Chapter 4.

Budgetary Control
 Meaning of Budget
A budget is ‘ a predetermined detailed plan of action developed
and distributed as a guide to current operations and as a
partial basis for the subsequent evaluation of performance’.
Following are the essentials of a budget:
 It is prepared in advance and is based on a future plan of
action.
 It relates to a future period and is based on objectives to be
attained.
 It is a statement expressed in monetary and/or physical units
prepared for the implementation of policy formulated by the
management.

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 Budgetary Control
It is the system of management control and accounting in which
all operations are forecasted and so far as possible planned
ahead, and the actual results compared with the forecasted
and planned ones. Thus, budgetary control involves :
 Establishment of budgets.
 Continuous comparison of actual with budgets for target
achievement and variance analysis.
 Revision of budgets in the light of changed circumstances.
The difference between, budgets, budgeting and budgetary
control has been stated as , ‘Budgets are the individual
objectives of a department etc., where as budgeting may be
said to be the act of building budgets. Budgetary control
embraces all and in addition includes the science of
planning the budgets themselves and the utilization of such
budgets to effect an overall management tool for the
business planning and control.’
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 Budgetary Control As A Management Tool
Advantages of Budgetary Control :
 Brings economy in working
 Buck passing is avoided
 Established Coordination
 Decrease in Production Costs
 Adoption of Standard Costing Principles
 Guards against Undue Optimism
 Adoption of Uniform Policy
 Management by Exception
 Finds favour with Credit Agencies
 Optimum Capitalization.

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 Limitations of Budgetary Control
 Opposition against the very spirit of budgeting : The
opposition is due to human tendency to resist change.
Moreover, any system of budgetary control cannot be
successful unless it has the full support of the top
management.
 Budgeting and changing economy: Preparation of a budget
which gives a realistic position of the firm’s affairs under
inflationary pressures and changing government policies is
very difficult.
 Time factor : Accuracy in budgeting comes through
experience. Management must not expect too much during
the development period.
 Not a substitute for management : It is a management tool
and cannot substitute management.
 Cooperation required : Its success depends upon willing
co-operation and teamwork.
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 Classification of Budgets
According to time:
 Long term Budget: Designed for a long period, generally 5
to 10 yrs. Concerned with the planning of the operations of
a firm over a considerably long period of time.
 Short term Budget : Designed for a period generally not
exceeding 5 yrs.
 Current budgets: Cover a very short period, say a month or
a quarter. They are essentially short term budgets adjusted
to current conditions.
 Rolling Budgets: A new budget is prepared at the end of
each month or quarter for a full year ahead. The figures for
the month or quarter which has rolled down, are dropped
and the figures for the next month or quarter are added.
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 Classification of Budgets ( Contd )
According to function:
 Sales Budget:
It is a forecast of sales to be achieved in a budget period.
Factors to be considered while preparation of sales budget
include past sales figures and trends, Salesmen’s estimates,
Plant capacity, Orders in hand, Seasonal fluctuations,
Potential market etc.
 Production Budget:
Provides an estimate of the total volume of production
product-wise, with the scheduling of operations by days,
weeks and months and a forecast of the closing finished
product inventory.
 Purchase Budget:
Forecasts the quantity and value of purchases required for
production.
 Capital Expenditure Budget :
Forecasts the amount of capital that may be required for
procurement of capital assets during the budget period. 7
 Classification of Budgets ( Contd )
 Cash Budget:
Forecasts the estimated amount of cash receipts and
payments and the likely cash balance in hand at the end of
different periods. A cash budget helps the management in
i) Determining the future cash needs of the firm.
ii) Planning for financing of those needs
iii) Exercising control over cash and liquidity of the firm.
A Cash budget can be prepared in any of the following
three ways:
i. Receipts and Payments Method : Cash receipts and
payments from various sources are estimated and a budget
is prepared using the estimates.
ii. Adjusted Profit & Loss Account Method: Cash budget is
prepared on the basis of opening cash and bank balances,
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 Classification of Budgets ( Contd )
projected profit and loss account and the balance of various
assets and liabilities.
iii. Balance Sheet Method: Under this method, at the end of
each period a projected balance sheet is drawn up listing
various assets and liabilities except cash and bank balances.
The balancing figure is taken as the closing cash/ bank
balance.
 Master Budget : It is a summary budget incorporating all
functional budgets in capsule form.

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 Classification of Budgets ( Contd )
According to Flexibility:

Fixed Budget : According to CIMA London, ‘ a fixed budget is a

budget which is designed to remain unchanged irrespective
of the level of activity actually attained’. Hence it is
unrealistic yardstick incase the level of activity actually
attained does not conform to the one assumed for budgeting
purposes.

Flexible Budget : According to CIMA London, a flexible budget

is , ‘ a budget designed to change in accordance to the level
of activity actually attained’.
A flexible budget can be constructed in any of the three ways:
 The Multi- Activity Method :Involves computing budget
figures for different levels of activity within a range.
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 Classification of Budgets ( Contd )

 Formula Method: Involves preparing budgets for the

expected normal level of activity and then working out
ratios showing the relationship of each expenses or group of
expenses per unit level of activity.
 Graphic Method : Costs are classified according to their
variability – fixed, variable or semi variable. Estimates are
then made for different costs at different levels of activity.
The data are then plotted on the graph paper showing the
costs at different levels of activity.

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 Performance Budgeting
 According to National Institute of Banking Management,
performance budgeting technique is ‘ the process of
analyzing, identifying, simplifying and crystallizing specific
performance objectives of a job to be achieved over a
period ,in the framework of the organizational objectives,
the purpose and objectives of the job. The technique is
characterized by its specific direction towards the business
objectives of the organization’.
 Thus, performance budgeting lays immediate stress on the
achievement of specific goals over a period of time.
However, in the long run it aims at the continuous growth of
the organization.
 It requires preparation of performance reports which
compare budget and actual data and show any existing
variances. The responsibility of preparing the performance
budget of each department lies on the respective
Departmental Head. 12
 Control Ratios
Ratios that are commonly used by the management to find out
whether the deviations of actual from budgeted results are
favourable or otherwise.
 Activity Ratio : It is a measure of the level of activity
attained over a period of time.
Activity ratio = Standard hrs for actual production x 100
Budgeted hrs
 Capacity Ratio : Indicates whether and to what extent
budgeted hrs of activity are actually utilized.
Capacity ratio = (Actual hrs worked / Budgeted hrs) x 100
 Efficiency Ratio : Indicates the degree of efficiency attained
in production.
Efficiency ratio : Standard hrs for actual production x 100
Actual hrs worked 13
 Zero Base Budgeting

 The traditional budgeting technique is quite meaningless

under the present dynamic conditions where the
management must review and evaluate every task in the
light of changed circumstances.
 Zero base Budgeting ( ZBB ) examines a programme or
function or responsibility from ‘scratch’. Nothing is allowed
simply because it was being done in the past. The manager
proposing the activity has, therefore, to prove that the
activity is essential and the various amounts being asked
for, are reasonable taking into account the volume of the
activity.

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 Zero Base Budgeting ( Contd )
Process of Zero Base Budgeting
 Determination of objectives of Budgeting : The objective
may be to effect cost reduction in staff overheads or analyze
and drop the projects which do not fit in the organizational
structure etc.
 Determination of the extent to which ZBB is to be
introduced: Whether it is to be introduced in all areas of
activities or only in a few selected areas on a trial basis.
 Development of decision units : Decision units refer to units
regarding which a cost benefit analysis will be done to
arrive decide whether they should be allowed to continue or
not. It may be a functional department, a programme, a
product line or a sub-line.

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 Zero Base Budgeting ( Contd )
 Development of decision packages: After identification of
decision units, the manager of each decision unit reviews
the activities of his unit and examines alternative ways of
accomplishing the objectives. He does a cost benefit
analysis and selects the best alternative. He then prepares a
decision packages which effectively summarize his plans
and the resources required to achieve them.
 Review and ranking of decision packages: The management
ranks the decision packages in order of increasing benefit or
importance to the organization.
 Preparation of Budgets: After the choice of decision
package to be implemented is made, resources are allocated
to different decision units and budgets relating to each unit
are prepared.
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 Zero Base Budgeting ( Contd )
Advantages of ZBB
 Provides the organization with a systematic way to evaluate
different operations and programmes.
 Ensures that every programme being undertaken by the
manager is essential to the organization and is being
performed in the best possible way.
 No arbitrary cuts or increase in budget estimates are made.
All approvals are made on the basis of cost benefit analysis.
 Helps identify areas of wasteful expenditure.
 Links budgets with corporate objectives. Nothing will be
allowed simply because it was being done in the past.
 It can be used for introduction and implementation of the
system of ‘management by objectives’.
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 Summary
In this chapter you have studied :
 The meaning of budget, budgeting and budgetary control
 Utility and limitations of budgetary control as a
management tool
 Classification of budgets into different categories
 Difference between fixed and flexible budgeting
 The concept of performance budgeting and control ratios
 The concept, utility and limitations of Zero base budgeting

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