Budgets In Corporate Sector-Tool For Cost Control

Latest News

Baseball is a game that is almost synonymous to the word American. Although it is played in a lot of places across the globe, it is in the United States where complete appreciation of the sport can ... [more..]

1st
NOV

Budgets In Corporate Sector-Tool For Cost Control

Posted by admin under Budgeting

INTRODUCTION:

In any Organization, departments prepare budgets and estimates for the smooth flow of business activity which is inevitable. Budgets are formal quantitative statements of the resources set aside for carrying out planned activities over given periods of time. As much, they are widely used means for planning and controlling activities at every level of the organization. There are a number of reasons for their wide usage. In a simple term budget refers to expenditure plan. In a normal parlance, there are two kinds of budgets. Namely, operating budgets and financial budgets. The operating budgets point out the goods and services the organization expects to devour in the budget period. They usually list both physical quantities (such as barrels of oil) and cost figures. The financial budget spell out in detail the money the organization proposes to spend in the same period and where that money will come from. These types of budgets make up the firm’s overall budgetary plan. Flexibility in budgeting is necessary because of the cyclicality of the market and to control the cost.

Operating Budgets:

Operating budgets are classified as expenses, revenue, and profit budgets.

Expense Budgets: There are two types of expense budgets, one for each of the two types of expenses centers – engineered cost budgets and discretionary cost budgets.

Engineered cost budgets are typically used in manufacturing plants but can be used by any organizational unit in which output can be accurately measured. These budgets usually describe the material and labor costs involved in each production item as well as the estimated overheads costs. Hewlett Packard, for example, has an annual budget that describes the labor, material, and overhead expenses involved in manufacturing its computer peripherals (printers, plotters, and boards). Such an engineered cost budget is designed to measure efficiency. Exceeding the budget means that operating costs were higher than they should have been.

Discretionary cost budgets are typically used for expenses centers — administrative, legal, accounting, research, and other such departments in which output cannot be accurately measured. Discretionary cost budgets are not used to assess efficiency because performance standards for discretionary expenses are difficult to devise. For example, if Procter & Gamble’s research and development department exceeds its budget, it will often be difficult for managers to determine how that department’s work could have been performed more efficiently.

Revenue Budgets: Revenue budgets are meant to measure marketing and sales effectiveness. They consist of the expected quantity of sales multiplied by the expected unit selling price of each product. The revenue budget is the most critical part of a profit budget, yet it is also one of the most uncertain because it is based on projected future sales. Companies with a large volume of back orders or companies whose sales volume is limited only by their productive capacity can make firmer revenue forecasts than can companies that must reckon with the fluctuations of an unstable or unpredictable market. However, marketing and sales managers of even the latter type of company can control the quality and quantity of their advertising, service, personnel training, and other factors that affect sales. This control gives them some influence over sales volume and frequently enables them to make reasonably accurate sales estimates. Deere also influences sales through its control promotion and dealer incentives.

Profit Budgets: A profit budget combines cost and revenue budgets in one statement. It is used by managers who have responsibility for both the expenses and the revenues of their units. Such managers head an entire division or company, like Corning Inc.’s technical products division. Profit budgets, sometimes called master budgets, consist of a set of projected financial statements and schedules for the coming year. Thus, they serve as annual profit plans.

Budgeting procedure
The budgeting process typically begins when managers receive top management’s economic forecasts and sales and profit objectives for the coming year, along with a timetable stating when budgets must be completed. The forecasts and objectives provided by top management correspond to guidelines within which other managers’ budgets will be developed.

In a few organizations, the preference is for “top-down” budgeting. Budgets are imposed by top managers with little or no consultation with lower level managers. Most companies, however, have a preference to the process of ‘bottom up” budgeting: Budgets are prepared, at least initially, by those who must implement them. The budgets are then sent up for approval to higher level managers.

Bottom up budgeting has a number of advantages for many organizations. First, supervisors and lower level department heads have a more intimate view of their needs than do managers at the top, and they can provide more realistic details to support their proposals. They are also less likely to overlook some vital ingredient or hidden flaw that might subsequently impede implementation. Managers are also more strongly motivated to accept and meet budgets they have had a hand in shaping. Finally, morale and satisfaction are usually higher when individuals participate actively in making decisions that affect them.

The process by which lower-level managers participate in developing budgets is similar to the multilevel planning process described. Supervisors prepare their budget proposals using the guidelines drawn up by upper management. Department heads then review the lower level budgets and resolve any inconsistencies before compiling them into department budgets. These budgets are then submitted to higher level managers for approval. The process continues until all budgets are completed, assembled by the controller or budget director, and submitted to the budget committee for further review. Finally, the master budget is sent to top management (the president, chief executive officer, or board of directors) for approval.

Role of budget Department and the workforce:

Even though developing budgets is the responsibility of managers, they may receive information and technical assistance from the staff of a planning group or formal budget department or committee. These groups are likely to exist in large, division organizations in which the division budget plays a key role in planning, coordinating and controlling activities.

The budget department, which generally reports to the corporate controller, provides budget information and assistance to organizational units, designs budget systems and forms, integrates the various departmental proposals into a master budget for the organization as a whole, and reports on actual performance relative to the budget.

The budget committee, made up of senior executives from all functional areas, reviews the individual budgets, reconciles divergent views, alerts or approves the budget proposals, and then refers the integrated package to the board of directors. Later, when the plans have been put into practice, the committee reviews the control reports that monitor progress. In most cases, the budget committee must approve any revisions made during the budget period.

Problems in budget development:

During the budget development process, when the organization’s limited resources are allocated, managers could fear that they will not be given their fair share. Tension can grow as competition with other manager’s increase. Anxieties might also arise because managers know they will be judged by their ability to meet or beat budgeted standards. Hence, they are anxious about what those standards will be and may over state their needs to create some slack. Conversely, their senior managers are concerned with establishing aggressive budget objectives As a result, the senior managers will often try to trim their mangers’ expenditure requests or raise their revenue targets. The result can be an ever widening web of distrust and anxiety, in particular if employees begin to suspect the budgets will not meet their needs. Organization wide participation in the budgeting process often minimizes these types of anxiety reactions. When all managers are involved in budget development, they are more likely to be satisfied with resources allocations.

One difficulty with budgets is that they are often inflexible. Thus, they could seem inappropriate for situations that change in ways beyond the control of the budget. For example an expense budget based on annual sales of million may be completely off track if sales of million are achieved. Since the expenses of manufacturing almost always increases when more items are produced to meet larger demand, it would be unreasonable to expect managers to keep to the original expenses budget under these circumstances.

To deal with this difficulty, many managers resort to a variable budget. This type of budget is also referred to as a flexible budget, sliding scale budget and step budget. Whereas fixed express what individual costs should be at one specified volume, variable budgets are cost schedules that show how each cost should vary as the level of activity or output varies. Variable budgets are therefore useful in identifying in a fair and realistic manner how costs are affected by the amount of work being done.

Three types of costs must be considered when developing variable budgets: fixed, variable, and semi-variable costs.

1. Fixed Costs: Fixed costs are those that are unaffected by the amount of work