Budgeting is the process of making a plan or forecast for the future of a business. Budgeting is an important part of the management and cost accounting of a business. The budgeting process of a business consists of forecasting its incomes and expenses. Once these incomes and expenses are determined, the forecasted profits of the business are calculated by subtracting the expenses from the incomes. These budgets are also usually made by taking the previous period’s budget as a base. For startups, budgets are made from scratch in their year of inception and then that budget is used as a base for upcoming periods. Usually, a business will have a budgetary control function to handle all its budget-related tasks.
What is Budgetary Control?
Budgetary control is the process of preparing budgets for the future of the business, comparing actual performance with the prepared budget, finding variances and taking corrective actions based on findings. This consists of all processes from preparing a budget at the start of the period to making decisions based on the comparison between actual performance and budgeted performance. Budgetary control is a continuous process which can help the business in planning and coordinating its activities.
Objectives of Budgetary Control
There are many objectives of a budgetary control function within a business. These objectives are listed below.
Planning
First and foremost, the objective of budgetary control is to plan for the future of the business. Budgets act as a tool for forecasting the future of the business and preparing for any contingencies. Budgets help remind the management of a business regarding the goals of a business. Therefore, it allows any plans made for the future of the business to be in line with the overall objective or mission of the business.
Every department or function within a business operates under a budget. It allows managers of different departments within a business to come together and formulate a plan for the future of the business. This allows the managers to make budgets for their respective departments that focus on achieving the overall goal of the business and avoiding budgetary slack.
Control
Once a budget is established, the goal of budgetary control becomes to control the performance of the business according to the budget. A business can plan its activities but without a robust control system, it cannot realize those plans. As discussed above, managers of different departments help in the preparation of budgets for their departments. The responsibility for the control of the performance of each department is delegated to its respective manager.
The purpose of controlling is to identify any deviations from the plan on time. Once any deviations are identified, these are communicated through the proper channels and promptly fixed. Furthermore, controlling the actual performance of a department may also identify any weaknesses within the budget of the business. In the absence of continuous monitoring and control, the budget of business will never realize.
Coordination
Another objective of budgetary control is to coordinate different departments and activities within a business. Businesses do not have infinite resources and are forced to work with limited resources. It is the objective of a budget to coordinate the use of these resources to ensure maximum efficiency is achieved. Through maximum efficiency, budgets also ensure that the profits of the business and, ultimately, the wealth of owners is maximized.
In the absence of a budget, many conflicts can arise within different departments of a business with regards to resource allocation. Therefore, budgets are made to ensure that not only are resources fairly allocated between different departments but also to ascertain that these conflicts are kept to a minimum. When allocating resources, while the needs of individual departments are considered, the goals are the business as a whole are prioritized.
Communication
Similarly, an objective of budgetary control is to promote communication within a business. Without proper communication within a business, a budget cannot be implemented. A good communication system within a business can also help with controlling and coordinating the activities of a business. Once a budget is prepared, it is communicated to the employees of the business. This can help each employee understand their role within the business and the budget.
Similarly, the objective of budgetary control is to also establish a communication channel and define communication lines within a business. Effective communication through the right channel and line can help a business run its processes smoothly and efficiently. This is because every employee within the business understands how and to whom they can communicate any issues related to the budgetary process of a business.
Motivation
One of the objectives of budgetary control is to motivate the employees of a business. However, for budgets to be motivational, they must be realistic. Unrealistic budgets can hurt the motivation of employees. Generally, budgets should be specific, measurable, achievable, relevant and time-based. This ensures that employees get standards that they perceive to be realistic, thus, increasing their motivation.
For managers, being involved in the budget-making process of a business is also motivational. When managers get to set their departmental budgets, they can use their knowledge to set goals for themselves that are challenging. Managers can use budgets as targets to aim for. Similarly, budgets also allow businesses to reward employees and managers for achieving what is expected of them in the budget. This can motivate them even further in the pursuit of achieving their targets.
Evaluation
As discussed above, managers of every department within a business contribute to the budget-making process of a business. Similarly, these managers are also responsible for the control of the actual performance of their departments against the budget. Since the role of a manager is to not only set a budget for their department but also control it, budgets can be used as a performance evaluation tool to appraise the performance of the managers.
This performance appraisal is based on how well a manager of a department achieved their budget. Higher-level management can use budgets to determine whether the targets that the departmental managers set for themselves were realistic. Similarly, budgets can also be used to determine whether the departmental managers were successful in controlling the actual performance of their department against the prepared budget.
The 5 Steps of Budgetary Control Process
To ensure an effective budgetary control process, the process must go through 5 essential steps. Each step depends on the proper completion of the previous step. The 5 steps of a budgetary control process are as below.
Step 1: Establishing the Current Position
The first step in a budgetary control process is establishing the current position of a business. This can be done through inspection of historical information of the business. This information is obtained from the management accounting reports of a business. This will include identifying the historical incomes and expenses of a business. This information can also be obtained from previous budgets of the business.
Similarly, once the historical information is obtained, the information is thoroughly checked and studied. This allows the business to understand how the business has performed in the past and adjust the budget for any expected changes. Information is also categorized according to its nature for easier comparisons in the future. Based on this information, the business can prepare its budgets. The process of making a budget may include tweaking the previous budget for expected changes such as inflation.
Step 2: Comparing Actual Performance with the Budget
The second step in the budgetary control process is to compare the actual performance of the business with the budget made in step 1. As mentioned above, if the information is properly categorized in the previous step, it should allow for easier comparisons with actual performance. The actual performance of a business is compared with the budget to identify any variances or deviations from the plan. This process is also known as Variance Analysis.
Step 3: Calculating Variances
In step 2, all the variances between actual performance and budget are identified. In this step, any variances found during the comparison are quantified. This process includes calculating the difference between the expenses or incomes actually made and comparing them with the standard for the specific expenses or incomes in the budget. However, the standards set in the budget may be set for the whole period and may need to be adjusted for the period being considered.
There are generally two types of variances that may occur. One type of variance may occur due to the units actually produced or the units of expenses and incomes not being achieved. The second type of variance relates to the cost of the units not meeting the standard cost set in the budget. Both of these variances must be calculated separately for a business to understand where the shortcomings are.
Step 4: Establishing the Reason for Variances
Once variances are calculated, the business will need to establish a reason why these variances have occurred. There are many reasons why variances may occur. For example, variances may occur due to errors, wastages, incorrect budgeting standards, unexpected events, etc. Establishing these reasons is vital for an effective system of budgetary control.
The type of variance and reason for the variance also defines the corrective actions that must be taken. These variances can either be positive or negative. Therefore, it may also be useful to not only investigate negative variances but also positive variances. Positive variances may be an indicator of efficiency in a certain process. However, it may also be caused due to an exaggerated budget.
Step 5: Taking Actions
The final process in the budgetary control process is to take actions for the variances identified in the above steps. Some variances may be too low; therefore, a business may choose to ignore them. Similarly, variances may be caused due to unforeseen events, thus, a business may not have any actions against these variances either. For other types of controllable variances, businesses will need to take corrective actions.
The actions for the variances also depend on the type and reason of the variance. For example, if a business identifies a variance is caused by lower units produced, then it may decide to increase its production. Other actions taken may include revising the budgets, controlling costs, eliminating bottlenecks, increasing or decreasing quality of materials and labour, etc.
Advantages Budgetary Control
Budgetary control can have many advantages for a business as follow:
Allow for Effectively Control the Operation of a Business
The first advantage of budgetary control is that it allows the management of a business to effectively control the operations of a business. It ensures that processes within a business are run as efficiently as possible. Due to increased efficiency, businesses can make more profits. Therefore, budgetary control can also help in increasing the profits of a business.
Define Objectives of a Business to Achieve Common Goal
Budgetary control can also define the objectives of a business and ensure that all the departments and activities within the business are focused on achieving a common goal. In the absence of budgetary control, every department will focus on departmental goals rather than the goals of the business as a whole. This can also give rise to conflicts of interest within the business.
Define the Pathway to Achieve Goals and Objectives
Budgetary control also defines the path for a business to achieve its goals and objectives. Through the planning, controlling, coordinating, communicating, motivating, etc. budgetary control helps managers and employees understand what is expected of them. Budgetary control also ensures that the responsibilities of everyone within the business are clear.
Help to Promote a Cost-Conscious Environment
Budgetary control also helps promote a cost-conscious environment. When every expense within the business is controlled against a standard, it helps everyone focus on decreasing the expenses of the business. Budgetary control, through performance appraisal, can also help in rewarding individuals who achieve their goals in controlling costs.
Limitations of Budgetary Control
Budgetary control may also have some limitations as follow:
It Depends on a Well-Prepared Budgeted
The first limitation is that budgetary control depends on a well-prepared budgeted. If the underlying budget is not accurate or not realistic, it can have a negative effect. Controlling such budgets can also be more difficult for managers. It can also disrupt the budgetary control process. For example, an unrealistic budget can increase favourable or adverse variances, thus, disrupting the budgetary control process.
Lead to Time-Consuming and Costly
The budgetary control process of a business can also be time-consuming and costly. This is because preparing a budget requires time from different levels of management. Once a budget is made, the monitoring and control process can also take a lot of time. Likewise, revising budgets constantly for any changes can be costly. This time can easily translate into costs for a business. These costs are also high for startups as they build a budget from scratch.
Source of Conflict within Departmental Managers
Budgetary control can also be a source of conflicts within managers of different departments. For example, when resources are allocated to each department, every department will want to have maximum resources available. This conflict arises mainly due to responsibility for the performance of each department given to the managers of those departments.
Conclusion
Budgetary control is an important part of any business. Budgetary control consists of creating budgets, controlling performance against budgets, calculating any variances from the budget and taking corrective actions. The main objectives of budgetary control are to plan and control the activities of a business and promote coordination, communication, motivation and evaluation. The budgetary control process consists of 5 steps. It starts from establishing the current position of a business, comparing actual performance with the budget, calculating variances, finding reasons for variances and taking corrective actions.
