Budgetary control, one of the most commonly used methods of managerial control, is the process of setting targets for an organization’s expenditures, results and comparing them to the budget, and making changes as required. As a control device, budgets are reports that list planned and actual expenditures for cash, assets, raw materials, salaries and other resources. In addition, budget reports usually list the variance between the budgeted and actual amounts for each item.
A budget is created for every division or department within an organization, no matter how small, so long as it performs a distinct project, or function. The fundamental unit of analysis for a budget control system is called a responsibility centre. A responsibility centre is defined as any organizational department or unit under the supervision of a single person who is responsible for its activity. A three person sales office is a responsibility centre as is a quality control department, a marketing department and an entire refrigerator manufacturing plant. The manager of each unit has budget responsibility. Top managers use budgets for the company as a whole, and middle managers traditionally focus on the budget performance of their department or division. Budgets that managers typically use include expense budgets, revenue budgets, cash budgets and capital budgets.
An expense budget includes anticipated and actual expenses for each responsibility centre and for the total organization. An expense budget may show all types of expenses or may focus on a particular category, such as materials or research and development expenses. When actual expenses exceed budgeted amounts the difference signals the need for managers to identify whether a problem exists and take corrective action if needed. The difference may arise from inefficiency or expenses may be higher because the organization’s sales are growing faster than anticipated. Conversely, expenses below budget may signal exceptional efficiency or failure to meet some other standards such as desired level of sales or quality of service. Either way, expense budgets can help identify the need for further investigation but do not substitute for it.
A revenue budget list forecasts actual revenues of the organization. In general, revenues below the budgeted amount signal a need to investigate the problem to see whether the organization can improve revenues. In contrast, revenues above budget would require determining whether the organization can obtain the necessary resources to meet the higher than expected demand for its products. Managers then formulate action plans to correct the budget variance.
Cash Budget: The cash budget estimates, receipts and expenditure of money on a daily or weekly basis is done to ensure that an organization has sufficient cash to meet its obligations. The cash budget shows the level of funds flowing through the organization and the nature of cash disbursements. If the cash budget shows that the firm has more cash than necessary to meet short term needs, the company can arrange to invest the excess to earn interest income.
The capital budget list plans investments in major assets such as buildings, heavy machinery, or complex information technology systems, often involving expenditures over more than year. Capital expenditures not only have a large impact on future expenses, they are investments designed to enhance profits. Therefore, a capital budget is necessary to plan the impact of these expenditures on cash flow and profitability. Controlling involves not only monitoring the amount of capital expenditures but evaluating whether the assumptions made about the return on the investments hold true. Managers should evaluate whether continuing investment in particular projects is advisable, as well as whether their procedures for making capital expenditure decisions are adequate. Some companies evaluate capital projects at several stages to determine whether they still are in line with the company’s strategy.
Top down budgeting:
A budgeting process in which middle and lower level managers set departmental budget targets in accordance with overall company revenues and expenditures specified by the top management.
Bottom up Budgeting:
A budgeting process in which lower level managers budget their departments’ resource needs and pass them up to the top management for approval.
Budgeting is an important part of organizational planning and control. Many traditional companies use top down budgeting, which means that the budgeted amounts for the coming year are literally imposed on middle and lower level managers. These managers set departmental budget targets in accordance with overall company revenues and expenditure specified by top executives. Although there are some advantages to the top down process, the movement toward employee empowerment, participation and learning means that many organizations are adopting bottom up budgeting, a process in which lower level managers anticipate their department’s resources, needs and pass them up to the top management for approval.