The observation that “ many managers considered budgetary information with which they were provided was not very useful, and it was frequently ignored” is thought provoking.. This versatile tool of finance management is not to blame. It all depends on how the practitioners make use of this tool. The following discussion will prove the fallacy of the above observation. I hasten to add that Dew and Gee’s remarks points to the state of affairs of the organizations giving no importance to Budgetary Control.
Budgetary Process and Budgetary Control
Budgeting will be worthwhile only if actual performance is measured and action taken as a result. In many organisations, performance compared with budget is considered the end of the process. Further, this process is worthwhile only if the budget is realistic. It is futile to analyse variances against an unrealistic budget.
In a well run organisation actuals and budget comparison is the basis for deciding action. The difference between what has been budgeted and what has actually happened is the variance. It is a favourable variance if the sales revenues are higher than budgeted and have yielded higher profits. Negative or adverse variance is the one by which profits are found to have been reduced, for instance costs are higher than budgeted. (www.tt.100.biz) The following are the four key situations that can cause adverse budget variance.
1 Faulty arithmetic in the Budget figures
2 Errors in the arithmetic of arithmetic figures
3 Reality is wrong
4 Difference between Budget assumptions and Actual outcome.
(David A. Palmer 213 page 2 of 10 Budgetary control and variance analysis)
Managers identify variances and take control actions accordingly. Like avoiding waste to reduce costs, or increasing promotional activities if sales have fallen short of the budget.
Budgeting is a feed forward system as one of management’s planning tools and budgetary control is part of the feed back system . Williamson D (1996) says that Budget by definition have to be prepared in advance and expressed in quantitatitive and monetary terms. In summary, a budget is a statement of an organisation’s planning in monetary, numerical or non quantitative aspects for the coming week or month or year.
Managers set out targets for given period. targets and communicate to all concerned. Managers motivate them to achieve the set targets. They control performance by monitoring the results against the targets thus trying to meet the organisation’s objectives. Budgetary control is the analysis of what happened to those planned and what the organisations did or did not do to correct for any variations from those plans.
Different departments of organisations prepare budgets for their respective departments and the following diagram show how the budgeting processes are interrelated.” We can see that this diagram begins with the sales forecast and then the sales budget. This is not an accident; and it doesn’t always have to be this way. The reason that sales are the starting point of the diagram is because the organisation on which the diagram is based must believe that sales are its limiting factor.” (Williamson D (1996) Cost and Management Accounting Prentice Hall)
A company will have the following budgets.
* Income and Expenditure Budgets.
* Production budgets.
* Profit budgets.
An outline of Budgetary process in KRAFT FOODS.
“KRAFT FOODS” is the world’s second largest food company. It is claimed that the company has 110,000 staff under their employ spread over in 60 countries from their modest beginning in 1903 as wholesale cheese business in 1903. The company’s certain brands are household names today. Kraft Inc’s shares are traded on the New York Stock Exchange. Kraft Foods UK Ltd is their wholly owned subsidiary 2500 employees in U.K. taking care of the groups manufacturing and distribution for UK and Ireland.
- The vision of Kraft foods is to become “the undisputed global food leader
An important objective is to reduce cost and reinvest cost savings by waste reduction which gives competitive advantage.
Budgeting and strategy
Kraft’s income and expenses budget
Sales turnover is the income and costs incurred to make those sales are expenses.
The finance team has formed cost centres under which different costs are classified to make a meaningful analysis and controlled by those authorised to spend. The company uses cost centres relevant to particular production units. Thus Kraft is in a position to formulate plans for individual cost centres which together make up budget for the organisation. The aim of this exercise is quantify likely costs of the entire operation with a focus on the Company’s future plans.
Kraft incurs the following costs in selling its wide variety of products to different kinds of customers like ‘The corner shop’’ “ cash and carry” and “large multinational supermarket chains”.
- raw material costs and production costs to manufacture its products.
- marketing expenses such as promotional activities like media campaigns
- selling expenses for selling its products to its different customers
- distribution expenses for transporting its products from different regional products to the customer points.
Before even planning the above expenditure, Kraft has to forecast the achievable sales based on the past history and current trends. This forecast is in terms of quantities of each product to be produced and the time limit. With these figures in readiness, budgeting heads of costs relating to sales, marketing and administration are determined and figures for relevant costs of storing and transportation (i.e distribution), selling and administration. Figures for capital expenses are inserted at a later stage. With these figures, a budgeted profit and loss account(income and expenses) and balance sheet is compiled.
The figure below shows the process of income and expenses (profit and loss budget)
The significance of feedback
The feedback is what gives rise to budgetary control which is cyclical ongoing process of review and monitoring. T Kraft food, they make monthly variance analysis and identify deviations from the forecast within the monthly result. As already said variance can be positive or negative which indicates greater income or greater expenses respectively. Senior Management of Kraft keeps itself posted of monthly variations by comparison of actual with budgeted ones and alerts cost centres suitably.
The variances lead to either correction of activities based on results known as “single loop feedback” or lead to changing the original forecasts according to reality which is as “ double feedback” Amending the budget itself is an important task of the top management. Kraft’s operative environment being rapidly changing in the areas of Consumer demand patterns, production technology and competitor attitudes, it managements to quite responsive to changes by changing the budget figures. Kraft does not have inhibitions in changing a budget number of times in a year for compelling reasons.
Among a number of budgeting types, Kraft uses a mix of the following .
! Zero based budgeting
Rather than formulating budgets based on past performance, it is prudent to start afresh. i.e. starting from Zero. This facilitates innovative thinking.
- Strategic budgeting
It is closely resembling Zero based budgeting but it takes into account of new and emerging opportunities to acquire competitive advantage.
In line with shareholders expectations for quick results because of rapid changes in business external environment, Companies in the US give reports to shareholders every 3 months, companies of UK, 6 months. So every 3 monthly or 6 monthly report shall be for the previous 12 months on an ongoing basis which warrant rolling budgets.
4 Activity based budgeting
Each activity’s impact is assessed for its contribution to company’s success and accordingly prioritized and assigned appropriate budgets.
It must be emphasized here that Kraft believes in consensus while formulating budgets in order to bring everybody concerned into the fold for the desired results. This is a necessity in a fast changing dynamic and highly competitive food market which calls for coordinated efforts..
De Franco L Agnes, Schimdgall S Raymond (The Bottom Line August 1987 pp 68) state that Budgetary control process shall consist of the following five steps
- Determine the budget variances
- Determine which variances are significant
- Analyze the significant variances
- Determine the cause of variances
- Take corrective action.
In general, budgeting establishes spending patterns as far as expense budgets are concerned by responding to variances. Employees are motivated when results are measured and appreciated for even better future performance. Besides it is not desirable to indulge in cost cutting for higher profits at the expense of long term strategy. and quality. More focus on short terms results should not be at the expense of long-term goals..
It will be clear from the above discussions budgetary process is for various purposes. They are viewed by the managers as fixed standards of performance against which they will be judged. Failure to achieve the objectives of the budgets are considered inefficiency on the part of the managers and not the budgeting system which is an effective one. Hence budgetary control is a double- edged sword in that it not only controls performance of the organisation on the one edge but also controls the Human Resources on the other.
Following could be few guide lines who ever is involved in budgetary process.
A manager who is involved in budgeting and budgetary control must establish clear link between his budget and strategy. If the people to approve of the budget can see benefits clearly, it will be much easier for them swallow higher costs.( Brain Food: your route to the Top. Get a budget through in Management Today(dec 2,2004). He must allow room for contingency plan but must be ready with answers when questioned on figures.
He should know where cuts could be made and impacts thereon and be in readiness to spell them out when asked. (Management Today (Dec 2, 2004): p14.) Specific numbers and real expenditure should be quoted instead of round figures which suggest guestimates or lazy thinking.. He must test his budget proposal with his team first and invite questions from them.
Wolinski, John (Nov 2004). Business Review (UK) 11.2 (Nov 2004): p16 (3).) says that careful control of budgets will ensure that a firm’s finance do not worsen unexpectedly as a result of a failure to limit spending to agreed levels. As a budget is a plan for the future it establishes priorities. For Instance large allocation to an activity will indicate importance attached to the particular policy or division. Wolinski, John gives an example of Hutchison giving priority to the mobile net work’3’ by allocating larger budget. This indicates that the company believes third-generation mobile phones are vitally important for company’s future development.
These objectives one must observe in budget process should answer how theory if put into practice will be a good budgetary control. (Management Today (Dec 2, 2004): p14).
We must now have had a paradigm shift in our thinking that Dew and Gee really did not mean uselessness of Budgetary information but only have pointed above easily removable bottle necks in the process by observing the above principles of Budgetary process and control. We should also remember that these remarks were made in 1973 when PCs (personal computers) were in embryonic stage and poor manually made arithmetic had its own drawbacks. We have really come a long way and have achieved perfection in calculations with speed and accuracy and therefore they can be no longer the excuses for the poor budgeting and budgetary control..
Management Control and Information: A Research Approach, B. Dew, Kenneth P. Gee, Macmillan. (April 26, 1973); Publisher: Macmillan…
Managing Financial Information 2nd edition by David Davies (CIPD 2005)
Brain food. Management today (Dec 2, 2004) Get a budget through (a brief article) (http://find.galegroup.com) accessed on 07 March 2006
David A Palmer 2000, 213 page 2 of 10 Budgetary control and variance analysis (hhtp://www.Financial Development com) accessed on 06, March 2006
Kraft Food U.K., http://www.thetimes100.co.uk/company_list.php accessed on 08 March 2006
Schmidgall, Raymond S., De Franco Agnes L on Budgetary control in the Lodging Industry “Control! Control! Control!” The Bottomline,
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Williamson D (1996) Cost and Management Accounting Prentice Hall, ( http://www.duncanwil.co.uk/budg.html) accessed on 07 March 2006
Wolinski, John. Business Review (U.K) 11.2 (Nov 2004): page 16(3) (http;//findgalegroup.co) accessed on 07 March 2006