“Budgetary control is part of overall organisation control and is concerned primarily with the control of performance. The use of budgetary control in performance management has of late taken on greater importance especially as a more integrative control mechanism for the organisation”. Critically evaluate this claim, supporting your discussion with both theoretical arguments and practical examples.
Introduction
The primary objective of budgetary control is to plan and control an organization’s activities in the short-term as opposed to the long-term corporate and strategic planning with broad objectives. While the short-term plan may be for the objectives for the subsequent accounting year, the long-term planning may be for the subsequent five years. The short-term objectives may be to achieve a targeted rate of return on capital, level of turnover or market share. For some organisations it may be just containing expenditure within the budgetary limits. The short-term budgetary plans must however be in line with the long-term objectives. The budgetary control in fact enables the application of principles of management by exception. Responsibilities are delegated to carryout activities, functions to middle level executives, keeping for themselves (top management) to focus only on deviations from plans and future strategy without being bogged down in day-to-day activities which must be already running to plan. In other words, budgetary control comes in the form of a control cycle. CIMA, London has defined budgetary control as the process of establishing benchmarks in monetary and/or quantitative terms that executives are mandated to achieve as a policy and comparing the actual results with budgeted i.e benchmarked figures on a continuous basis for the ultimate aim of securing objective of the policy or initiating action for revision of benchmarked targets.
Budgetary control cycle consists of six sequential stages. Stage 1 is setting of a new budget which sets in motion the control cycle. Stage 2 defines performance measurements by which budget holder’s performance is measured. Some of the typical measures are a pre-defined return on capital, targeted sales or market share. Others include profit target and keeping expenditures or costs within budgets. Stage 3 involves measurement of actual performance. This is enabled by feeding financial transactions to the financial data in the respective cost centres for revenue expenditure and capital expenditures assigned with certain identification numbers. Stage 4 involves comparison of actual performance with the original or revised budget figures. Stage 5 involves examining variances between the actual and budgeted figures in terms of absolute money or percentage and examining the causes for the variance. Stage 6 involves taking action in response to variances if necessary so as to avoid recurrence. Stage 1 involves setting new budget again for the next year.
Advantages of budgetary control
Budgetary control serves as a cost control tool. It provides benchmarks for evaluation of actual performance. It demarcates roles and responsibilities for all the executives engaged in various business activities. It helps identify efficiency of business activities and enhances their operational efficiency. Management is benefited by the process of planning in respect of various business activities. Coordination is enabled among different sections, divisions or departments of an organisation engaged in various activities. Effective utilisation of all organizational resources is ensured. A culture of planning is developed in the organisation and in turn in the minds of employees as a habit. Communication in the organisation is made possible through budgetary control activities. Budgetary control is not without limitations. Estimates based on which plans are made are not always accurate. Its role in control of various business activities is only limited. Budgetary control as a system in the organisation may not be liked by less efficient employees. The budgetary control system is expensive for organisations. It is not a substitute for the management but only acts as a tool of management. Changes in circumstances often render budgeted figures less useful..
Performance evaluation
One of the objectives of the budgetary control is performance evaluation, others being planning, defining responsibilities, coordinating, communicating, motivating and cost control. Budgetary control system which has some element of cost for its implementation and regular upkeep in the subsequent period helps managers plan for the future in a staggered manner. As the budgets are statement of expectations, they are used to evaluate actual performance which is made possible by putting in place a budgetary control system which takes into account of the budget data for monitoring and controlling progress. Thus, any difference between estimates and actual is known as a variance. Significant variances are worth investigating and reasons for variance are ascertained. It serves as a check on the accuracy of budgets. Problems are identified in a timely manner for necessary remedial action. Thus, it serves as a continuous measure of performance of individual employees, division or company. Investigation and explanation of variances are the crucial part of the management control. It also serves as a process of motivation and inspiration to carryout organisational activities to perpetuate the organisation’s goal. Unintentional errors on performance and intentional irregularities are also detected and corrected, .
Budget variances
Budget should be realistic as otherwise variance analysis is not worthwhile. Variances are caused due to four reasons but remedial action required may be different for each case. The reasons for variance are; calculation mistakes in the budget estimates; calculation mistakes in the actual results; reality is different; differences between budget assumptions and actual results. Variance analysis involves four stages viz flexing the budget, analysing the variances, identifying the causes and taking appropriate action. While the last stage is value adding action, the first three are worthwhile only if the last one is timely. Hence the first three must be done fast even at the cost of their accuracy.
Flexing the budget
In the above there is a sales volume variance of £ (250). It is a practice to put negative variance in brackets. The budget has been revised as per actual sales volume with the same price. The expected profit for 450 units is £ 1,250 resulting in a negative impact on profit showing a reduction of £ 250.
Other variances
The budget data above can be compared against actual. The variance on sales could have occurred only due to price. The sales price variance is £ 900.
The variable costs need to be further investigated. Assuming that original budget was for 1000 units of goods and cost of each unit of goods was £ 5, the resulting budget figure would work out as 1000 x 5 x £ 5 = £ 5,000.
The actual result would work out as 900 units @ £ 5.50 per unit = 4,950.
This is to be compared against the flexed budget figure of 900 x 5 = 4,500.
The variance is £ (450) cause for which can be identified as follows.
Price anticipated was £ 5 per unit but actually it resulted as £ 5.50 per unit. Hence the material price variance of £ (450).
While identifying the causes, there could be possibility of different comments on the figures.
The raw material price increased and hence factory was cautioned against wastage and sales division was asked to increase price.
Because sales volume decreased, lesser quantity of raw material was purchased thus lost the opportunity to make use of volume discount.
Price was increased to make up shortfall sales and also to show an increase in profit.
Accounting function cannot show the cause of variances. The above example assumes that the correct figures have been furnished and that the budget was realistic. The finance department could only quantify the impact and it was for the operational managers who were in the know of things should be able to provide input in to the management report on the resulting figures. Without the knowledge of actual cause, it is impossible to take effective management decisions.
In a case study of budgeting approach in a large UK Plc, the following findings have been observed.
The company employing 90,000 employing has interrelated lines of businesses. It is under the regulatory control. The company has the practice of projecting its revenue and expenditure at a high level. The budgetary process developed over the years has been under continuous improvement. The company adopts three different budget processes: Resource Budgeting, Transformation Budgeting, and Capital Budgeting. The resource budgeting: It is a combination of methods but is incremental. Budgets are created at group level viz Top Line Revenue, Profits (EBITDA), Net Cash Flow and Total Employment. The budgeting process is the responsibility of the Finance function at the Group level and within each line of business. A Central Finance Team at the group level consolidates the budgets coming from different lines of business. As a top-down approach, the Central Finance team makes series of budgetary scenarios for each line of business. As a bottom-up approach, all the lines of business prepare their respective budgets on incremental basis and based on trends. Finally the top-down and bottom-up budgets are aligned through discussions wherein budgetary targets are agreed upon. The targets are then translated into the forms of specific KPIs and metrics. This is an end-to-end planning cycle which lasts 4-4.5 months to be finalised. Transformation budgeting: This relates to projects that are growth related such as new product introduction or cost reduction such as organisation restructuring. There is a Head of Transformation having overall financial targets to achieve. These projects are managed at the respective lines of business level, cross-line of business level or group level. Capital budgeting: The company has more than 100 capital projects in the process at a time. The projects can be aimed as either cost transformational, revenue generating or infrastructural. The CFO makes a commitment of certain percentage of revenue to capital expenditure. The projects are prioritised under the supervision of the Capital Board which comprises of the CFO, Capital managers and representatives from operational teams. The budget is reviewed two to four times in a year. The on-going budget monitoring is part of performance evaluation in the company. Monthly reports on progress are generated with explanation of all variances that are significant. The company has the history of ensuring budgetary accuracy at the aggregate level. Flexing the budgets has no deadlines as such. Monthly reviews or even at the lesser interval if necessary involve escalation process during which changes are brought to the senior management’s attention. The company’s Budget Adjustment Process is a rigorous one for the ultimate approval of the budget adjustment from the senior management. The company links budgetary performance to budget holders’ personal assessments. The effectiveness of budget accuracy had been linked to their personal scorecards. This practice has been stopped since it encouraged undesirable behaviours such as resorting to hidden contingencies and enhanced discretionary expenditure at the end of the year. However, all the lines of business have their performance scorecards which are linked to the performance parameters of the respective business units.
Another case study of a research to link budgeting, budgetary control and performance evaluation has established the key actors at the lower level have found the budget’s purposes useful to them. And that the monthly performance reports never reach the project managers though most of them are ready and enthusiastic to participate as they have the accountability at the end of each month. The report also insists that the project managers should have a certain level of computer literacy and good oratory skills for development of rapport with clients. Performance appraisal must be examined and approved before promotion of the respective project managers and other higher cadres. In the company of the case study, 57 % of the employees were not aware of the budget practice in the company as they were not using budget elements in their daily activities. Remaining 43 % who were aware of it did not fully use the budget. 58% of the respondents felt disheartened on being informed that their performance was bad. The findings showed that 67% never participated in the budget process or review which is not a good feature for a realistic budget or budgetary control.
Conclusion
References
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