Budgetary control: All You Need to Know

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A person planning her budget
A person planning her budget

Budgetary control: All You Need to Know

A well-developed budgetary control system can help an organization avoid many cost overruns and improve client service quality. Poor budgetary control may result in mismanagement of funds, financial losses due to a lack of proper forecasting, and unreasonable fees. 

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An effective budgetary control system is easy to create with a few essential components. First, an organization should have an accounting framework, including a balance sheet and capitalization table. Staff should use this accounting framework to keep track of incoming and outgoing funds. This article will discuss the importance of having a budget control system.

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What is Budgetary Control?

Budgetary control is a management tool designed to prevent cost overruns. It involves controlling the amount of money an organization will spend and helps to identify potential problems. An effective budgetary control system should allow accounting staff to accurately forecast and document expenditures early in the planning process.

Objectives of Budgetary Control

The objectives of budgetary control include:

1. Predict Cash Flow

Budgetary control aims to predict cash flow by evaluating cash inflows, outflows, and giving assessments.

a. Cash Inflows

The first step in budgetary control is forecasting incoming funds. Using the company’s accounting framework, staff should forecast cash inflows such that they add up to zero at the end of the year. An increase in funds from one year to the next is a positive factor for the budget these funds represent; however, a decrease in funds from one year to the next can be a negative factor for the budget.

b. Cash Outflows

The next step in budgetary control is forecasting outgoing funds. Using the company’s accounting framework, staff should forecast cash outflows such that they add up to zero at the end of the year. An increase in funds from one year to the next is a negative factor for the budget since these funds represent a cost for the organization; however, a decrease in funds from one year to the next can be a positive factor for the budget.

c. Give Assessments

 Give assessments are funds promised to an individual before the year. These funds should be accounted for before the start of the year to account for them in budgetary control appropriately.

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2. Control Costs

Budgetary control aims to control costs by limiting expenditures and spotting over-expenditures early in the process.

a. Limiting Expenditures

An effective budgetary control system should limit expenditures. An organization should set a strict budget that the accounting personnel follows to limit expenditures. This budget should set limits on everything from wages to rent. Accounting personnel should not exceed these limits unless necessary. 

Even then, when staff plans to exceed the budgeted amount, they should notify management of their change in expenditure and acquire their approval for the waiver before proceeding with the expenditure.

b. Spotting Over

Expenditures: An effective budgetary control system should spot over-expenditures early in the process. To spot over-expenditures early in the process, accounting personnel should follow their budget closely and alert management if they exceed approved spending amounts.

3. Measure Performance

Budgetary control aims to measure performance such that appropriate steps can be taken to maximize revenue and minimize expenditures.

a. Measure Revenue

An effective budgetary control system should measure revenue by tracking monthly and yearly sales and cash flow. Using sales data collected over several years, management should forecast future sales. This forecast should help management identify potential problems in creating their budget.

b. Measure Expenditures

An effective budgetary control system should measure expenditures by tracking monthly and yearly costs. Using costs collected over some years, management should forecast future costs. This forecast should help management identify potential problems in creating their budget.

c. Take Appropriate Action

 Once accounting personnel identifies potential problems, they should take appropriate action to correct the problem and maximize revenue while minimizing expenditures.

Types of Budgetary Control

There are three types of budgetary control: Non- monetary control, operating budget, and financial budget.

Non-monetary Control

Non-monetary control is used to control expenditures but does not have a complete budgeting or accounting system. Steps may need to be taken to boost the sales budget or reduce the spending budget if the expected profit figure is too low. Non-monetary control is used mainly in a local government unit but can also be applied to individuals and small businesses.

Operating Budget

An operating budget is a detailed spending plan by the department or division and divisional manager, which shows all of the planned expenditures for each fiscal year. This type of budget control intends to create a long-range financial plan for each division or department supervisor. These are typically the types that they are:

The revenue or sales budget

It focuses on the revenue that the business anticipates generating from regular operations. It is significant because it aids the manager in comprehending the organization’s projected financial situation.

The expenditure plan

It lists the organization’s projected costs for a given time frame. Additionally, it highlights impending costs so the manager can better plan for them.

The cost of the project

The main focus is the predicted discrepancies between sales or revenues and expenses or profit. Increasing the sales budget or reducing the spending budget may be necessary if the expected profit is too low.

Financial Budget

A financial budget is a detailed plan for the entire organization, not just one department or division. It extends to all anticipated revenues and expenditures for a given time frame, ranging from a few months to more than a year. A financial budget includes both monetary and non-monetary control systems.

The budget provides management with an easy-to-follow report tracking actual results compared with original estimates.

Essentials of a Budgetary Control

The key essentials of a budgetary control system include:

1. Goal Orientation

An effective budgetary control system should adjust expenditures during the year to meet targeted revenue.

2. Control Period

A company’s budgetary control system should cover a specific time, for example, one year. Organizations should update their system before the beginning of each period. The most common control period is one year; however, other organizations use a different control period if it better suits their needs.

3. Flexibility

An effective budgetary control system should have the flexibility to adjust over time. For example, one year’s control period may not fit all organizations’ needs. An organization can easily change how it plans for its budget by adjusting spending, revenue, and expenses from the previous year.

4. Participation

An effective budgetary control system should be a participatory process, meaning management and staff should participate in creating the budget. Participation shows a company’s commitment to its budgetary control system by involving everyone in the planning process.

5. Measurement

An effective budgetary control system should be a measurement-oriented system, meaning it measures performance and takes appropriate action based on the measurement taken during the year. For example, if an organization finds that they are spending far beyond their budget, they will adjust their expenditures during the year to meet targeted revenue.

6. Reward and Punishment

An effective budgetary control system should provide rewards for meeting revenue goals and punishments for failing to meet revenue goals. For example, if the organization met its revenue goal, it may reward staff with a raise or special vacation; however, if it missed its revenue goal by a wide margin, it may cut pay or lay off staff.

5 Steps of Budgetary Control

The following five steps should be followed to achieve a successful budgetary control system:

1. Establish an Actual Position

Finance managers should compare the actual position of the business with the desired budgeted position to show a potential problem and measure discrepancies. Achievement of long-range goals depends on budgetary control.

2. Compare with Actual Budget

The data gathered must be compared to the budgeted amounts established at the start of the fiscal year after Step 1 is finished. This comparison should be easy if the actual income and expense headings match the initially established ones.

A “variance” is the discrepancy between actual income and expenses and those planned. Variance analysis is a crucial tool in the process of controlling the budget.

3. Calculate Variance

A summation is used to match actual income and expenses with the initial budgeted figures. This calculation shows how far the business has deviated from the expected income and expense amounts.

4. Establish Reasons for Variances

Differences between the budgeted and actual expenditures can be attributed to several factors. All variations must have their causes determined. Effective budgetary control depends on this procedure since it tells the budget holder when to take corrective action. Variances can be positive and negative, representing excessive or insufficient spending and above- or below-average income performance. The table below shows some o the causes of variances:

5. Take Action

The budget holder must take corrective action to improve the business’s performance. The budget holder must decide how to adjust the budget during the current quarter or future months. Budget holders should follow a few steps to take corrective action:

Advantages of Budgetary Control

1. It creates budget consciousness

2. It helps determine weaknesses

3. It increases organizational effectiveness

4. It increases budget predictability

Disadvantages of Budgetary Control

1. It may spearhead conflict in different departments

2. It may lead to increased bureaucracy

3. It may lead to unrealistic goals

4. Ineffective budgetary control management may result in a waste of funds and overspending.

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Categories: Business