Thursday, April 23, 2009

How to Control and Administer Budgets

Budgetary control can be defined as the establishment of departmental budgets relating the responsibilities of executives to the requirements of a policy, and the continuous comparison of actual with budgeted results, either to secure by individual action the objectives of that policy or to provide a firm basis for its revision.

It is one of the basic techniques used by management in the planning and controlling of the business resources. Budgetary control is the planning in advance of the various functions of a business so that the business as a whole can be controlled.

1. Plan and control income and expenditure in order to achieve maximum profitability.
2. Ensure that sufficient working capital is available for the efficient operation of the company.
3. Direct capital expenditure in the most profitable direction.
4. Centralize control.
5. Decentralize responsibility.
6. Provide a yardstick against which actual results may be compared.
7. Show management when action is needed to remedy a situation.
8. Aid management in decision making when unforeseen conditions affect the budgets.
9. Coordinate all the activities of a business.
10. Control the ideas of all levels of management during budget preparation.

In order for a budgetary control to be properly an effective tool of cost control, there should be a proper organization structure. As a business size becomes increasingly complex, greater decentralization and the demand for higher productivity and vigilant cost control would be emphasized by the top management.

1. The organization of the business should be more closely defined, and with it the responsibilities of individual managers.
2. Managers are given greater awareness of the business objectives and become more closely involved with the need for profit achievement.
3. There is better coordination of the various functions of the business.
4. Management skills are progressively improved. Budgetary control should lead to a better understanding of the company’s budgets, the accounting system and the responsibilities of each manager. With the latter involved in the preparation of budgets, there should be a ready acceptance of the budgeted figures which should lead to better control. At the same time, the budgetary control system acts as a kind of monitor so that all managers are accountable for their particular areas and should stimulate greater effort.
5. Variance analysis identifies areas of weakness in the business operation.

Without proper organization structure, the following problems are likely to arise in the application of budgetary control:

1. There would be no clear cut decision as to who will be responsible for costs which are controllable.
2. Cost centres would not be easily identified.
3. The appropriate person to report variances may be wrongly determined.
4. The task of delegating authority and responsibility for costs to be incurred may not justify the benefits on the long run.
5. Those who are to participate in the budgeting procedures might be wrongly chosen.

Pressures from employees to underestimate budgeted revenues can occur when a company uses the difference between actual and budget amounts to evaluate marketing managers. These managers may respond by giving highly conservative forecasts.

Padding the budget or introducing budgetary slack refers to the practice of underestimating budgeted revenues or overestimating budgeted costs in order to make budgeted targets more easily achievable. Introducing budgetary slack makes it more likely that actual revenues will exceed budgeted amounts. From the marketing managers standpoint, budgetary slack hedges against unexpected adverse circumstances.

A Fixed Budget is defined as “A budget which is designed to remain unchanged irrespective of the volume of output or turnover attained”. In order words, it is single budget with no analysis of cost. On the other hand, a flexible budget is a budget which is designed to adjust the permitted cost levels to suit the level of activity attained. A flexible budget is essential for the control aspect of budgeting but as it is an important part of the planning process to consider what control procedures will be necessary, it is usual to carry out the required cost analyses and breakdowns at the planning stage so that the budget may be flexed in due course if this is necessary.


This can be categorized into two parts – Budgetary Planning and Budgetary Control.

1. Budgetary Planning:
a)Setting up the budget committee
b)Deriving key forecasts
c)Preparing “quantity” budgets with appropriate managers
d)Checking feasibility and adherence to policies of quantity
e)Amending if necessary
f)Producing financial budgets
g)Producing master budgets
h)Submitting budgets to chief executive for approval/amendment

2. Budgetary Control:
a)Publishing agreed budgets for ensuing period
b)Recording of actual results
c)Comparing actual/budget and identifying variances
d)Reporting to budget holders or senior management
e)Investigating variances
f)Developing solutions to problems revealed by budgetary control

1. Ascertain the enterprise objectives.
2. Prepare forecasts.
3. Determine enterprise policies, for example, product range, normal hours of work per week, channels of distribution, stock-holdings, investments, etc.
4. Identify principal budget factors.
5. Basing all calculations on the principal budget factors, calculate the requirements in terms of quantities needed to comply with the forecast and policies to meet the enterprise objectives (e.g. man, machine, materials, etc) and convert them to money values. This results in the initial budget.
6. Review the budget policies and initial budget. Amend the policies or budgeted requirements or both until an acceptable budget emerges.
7. Formally accept the budget upon which it becomes the master budget.

In conclusion, it is obvious that budgets help managers, but budgets need help. Top management therefore has the ultimate responsibility for the budgets of the organization they manage. Management at all levels however should understand and support the budget and all aspects of the management control system. Top management support is especially critical for obtaining active line participation in the formulation of budgets and for successful administration of the budget. If line managers feel that top management does not `believe’ in the budget , the managers are unlikely to be active participants in the budget process. Similarly, a top management that always mechanically institutes `across the board’ cost reduction in the face of revenue reductions is unlikely to have line managers willing to be `fully honest’ in the budget communications.

Budgets should not be administered rigidly. Changing conditions call for changes in plans. A manager may commit to the budget, but a situation might develop where some special repairs or a special advertising program would better serve the interest of the organization. The manager should not defer the repairs or the advertising in order to meet the budget if such actions will hurt the organization in the long run. Attaining the budget should not be an end in itself.

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