Budgetary control: meaning, objectives, preparation, advantages, limitations and zero-base budgeting

1. Budget and budgetary control

A budget is a plan expressed in money and quantities for a definite future period. CIMA: “a quantitative statement, for a defined period of time, which may include planned revenues, expenses, assets, liabilities and cash flows.” Its features: prepared in advance, for a fixed period, in financial or physical terms, for a defined policy.

Budgetary control is the use of budgets to control the business. CIMA’s classic definition: “the establishment of budgets relating the responsibilities of executives to the requirements of a policy, and the continuous comparison of actual with budgeted results, either to secure by individual action the objective of that policy or to provide a basis for its revision.” Three steps follow from it: set budgets by responsibility, compare actual with budget continuously, and act on the variances (or revise the budget).

2. Objectives

1. Planning: forcing management to think ahead about sales, output and cash.
2. Co-ordination of departments: production must match sales, purchases must match production, cash must cover all.
3. Control: comparison of actual with budget shows where performance went wrong.
4. Fixing responsibility on named executives for each budget.
5. Economy in the use of resources and elimination of waste.
6. Motivation: targets that managers helped to set.

3. Preparation of the budget

1. Organisation chart showing the responsibility of each executive.
2. Budget centres: sections of the organisation for which budgets are set.
3. Budget committee of departmental heads with the budget officer (often the chief accountant) as co-ordinator; it reviews and approves the budgets.
4. Budget manual: a written document of procedures, forms, timetable and responsibilities.
5. Budget period: usually one year, split into months or quarters for control.
6. Key factor (principal budget factor): the factor that limits activity, usually sales, sometimes material, labour or plant capacity. The budget for the key factor is prepared first and all others follow from it.
7. Functional budgets are prepared, co-ordinated, and summarised in the master budget, which the board approves.

4. Advantages

• Sets clear targets and makes management plan ahead.
• Co-ordinates departments towards a common goal.
• Applies management by exception: attention goes only to significant variances.
• Fixes responsibility and measures performance.
• Controls costs and promotes economy.
• Helps obtain bank finance, since a cash budget shows when and how much is needed.
• Serves as a base for standard costing and for incentive schemes.

5. Limitations

• Based on estimates; accuracy is no better than the forecasts.
• Rigid budgets fail when conditions change unless revised (flexible budgets meet this).
• Costly and time-consuming for a small firm.
• Can create inter-departmental conflict and “budget padding” by managers who want an easy target.
• A tool of management, not a substitute for it: it needs top-management support and staff co-operation.

6. Classification of budgets

7. Zero-base budgeting

Zero-base budgeting (ZBB) requires every activity to be justified afresh each budget period, as if it were starting from zero, instead of taking last year’s figure and adding an increment. It was developed by Peter A. Pyhrr at Texas Instruments and described in his 1970 Harvard Business Review article; Jimmy Carter used it as Governor of Georgia and later in the US federal budget. The Government of India adopted it for ministries in the 1980s.

Steps: (1) identify decision units (activities or programmes); (2) prepare a decision package for each, describing its purpose, alternatives, cost and benefit, and the consequences of not doing it; (3) rank the packages by cost-benefit; (4) allocate funds in order of rank until resources run out.

Merits: removes obsolete activities, allocates resources to priorities, involves managers at every level. Limits: heavy paperwork, difficulty ranking unlike activities and measuring benefits of service functions, and the need for trained staff.

How this is examined

The 16-mark (100-mark paper) or 10-mark (80-mark paper) Unit I essay: define budget and budgetary control with the CIMA wording, then objectives or advantages and limitations as lists of six or seven. ZBB as a 6-mark note: definition, origin, four steps and the comparison table. The cash budget and flexible budget problems are in the next two notes.