Budgeting and Budgetary Control

1. Introduction

Budgeting is the process of creating detailed financial plans for the future, usually for a one-year period. It helps
an organization plan, allocate resources, and set performance benchmarks.

Budgetary control involves the continuous comparison of actual performance with budgeted figures to monitor
progress and make necessary adjustments.

2. Objectives of Budgeting

• Planning: Facilitates forward-looking management decisions.

• Coordination: Ensures all departments are aligned with company goals.

• Resource Allocation: Helps allocate limited resources effectively.

• Performance Evaluation: Provides standards for measuring results.

• Motivation: Sets clear targets for managers and employees.

• Decision-Making: Offers data-driven insights for strategic choices.

3. Types of Budgets

• Operating Budget: Income and expenditure from day-to-day operations.

• Cash Budget: Cash inflows and outflows to manage liquidity.

• Capital Budget: Investments in long-term assets like buildings and equipment.

• Flexible Budget: Adjusts based on different levels of activity.

• Zero-Based Budget: Every item must be justified from zero.

• Master Budget: The consolidated summary of all functional budgets.

4. The Budgeting Process

1. Communicate budgeting guidelines to all departments.

2. Identify the key budget factor (the limiting factor such as sales or capacity).
3. Establish the Budget Committee to oversee coordination.
4. Prepare functional budgets (e.g. sales, production, procurement).
5. Review and harmonize functional budgets for consistency.
6. Prepare the Master Budget (income statement, cash flow, balance sheet).
7. Approve and implement the budget.
8. Monitor performance and review periodically.

5. Key Budget (Limiting) Factors

This is the constraint that restricts an organization’s activities. Examples include:
• Sales demand
• Machine or production capacity
 • Material or labor shortages
• Financial resources
This factor determines how other budgets will be prepared.

6. Budget Committee

This is a group of senior staff tasked with:

• Preparing and approving budget policies

• Coordinating functional budgets

• Resolving budget conflicts

• Approving final budgets

• Reviewing budget performance reports

The committee often includes the CEO, CFO, department heads, and budget officers.

7. Budget Manual

A budget manual is a document that outlines the procedures, responsibilities, and formats for budget preparation.
It usually includes:
• Budget preparation timetable
• Responsibilities of personnel involved
• Data collection formats and templates
• Procedures for reviewing and revising budgets
• Approval authorities

8. Budgetary Control
This refers to the continuous process of comparing actual results with the budget to identify variances and take
corrective action.
Key aspects include:
• Variance Analysis: Difference between actual and budgeted figures.
• Responsibility Accounting: Accountability for budgets by managers.
• Reporting System: Regular reports on financial performance.
• Feedback Mechanism: Helps revise actions to meet budget objectives.

9. Advantages of Budgeting
• Promotes efficient planning and control.
• Enhances coordination across departments.
• Facilitates monitoring and performance measurement.
• Encourages cost-consciousness and resource management.
• Serves as a motivation tool through goal setting.

10. Limitations of Budgeting

• Can be rigid and discourage flexibility.
• Time-consuming and resource-intensive.
• May result in conflicts between departments.
 • Unrealistic targets can demotivate staff.
• Encourages short-term focus if not managed well.

11. Behavioural Aspects of Budgeting

• Participation: Involving staff in the budgeting process improves commitment.
• Goal Congruence: Aligning individual and organizational goals is crucial.
• Budget Slack: Managers may inflate costs or deflate revenues to make targets easier.
• Motivation: Clear, achievable budgets can inspire performance, but unattainable ones can frustrate staff.

12. Conclusion
Budgeting and budgetary control are foundational to financial planning and control in any organization. When
executed properly, they guide strategy, improve efficiency, and provide a reliable framework for managing
performance.

SOLUTION 3

The key stages in the planning process that links long term objectives and budgetary control can be divided between
long term planning and the budgeting process. Long term planning involves identifying objectives, and identifying,
evaluating and selecting alternative courses of action The budgeting process involves implementing the long term
plan in the annual budget, monitoring actual results and responding to divergences from
plan This can be stated thus
Stage one: Identifying objectives
The planning process cannot take place unless organizational objectives are identified, since these determine what
the organization is seeking to accomplish through its operations and activities These objectives will be lang term or
strategic in nature and will give direction to the organization’s operational activities

Stage two: Identifying alternative courses of action

Once organizational objectives have been identified, alternative courses of action that may lead to achieving those
objectives can be identified Strategic analysis of the organization and its environment can indicate potential courses
of action. For example, a company may look a its existing products and markets, its potential markets, the threat
posed by its competitors, the impact of changes in technology on its products and production processes, and so on,
and decide that a key objective is the development of new products to replace existing products in existing markets
that are reaching the end of their product life cycle.

Stage three: Evaluating alternative courses of action

At this stage the various alternative courses of action are considered from the point of view of suitability, feasibility
and acceptability. In order for this to be done, detailed information about each alternative course of action needs
to be gathered and analyzed.

Stage Four: Selecting alternative courses of action

Once the most appropriate alternative courses of action have been selected, long-term plans to implement them
are formulated. Because these plans are long term in nature, they will of necessity be less detailed than short term
plans, and will need to allow a degree of flexibility is responding to the changing organizational environment.
Stage Five: Preparing and implementing of long-term budget
Preparing and implementing the budget: A budget is a short-term plan formulated in financial terms and will show
in detail the short-term actions the organization will take in working towards its long-term objectives. Once the
budget has been formulated, finalized and agreed it can be implemented

Stage Six: Monitoring actual results

In order to achieve the long term objectives that are reflected in the budget, the organisation must ensure that
actual performance is proceeding according to plan it will therefore need to monitor actual performance and results

Stage Seven: Responding to divergences from plan

Divergences from planned activity, as measured by variances from budget, can lead to action if they are deemed to
be significant. This action may be corrective in nature, in order to bring actual activity back into line with planned
activity, or may entail revision of the budget if one of its underlying assumptions is seen as being in error

A fixed budget is one prepared in advance of the relevant budget period which is mot changed or amended as the
budget period progresses. This budget represents a periodic approach to budgeting, since a new budget is prepared
towards the end of the budget period for the subsequent budget period. In this way, an organisation may set a new
budget on an annual basis.

A rolling budget, sometimes called a continuous budget, represents an Alternative approach to periodic budgeting.
Here, a portion of the budget period is replaced on a regular basis so that the overall budget period remains
unchanged. For example, with a budget period of one year, at the end of each quarter a new quarter could be added
to the end of the budget period and the elapsed quarter could be deleted, so that the budget was always looking
one year ahead. Continuous budgeting continues to increase in popularity.

A zero-based budget is a periodic budget which seeks to dispose of the incremental approach to budgeting. In the
incremental approach, an increment is added to the relevant figure from last year's budget, for example to take
account of inflation. In this way. inefficiency can become embedded in the annual budget and profitability may suffer
as a result. With the zero-based approach, each element of planned activity is required to be justified in terms of its
contribution towards achieving organizational objectives. This involves the formulation of decision packages, which
describe particular activities in such a way that managers can compare them in terms of their competing claims on
organizational resources, and then rank them from a cost-benefit point of view. In this way, zero-based budgeting
looks at each budget period with a new perspective.
A zero-based budgeting approach tends to be most beneficial when used with services and with discretionary
activities, and so is most widely used in the public sector.

A fixed budget is likely to be useful in circumstances where the organizational environment is relatively stable and
can be predicted with a reasonable degree of certainty.

A rolling budget is likely to be useful in circumstances where the future is less certain and more flexibility is needed
in the organizational response to its changing environment For this reason, rolling budgets are popular with new
organizations. A cash budget is often a rolling budget because of the need to keep tight control over this aspect of
financial management. A rolling budget is also supported by the availability of cheap and powerful information
processing via personal computers and computer networks.
Linear regression is a powerful way of analyzing past information in order to derive linear relationships and so is
ideally suited to deriving cost equations from past accounts. Sales volume, however, is unlikely to follow a linear
relationship alone. Linear regression could be used to determine the overall trend being followed by sales volume
on, for example, an annual basis, but inspection of historic sales volumes is likely to show variations about the trend.
These could be due to seasonal variations, or longer-term cyclical variations. Time-series analysis can extract these
seasonal and cyclical variations and therefore produce forecasts of sales volumes that are likely to be more accurate
in a given period than forecasts based on the underlying trend alone. In forecasting future sales volumes, therefore,
both quantitative methods have their place in increasing forecasting accuracy.