Updated July 15, 2023
What is Budgetary Control?
The term “budgetary control” refers to the corporate mechanism of preparing budgets for the upcoming period, which is then compared with the actual performance to determine whether the company is in line with expectations.
Such comparison between budgeted figures and actual figures helps the company’s management to find out any unfavorable variances and take remedial measures as soon as possible.
The budgetary control process is set up to closely monitor whether the actual sales and expenses align with the financial plan. The process involves setting up goals at the organizational level and then percolating them to match each employee’s personal goals. The employees and departments are rewarded when the goals are achieved, but if the actual results seem to fall well below expectations, then correction measures are undertaken.
Characteristics of Budgetary Control
The characteristics are as follows:
- It ensures the participation of a maximum number of people during its preparation.
- It covers the entire organization.
- The expected performance benchmark against established standards.
- In some cases, budgetary control is flexible enough to incorporate changes due to unpredictable circumstances.
- It is monitored constantly.
Budgetary Control Process
The budgetary control process can be broadly broken down into 3 steps, as shown below:
- Preparation of budget: The preparation of the budget is the very first step in the process wherein the management decides on a set of financial targets based on the goals set forth by the organization.
- Comparison of budgeted performance with actual performance: This step starts once the company records the actual performance. The management compares the actual performance with the budgeted performance to determine how well the company’s performance aligns with the expected performance.
- Performance of corrective measures: This step comes into play only when there is a variance between actual and budgeted performance. The management then initiates root cause analysis for the deviation, and once it is unearthed, it takes corrective measures. In this way, the corrective actions may improve the underperforming operations’ performance.
Types of Budgetary Control
There are three main types that companies usually implement. They are as follows:
- Operation budgetary control: This monitors a company’s sales and operating expenses. Effectively, it closely scrutinizes the company’s day-to-day activities and ensures adherence to the financial plan. The companies usually conduct such checks monthly, enabling them to take timely corrective measures. Operation budgetary control can be instrumental in achieving the desired profitability level.
- Cash flow budgetary control: This type of budgetary control checks whether or not the actual cash flow is in adherence with the forecasted cash flow. Such control is important as it ensures that the company has an adequate level of cash available to meet repayment obligations. If there is excess cash vis-à-vis the budget, the company may invest the idle cash for other available business opportunities.
- CapEx budgetary control: This type of budgetary control looks into the capital expenditures of a company, such as the purchase or expansion of PP&E (plant, property, and equipment). It helps companies to plan and control capital expenditure which invariably involves huge investments.
Following are the examples are given below:
Let us take the example of a company to illustrate how budgetary control works. Let us assume that the company had decided on the budget for January 2020 at the start of the month. Now the management is reviewing the actual performance vis-à-vis the budgeted performance the following month. The comparison of the actual figures with the budgeted figures is shown in the table below.
|Cost of goods sold (COGS)||$12,000,000||$12,500,000||-4.2%|
|Selling, general & administration (SG&A)||$10,000,000||$9,000,000||10.0%|
The table shows that the sales have remained 2.0% below the expected performance while the COGS was 4.2% higher than budget, resulting in a lower than expected gross margin. However, SG&A has been 10.0% better than budget, offsetting the impact of higher COGS on the EBITDA margin. In this case, the company would like to investigate the reason for lower sales and higher COGS to take corrective actions in the following months. This is how budgetary control works.
Scope of Budgetary Control
The scope broadly covers the following:
- To define the business objectives precisely and establish the performance targets.
- To delineate the responsibilities of each department as well as each person.
- To create a standard benchmark for measuring performance.
- To identify the reasons for variation, if any, and take necessary corrective actions.
- To ensure optimal utilization of available resources to improve productivity and profitability.
- Monitor and revise the budgetary plans if there is any such requirement due to changing environment.
- To articulate long-term policies with maximum accuracy.
Importance of Budgetary Control
The importance is reflected in the fact that it helps the management to track the company’s performance efficiently. Such monitoring ensures that the deviation of the company’s actual performance from the budgeted one is always under the scanner and can be rectified before it is too late. In this way, the unfavorable impact of the deviations on corporate profit is mitigated to a large extent.
Some of the major advantages are as follows:
- It facilitates centralized control of various decentralized activities.
- This encourages more coordination among the different departments.
- It helps eliminate wasteful expenses to improve profitability.
Some of the major disadvantages are as follows:
- It is very difficult to accurately prepare the budgets for the future, especially during times of high uncertainties.
- Small firms can’t afford budgetary control as it involves heavy additional expenditure.
So, it can be seen that budgetary control is an important management tool used to monitor day-to-day activities and long-term prospects. If utilized properly, it can help control costs while ensuring improved efficiency.
This is a guide to Budgetary Control. Here we also discuss the introduction, characteristics of budgetary control, and advantages and disadvantages. You may also have a look at the following articles to learn more –