Budgetary Control as a Tool of Management - Thesis Example

Budgetary Control Table of Contents Introduction 3 Budgetary control 3 Budgetary control as a tool of performance management 5 Relationship between budgetary control and organizational control 8 Budgetary control as an integrative control mechanism 11 Conclusion 12 13 Reference list 14 Bibliography 15 Introduction A budget is comprehensive business plan expressed in quantitative form which is prepared in advance for achieving a given objective within a definite period of time. It is developed with the aim to make an effective utilisation of resources and for the recognition of the business objectives as early as possible (Abdel, 2011). The process of shaping various budgeted figures for the enterprise and then comparing actual performance with the budgeted figures for calculating the deviations is known as budgetary control (Ray, 2009). Budgetary control, performance management and organizational control are to a large extent interlinked with one another. Budgetary control is part of overall organisation control and is concerned primarily with the control of performance (Abdel, 2011). The use of budgetary control in performance management has of late earned greater importance especially as an integrative control mechanism for the organisation. The purpose of this thesis is to analyze the role of budgetary control in performance management, organisational control and as an integrative control mechanism within an organization. Budgetary control According to Chartered Institute of Management Accountants (CIMA), London, budgetary control refers to establishment of budgets for the continuous comparison of actual with the budgeted information for achieving the goals and recording the deviation and conducting a revision of budgets under the fresh circumstances (Ray, 2009). Planning, Coordination, Communication and Control are the primary objectives of budgetary control. Planning involves preparing a table of action for a business over a specified period of time. Coordination refers to synchronization or bringing together of different activities of a company or an organization to ensure cooperation of all the concerned towards the common goal. Communication as an objective of budgetary control refers to informing the budget to the concerned about what is expected of them to accomplish (Abdel, 2011). The budget which is approved contains all the plans of the management regarding the future course of action which are communicated to the concerned departments. The departments follow the approved budget and are expected to adhere to it for the specified period. Control refers to process, necessary to bring the performance according to the original plan. Control is possible with pre-determined standards laid down in the budget. To enable budgetary control a continuous comparison of real performance with that of budget is maintained to find out the variances and report them for necessary corrective action (Ray, 2009). Profit maximization, effective communication, efficient coordination, economic efficiency, determination of weaknesses, responsibility allocation, timely corrective actions and performance assessment are the advantages of budgetary control. Budgetary control exercises appropriate control over revenue and capital expenditure. Proper planning and coordination ensures in reducing losses and maximizing profits. A budget serves as a means of communicating information throughout the organization which enables every department to know the performance expectation and its ability for achieving the target (Ray, 2009). Budgetary control helps in establishing coordination between the plans, policies and the control standards. The budgets of various departments are dependent on each other as the operations of the departments are inter-related. Coordination amongst the various department increases as the size of company and its operations increases in order to achieve its goals and objectives. Planning at each level brings efficiency and economy in the working of the business enterprise. Resources are put to optimum use. All this leads to elimination of wastage and achievement of overall efficiency. The weakness of the system or the overall performance is determined by focusing on the variances and highlighting the deviations of the actual performance from the planned performance (Abdel, 2011). As the budgets are prepared in advance, every employee knows what is expected of him/her as they are well aware about their responsibilities. Due to the presence of budgetary control, the deviations are reported to the attention of the top management as well as functional heads which ensures suitable and timely corrective action. In the absence of budgetary control, deviations would be known only at the end of the period and the opportunity for necessary corrective action would reduce (Rajasekaran, 2011). As the budgetary control system measures the performance of various departments it helps the management to assess the actual performance of the individual department with the pre-planned performance and ascertain the deviation so that timely corrective actions are taken. In order to establish budgetary control, an organization must give importance to the following aspects: Budget committee, budget centers, budget period, preparation of an organization chart, budget manual, principal budget factor or key factor and establishment of adequate accounting records (Rajasekaran, 2011). Budgetary control as a tool of performance management Budgetary control system acts as a tool for measuring the performance of various departments, which is compared with the pre-planned performance format to ascertain the variations in the current performance (Avis, 2009). Budgetary control when applied as a performance management tool it is termed as performance budgeting. Performance budget aims to evaluate performance at various responsibility centers and execute efficient management of the overall performance of the organization (Otley, 1999). It is a modern management tool that ensures control through measuring performance at various levels. Performance management in an organization is ensured by establishing a budgetary control system (Robert and Leonard, 2011). The budgetary control system consists of: Budget Center: it is a section or department of the organization or group of activities for which budget can be developed. It is established with the purpose of controlling costs and the budgets are related to cost centers. Budget centers will disclose the section of organization where planned performance is not achieved. Budget centers are specifically isolated in order to facilitate preparation of various budgets with the help of the head of the department concerned (Hussey and Ong, 2005). For example, in order to prepare the production budget the production manger is consulted. Budget manual: it is a booklet containing instructions regarding the procedures to be followed and time schedules to be observed governing the responsibilities of persons engaged in a particular department or section of the organization. The budget manual contains the managerial policies and the objectives of the organization, the important factors that must be considered for each plan and forecast, the procedure of finalization of the functional budgets and their assemblage into the master budget, the reporting of the remedial action, the procedure for revising or amending the budgets after issuance or acceptance, the matters that are to be included in the budget on the approval of the top management and the dates by which preliminary plans and forecasts are to be submitted (Rajasekaran, 2011). Budget period: According to CIMA, budget period is the period which may be divided into several control periods for which the budget is prepared and used. Budget period is specified in order to measure the short-term and long-term performance of the organization. Budget key factor: According to CIMA, London, a factor which will limit the operations and activities of an organization and which is considered while preparing the budget is known as s budget key factor. For assessing the performance of an organization it is very important to consider the limiting factors, because availability or non-availability of the limiting factor will affect the performance of the organization (Rajasekaran, 2011). Budget Reports: Reporting of deviations or variances is a significant part of budgetary control system as it is essential for assessing the causes for deviation and estimation of the organization’s performance. Budget report evaluates the performance of the different departments and reveals the responsibility of a department or an executive within an organization. By analyzing the budget report management can appraise the performance of the organization accordingly (Abdel, 2011). Budget Controller: The budget controller provides assistance to the budget committee and helps in preparation of the various budgets and their compilation and implementation into the master budget (Avis, 2009). He compares the actual performance to the planned performance on a continuous basis and ascertains the causes of deviation to the management for the purpose of efficient performance of the budget and the entire organization. A fundamental part of modern management is budgetary control which influences the performance of the organization. All the components of the budgetary control system are implemented successfully to enhance the organizational performance and achieve the goals and objectives of the organization by maximizing the profits and reducing the economic costs (Otley, Merchant and Emmanuel, 1990). Relationship between budgetary control and organizational control In order to establish an effective budgetary control system it is essential on the part of the organization to have a definite structure of organizational control (Lyne and Dugdale, 2010). The organizational control is embedded in the organization chart which explains the functional responsibility and authority of a particular executive and delegates the authority to various levels. The functional heads are delegated with responsibility of ensuring appropriate implementation of budgets of their respective departments (Lyne and Dugdale, 2010). An organization chart for budgetary control in depicting as follows: (Source: Author’s creation) From the above organization chart, it is observed that the Chief executive officer is the head of the organization and is the overall in charge of the budget committee. The roles of budget officer are to plan, coordinate, control and implement the budget. The budget committee which comprises of all the functional head such as production manager, purchase manager, personnel manager, sales manager, finance manager and accounts manager are responsible for preparing the budgets of their respective departments and exercises control. Budgetary control is associated with formal organizational control especially when the control is over inputs and processes. Organizational control is divided into input control, process control and output control where budgetary control is linked with input control in formal organizational control for distribution of financial assets (Lyne and Dugdale, 2010). Budgetary control helps in establishing organizational control by ensuring preparation of budgets for the different departments of the organization. Organizational control is established through preparation of the different functional budgets such as: Sales budget: it is a forecast of total sales expressed in monetary terms and quantity. The sales manager prepares this budget by accurately forecasting and anticipating the sales of the budget period (Drury, 2006). The sales and market research department are expected to function according to the forecasted sales budget. Production budget: Through the production budget which is a forecast of the production for the budget period control over production department is exercised which results in optimum utilization of productive resources of the enterprise, production of goods according to schedule enabling the concern to adhere to delivery dates and appropriate scheduling of factors of production (Rajasekaran, 2011). Labour budget: The personnel manager is entrusted with the duty of preparing the labour budget which consists of the rates of pay, allowances, bonus etc that are considered against the labour hours and the number of units of production. The function of labour budget is to exercise control over the labour wage rate and the performance (Rajasekaran, 2011). Cash Budget: The finance manager is responsible for preparing the cash budget for the budget period which is a detailed estimation of the cash receipts and cash disbursements within the organization. This enables the finance manager to establish certain control mechanism within the finance department of the organization regarding the credit policies, inventory position and collection period (Rajasekaran, 2011). From the above analysis it is inferred that budgetary control plays a significant role in organizational control as it also forces the management to focus attention on particular financial and operating problems so that effective planning would be made to address those problems and transform the objective of the organization into action. Budgetary control as an integrative control mechanism Controlling refers to the process by which an entity ensures that all its operations are being carried out in accordance with the plan which has been adopted, the principles which have been laid down and the orders that has been delegated from the higher authority (Trenerry, 1999). The ultimate objective of the control mechanism is to highlight the deviations from the plan, rectify those deviations and avoid such divergences in future. An organization that faces a financial constraint is expected to manage its financial resources skillfully, failure to control the financial resources will lead to distress followed by bankruptcy and ultimately ruining the entire business (Otley, 2001). Budgetary control is an integrative control mechanism because it aims at maximization of profits through effective planning and control of income and expenditure directing capital and resources to the best and most profitable channel. It makes a planned approach to expenditure and financing of the business. As each level of management is aware of their task and knows the best way by which it is to be accomplished, maximum effective utilization of resources is attained. Control mechanism is accomplished fully when the deviations and the inefficiencies are properly looked into. It enables the management to make careful study of the problems in advance before taking decisions (Rajasekaran, 2011). Budgetary control system provides assistance in delegation of authority and is an effective tool of responsibility accounting (Barsky, 1999). The process of evaluating performance against budgets provides a suitable basis for establishing incentive system of remuneration by results and also spotting people with exceptional qualities of leadership and management (Flamholtz, 1996). One of the major aspects of management control is budgetary control, but in the later part of 20th century it has undergone a major change in both literature and practice. Budgetary control is influenced by internal and external factors; the internal factors influencing budgetary control are the members of the organization and the influence of shareholders act as external factor (Ryan, 2007). Conclusion Budgetary control is considered as an effective management tool. It is one of the systems whereby efficiency is infused into an organization through the process of targets. The achievement of the targets will mean progress which allowed a good deal of freedom of action within delegated field of executives. From this study it is inferred that budgetary control is interlinked with performance management of the organization and entire organizational control as it involves participation of all level of employees simultaneously human aspect of budgeting is also examined. Budgeting is seen as a management activity involving both staff and line management support for planning and control purposes. By employing efficient budgetary control the management employs effective management of the performance and control of the organization and establishes an integrative control mechanism. Organizations adopt different budgeting techniques such as zero base budgeting, performance budgeting, fixed and flexible budgeting depending on the financial policies and objectives of the organization. Budgetary control is a technique for planning, for authorization and for control. The key link between budgetary control and delegation of responsibility has facilitated the growth of large business houses. Budgetary control also functions as motivator because when budgets are tightened, achieving the targeted budget becomes challenging. Reference list Abdel, M., 2011. Review of management accounting research. New York: Palgrave Macmillan. Avis, J., 2009. 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Budgetary criteria in performance evaluation: a critical appraisal using new evidence. Accounting, organizations and Society, 25(4), pp. 483-496. Otley, D., 2003. Management control and performance management: whence and whither. The British Accounting Review, 35(4), pp. 309-326. Van der Stede, W. A., 2001. Measuring tight budgetary control. Management Accounting Research, 12(1), pp. 119-137. Read More