Budgetary control – Concept, Objective, Advantages, and More

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 no. The variance might be favourable or adverse depending on the situation that helps to decide the performance of the managers.

Objectives:

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 the 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 budget for 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 the budget include production budgets, sales budgets, capital budgets, expense budgets, labor budgets, and cash budgets, etc.

These different types of the budget help in 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.

Advantages

Planning and monitoring of the budget require consumption of energy. However, there are massive advantages of applying principles of the budget. These advantages include but 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.

Limitations

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 the 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.

Beyond Budgeting – Overview, Definition, Principle, And More

Overview

Budgeting and Monitoring tend to be an increasingly important part of all organizations, regardless of their size and functionality. It helps to give numerous valuable insights regarding the company, and what needs to be done in order to ensure that there are no financial losses as a result of inefficiency on the part of the company.

Beyond Budgeting is defined as a relatively fresher approach towards budgeting. It is defined as the principle where companies make a shift from traditional budgeting techniques because of their inherent flaws. It proposes a wide range of techniques, which mainly vest on the grounds of better analytics that are highly relevant to the market dynamics. Therefore, beyond budgeting mainly advocates a faster and smarter strategy as opposed to traditional techniques. The main rationale beyond budgeting is decentralization that helps all managers to make their own decisions accordingly.

Principles of Beyond Budgeting

Beyond Budgeting is structured around two main principles, defined as leadership principles and management principles. Within each of these subcategories, there are 6 principles of them that help in developing an understanding of the rationale behind budgeting. These principles are given below:

Subsequent description of these principles is given below:

Leadership Principles

  • Purpose: This involves motivating and inspiring people to direct their energies towards noble causes that are largely beneficial for everyone, and not around short-term financial goals.  
  • Values: under this leadership principle, workers are required to govern through shared values and sound judgment. It discourages seeking values from detailed rules and regulations.
  • Transparency: This particular principle implies that information should be sought as a by-product of self-regulation, innovation, and learning and control. It should not be restricted, and all ideas should be discussed with others in order to gauge the best possible course of action.
  • Organization: It requires cultivating a strong sense of belonging and organizing around a very stringent hierarchy. Therefore, it involves avoiding hierarchy control and bureaucracy.
  • Autonomy: Under this principle, all members of the organization should be given freedom in how they want to act. This means that they should not be called out upon in the case where they try to do something differently.
  • Customers: This is directed towards realizing how customers are an important part of the business, and how they cannot be entirely ignored. The main premise here is to ignore conflict of interest as much as possible.

Management Processes

  • Rhythm: This Principle states that management processes should be directed around business rhythms and cyclicality. It should not always be focused on particular calendar years.
  • Targets: Fixed and cascaded targets are known to be less effective than directional and ambitious targets. Therefore, targets should be set using a SMART methodology, so that better results can be obtained.
  • Plans and Forecasts: Planning and forecasting should be considered as lean and unbiased processes. They should not be rigid and short-term in order to extrapolate the best possible results.
  • Resource Allocation: Resource Allocation should be a perpetual state of affairs, as opposed to typical detailed annual budget allocations. This requires organizations to foster a cost-conscious mindset, which is flexible across all business events.
  • Performance Evaluation: This requires evaluating performance on a consistent basis with all the required feedbacks. These concurrent feedbacks are supposed to be further utilized for learning and development so that better results can be achieved.
  • Rewards: Rewards should be shared against competitiveness and projective growth as compared to fixed performance contracts.

Beyond Budgeting Techniques

Beyond budgeting mainly propagates business agility to better business practices that are different from the previous standards. Regardless of the fact that beyond budgeting does not specifically mention the techniques that are applicable to the given companies, yet there are a couple of other different techniques that can be used by businesses in order to implement Beyond Budgeting Techniques. They are as follows:

  • Rolling Budgets: creating rolling budgets and forecasts involves companies approaching forecasts on a monthly, or quarterly basis as opposed to the annual basis that was previously used.
  • Identification of Key Performance Indicators (KPIs): Identification and subsequent utilization of KPIs for the company imply that companies are able to set their targets in accordance with the KPIs.
  • Benchmarking: Rather than aiming towards achieving internal efficiency, companies should ideally focus on external benchmarks. External benchmarking is likely to make a company more competitive in terms of the industry dynamics they are subject to.
  • Encouraging innovation: Since beyond budgeting mainly talks about decentralization and autonomy, business innovation can be considered to be one of the most important premises of beyond budgeting.

Differences between Beyond Budgeting and Traditional Budgeting Model

Differences between beyond budgeting and traditional budgeting model are described in the table below:

 Traditional Budgeting Management ModelBeyond Budgeting Management Model
Targets and rewardsFixed Incentives and Incremental TargetsRelative Targets and Flexible Rewards
Planning and controllingFixed Annual Plans with variance controlsContinuous planning using KPI Approach
Resource and coordinationPre-allocated resources using a centralized systemDynamic coordination and resource allocation on demand
Organizational CultureCentral Control and focus on managing numbersFocus on value creation

Advantages of Beyond Budgeting

Beyond Budgeting is rapidly accelerating in terms of popularity and application by companies from almost all corners of the globe. There are a number of reasons as to why companies normally advocate beyond budgeting. These advantages of beyond budgeting are as follows:

  • It aims for business agility: Business agility is considered to be an antidote for the increasingly competitive and complex business environment. Beyond budgeting propagates business to be more agile, so that they are able to respond swiftly to the rapidly changing business dynamic. Hence, it empowers businesses, and helps them to be better prepared for the future.
  • Improvement in inner culture of the organization: As a matter of fact, beyond budgeting encourages organizations to liberate their workers so that they have more control over the decision making in the company. Therefore, it significantly results in improvement in the business culture. The workers end up feeling more motivated, and it results in a much needed influx of creativity within the organization.
  • Customer Orientation: Beyond budgeting also focuses on customer service, and ensuring that customers have a good experience. Therefore, it helps in leveraging high customer lifetime value, which tends to hold tantamount importance for the company in the longer run.
  • Team-Based reward System promotes team building: Since beyond budgeting involves team based reward systems, it helps in cultivating good relationships within the workforce. Since it puts more emphasis on team based rewards, it encourages individuals to be more collectivist as opposed to individualists. The trickle down affect is subsequently enjoyed by the company in terms of higher profits.

Limitations of Beyond Budgeting

Regardless of the fact that beyond budgeting seems to be an increasingly attractive option when it comes to achieving business agility, yet there are certain limitations of beyond budgeting that also need to be considered. These limitations are as follows:

  • Beyond budgeting is often considered to be time-consuming, because it is often difficult to implement it across organizations.
  • It is not applicable to all organizational types – particularly those organizations that have a fast-paced culture. Particularly, for those organizations that need to have a centralized organizational culture, this might be practical.
  • Since they focus on short-term financial rewards, it often makes it difficult to retain key metrics like shareholder value, and brand equity. It might not always be a feasible strategy in the long term.
  • It often results in an over-complex business dynamic, which might not be well-suited to all employee types. Working without direction might be overwhelming for these particular workers, and hence the required targets might not be achieved.

Imposed Budgeting – Definition, Example And How does Imposed Budgeting work?

Definition

Imposed budgeting can be described as a process where the top management of the company is responsible for preparing a budget, and then that particular budget is then imposed on the lower management staff to be duly implemented.

It is also referred to as a top-down budgeting process because it involves the higher management preparing the budget, and then it trickles down to the lower rungs of the organization.

The manner in which this budget works is that the higher management sets the budgets based on what the company is looking to achieve in the forthcoming financial year.

In this regard, it can be seen that when decisions are being made, higher-level managers may, or may not include the opinion of lower managers during the budget creation process.

However, it is up to the discretion of the higher manager whether they want to include those recommendations or not.

Therefore, those budgets are strictly made by the higher management, and lower management is required to abide by the budget and make sure that targets are duly met in this regard.

Example of Imposed Budgeting

The example of imposed budgeting is described using the illustration below:

Tree Co. is looking to expand business in the coming year. They plan on doing this by increasing their sales by 15%, while keeping the marketing budget down to 12%, and sustaining the net profit margin of 17%.

These targets were communicated by the top management to the higher management so that they can duly be planned and executed by the lower management staff in the coming year.

The illustration given above is a classic example of imposed budgeting. In this example, the top management of Tree Co. has laid down strict and stringent rules about the Key Performance Indicators they want to improve on in the coming year.

How does Imposed Budgeting work?

When implementing imposed budgeting, the managers are normally expected to follow the steps given below:

  • Target Setting: This is the first step in the budgeting process, and it involves higher management deciding on the broader target or goal that they have for the particular financial year. This broader goal then needs to be broken down into smaller parts, so that it can be allocated across departments in an effective manner. For example, in the illustration mentioned above, Tree Co. laid down that they need to expand, by increasing their sales. This was the broader goal that was set.
  • Department Approval: After setting the goals, it is important for the higher management to take the finance department on board. This is because it would help them to study the impact quantitative impact of the goal on the organization. From the illustration above, it would mean that managers would get a chance to see how a 10% increase in sales is going to increase the profit of the company, in the case where the company is met.
  • Allocations to different departments: After targets have been set, and the viability and the economic impact of the budget have been decided upon by the managers, it is then important to allocate the budgets to the respective departments, in order to get their feedback about the targets that are set. This is important because budgets would otherwise not be implemented if they are not on board with these targets.
  • Allocation and Review of budgets: After approval and discussion from different departments, budgets are set, and then allocated to the departments to work towards. This will then be reviewed by companies after the end of the period to determine which targets have been achieved, and which have been left out.

Advantages of Imposed Budgeting

There are numerous advantages of using imposed budgeting. Some of the advantages are given below:

  • It helps companies to target greater efficiency: Imposed budgeting is greatly helpful for companies because it helps departments to have strict and clear directions to work towards. This prudent approach is considered to be extremely pivotal in helping companies to combat the issue of declining productivity.
  • Better financial planning: Since imposed budgets are created in collaboration with the finance department, the organization is able to identify key areas that need to be focused on in order to ensure that they are able to identify areas that need to seek further improvement so that better results can be generated. Financial planning will ensure that the company does not suffer unprecedented financial setbacks.

Limitations of Imposed Budgeting

Regardless of the advantages mentioned above, there are a couple of limitations of imposed budgeting that also need to be incorporated.

  • Imposed budgeting leads to declining motivation on the part of the lower staff. In certain cases, the higher management might not be fully aware of the problems faced by the lower management, and therefore, they might end up losing motivation as a result of imposed budgets. This is also because of the fact that higher-level decision-making might not always involve lower management when setting those budgets.
  • The loss of productivity as a result of excessive pressure on the employees might also occur because employees would end up feeling excessively pressurized as a result of strict targets being set by the higher management.

9 Types oF Budgeting – With Detail Explanation

A budget is a projection or forecast of the financial performance of a business. A budget is a plan of action that is prepared in advance and expressed in monetary terms.

Managers of a business can use budgets to plan for the business as a whole or to plan for specific responsibility centers, departments, functions, projects, or business units.

Similarly, managers prepare budgets to use over a particular period. Most businesses make a budget annually, although, they can also make monthly, quarterly, or biannual budgets.

There are many benefits to making a budget for businesses. Businesses use budgets as a planning tool for the future. Similarly, they also use budgets as a monitoring and controlling tool to ensure the business follows its set plans and strategies.

Likewise, businesses use budgets to coordinate different business activities to achieve a common goal. Businesses can also use budgets to communicate the objectives of the business to its employees.

Businesses can choose to use different types of budgets. Some of the main types of budgets are listed below.

1) Fixed Budget

A fixed budget remains fixed regardless of the level of activity of a business. This budget is prepared based on the assumption that there will be no changes in the level of activity of a business.

Businesses use a fixed or standard level of activity as a basis for the preparation of this budget. Fixed budgets are very rigid and inflexible.

These budgets are usually used for short periods or for smaller projects where the level of activity is pre-determined. Businesses don’t use fixed budgets often.

2) Flexible Budget

A flexible budget, also known as a variable budget, is the opposite of a fixed budget. Businesses design flexed budgets to change according to the level of activity of these businesses.

Initially, businesses prepare flexible budgets with a fixed level of activity, though, once the actual level of activity of a business is determined, they adjust the budget accordingly.

For example, at the start of the year, the business may budget 10,000 units produced at $100,000 but in case the actual production is 11,000 units, the budget will be adjusted according to the 11,000 units, thus, making the production cost budget $110,000.

3) Rolling Budget

A rolling budget is a budget used by a business that is continuously updated in every accounting period once the previous accounting period has expired. Businesses that use rolling budgets will always have a budget that extends into the future.

These budgets are more accurate as they require continuous updates according to the needs of a business. Rolling budgets are more suited to fast-paced businesses where changes occur constantly and the budgets need to be revised accordingly.

Rolling budgets are mostly short-term budgets, thus, making them more reliable in times of uncertainty. However, these budgets are most costly as they require constant updates and may demotivate managers if they spend a large portion on budgeting.

4) Incremental Budget

An incremental budget is a budget that is prepared by the management of a business for the current year of the business based on the last year’s budget.

Incremental budgets are mostly utilized in stable businesses where adjustments for inflation are made to previous years’ budgets each year. Incremental budgets are the easiest budgets to make as they require minimal effort.

However, undetected mistakes in one period are likely to get carried over to the next period. Incremental budgets may also decrease some budgets that that departmental managers do not fully utilize in the previous period which can lead to unnecessary spending by the managers to ensure their budgets aren’t cut in the next period.

5) Zero-based Budget

Zero-based budgets are the opposite of incremental budgets. In zero-based budgets, a business prepares a new budget from scratch for every financial period.

The business does not consider the previous period’s budget when making the budget for the next period. The resources allocated to a particular expense or a particular department are justified for that particular period without considering any prior information during the preparation of these budgets.

Zero-based budgets are more accurate as compared to incremental budgets; however, these budgets can take a long time to make as everything businesses have to do everything from scratch.

6) Imposed Budget

An imposed budget, also known as a top-down budget, is a budget that is set by the higher authorities in business without letting the lower-level management or employees participate in setting the budget.

Imposed budgets can save quite some time for business as the senior management of the business will set the budget according to the strategies of the business.

Imposed budgets are better for achieving the overall goal of the business rather than the goal of a particular department or project.

7) Participative Budget

A participative budget, also known as a bottom-up budget, is the opposite of imposed budgets. All levels of management participate in the preparation of these budgets.

Participative budgets can improve the morale and motivation of the lower-level managers and employees as it allows them to set their own goals.

Managers are more likely to follow and accept these budgets as they get to participate in the making of these budgets. Participative budgets are more task and operation oriented rather than strategy-oriented.

8) Functional Budget

A functional budget, also known as an operating budget, is a budget which relates to specific functions within a business. Functional budgets are prepared for each function in a business and are part of the master budget of a business.

A business makes functional budgets for every function within the business, such as production budgets, sales budgets, purchase budgets, etc.

9) Master Budget

A master budget is a budget that consists of a summary of all functional budgets of a business. It gives an overall view of the business rather than a specific function within the business. The preparation of master budgets requires consolidating all the functional budgets of a business.

Master budgets mostly come in the form of a budgeted profit or loss account and a budgeted balance sheet of the business.

Conclusion

Budgets are plans or forecasts for the future period of a business. Businesses use budgets for many different purposes such as planning, monitoring and control, communicating, coordinating, evaluating, motivating etc.

There are many types of budgets that businesses may use. For example, they may use fixed budgets, flexible budgets, rolling budgets, incremental budgets, zero-based budgets, imposed budgets, participative budgets, functional budgets and master budgets.

Top-Down Budgeting – What is it? And How Does It Work?

Budgets play an important role in financial planning and control measures. Budgets often represent quantitative measures of performance appraisals known as “targets”.

Deviation from these targets is measured through variance analysis. An organization can take many approaches consistent with its corporate governance set up in the budgeting process.

In large organizations with a more authoritative approach, budgeting is often planned at top-level management. Top-down budgeting is a process defined as:

“Budgeting plan defined by top-level management and communicated towards the middle and lower management for implementation”

As the name suggests, the top-level management decides on the performance metrics and budget targets. This type of budgeting approach suits larger organizations, where top-level management takes all the strategic decisions.

In this approach, top management evaluates the past performances using variance and deviation analysis, incorporates business objectives, and sets new targets. Operational and department managers are often ignored in this budget approach, which may sometimes lead to conflicts.

Operational and department managers receive set budgets often adjusted with historic financial data. Departments then make their detailed budgets for various activities such as material purchases, repairs, and maintenance, labor and energy, and so on.

The allocation of resources and department break-down of budgets is often inflation-adjusted. Also, special consideration is given to specific needs such as new machinery purchase, the launch of a new product, or staff hiring.

The Finance department reviews department budgets regularly, with adjustments made to ensure the total budget targets are achieved.

This approach offers great control to the top level management and makes performance measurement easier.

Some advantages of top-down budgeting include:

  • Budgeting is a complex and complicated job, top-down approach relieves operational and department managers from this cumbersome duty
  • Top-level management has access to the required information and resources to analyze and allocate budget in-line with business objectives
  • Operational managers are tasked with readily set performance targets
  • It offers an increased sense of control and performance measurement

However, the top-down budgeting approach often creates conflicts and has some limitations:

  • Operational and departmental managers find demotivation without participation in the budgeting process
  • The process may prolong and cause delays if the allocated budgets do not match with department needs
  • Top management uses historic data, budgets are set at the beginning of the period which may lead to outdated targets
  • It may cause conflict in the performance appraisal of lower staff

Performance and rewards are closely linked in any organization; however, managers should only be appraised for the controllable actions.

Flexibility and responsiveness can eliminate the friction between top-level and lower management in the top-down budgeting approach. One positive aspect of this approach though is it challenges the limitations of department managers and operational staff, which can motivate them to achieve tough targets.

In financial terms, budgets are set as targets, too rigid, and tough targets may lead to demotivation and too easy targets to complacency.

Top management is concerned with business objectives at ideal levels of performance that can be difficult to achieve for operational managers.

Performance measurement can take both financial and non-financial metrics. The budget-oriented approach concerns with a rigid approach to achieving targets within the set limits.

In contrast, the profit-oriented approach often disregards the budgetary targets and focuses on profit targets.

The non-financial performance measurement may take several parameters for performance appraisal such as customer turnover, staff turnover, customer complaints, etc.

In conclusion, the imposing style of top-down budgeting offers great control to the top management; however, it demands flexibility to achieve effective results.

Increased participation and feedback can enhance the overall performance of the organization. Motivation and rewards are closely linked with performance measurement, so a higher level of participation would result in higher performance.

On one hand, it saves operational managers the time and resources required for the budgeting process. It also challenges them to achieve targets within the set parameters. For top management, the approach provides great control and a performance appraisal tool.

Operating and Financial Budgets: How Does It Work?

The budgeting process for any company starts with a capital or master budget. The capital budget is a forecast for the company’s long-term financial achievements.

Top level management formulates the master or capital budget during the strategic planning process.

The capital budget is then passed on to the departments or divided into categories by functions e.g. manufacturing and marketing, etc. in general, the master budget can be divided into three categories:

  1. Financial budgets
  2. Operating budgets
  3. Special activity budgets

A Financial Budget is the estimation of all cash flows arising from capital activities. It includes all cash flows from operating activities, capital investments, and changes in equity.

Therefore, the financial budget is reflected through changes in the balance sheet, income statement, and statement of equity for the shareholders.

Financial budgets are long-term in nature, often connected with capital expenditures. Top-level management primarily makes the financial budgets, and then specific roles and tasks are assigned to departments to achieve the set goals.

For any business, there are three key financial decisions: Investment, Financing, and Dividend. All of these decisions require strategic planning.

For example, a business needs to invest in a positive NPV project, for that it will need initial financing. That financing can be sourced through cash balance, bank loan, or equity finance.

Either way, the decision will impact the cash flow for the business, financial budgeting includes all of these cash flows. Financial cash flows come from both operating and financing activities. So in a way, both operating and financial budgets are linked.

An Operating budget is an estimation of all cash flows arising from operating activities of the business. Operating activities make up for the largest portion of expenditure for any business and the most important factor in the unit cost calculation.

Operating expenses and revenues directly affect the cost of goods sold, sales, and hence profits. So operating budget forms a crucial part in performance appraisal for a business.

Operating budgets form the basis of financial budgets, and hence an integral part of the master budget. Operating budgets can be divided according to operating activities depending on the business nature:

  • Manufacturing expenses
  • Raw materials and required labor
  • Sales and marketing expenses
  • Production budgets
  • Sales volume budgets and so on…

Operating budgets are primarily concerned with business operations efficiency. As business sales or revenue increases and expenses are controlled efficiently, profitability increases.

Total sales budgets, sub-divided into sales volume and sales price analysis, manufacturing budgets, and purchases are all integral components of operating budgets.

Operating budgets should be made for the short-term and often require revision. Revised budgets should then be compared for any variances with the original budgets. At the end of the budgeting period, the actual results should be compared with revised budgets.

This operating and planning variance analysis can help achieve operating efficiencies and make operating budgets realistic.

Both operating and financial budgets directly affect the cash flows or the cash budgets of the business. Cash budgets can be categorized as operating and financial activities.

Operating cash flows include:

  • Sales of products and services
  • Procurement of raw material and labor
  • Purchase of manufacturing machinery and tools
  • Marketing and sales expenses
  • Sale or purchase of current assets

Financial cash flows include:

  • Financing facilities such as bank loans
  • Interest payments on existing loans
  • Sale or purchase of capital assets such as land or property
  • Income tax and dividend payments

Both operating and financial budgets provide valuable forecast and control measures to the management. However, both differ in the nature of time, expenses, and revenue streams.

Some of the advantages for both operating and financial budgets are:

Operating BudgetsFinancial Budgets
Estimate expenses and revenue from operating activitiesEstimate revenue and expenses from capital activities
Provides short-term analysisProvide long-term analysis
Concerned with operating efficiencies such as manufacturing, sales, and laborConcerned with capital and financial health of the business at large
Offers critical variance analysis in sales volume, sales price, etcOffers capital assets analysis on the balance sheet and income statement
Planning and operational variances help improve operating efficiencyProvides top management with in-depth analysis for all business activities such as Financing, investing, and dividend

The sequence of budget preparation often depends on the budget approach taken by management, e.g. in a bottom-up budget approach the operating budget will be prepared first.

However, both operating and financial budgets are closely linked, and a variance in one budget will cause a variance in the other.