Budgetary Control Meaning Advantages Disadvantages

Budgetary Control Meaning

It is a process of planning and controlling all the functions of an organization through comparison and analysis of budgeted numbers to actual results. Comparing the budgeted numbers with actual results identifies the areas that need improvement and where cost reduction is feasible or budgeted numbers need to be revised.

Budgetary Control Types

There are various types of control an organization can implement –

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#1 – Operational Control

It covers the revenue and operating expensesOperating ExpensesOperating expense (OPEX) is the cost incurred in the normal course of business and does not include expenses directly related to product manufacturing or service delivery. Therefore, they are readily available in the income statement and help to determine the net profit.read more, which are essential to running a day-to-day business. The actual numbers to a budget are compared monthly in most cases. It helps achieve control over EBITDAEBITDAEBITDA refers to earnings of the business before deducting interest expense, tax expense, depreciation and amortization expenses, and is used to see the actual business earnings and performance-based only from the core operations of the business, as well as to compare the business’s performance with that of its competitors.read more – Earnings before interest, taxes, depreciation, and amortization.

#2 – Cash Flow Control

This is an important budget that controls the working capital requirement and cash managementCash ManagementCash Management refers to the appropriate collection, handling, & disbursement of cash for ensuring financial stability & avoiding insolvency risk. read more. Therefore, cash crunches could be detrimental to everyday functioning, which is an important aspect.

#3 – Capex Control

It covers capital expendituresCapital ExpendituresCapex or Capital Expenditure is the expense of the company’s total purchases of assets during a given period determined by adding the net increase in factory, property, equipment, and depreciation expense during a fiscal year.read more, like buying machinery or constructing a building. Because it involves a huge amount of money, the control here helps eliminate waste and reduce costs.

How is the Budget Prepared?

In this case, the actual sales for July have exceeded the budget by $150. This could be because more quantities were sold or the sales price per unit has increased slightly. If the sales price per unit remained constant in July, it means that the sales team has performed better than average, which is why sales have increased.

For example – if we want to prepare the budget for July 2019 based on Q2 results, it will look like this – Here, July Budget Formula = (April + May + June)/3, i.e., the average of April, May, and June. Based on April, May, and June actual results in the above table, we expect the sales to be $6,250 and the net profit to be $383 for July. Now let’s assume that we got actual results for July and compare them with the July Budget to get the difference –

For example – if we want to prepare the budget for July 2019 based on Q2 results, it will look like this –

Now let’s assume that we got actual results for July and compare them with the July Budget to get the difference –

Further analysis will show which region and which product the sale has increased. In the same way, the operating cost has gone up by $33, which could be due to an increased cost of any input material or incidental to extra sales.

Advantages and Disadvantages of Budgetary Control

Advantages

An effective tool for performance measurement of departments, individuals, and cost centersCost CentersCost center refers to the company’s departments that don’t contribute directly to the corporate revenue; however, the firm has to incur expenses for keeping such units operative. It comprises research and development, accounting and human resource departments.read more;Identification of areas for reduction and efficiency improvement;Increased efficiency and cost reduction result in profit maximization;It also helps in introducing incentive schemes based on performance.Cost reduction is always the primary target.Improves coordination between departments as the results and costs are interrelated.It provides insight for in-depth analysis and any corrective action.Helpful in achieving an organization’s long-term goal.

Disadvantages

Budgeted numbers often need revision as future prediction is difficult.Time-consuming and costly process, need people and resources Budgetary control processes.This process sometimes requires coordination between various departments and is a difficult task.This process requires approval and support from top senior management.Always comparing the actuals with a budget is detrimental to employees’ motivation.

Limitations

The future is unpredictable, so a budget always does not guarantee a smooth future for an organization.Mostly usage of past recorded numbersIgnores demographics and many other economic factorsEconomic FactorsEconomic factors are external, environmental factors that influence business performance, such as interest rates, inflation, unemployment, and economic growth, among others.read moreGovernment policies and tax reformsTax ReformsTax reform refers to the changes and amendments made in the nation’s tax structure or system to fix the loopholes and make it more efficient. It even ensures that there are fewer chances of tax evasion and avoidance by the taxpayers.read more are not always predictableNatural events like rain, monsoon, drought and other uncontrollable factors affect an organization’s actual performance, which cannot be considered for the budget.

Important Points to Note

Any foreseeable revenue or expenses not included previously should be included in the budget.The control functions should not be extreme to put personnel under pressure. If it is, a change is needed.The standards need revision periodically.Any change must be informed to all the stakeholders immediately or in advance.The change in production, sales, or any function within the organization will impact the control functions.
The basis of cost allocationBasis Of Cost AllocationCost Allocation is the procedure of recognizing & assigning costs to different cost objects like a product, department, program, customer, etc., as per the cost driver serving as the base for this process. read more becomes important at micro-level analysis, so if there is a change in the basis of cost allocation, it should be analyzed fully before putting it in place.

Conclusion

Budgetary control is an important aspect of an organization’s day-to-day activities and long-term prospects. When placed carefully, it helps in controlling cost and helps in efficiency improvement. There are other things like standard costing, which is also a part of it.

We can calculate the cost, efficiency, yield or mix variances, etc. So, it identifies the exact reason behind any variance when we compare the one-period activity to another. Because in today’s cut-throat competition, the organizations are always striving for excellence and best practices, and budgetary control helps identify and attain those policies and practices.

It identifies if there is any issue or chance of improvement with input material procurement, the desired output from the material, any processing issue, or sales team administration. So, to understand the business functions completely and root causes analysisRoot Causes AnalysisRoot cause analysis is a problem-solving technique in which the source of a problem is identified, thereby finding the best possible solutions to it. It is a permanent fix to an issue since it establishes a cause-effect relationship for every adverse situation.read more of various outcomes, budgetary control is one important tool in the hands of parties associated with the organization.