Budgeting and Budgetary Control

A shop owner who plans nothing finds out at year-end whether she made money. One who plans can find out in March that sales are behind plan, and act in April. The plan is the budget, and the checking is control.

Preparing a budget. Define the goals. Estimate income from fixed and variable sources. Classify expenses as fixed, variable and irregular. Draft the budget and allocate resources. Plan for contingencies, debt repayment and savings. Then review actual results, revise the budget when needed and keep up continuous reporting.

The control system, in order. Set objectives and the key budget factor, prepare the budgets for each department, compare actual performance with the budgets, analyse the variances, and take corrective action.

Don’t confuse budgeting with budgetary control. A budget is the plan. Budgetary control is the continuing process of checking it and acting. A budget with no control is only a forecast, and the saying goes: a budget is a plan, but control makes it work.

Where it breaks. A budget can be padded by managers who expect to be cut. It can encourage ‘spend it or lose it’. A rigid budget makes a firm slow to react when conditions change. Targets that people had no say in are often resented.

For exams. Give the two definitions, the functions, and the order of the steps in the control system. Remember the key budget factor: the one limit, often sales, that comes first.

Plan, act, compare, correct.

The sales team plans to sell 12,000 fans. How many must the factory make, how much material must be bought, and will there be cash to pay for it? One department’s plan sets every other department’s task.

The production budget, worked. Tirunelveli Fans plans to sell 12,000 fans at ₹80, a sales budget of ₹9,60,000. It holds 1,500 fans at the start of the year and wants 2,000 at the end.

The purchase budget. Each fan needs 2 kg of material, so 12,500 fans need 25,000 kg. With 3,000 kg in stock and 4,000 kg wanted at the end, the firm must buy 25,000 + 4,000 − 3,000 = 26,000 kg.

The cash budget. There are three methods: the receipts and payments method, the adjusted profit and loss method and the balance sheet method. By the first, the firm starts with ₹50,000, expects receipts of ₹3,00,000 and payments of ₹3,20,000, and so ends with ₹30,000. If it wants a minimum of ₹40,000, the budget warns of a ₹10,000 gap, and the firm can arrange an overdraft in advance.

Don’t add the closing stock the wrong way round. Production is not sales. To end with more stock than you started with, you must make more than you sell. The formula adds the closing stock and subtracts the opening stock, and the same rule holds for materials.

Where it breaks. Everything flows from the sales budget. If sales are over-estimated, production, purchases and cash are wrong in turn, and unsold stock builds up. The master budget is only as good as its weakest forecast.

For exams. Remember the production budget formula, the three cash budget methods, and that the master budget consolidates the others.

Sales first, then production, then purchases; cash tells whether it can be paid.

One manager says a plant’s costs were ₹50,000 under budget. Another says they were ₹10,000 over. Both are right, and the difference is whether the budget was adjusted for how much was actually made.

Fixed against flexible. A plant budgets for 10,000 units at ₹30 a unit of variable cost, plus ₹1,20,000 of fixed cost, so ₹4,20,000. It makes only 8,000 units, and spends ₹3,70,000.

The fixed budget praises a plant that made 20% fewer units. The flexible budget shows it spent ₹10,000 more than it should have for the work done.

Zero-based budgeting (ZBB). Divide the organisation into decision units. Write a decision package for each, setting out its cost and benefit. Rank the packages by importance and return. Approve and fund them in rank order until the money runs out.

Don’t think zero-based means starting with no money. Zero-based means starting without assuming last year’s costs are justified. Every activity must show its case again. A useful activity usually survives, but its cost is questioned.

Where it breaks. ZBB takes a great deal of time and paperwork if done every year, and managers can overstate the benefits. Many firms use it every few years, or only for overheads. A flexible budget needs a reliable split of cost into fixed and variable.

For exams. Define each type, give two features of each and the four ZBB steps (identify decision units, develop decision packages, rank them, approve and fund).

Fixed is rigid; flexible follows the work; zero-based starts again.