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 find out whether or not the company is in line with the expectations. Such comparison between budgeted figures and actual figures helps the management of the company to find out any unfavorable variances and take remedial measures at the earliest possible.
The process of budgetary control is set up with the objective to closely monitor whether or not the actual sales and expenses are in line with the financial plan. The process involves setting up goals at the organizational level and then percolate it to match the personal goals of each employees. 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 of budgetary control are as follows:
- It ensures the participation of a maximum number of people during its preparation.
- It covers the entire organization.
- The expected performance are benchmarked against established standards.
- In some cases, the budgetary control are 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 a set of financial targets are decided by the management based on the goals set forth by the organization.
- Comparison of budgeted performance with actual performance: This step is started once the company starts to record the actual performances. The management compares the actual performance with the budgeted performance in order to find out how well the company’s performance is aligned with the expected performance.
- Performance of corrective measures: This step comes into play only when there is a variance between actual performance and budgeted performance. The management then initiates root cause analysis for the deviation and once it is unearthed it then takes corrective measures. In this way, the corrective actions may potentially improve the performance of the underperforming operations.
Types of Budgetary Control
There are three main types of budgetary controls that companies usually implement. They are as follows:
- Operation budgetary control: This type of budgetary control is used to monitor the sales and operating expenses of a company. Effectively, it closely scrutinizes the day-to-day activities of the company and ensures adherence to the financial plan. The companies usually conduct such checks on a monthly basis that enables them to take timely corrective measures. Operation budgetary control can be instrumental in the achievement of the desired level of profitability.
- 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 availability to meet repayment obligations. In case there is excess cash vis-à-vis the budget, then 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 ofPP&E (plant, property, and equipment). It helps companies to plan and control capital expenditure which invariably involves huge investment.
Examples of Budgetary Control
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 in 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%|
From the table, it can be seen that the sales has 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 resulting in offsetting the impact of higher COGS on EBITDA margin. Now, 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 how budgetary control works.
Scope of Budgetary Control
The scope of a budgetary control 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 personnel.
- 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 as well as profitability.
- To monitor and revise the budgetary plans in case there is any such requirement due to changing environment.
- To articulate long-term policies with maximum accuracy.
Importance of Budgetary Control
The importance of budgetary control is reflected from the fact that it helps the management to efficiently track the company’s performance. 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 the corporate profit is mitigated to a large extent.
Some of the major advantages of budgetary control are as follows:
- It facilitates a centralized control on various decentralized activities.
- It encourages more co-ordination among the different departments.
- It helps in eliminating wasteful expenses to improve profitability.
Some of the major disadvantages of budgetary control 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 that is used to monitor day-to-day activities as well as long-term prospects. If it is utilized properly, then it can help in controlling cost while ensuring improved efficiency.
This is a guide to Budgetary Control. Here we also discuss the introduction and characteristics of budgetary control along with advantages and disadvantages. You may also have a look at the following articles to learn more –