of Adequate Accounting Records: An efficient accounting system should be established for the recording of transactions and related data so that the information required to analyze the variance between actual and budgeted be available on real-time for each budget centre.
4. Establishment of a Budget Committee: Budget committee oversees the budget formation of every department within an organisation. A budget committee is established under the charge of a budget officer. In case of a large organisation, members of a budget committee usually consist of top management, CFO and department heads. The budget committee prepares manual for collection & collation of information related to budgeting. Details of budget are submitted to the budget committee by respective functional departments duly approved by department/functional heads. Budget Committee reviews and approves departmental budgets of the organisation. 
5. Budget Officer: Appointment of a specialist in budgeting is known as budget officer, budget accountant, budget controller, or a budget director. He is answerable for the planning and execution of the whole budgetary program.
6. Budget Manual: A budget manual is a set of rules and directions for the preparation of various budgets and related reports. It should be well-drafted, indexed and divided into sections. A Budget Manual should contain the following details:

1. objectives and description of budgetary control;
2. Standard Operating Procedure (SOP) to be followed in formulating budgets; key drivers, standard parameters or indices to be used for budgets like Growth %, Exchange rate etc.
3. Key performance parameters like Market share, Material cost per unit, Productivity etc derived from Industry benchmarks with the objective of continuous improvement
4. Functions and responsibilities of each member of the budget committee;
5. Accounting method and control;

7. Determination of Key Factor: Key factor is a limiting factor or governing factor on sales volume, production volume, labour and materials etc. at a particular point of time or over a period of time. It is also known as 'Principal Budget Factor'.

Sales volume can be a Key factor for production volume. Limiting factor for production can be the supply of raw materials and labour etc. The key factor, therefore, is a factor whose impact has to be evaluated first to ensure that functional budgets are reasonably capable of fulfilment.

For example, if consumer demand for a product is limited, then the sales budget should be prepared first of all. Other functional budgets should then be prepared to manage consumer demand i.e. sales.

Sometimes, there may be two or more key factors in operation. In such a case, before planning budgets, their relative impact should be evaluated.

Key Factor is not of a permanent nature. It keeps changing from time to time. For example, there may be an increase in consumer demand; production facility may be increased by adding a plant to meet required demand etc.

The following variables are known as key factors:

1. Raw Materials

1. Non-availability of Raw Materials due to short supply
2. Restrictions imposed by Government agencies such as licenses, quotas etc.

2. Key Factor in Labour:

1. Shortage of general labour
2. Shortage of skilled labour

3. Key Factor in Plant & Machinery capacity utilization:

1. Shortage of capacity due to lack of capital,
2. Shortage of capacity due to lack of space
3. Capacity underutilization due to lack of market
4. Bottlenecks in certain key processes or operations

4. Key Factor in Sales:

1. Low market demand of products,
2. Shortage of experienced salesmen,
3. Insufficient advertising due to lack of money.

5. Key Factor in Management:

1. Lack of capital, restricting policy,
2. Lack of know-how,
3. Inefficient executives,
4. Insufficient research into product design and methods.

Activity Level Determination: It is important to establish a normal level of activity that can be reasonably achievable in a specified period of time. Level of activity should be determined by considering the historical results, efficiency of labour and other operating condition.

For example:  Level of production and sales can be established on the basis of past period’s demand for products, Industry Forecast, Customers Business plans etc. Therefore, Establishing of the level of activity is important in the budgeting process.

8. Quantification of Organisational Goal: organisation goals should be clearly articulated and quantified. The organisation goals must be divided into functional goals. The functional goals should be in conformity with overall organisational goals.

Major categories under which budgets can be divided.

1. Sales/Marketing Budget:

- Sales Volume Budget
- Revenue budget based on sales volume and budgeted sale prices- Selling and Distribution Cost Budget
- Advertising Cost Budget

      2. Production Budget:

- Production Budget
- Purchases Budget

3. Personnel budget:

- This budget shows the requirement of direct labour and other support personnel
- Direct labour budget should be in agreement of standard hours required for production
- Direct labour cost budget is estimated by multiplying the standard wage rate to standard
  hours required for production

4. Overheads Budget: Overheads include Production overheads, Utilities  & expenditure budgets of different cost centres of the organisation like Stores, Human Resource, Information Technology, Quality Control, Quality Assurance, R&D, Finance & Accounts, Administration etc.

5. Financial Budget: A financial budget shows the requirement of cash flow to achieve the budgeted target of the income and expenses of the business in an effective way. Financial budget preparation includes Budgeted Profitability, Budgeted balance sheet, and Budgeted cash flow, etc.   

The following are the constituents of the financial budget;

1. Budgeted Profitability: This is the summation of functional budgets as explained above in monetary terms incorporating  Budgeted revenue & expenditure to define gross & net profits The operating budget shows the operational expenses to be incurred and revenue from sales to be generated during a particular periodicity.

This also includes Borrowing cost based on working capital budget and other finance charges which shall be required to be incurred to achieve budgeted results.

2. Working Capital Budget:  Working capital represents operating liquidity available to an organisation. The working capital budget is derived from targets given to functional heads in terms of Receivables, Inventory & payable as well as capital expenditure budget. Working capital management is a key result area of the Chief Financial Officer of the organisation.  Following are the key ratios used for the analysis of balance sheet and profit & loss of an organisation and for monitoring the working capital efficiency of an organisation:

3. Capital Budget: This is also known capital expenditure budget. This budget relates to expenses related to the expansion of a project, or replacement of an existing capital asset, or purchase of a new capital asset.

The following are the factors which are considered for preparing an effective capital budget;

- Cost of capital assets
- Depreciation
- Economical life capital assets
- Borrowing Cost of Capital

The element of successful Budget Plan

The success of a budget plan depends on the following essential lines:

• Realistic forecasting of business activities:
• Coordinating business activities
• Reasonable flexibility
• Adequate Availability of Financial Resources:- An organisation should allocate adequate financial resources efficiently so as to ensure effective budget implementation. An organisation must ensure that it has adequate access to financial resources in order to finance its projects and to carry out its activities.

Conclusion:

Budgetary control is an important tool for the management to realize the vision & objectives of the Organisation as budgetary control system makes an organisation well-knit, target driven run by efficient motivated employees with clearly defined authorities & responsibilities.

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Authors:
CMA C. P. Kalra, FCMA 
Cost Accountants | Partner at CKC LLP
ckalra@cmackc.com

CMA Md Rehan, ACMA
Cost Accountants | Partner at CKC LLP
rehan@cmackc.com