Definition: Budget is a financial and /or quantitative statement, prepared and approved prior to adefined Period of time of the policy to be pursued during that period for the purpose of attaining agiven objective. It may include income, expenditure and employment of capital.Features:1. Financial and/or Quantitative Statement.2. Futuristic preparedand approved prior to a defined period of time.3. Goal Oriented for the purpose of attaining a given objective.4. Components Income, Expenditure and Employment of Capital.The objectives of Budgeting are1.To encourage self-study in all aspects of a Company's operations.2. To get all members of management to “put their heads” to the basic question of how the business should be run, to make them of a coordinated team operating in unison towards clearly defined objectives.3. To promote the planning process and provide a sense of direction to every member of theorganization.4. To force a definition and crystallization of Company policies and aims.5. To increase the effectiveness with which people and capital are employed.6. To disclose areas of potential improvement in the Company’s operations.7. To stimulate study of relationship of the Company to its external economic environment forimproving the effectiveness of its direction.8. To direct and coordinate business activities and units to achieve stated targets of performance.9. To facilitate the control process, by comparing actual results with plan, and provide feedback tothe employees about their performance.

BUDGETARY CONTROL1. Definition: Budgetary Control is defined as "the establishment of budgets, relating theresponsibilities of executives to the requirements of a policy, and the continuous comparison ofactual with budgeted results either to secure by individual action the objective of that policy or toprovide a base for its revision.2. Salient features:a. Objectives: Determining the objectives to be achieved, over the budget period, and the policy(ies) that might be adopted for the achievement of these ends.b. Activities: Determining the variety of activities that should be undertaken for achievement ofthe objectives.c. Plans: Drawing up a plan or a scheme of operation in respect of each class of activity, inphysical a well as monetary terms for the full budget period and its parts.d. Performance Evaluation: Laying out a system of comparison of actual performance by eachperson section or department with the relevant budget and determination of causes for thediscrepancies, if any.e. Control Action: Ensuring that when the plans are not achieved, corrective action are taken;and when corrective actions are nThe objectives of a Budgetary Control System are

1.Definition of Goals: Portraying with precision, the overall aims of the business and determiningtargets of performance for each section or department of the business.2. Defining Responsibilities: Laying down the responsibilities of each individual so that everyoneknows what is expected of him and how he will be judged.3. Basis for Performance Evaluation: Providing basis for the comparison of actual performancewith the predetermined targets and investigation of deviation, if any, of actual performance andexpenses from the budgeted figures. It helps to take timely corrective measures.4. Optimum use of Resources: Ensuring the best use of all available resources to maximize profit or production, subject to the limiting factors.5. Coordination: Coordinating the various activities of the business and centralizing control, butalso making a facility for the Management to decentralize responsibility and delegate authority.6. Planned action: Engendering a spirit of careful forethought, assessment of what is possible and an attempt at it. It leads to dynamism without recklessness. It also helps to draw up long rangeplans with a fair measure of accuracy.7. Basis for policy: Providing a basis for revision of current and future policies.

LIMITATIONS OF THE BUDGETARY CONTROL SYSTEM1. Estimates: Budgets may or may not be true, as they are based on estimates. The assumptionsabout future events may or may not actually happen.2. Rigidity: Budgets are considered as rigid document. Too much emphasis on budgets may affect daytoday operations and ignores the dynamic state of organizational functioning.3. False Sense of Security: Mere budgeting cannot lead to profitability. Budgets cannot beexecuted automatically. It may create a false sense of security that everything has been takencare of in the budgets.4. Lack of coordination: Staff cooperation is usually not available during Budgetary Control exercise.5. Time and Cost: The introduction and implementation of the system may be expensive.

CLASSIFICATION OF BUDGETS

Budgets may be classified on the following bases –1. BASED ON TIME PERIOD:Long Term Budget Short Term Budget Budgets which are prepared for periods longer than a year are called Long Term Budgets. Such Budgets are helpful in business forecasting and forward planning.Examples: Capital Expenditure Budget and R&D Budget.Budgets which are prepared for periods less than a year are known as ShortTerm Budgets.They are prepared in cases where a specific action has to be immediately taken to bring any variation under control.Example: Cash Budget. 2. BASED ON CONDITION:Basic Budget Current BudgetA Budget, which remains unaltered over a long period of time, is called Basic Budget.A Budget, which is established for use over a short period of time and is related to thecurrent conditions, is called Current Budget.

3. BASED ON CAPACITY:

Fixed Budget It is a Budget designed to remain unchanged irrespective of the level of activity actually attained. It does not change with actual volume of activity achieved. Thus it is known as a Rigid or Inflexible budget. It operates on one level of activityand under one set of conditions. It assumes that there will be no change in the prevailing conditions, which is unrealistic. If the budgeted and actual activity levels differ significantly, thenaspects like cost ascertainment and price fixation do not give a correct pictureComparison of actual performance with budgeted targets will be meaningless, especially whenthere is a difference between two activity levelsFlexible BudgetIt is a Budget, which by recognizing the difference between fixed, semi variable and variable costs is designed to change in relation to level of activity attained.It can be recasted on the basis of activity level to be achieved. Thus it is not rigid. It consists of various budgets for different levels of activity. If facilitates the ascertainment of cost, fixation of selling price and submission of quotations. It provides a meaningful basis of comparison of the actual performance with the budgeted targets.

4. BASED ON COVERAGE:Functional Budget Budgets, which relate to the individual functions in an organization, are known as Functional Budgets, e.g. purchase Budget, Sales Budget, Production Budget, plant UtilizationBudget and Cash Budget.Master Budget It is a consolidated summary of the various functional budgets. It serves as the basis upon which budgeted Profit & Loss Account and forecasted Balance Sheet are built up.

ADVANTAGES OF THE BUDGETARY CONTROL SYSTEM1. The use of budgetary control system enables the management of a business concern to conduct its business activities in the efficient manner.2. It is a powerful instrument used by business houses for the control of their expenditure. It in factprovides a yardstick for measuring and evaluating the performance of individuals and their departments.3. It reveals the deviations to management, from the budgeted figures after making a comparison with actual figures.4. Effective utilization of various resources like men,material, machinery and money is madepossible, as the production is planned after taking them into account.5. It helps in the review of current trends and framing of future policies.6. It creates suitable conditions for the implementation of standard costing system in a businessorganization.7. It inculcates the feeling of cost consciousness among workers.

Steps in preparation of budgets1. Definition of objectives – A budget being a plan for the achievement of certain operationalobjectives, it is desirable that the same are defined precisely. The objectives should be writtenout; the areas of control demarcated; and items of revenue and expenditure to be covered by thebudget stated. This will give a clear understanding of the plan and its scope to all those whomust cooperate to make it a success.2. Location of the key (or budget) factor – ‘There is usually one factor (sometimes there may bemore than one) which sets a limit to the total activity. For instance, in India today sometimes

non- availability of power does not allow production to increase in spite of heavy demand.Similarly, lack of demand may limit production. Such a factor is known as key factor. For properbudgeting, it must be located and estimated properly.3. Appointment of controller – Formulation of a budget usually required whole time services of asenior executive; he must be assisted in this work by a Budget Committee, consisting of all the heads of department along with the Managing Director as the Chairman. The Controller is responsible for coordinating and development of budget programmes and preparing the manual of instruction, known as Budget manual. The Budget manual is a schedule, document or booklet which shows, in written forms the budgeting organization and procedures. The manual should be well written and indexed so that a copy thereof may be given to each departmental head for guidance.4. Budget Period – The period covered by a budget is known as budget period. There is no generalrule governing the selection of the budget period. In practice the budget committee determines thelength of the budget period suitable for the business. Normally, a calendar year or a periodcoterminous with the financial year is adopted. The budget period is then subdividedinto shorter periods it may be months or quarters or such periods as coincide with period of trading activity.5. Standard of activity or output – For preparing budgets for the future, past statistics cannot becompletely relied upon, for the past usually represents as combination of good and bad factors.Therefore, though results of the past should be studied but these should only be applied whenthere is a likelihood of similar conditions repeating in the future. Also, while setting the targets forthe future, it must be remembered that in a progressive business, the achievement of a year mustexceed those of earlier years. Therefore what was good in the past is only fair for the current year.

Functional budget – A functional budget is one which is related to function of the business as for example, production budget relating to the manufacturing function. Functional budgets areprepared for each function and they are subsidiary to the master budget of the business. Thevarious types of functional budgets to be prepared will vary according to the size and nature of thebusiness. The various commonly used functional budgets are:1. Sales budget2. Production budget3. Plant utilization budget4. Direct materialusage budget5. Direct materialpurchase budget6. Direct labour(personnel) budget7. Factory8. Production cost budget9. Ending inventory budget10. Cost of goods sold budget11. Selling and distribution cost budget12. Administration expenses budget13. Research and development cost budget

14. Capital expenditure budget15. Cash budget16. Budget Summaries / master budget – budgeted income statement and Budgeted balance sheet.Flexible budget: A flexible budget is defined as “a budget which, by recognizing the differencebetween fixed, semi variable and variable costs is designed to change in relation to the level ofactivity attained”. A fixed budget, on the other hand is a budget which is designed to remainunchanged irrespective of the level of activity actually attained. In a fixed budgetary control, budgets are prepared for one level of activity whereas in a flexible budgetary control system, a series of budgets are prepared one for each of a number of alternative production levels or volumes. Flexible budgets represent the amount of expenses that is reasonably necessary to achieve each level of output specified. In other words, the allowances given under flexible budgetary control system serve as standards of what costs should be at each level of output.

Need: The need for the preparation of the flexible budgets arises in the following circumstances:1. Seasonal fluctuations in sales and/or production, for example in soft drinks industry;2. A company which keeps on introducing new products or makes changes in the design of its products frequently;3. industries engaged in make to order business like ship building;4. an industry which is influenced by changes in fashion; and5. general changes in sales.

Advantages of budgeting and budgetary control

There are a number of advantages to budgeting and budgetary control:

Compels management to think about the future, which is probably the most important feature of a budgetary planning and control system. Forces management to look ahead, to set out detailed plans for achieving the targets for each department, operation and (ideally) each manager, to anticipate and give the organisation purpose and direction.

Promotes coordination and communication.

Clearly defines areas of responsibility. Requires managers of budget centres to be made responsible for the achievement of budget targets for the operations under their personal control.

Provides a basis for performance appraisal (variance analysis). A budget is basically a yardstick against which actual performance is measured and assessed. Control is provided by comparisons of actual results against budget plan. Departures from budget can then be investigated and the reasons for the differences can be divided into controllable and non-controllable factors.

Enables remedial action to be taken as variances emerge.

Motivates employees by participating in the setting of budgets.

Improves the allocation of scarce resources.

Economises management time by using the management by exception principle.

Problems in budgeting

Whilst budgets may be an essential part of any marketing activity they do have a number of disadvantages, particularly in perception terms.

Budgets can be seen as pressure devices imposed by management, thus resulting in: a) bad labour relationsb) inaccurate record-keeping.

Departmental conflict arises due to:

a) disputes over resource allocationb) departments blaming each other if targets are not attained.

It is difficult to reconcile personal/individual and corporate goals.

Waste may arise as managers adopt the view, "we had better spend it or we will lose it". This is often coupled with "empire building" in order to enhance the prestige of a department.

Responsibility versus controlling, i.e. some costs are under the influence of more than one person, e.g. power costs.

Managers may overestimate costs so that they will not be blamed in the future should they overspend.

Characteristics of a budget

A good budget is characterised by the following:

Participation: involve as many people as possible in drawing up a budget. Comprehensiveness: embrace the whole organisation. Standards: base it on established standards of performance. Flexibility: allow for changing circumstances. Feedback: constantly monitor performance. Analysis of costs and revenues: this can be done on the basis of product lines, departments or cost centres.

Budget organisation and administration:

In organising and administering a budget system the following characteristics may apply:

a) Budget centres: Units responsible for the preparation of budgets. A budget centre may encompass several cost centres.

b) Budget committee: This may consist of senior members of the organisation, e.g. departmental heads and executives (with the managing director as chairman). Every part of the organisation should be represented on the committee, so there should be

a representative from sales, production, marketing and so on. Functions of the budget committee include:

Coordination of the preparation of budgets, including the issue of a manual Issuing of timetables for preparation of budgets Provision of information to assist budget preparations Comparison of actual results with budget and investigation of variances.

c) Budget Officer: Controls the budget administration The job involves:

liaising between the budget committee and managers responsible for budget preparation dealing with budgetary control problems ensuring that deadlines are met educating people about budgetary control.

d) Budget manual:

This document:

charts the organisation details the budget procedures contains account codes for items of expenditure and revenue timetables the process clearly defines the responsibility of persons involved in the budgeting system.

Budget preparation

Firstly, determine the principal budget factor. This is also known as the key budget factor or limiting budget factor and is the factor which will limit the activities of an undertaking. This limits output, e.g. sales, material or labour.

a) Sales budget: this involves a realistic sales forecast. This is prepared in units of each product and also in sales value. Methods of sales forecasting include:

sales force opinions market research statistical methods (correlation analysis and examination of trends) mathematical models.

Factors influencing sales budget.:

company's pricing policy general economic and political conditions changes in the population competition consumers' income and tastes advertising and other sales promotion techniques after sales service credit terms offered.

b) Production budget: expressed in quantitative terms only and is geared to the sales budget. The production manager's duties include:

analysis of plant utilisation work-in-progress budgets.

If requirements exceed capacity he may:

subcontract plan for overtime introduce shift work hire or buy additional machinery The materials purchases budget's both quantitative and financial.

c) Raw materials and purchasing budget:

The materials usage budget is in quantities. The materials purchases budget is both quantitative and financial.

Factors influencing a) and b) include:

production requirements planning stock levels storage space trends of material prices.

d) Labour budget: is both quantitative and financial. This is influenced by:

production requirements man-hours available grades of labour required wage rates (union agreements) the need for incentives.

e) Cash budget: a cash plan for a defined period of time. It summarises monthly receipts and payments. Hence, it highlights monthly surpluses and deficits of actual cash. Its main uses are:

to maintain control over a firm's cash requirements, e.g. stock and debtors

to enable a firm to take precautionary measures and arrange in advance for investment and loan facilities whenever cash surpluses or deficits arises

to show the feasibility of management's plans in cash terms

to illustrate the financial impact of changes in management policy, e.g. change of credit terms offered to customers.

Receipts of cash may come from one of the following:

cash sales payments by debtors the sale of fixed assets the issue of new shares the receipt of interest and dividends from investments.

Payments of cash may be for one or more of the following:

purchase of stocks payments of wages or other expenses purchase of capital items payment of interest, dividends or taxation.