Budgetary control is a concept of financial accounting that helps to oversee the payments and receipts within an organization. It provides a greater tool to plan, monitor, and control financial activities within an organization.
The concept of budgetary control can be linked with liquidity and management of the cash flow. However, the concept of budgetary control is not limited to cash flow management, it extends to include profitability, capital management, financial management, and all other aspects of business management.
Concept
The concept of budgetary control is based on a comparison between budgeted amounts and actual amounts. The budgeted amounts are forecasted based on the current market and business conditions.
That’s the planning stage of the operations that need to be set in line with the market research and expectation.
Although the budget needs to be challenging it must be realistic and designed to increase the efficiency of the managers.
A good budget needs to be comprehensive, easy to understand, in line with the motives of the organization, and free from unrealistic assumptions.
The preparation of the budget can be top to bottom or bottom to top. The top to bottom does not include input from the lower employees in the hierarchy and the bottom-to-up approach of setting a budget involves operational staff in the process of setting a budget.
At the end of the period, an actual amount is compared with the estimated or budgeted figures to come up with the variance.
The obtained variance needs to be analyzed if that’s controllable or not. The variance might be favorable or adverse depending on the situation that helps to decide the performance of the managers.
What Are the Objectives of Budgetary Control?
The objective of budgetary control is to measure the performance, control the financial and operational activities, the establishment of responsibilities, and close monitoring of the different managerial aspects.
Further. If budgets are prepared and monitored effectively, it helps to improve the profitability and liquidity structure of the business.
Let’s understand how budgetary controls help the business in the achievement of organizational objectives.
1) Performance measurement
The comparison of budgeted and actual financial figures generates variance. The variances can be negative or positive, if the variance is positive it’s good news for the managers as their performance exceeds an expectation.
On the contrary, if a variance is negative the reasons need to be investigated for the lower performance of the manager.
Further, the business needs to consider if performance was severely affected by the external market conditions or if it was negligence on the side of the manager.
The volume of variance indicates the intensity of the variation. If an adverse variation is not material the cost of action might be more than the benefits obtained from it.
2) Control of financial and operational activities
The system of budget pre-actively sets the direction for managers responsible to make decisions. They have targets in the mind from the start of the period and the capability to direct their energy towards the achievement of periodic targets/goals.
The mechanism of budget further allows the managers to decide the risk exposure of the company. For instance, if the target is set to increase sales exponentially, it’s logical to look for acquisitions and mergers.
In addition to this, managers with expense budgets in mind are expected to have more skepticism before approval.
3) Establishment of responsibilities
In the world of accounting, there is a concept of responsibility centers. These responsibility centers have their own revenue and expenses.
The process of setting a budget helps to set the target of revenue and expenses for the specific responsibility center.
The setting of the budget for the responsibility center helps to easily identify its performance and contribution in the overall profit/loss for the company.
The combination of budgetary controls and responsibility accounting increases the transparency and culture of enhanced efficiency throughout an organization.
4) Close monitoring of managerial aspects
The budget is of prime importance in the management of the company. It brings collaboration between different departments that sit at the table and decide what needs to be done with how many resources.
Effective implementation of the budget process makes managers think about activities that will take place throughout the organization.
The budget helps to think about all the managerial aspects including the purchase of inventory, cost of inventory holding, cost of production, production losses, forecasted sales, forecasted expenses, required threshold of inventory, expected sales, cost of sales, related administrative and operational expenses, etc.
It makes managers think about different managerial aspects that help them to improve their efficiency and organizational profits.
Types of Budgetary Control
Various budget types have been developed to cover different areas of financial statements and managerial information.
Budgetary control encompasses various types employed to monitor and manage different aspects of an organization.
Let’s explore the different types of budgetary control:
- Operational Control: Operational control involves monitoring and managing the day-to-day activities of an organization. It focuses on specific tasks and activities, ensuring efficient and effective completion. Operational control budgets enable organizations to allocate resources, set performance targets, and track progress at the operational level. This type of control helps ensure that operations are carried out smoothly and in line with organizational objectives.
- Financial Control: Financial control revolves around monitoring and managing the overall financial performance of an organization. It involves assessing and controlling financial aspects such as revenue, expenses, cash flow, and profitability. Financial control budgets provide a comprehensive overview of the organization’s financial health, enabling management to make informed decisions, identify financial risks, and ensure long-term financial stability.
- Capital Expenditure Control: Capital expenditure control focuses on monitoring and managing the organization’s spending on capital assets. It involves budgeting and controlling investments in buildings, equipment, and vehicles. Capital expenditure control budgets help ensure that the organization allocates resources efficiently, invests in necessary assets, and evaluates the feasibility and affordability of capital projects—this type of control safeguards against unnecessary or imprudent spending on capital items.
- Sales Control: Sales control involves monitoring and managing the organization’s sales performance. It encompasses setting sales targets, tracking revenues, analyzing market trends, and assessing customer demand. Sales control budgets provide insights into sales strategies’ effectiveness and help identify improvement areas. By closely monitoring sales performance, organizations can optimize their sales efforts, meet revenue goals, and adapt their sales strategies.
- Cost Control: Cost control focuses on monitoring and managing expenses. It entails budgeting and controlling costs across various operational areas, such as procurement, production, and administration. Cost control budgets help organizations identify cost-saving opportunities, eliminate unnecessary expenses, and keep costs in check. This type of control aids in maintaining profitability, improving operational efficiency, and optimizing resource utilization.
Each type of budgetary control plays a crucial role in monitoring and managing specific aspects of an organization’s operations and finances.
By implementing and effectively utilizing these types of budgetary control, organizations can enhance their operational efficiency, financial stability, sales performance, and overall cost-effectiveness.
The selection and implementation of specific types of budgetary control depend on the organization’s priorities, industry, and strategic objectives.
What Are the Advantages of Budgetary Control?
Budgetary control offers several advantages to organizations.
Let’s explore them in detail:
Budgetary control aids in effective planning for the future. By forecasting income and expenses, organizations can establish financial goals and ensure they are on the right path to achieving them.
It provides a structured framework for financial planning and guides decision-making processes.
Additionally, budgetary control enables organizations to allocate their resources wisely.
By carefully managing their funds, organizations can ensure that their money is directed toward the most crucial areas and aligned with their strategic objectives.
It helps prevent overspending in any particular area and promotes optimal resource utilization.
Furthermore, budgetary control assists organizations in controlling their spending.
By consistently tracking expenses and comparing them to the budgeted amounts, organizations can identify areas of potential overspending and make necessary adjustments.
This control mechanism promotes fiscal discipline and accountability within the organization.
Moreover, budgetary control serves as a source of motivation for employees to save money and contribute to the organization’s financial goals.
When employees understand how the organization’s finances are allocated and spent, they become more conscious of their spending habits. They may actively seek ways to contribute to cost-saving efforts.
Budgetary control also enhances decision-making processes within organizations.
By having a clear and comprehensive budget, organizations better understand their financial situation.
This enables them to make more informed decisions about resource allocation, investment opportunities, cost-saving measures, and other financial matters.
Additionally, budgetary control facilitates improved communication between different departments within an organization.
By sharing budget information, departments can gain insights into each other’s needs, priorities, and financial constraints.
This promotes collaboration, coordination, and a better understanding of the organization’s financial objectives.
Furthermore, budgetary control can drive increased efficiency. By regularly comparing actual and budgeted expenses, organizations can identify areas where overspending or inefficiencies exist.
This analysis helps pinpoint opportunities for improvement, cost reduction, and streamlining of operations.
Lastly, budgetary control is vital in reducing the risk of financial problems.
Organizations can anticipate potential issues by forecasting income and expenses and taking corrective actions to mitigate risks.
It identifies financial challenges early and allows organizations to address them before they escalate proactively.
What Are the Limitations of Budgetary Control?
Budgetary control, while advantageous, also has certain limitations that organizations should be aware of.
Let’s delve into these limitations.
Firstly, one of the key limitations of budgetary control is the uncertainty of the future.
Budgets are based on forecasts of future income and expenses, and these predictions may not always align with actual results.
Fluctuations in market conditions, changes in consumer behavior, or unexpected events can significantly impact the accuracy of budget forecasts.
Consequently, organizations may need help if the actual results deviate significantly from the budgeted figures.
Moreover, budgeting can be time-consuming and costly, posing a limitation for small businesses or organizations with limited resources.
Developing, implementing, and monitoring budgets require significant effort, data collection, and analysis.
The financial and human resources required for budgetary control can be a barrier for organizations operating with constrained budgets.
Another limitation of budgetary control is its inherent rigidity. Budgets are typically designed for a specific period and may not easily accommodate changes in the business environment.
In a dynamic and unpredictable market, budgets can become outdated quickly if they are not adjusted to reflect changing circumstances.
This inflexibility can hinder an organization’s ability to adapt to evolving customer demands, cost fluctuations, or other external factors.
Ineffective budgeting practices can also result in demotivation among employees.
Unrealistic or poorly communicated budgets can create a sense of frustration and demoralization.
If employees perceive budgets as achievable or relevant, it can decrease productivity, innovation, and employee morale.
To mitigate this limitation, organizations should ensure that budgets are realistic, include employee inputs, and effectively communicate throughout the organization.
Furthermore, budgetary control may encounter limitations due to a lack of coordination between different departments or levels of the organization.
Effective budgeting requires collaboration and alignment between various stakeholders to coordinate goals, objectives, and resources appropriately.
With proper coordination, departments may work towards conflicting objectives, resource allocation may be efficient, and overall budgetary control may improve.
