BUDGETARY CONTROL

MODULE-V

Dr. Gunjan Dwivedi

Assistant Professor Finance ABS
 Meaning & Definition of Budget

 A budget is the monetary or quantitative presentation of

business plans and policies to be pursued in the future
period of time.

 According to ICMA London, “A budget is a financial

statement prepared prior to a predetermined period of time
of the policy to be pursued during that period for the
purpose of attaining a given objective.”
 Forecast & Budget
 Forecast is the foundation of any budget. Forecast is done
first and then budget is prepared on that basis.

 Forecast means pre-estimate of events keeping in view the

record of past period and possible variations in future.

 There is no commitment for achieving forecast but on the

other hand budget is a document which shows the
commitment of management for necessary steps and
efforts to achieve forecast.
 Budgetary Control
 Budgetary control is the process of preparation of budgets
for various activities and comparing the budgeted figures
for arriving at deviations if any, which are to be eliminated
in future.

 Thus budget is a means and budgetary control is the end

result.

 Budgetary control is a continuous process which helps in

planning and coordination. It also provides a method of
control.
 Definition
 Welsch has defined Budgetary Control as “The use of
budgets and budgeting reports throughout the period to
coordinate, evaluate and control day-to-day operations in
accordance with the goals specified by the budget.”
 Objectives of Budgetary Control

i. To assist in policy formulation on the basis of proper and

reliable data.
ii. To ensure planning for future by setting up various
budgets.
iii. To determine short term and long term financial and
physical targets.
iv. To operate various cost centres and departments with
efficiency and economy.
v. To classify expenses according to their nature such as
direct and indirect expenses, fixed, variable and semi-
variable expenses, etc.
 Cont…

vi. To anticipate capital requirements and to make necessary

arrangement for it.
vii. To make cost accounting more reliable and systematic.
viii. To develop co-ordination and co-operation among
employees and executives.
ix. To eliminate wastes and increase in profitability.
x. To fix the responsibility of various individuals in the
organizations.
 Advantages / Importance of
Budgetary Control

 A tool for improvement in planning

 As an aid in co-ordination

 A vehicle of comprehensive control

 An instrument of motivation

 A media of communication
 Disadvantages / Limitations of Budgetary
Control

 Changing situations
 Effect of un-clarified facts
 Dictatorial attitude
 Limited freedom for accountants
 Formal arrangement
 Efforts to hide variations
 Types of Budget
 On the basis of Time

 On the basis of Flexibility

 On the basis of Functions

 On the Basis of Time
 Long Term Budget- (5-10 Years)

 Short Term Budget- (1-2 Years)

 Current Budget- (1 Month or More)

 On the Basis of Flexibility
 Fixed or Static Budget

 Flexible Budget
 On the Basis of Functions
 Cash Budget

 Sales Budget

 Purchase Budget

 Production Budget
 Flexible Budget & Fixed Budget
 A flexible budget is a budget that adjusts or flexes with changes in
volume or activity. A flexible budget is usually designed to predict
effects of changes in volume and how that affects revenues and
expenses.
 In order to accurately predict the changes in costs, management has
to identify the fixed costs and the variable costs. Fixed costs will
be constant within relevant range of operations where the variable
costs will continue to increase as production increases.
 On the other hand, a fixed budget, also known as a static budget,
is a budget that does not change or adjust to the actual volume of
output produced or sales levels achieved. Once it's set, the
budgeted amounts for revenues and expenses remain unchanged
regardless of actual business performance.
 Uses of Flexible Budget
 Where nature of business is such that sales are difficult to
predict, for example demand for luxury goods is quite
unpredictable.

 Where sales are affected by weather conditions, for example,

soft drink industry, woolen garments.

 Where sales are affected by changes in fashion, for example,

readymade garments.

 Where company frequently introduces new products.

 Cash Budget
 A cash budget is a budget or plan of expected cash receipts
and payments during the period.

 These cash inflows and outflows include revenues

collected, expenses paid, and loans receipts and payments.

 In other words, a cash budget is an estimated projection of

the company's cash position in the future.
Objectives of Preparing Cash Budget

 It ensures that sufficient cash is available when required.

 It indicates cash excesses and shortages so that action may be

taken in time to invest any excess cash or to borrow funds to
meet any shortages.

 It establishes a sound basis for credit.

 It shows whether capital expenditure may be financed internally.

 It establishes a sound basis for control of cash position.

 Purchase Budget
 A purchases budget contains the amount of inventory that
a company must purchase during each budget period.
 The amount stated in the budget is the amount needed to
ensure that there is sufficient inventory on hand to meet
customer orders for production.
 At the simplest level, the purchases budget can simply
match the exact number of units expected to be sold in the
budget period.
 Purchase Budget gives the details of material purchases to
be made in the budget period. It correlates with sales
forecast and production planning.
 Production Budget
 The production budget is a plan or estimate of the quantum of
products required for production by the organization over a
period. It is an estimate based on the sales forecast, or how much
the company will sell in the coming period.

 The production budget is the basis for developing cost budgets

about the raw materials and other consumables to be purchased.
Also, it forms the basis for deciding how much manpower to be
employed. Other important managerial decisions like need and
quantum of advertising and promotions, purchasing or taking
storage spaces or go downs on rent, etc. are based upon the
number of items to be produced.
Concept of Zero Based Budgeting
 Zero based budgeting is the preparation of budget starting
from zero.

 This technique was first introduced to the public in

a 1970 article by Peter Pyhrr.

 In this approach the budget is not based on

previous budgets. Instead, the budget starts at zero.

 With zero-based budgeting, it needs to justify every

expense before adding to the official budget.
 Steps Involved in
Zero Based Budgeting

Identification of
Decision Units

Development of
Decision
Packages

Review &
Ranking of
Decision
Making
 Identifying of Decision Units

 An organization is divided into many decision units.

 Each cost center like marketing department, production

department, human resource department, research, and
development department, etc. acts as a decision unit.

 Each decision unit has to give justification for the expenses

and required budget allotment. The justification given by
the manager should not be based on prior period budget or
based on expenditure in the preceding year.

 The justification for the required budget should also be

 Development of Decision Packages

 In this step, the decision units that were identified in the

first step are broken down into smaller decision packages.

 These decision packages must be in line with the

objectives of the organization. Each decision package acts
as a standalone proposal which is appealing for allocation
of funds.

 Each decision package defines the functions, activities,

and operations of the proposal
 Review & Ranking of Decision Making

 In this step, all the decision packages within a decision unit

and among various decision units are ranked in the order of
their importance and priority.

 The logic behind prioritizing decision packages is to have an

efficient allocation of scarce resources. Decision packages are
ranked based on the cost-benefit analysis.

 While doing this, all the alternatives options are evaluated so

as to select all the better and cost-effective options. Top
management reserves all the rights to approve or reject a
decision package.
 Advantages of Zero Based Budgeting

 Allow managers to quickly respond to changes in external

environment.
 It Promotes questioning and challenging attitudes.
 It ensures efficient use of limited resources by allocating them
according to the relative importance of the programs.
 The annual review of the programs indicates the relative worth of
the programs and thus ensures no programs continues beyond its
productive life.
 The establishment of decision units makes the performance
evaluation system more effective.
 Limitations of Zero Based Budgeting

 Increased paper work.

 Cost of preparing many packages.
 More emphasis on short term benefits and Qualitative benefits
are ignored.
 Small organization cannot afford it.
 The identification of decision units and decision packages
creates number of problems for the organization (Decentralized).
 The process of zero base budgeting requires experiences,
intelligence, expertise, and continuous training on the part of
executives. Thus, it is not suitable for an ordinary organization.