WHAT IS A BUDGET?:Budgetary control, Making a Forecast, Preparing budgets

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Cost & Management Accounting (MGT-402)

LESSON-33

WHAT IS A BUDGET?

A budget is a plan expressed in quantitative, usually monetary terms, covering a specific period of

time, usually one year. In other words, a budget is a systematic plan for the utilization of

manpower and material resources. In a business organization a budget represents an estimate of

future costs and revenues. Budgets may be divided into two basic classes; Capital Budgets and

Operating Budgets, Capital budgets are directed towards proposed expenditures for new projects

and often require special financing (this topic is discussed in the next Unit). The operating budgets

are directed towards achieving short-term operational goals of the organization, for instance,

production or profit goals in a business firm. Operating budgets may be sub-divided into various

departmental or functional budgets. The main characteristics of a budget are:

It is prepared in advance and is derived from the long, term strategy of the organization.

It relates to future period for which objectives or goals have already been laid down.

It is expressed in quantitative form, physical or monetary units, or both.

Different types of budgets are prepared for different purposes e.g. Sales. Budget, Production

Budget. Administrative Expense Budget, Raw material Budget, etc. All these sectional budgets are

afterwards integrated into a master budget- which represents an overall plan of the organization. A

budget helps us in the following ways:

1. It brings about efficiency and improvement in the working of the organization.

2. It is a way of communicating the plans to various units of the organization. By establishing

the divisional, departmental, sectional budgets, exact responsibilities are assigned. It thus

minimizes the possibilities of buck-passing if the budget figures are not met.

3. It is a way or motivating managers to achieve the goals set for the units.

4. It serves as a benchmark for controlling on going. Operations.

5. It helps in developing a team spirit where participation in budgeting is encouraged.

6. It helps in reducing wastage's and losses by revealing them in time for corrective action.

7. It serves as a basis for evaluating the performance of managers.

8. It serves as a means of educating the managers.

Budgetary control

No system .of planning can be successful without having an effective and efficient system of

control. Budgeting is closely connected with control. The exercise of control in the organization

with the help of budgets is known as budgetary control. The process of budgetary control includes

(i) preparation of various budgets (ii) continuous comparison of actual performance with budgetary

performance and (iii) revision of budgets in the light of changed circumstances.

A system of budgetary control should not become rigid. There should be enough scope for

flexibility to provide for individual initiative and drive. Budgetary control is an important device for

making the organization more efficient on all fronts. It is an important tool for controlling costs

and achieving the overall objectives.

Installing a budgetary control system

Having understood the meaning and significance of budgetary control in an organization, it will be

useful for you to know how a budgetary control system can be installed in the organization. This

requires, first of all, finding answers to the following questions in the context of an organization:

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What is likely to happen?

What can be made to happen?

What are the objectives to be achieved?

What are the constraints and to what extent their effects can be minimized?

Having found answers to the above questions, the following steps may be taken for installing an

effective system of budgetary control in an organization.

Organization for budgeting

The setting up of a definite plan of organization is the first step towards installing budgetary

control system in an organization. A Budget Manual should, be prepared giving details of the

powers, duties, responsibilities and areas of operation of each executive in the organization.

Responsibility for budgeting

The responsibility for preparation and implementation of the budgets may be fixed as under:

Budget controller

Although the Chief Executive is finally responsible for the budget programme, it is better if a large

part of the supervisory responsibility is delegated to an official designated as Budget Controller or

Budget Director. Such a person should have knowledge of the technical details of the business and

should report directly to the President or the Chief Executive of the organization.

Budget committee

The Budget Controller is assisted 'in his work by the Budget Committee. The Committee may

consist of Heads of various departments, viz., Production, Sales. Finance Personnel, Purchase, etc.

with the Budget Controller as its Chairman. It is generally the responsibility of the. Budget

Committee to submit discusses and finally approves the budget figures. Each head of the

department should have his own Sub-committee with executives working under him as its

members.

Fixation of the Budget Period

Budget period' means the period for which a budget is prepared and employed. The budget period

depends upon the nature of the business and the control techniques. For example, a seasonal

industry will budget for each season, while an industry requiring long periods to complete work

will budget for four, five or even larger number, of years. However, it is necessary for control

purposes to prepare budgets both for long as well as short periods.

Budget procedures

Having established the budget organization and fixed the budget period, the actual work or

budgetary control can be taken upon the following pattern:

Key factor

It is also termed as limiting factor. The extent of influence of this factor must first be assessed in

order to ensure that the budget targets are met It would be desirable to prepare first the budget

relating to this particular factor, and then prepare the other budgets. We are giving below an

illustrative list of key factors in certain industries.

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Cost & Management Accounting (MGT-402)

Industry

Key factor

Motor Car

Sales demand

Aluminum

Power

Petroleum Refinery

Supply of crude oil

Electro-optics

Skilled technicians

Hydral Power generation

Monsoon

The key factors should be correctly identified and examined. The key factors need not be a

permanent nature. In the long run, the management may overcome the key factors by introducing

new products, by changing material mix or by working overtime or extra shifts etc.

Making a Forecast

A forecast is an estimate of the future financial conditions or operating results. Any estimation is

based on consideration of probabilities. An estimate differs from a budget in that the latter

embodies an operating plan or an organization. A budget envisages a commitment to certain

objectives or targets, which the management seeks to attain on the basis of the forecasts prepared.

A forecast on the other hand is an estimate based on probabilities of an event. A forecast may be

prepared in financial or physical terms for sales, production cost, or other resources required for

business. Instead of just one forecast a number of alternative forecasts may be considered with a

view to obtaining the most realistic overall plan.

Preparing budgets

After the forecasts have been finalized the preparation of budgets follows. The budget activity

starts with the preparation of the said budget. Then, production budget is prepared on the basis of

sales budget and the production capacity available. Financial budget (i.e. cash or working capital

budget) will be prepared on the basis of sale forecast and production budget. All these budgets are

combined and coordinated into -a master budget- The budgets may be revised in the course of the

financial period if it becomes necessary to do so in view of the unexpected developments, which

have already taken place or are likely to take place.

Choice between Fixed and Flexible Budgets

A budget may be fixed or flexible. A fixed budget is based on a fixed volume of activity, 11 may

lose its effectiveness in planning and controlling if the actual capacity utilization is different from

what was planned for any particular unit of time e.g. a month or a quarter. The flexible budget is

more useful for changing levels of activity, as it considers fixed and variable costs separately. Fixed

costs, as you are aware, remain unchanged over a certain range of output such costs change when

there is a change in capacity level. The variable costs change in direct proportion to output if

flexible budgeting approach is adopted, the budget controller can analyze the variance between

actual costs and budgeted costs depending upon the actual level of activity attained during a period

of time.

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Objective of Budget

Profit maximization.

Maximization of sales.

Volume growth.

To compete with the competitors.

Development of new areas of operation.

Quality of service.

Work-force efficiency.

Divisions of Budget

Division of Budgets

Functional Budget

Master Budget

Functional Budget

Sales Budget

Production Budget

Raw material

Labor

Factory

overhead

Cost of goods

sold

Selling &

General &

Financial

distribution

Administrative

charges

expenses

budget

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