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.
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.
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 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 much 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 budget
Various budget types have been developed to cover different areas of financial statements and managerial information. These types of budgets include production budgets, sales budgets, capital budgets, expense budgets, labor budgets, and cash budgets, etc.
These different types of budgets help in the identification of areas that need to be improved. For instance, if there is adverse variance in the sales it suggests the company enhance marketing efforts. If all the negative areas with massive adverse variance are considered and improved, it definitely helps to improve the financial performance of the company.
Planning and monitoring of the budget require the consumption of energy. However, there are massive advantages of applying principles of the budget. These advantages include but are not limited to ease in goal setting, setting targets, improved departmental coordination, enhanced responsibility accounting, enhanced centralized control, and identification of financial areas that need to be improved. If the business gets success in improving specific areas, it gets to improved performance of the business.
The concept of budgeting is based on estimates that might not be always accurate. There may be a gap in expectation or goal, this might lead to demotivation if targets are not achieved. Another side of budgeting is difficulty in coordination and collaboration between different departments of the company. Hence, the activity of budgetary control may be costly and time-consuming.
Sometimes, there may be significant changes in the external environment of the business that have severe impacts on performance. If changes in the external environment are not considered the use of budget may be full of problems instead of enhancement in the business efficiency.