Techniques of Cost Control and Cost Reduction: Budgeting as a tool of Planning and Control | Commerce & Accountancy Optional Notes for UPSC PDF Download

Budgetary Control

Budgetary Control is a method of managing costs through preparation of budgets. Budgeting is thus only a part of the budgetary control.

Main Features of Budgetary Control 

The main features of budgetary control are:

1.  Establishment of budgets for each purpose of the business. 
2. Revision of budget in view of changes in conditions. 
3. Comparison of actual performances with the budget on a continuous basis. 
4. Taking suitable remedial action, wherever necessary.
5. Analysis of variations of actual performance from that of the budgeted performance to know the reasons thereof.

The budgeting process involves planning for future profitability because earning a reasonable return on resources used is a primary company objective. A company must devise some method to deal with the uncertainty of the future. A company that does no planning whatsoever chooses to deal with the future by default and can react to events only as they occur. Most businesses, however, devise a blueprint for the actions they will take given the foreseeable events that may occur. 

A budget:

1.  shows management's operating plans for the coming periods; 
2. formalizes management's plans in quantitative terms; 
3. forces all levels of management to think ahead, anticipate results, and take action to remedy possible poor results; and 
4. may motivate individuals to strive to achieve stated goals. 

Companies can use budget-to-actual comparisons to evaluate individual performance. For instance, the standard variable cost of producing a personal computer at IBM is a budget figure. This figure can be compared with the actual cost of producing personal computers to help evaluate the performance of the personal computer production managers and employees who produce personal computers.

Many other benefits result from the preparation and use of budgets. For example:

1.  businesses can better coordinate their activities;
2. managers become aware of other managers' plans; 
3. employees become more cost conscious and try to conserve resources;
4. the company reviews its organization plan and changes it when necessary; and 
5. managers foster a vision that otherwise might not be developed.

 The planning process that results in a formal budget provides an opportunity for various levels of management to think through and commit future plans to writing. In addition, a properly prepared budget allows management.

to follow the management-by-exception principle by devoting attention to results that deviate significantly from planned levels. For all these reasons, a budget must clearly reflect the expected results. Failing to budget because of the uncertainty of the future is a poor excuse for not budgeting. In fact, the less stable the conditions, the more necessary and desirable is budgeting, although the process becomes more difficult. Obviously, stable operating conditions permit greater reliance on past experience as a basis for budgeting. Remember, however, that budgets involve more than a company's past results. Budgets also consider a company's future plans and express expected activities. As a result, budgeted performance is more useful than past performance as a basis for judging actual results. 

A budget should describe management's assumptions relating to: 

1. the state of the economy over the planning horizon;
2. plans for adding, deleting, or changing product lines; 
3. the nature of the industry's competition; and 
4. the effects of existing or possible government regulations.

 If these assumptions change during the budget period, management should analyze the effects of the changes and include this in an evaluation of performance based on actual results. Budgets are quantitative plans for the future. However, they are based mainly on past experience adjusted for future expectations. Thus, accounting data related to the past play an important part in budget preparation. The accounting system and the budget are closely related. The details of the budget must agree with the company's ledger accounts. In turn, the accounts must be designed to provide the appropriate information for preparing the budget, financial statements, and interim financial reports to facilitate operational control. Management should frequently compare accounting data with budgeted projections during the budget period and investigate any differences. Budgeting, however, is not a substitute for good management. Instead, the budget is an important tool of managerial control. Managers make decisions in budget preparation that serve as a plan of action. The period covered by a budget varies according to the nature of the specific activity involved. Cash budgets may cover a week or a month; sales and production budgets may cover a month, a quarter, or a year; and the general operating budget may cover a quarter or a year. 

Budgeting involves the coordination of financial and nonfinancial planning to satisfy organizational goals and objectives. No foolproof method exists for preparing an effective budget. However, budget makers should carefully consider the conditions that follow: 

Top management support All management levels must be aware of the budget's importance to the company and must know that the budget has top management's support. Top management, then, must clearly state long range goals and broad objectives. These goals and objectives must be communicated throughout the organization. Long-range goals include the expected quality of products or services, growth rates in sales and earnings, and percentage-of-market targets. Overemphasis on the mechanics of the budgeting process should be avoided. Participation in goal setting Management uses budgets to show how it intends to acquire and use resources to achieve the company's long-range goals. Employees are more likely to strive toward organizational goals if they participate in setting them and in preparing budgets. Often, employees have significant information that could help in preparing a meaningful budget. Also, employees may be motivated to perform their own functions within budget constraints if they are committed to achieving organizational goals.

Communicating results People should be promptly and clearly informed of their progress. Effective communication implies (1) timeliness, (2) reasonable accuracy, and (3) improved understanding. Managers should effectively communicate results so employees can make any necessary adjustments in their performance. 

Flexibility If significant basic assumptions underlying the budget change during the year, the planned operating budget should be restated. For control purposes, after the actual level of operations is known, the actual revenues and expenses can be compared to expected performance at that level of operations.

 Follow-up Budget follow-up and data feedback are part of the control aspect of budgetary control. Since the budgets are dealing with projections and estimates for future operating results and financial positions, managers must continuously check their budgets and correct them if necessary. Often management uses performance reports as a follow-up tool to compare actual results with budgeted results.