Question 3: Budgeting is the one of the main tool to control the cost Give your views.

Answer:

BUDGETING
INTRODUCTION
A budget is a plan of action expressed in financial terms or non financial terms. It is prepared for a definite period of time. It is a planned estimate of future business conditions such as the sales, cost and profit. A budget is a tool which helps the management in planning and control of business activities. Budgets are the common denominator of an organization and a constant in the life of any organization. "A budget is Financial and/or quantitative statements, prepared and approved prior to a defined period of time, of the policy to be pursed during the period for the purpose of attaining a given objective. - ICMA, England "Budget is a blue print of a projected plan of action of a business for a definite period of time." According to the definition, the essential features of a budget are: It is prepared for a definite period well in advance. It may be stated in terms of money or quantity or both. It is a statement defining the objectives to be attained and the policy to be followed to achieve them in a future period. Typically, budgets serve three major purposes: Planning; Coordinating; and Controlling. These three functions dictate that budgeting and the financial management process be flexible but accountable throughout the fiscal period. At all management levels, budgets typically represent an effective element of control, whether on a day-to-day operational basis or on a longer term basis. Controlling and monitoring are terms often used interchangeably; as one considers controlling/monitoring.

TYPES OF BUDGETS
There are many types of budgets. They may be classified into several basic types. Most organizations develop and make use of three different types of budgets: 1. Operating budgets; 2. Capital expenditures budgets; 3. Financial budgets; and 4. Zero-Base Budgets;

1. OPERATING BUDGETS
An operating budget is a statement that presents the financial plan for each responsibility centre during the budget period and reflects operating activities involving revenues and expenses. The most common types of operating budgets are: Expense Budget, Revenue Budget and Profit budgets.

i. Expense Budget: An expense budget is an operating budget that documents expected expenses during the budget period. Three different kinds of expenses normally are evaluated in the expense budget - fixed, variable and discretionary. Discretionary expenses - costs that depend on managerial judgment because they cannot be determined with certainty, for example: legal fees, accounting fees and R&D expense. ii. Revenue Budget: A revenue budget identifies the revenues required by the organization. It is a budget that projects future sales. iii. Profit Budget: A profit budget combines both expense and revenue budgets into one statement to show gross and net profits. Profit budgets are used to make final resource allocation, check on the adequacy of expense budgets relative to anticipated revenues, control activities across units, and assign responsibility to managers for their shares of the organization's financial performance.

2. FINANCIAL BUDGETS
Financial Budgets outline how an organization is going to acquire its cash and how it intends to use the cash. Three important financial budgets are the cash budget, capital expenditure budget and the balance sheet budget. i. Cash budget : Cash budgets are forecasts of how much cash the organization has on hand and how much it will need to meet expenses. The cash budget helps managers determine whether they will have adequate amounts of cash to handle required disbursements when necessary, when there will be excess cash that needs to be invested, and when cash flows deviate from budgeted amounts. ii. Capital Expenditure Budget: Capital Expenditure Budgets. Investment in property, buildings and major equipment are called capital expenditure. Such capital expenditure budgets allow management to forecast capital requirements, to on top of important capital projects, and to ensure the adequate cash is available to meet these expenditures as they come due. iii. The balance sheet budget: The balance sheet budget plans the amount of assets and liabilities for the end of the time period under considerations. A balance sheet budget is also known as a Performa balance sheet. Analysis of the balance sheet budget may suggest problems or opportunities that will require managers to alter some of the other budgets.

3. VARIABLE BUDGETS
Because of the dangers arising from inflexibility in budgets and because of maximum flexibility consistent with efficiency underlines good planning, attention has been increasingly given to variable or flexible budgets. To deal with this difficulty, many managers resort to a variable budget. Whereas fixed budgeted express that 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. There are three types of costs that must be considered when variable budgets are being developed: fixed, variable, and semi-variable costs. The problem in devising variable budgets is that cost variability is often difficult to determine and that they are often quite expensive to prepare.

4. ZERO-BASE BUDGETS
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The conventional budgeting process does have one major disadvantage. Managers tend to prepare new budget requests by adding an incremental amount to their previous year's budget requests, rather than re-evaluating the need for things already included. Zero-base budgeting (ZBB), in contrast, enables the organization to look at its activities and priorities a fresh. Zero-base budgeting assumes that the previous year's budget is not a valid base from which to work. It forces department managers to thoroughly examine their operations and justify their departments activities based on their direct to the achievement of organizational goals. The specific steps used in zero-based budgeting are as follows:
1. Break down each of an organization's activities into decisions packages. The decision package

includes written statements of the department's objectives, activities, costs, and benefits; alternative ways of achieving objectives; plus the consequences expected if the activity is not approved. Managers then assign a rank order to the activities in their department for the coming year.
2. Evaluate the various activities and rank them in of decreasing benefits to the organization.

Rankings for all organizational activities are reviewed and selecting by top managers.

THE BUDGET PREPARATION

There are two type of budgeting process: i. Top-down Budgeting; ii. Bottom-up Budgeting;

i. Top-down Budgeting: Many traditional companies use, a process of developing budgets in

which top management outlines the overall figures and middle and lower-lever managers plan accordingly. The top-down process has certain advantages: Top managers have comprehensive knowledge of the organization and its environment, including their familiarity with the company's goals, strategic plans, and overall resources availability. Thus, the top-down process enables managers set budget targets for each department to meet the needs of overall company revenues and expenditures.

ii. Bottom-up Budgeting: Other organizations use, a process developing budgets in which
lower-level and middle managers anticipate their departments' resource needs, which are passed up the hierarchy and approved by top management. The bottom-up approach builds on the specialized knowledge of operating managers about environment and marketplace, which they have gleaned from day-to-day operations. In reality, the budgetary process usually involves a mixture of both styles.

Budgetary Control
Budgets are the most widely used control system, because the plan and control resources and revenues are essential to the firm's health and survival.
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"The establishment of budgets relating to the responsibilities of executives to the requirements of a policy and the continuous comparison of actual with budgeted results, either to secure by individual action the objectives of that policy or to provide a basis for its revision. - ICMA, England "Budgetary control is a system which uses budgets as a means of planning and controlling all aspects of producing and/or selling commodities and services." - J. Batty The main steps in budgetary control are: Establishment of budgets for each section of the organization. Recording of actual performance. In case there is a difference between actual and budgeted performance taking suitable remedial action Monitoring of the actual performance with the budget and revise budgets if necessary.

Objectives of Budgetary Control

The objectives, of budgetary control are: To define the goal and provide long and short period plans for attaining these goals. To co-ordinate the activities of different departments. To operate various cost centers and departments with efficiency and economy. To estimate waste and increase the profitability. To estimate future capital expenditure requirements and centralize the control system. To correct deviations from Established standards. To fix the responsibility of various individual in the organization. To indicate to the management as to where action is needed to solve problems without delay. The following steps should be taken in a sound system of budgetary control: 1. Organization Chart; 2. Budget Centre; 3. Budget Committee; 4. Budget Manual; 5. Budget Period; 6. Key Factor; 1. Organization Chart: There should be a well defined organization chart for budgetary control. This will show the authority and responsibility of each executive. 2. Budget Centre: A, budget centre is that part of the organization for which the budget is prepared. A budget centre may be a department, or a section of the department. (say production department or purchase section). The establishment of budget centre is essential for covering all parts of the organization. The budget centre" are also necessary for cost contra] purposes. The evaluation of performance becomes easy when different centers are established. 3. Budget Committee: In small companies, the budget is prepared by the cost accountant. But in big companies, the budget is prepared by the committee. The budget committee consists of the chief executive to managing director, budget officers and the managers of various departments. The Manager of various departments prepares their budgets and submits to this committee. The committee will take necessary adjustments, co-ordinate all the budgets and prepare a master Budget. The main functions of the committee are:
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To receive and scrutinize all budgets and decide the policy to be followed. To suggest revision of functional budgets if needed and approve finally revised budgets. To prepare the Master Budget after functional budget are approved. To study variations of actual performance from the budget. To recommend corrective action if and when required.

4. Budget Manual: Budget Manual is a book which contains the procedure to be followed by the executives / concerned with the budget. It guides all executives in preparing various budget. It is the responsibility of the budget officer to prepare and maintain this manual. The budget manual may contain the following particulars: A brief explanation of objectives and principles of budgetary control. Duties and powers and functions of the budget officer and the budget committee. Budget period, account classification, Reports, statements form and charts to be used. Procedure to be followed for obtaining approval. 5. Budget Period: A budget period is the length of time for which a budget is prepared and deployed. It may be different for different industries or even it may be different in the same industry or business. The budget period depends upon the following factors. The type of budget whether it is a sales budget, production budget, raw material purchase budget, by capital expenditure budget. A capital budget may be for a longer period i.e. 3 to 5 years; purchase and sales Budget may be for one year. The nature of the demand for the producer and timings for the availability of finance. 6. Key Factor: It is also known as limiting factor or governing factor or principal budget factor. A key factor is one which restricts the volume of production. It may arise due to the shortage of material, labor, capital, plant capacity or sales. It is a factor which affects all other budgets. Therefore the budget relating to the key factor is prepared before other budgets are framed. The following ore the requirements of a good budgetary control system: Budgetary control system should have the whole-hearted support of the top management. A budget committee should be established consisting of the budget director and the executives of various departments of the organization. There should be a proper fixation of authority and responsibility. The delegation of authority should be done in a proper way. The budget figures should be realistic and easily attainable. Variation between actual figures and budgeted figures should be reported properly and clearly to the appropriate levels of management. A good accounting system is essential to make budgeting successful. The budget should not cost more to operate than is worth.

Advantages of Budgetary Control

Budgetary control has become an essential tool of the management for controlling costs and maximizing profits. It acts as a friend, philosopher, and guide to the management. The following are the advantages of budgetary control: Budgetary control defines the objectives and policies of the undertaking as a whole. It is an effective method of controlling the activities of various departments of a business unit. It fixes targets and the various departments have efficiently to reach the targets.
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It helps the management to fix up responsibility to reduce wasteful expenditure. This leads to reduction in the Cost of production. It brings in efficiency and economy by promoting cost consciousness among the employees and facilitates introduction of standard costing. It acts as internal audit by a continuous evaluation of departmental results and costs. It helps in estimating the financial needs of the concern. Hence the possibility of under capitalization is eliminated. It provides a basis for introducing incentive remuneration plans based on performance. It helps in the smooth running of the business unit. There will be no stoppage of production on account of shortage of raw materials or working capital. The reason is that everything is planned and provided in advanced. It indicates to the Management as to where action is needed to solve problems without delay.

Budgeting as a Control Tool

A budget serves as a control tool to provide standards for evaluating performance. A budget can cover any of the following: Profit planning forecast of revenues and expenses Cash budgeting forecast of cash needs and sources Balance sheet forecasting anticipating future assets, liability and net worth position of the business Profit Planning: The sales forecast and corresponding costs and expenses are the major inputs to a Profit Plan. Why is profit planning important? It enables the entrepreneur to see the complete picture and to analyze how each cost and expense item behaves in relation to changes in the level of sales. Budgeted amounts are then compared with actual results and variances are analyzed and corrected. Cash Budgeting: A Cash Budget is used to determine anticipated cash inflows and outflows so that the business maintains the optimum level of cash. It also provides information on whether or not additional financing is required to address cash shortfalls. The first step in preparing a Cash Budget is to list down all transactions having cash flow implications. Cash Disbursements, on the other hand, may include cash operating expenses, raw material purchases, equipment and other asset purchases, and repayments on bank loans. From this exercise, a Net Cash Balance is derived. This is then carried over to the next as the beginning cash balance. Some businesses choose to have a pre-determined minimum required cash balance which they maintain at all times. Balance Sheet Forecasting: This involves estimating asset levels to support the forecasted sales targets. For example, if the higher sales targets would necessitate opening more retail outlets, then necessarily, investments in fixed assets are a must. Moreover, changes in the funding mix (i.e., a higher level of long-term loans vs. short-term borrowings) may also occur.

Example:
The Sales Director of a manufacturing company reports that next year he expect to sell 50,000 units of a particular product. The production Manager consults the Storekeeper and casts his figures as follows:

Two kinds of raw materials A and B, are required for manufacturing the product. Each unit of the product requires 2 units of A and 3 units of B. The estimated opening balances at the commencement of the next year are: Finished product : 10,000 units Raw Materials A: 12,000 units, B: 15,000 units The desirable closing balances at the end of the next year are: Finished product 14,000 units, A: 13,000 units B : 16,000 units Prepare Production Budget and Materials Purchase Budget for the next year

Solution:
PRODUCTION BUDGET (Units) Estimated sales Add: Desired closing stock 50,000 14,000 ---------64,000 10,000 ----------54,000

Less: Opening Stock Estimated Production

MATERIALS PURCHASE OR PROCUREMENT BUDGET . (units) Material A Material B Estimated consumption 2 x 54000 1,08,000 3 x 54000 1,62,000 Add: Desired closing stock Less: Opening Stock Estimated Purchase 13,000 16,000 --------------------------------1,21,000 1,78,000 12,000 15,000 --------------------------------1,09000 1, 63,000

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