Budgeting is the formulation of plans for a given future period in numerical terms. It is statement of anticipated results, in financial terms (as in revenue and expense and capital budgets) or in non-financial terms (as in budgets of direct labour hours, materials, physical sales volume or units of production).
The Institute of Cost and Management Accountants of England and Wales defines a Budget as ‘a financial and/or quantitative statement, prepared prior to a defined period of the time for the policy to be pursued during that period for the purpose of attaining a goal objective.’
As budgets provide standards of performance, they usually become the basis for control. All results and performances are measured and appraised against budget standards, which are developed through a comprehensive budgetary programme. Control exercised for the execution of budgets is known as budgetary control.
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Budget making is concerned with the planning function of management, while budgetary control is associated with controlling in organization. Budgetary control is ‘the establishment of objectives relating to the responsibilities of execution to the requirements of a policy and the continuous comparison of actual with budgeted results, either to secure by individual action the objective of that policy or provide a basis for its revision.’
Characteristics of Budget:
1. Budget is essentially for a given period.
2. It differs from objectives and policies because it is set down in specific numerical terms.
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3. A good budget is flexible.
4. It secures maximum participation of the entire organization both in preparation and follow up.
5. Budget is fundamental to the organization. It generally receives attention and support of the top management.
Classifications Yardsticks:
1. By coverage of functions
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2. By characteristics of activities
3. By period
4. By flexibility
Purpose of Budgeting:
Budgeting is used for a variety of purposes. Some of the basic general purposes for which budgeting is used are as follows:
1. To Develop an Organized Procedure for Planning:
Budgeting is used as an aid to planning and budget is sometimes known as the profit plan. A budget requires planning and is also in itself an instrument of planning. Budgeting involves anticipation of results and expressing them in numerical terms. Forecasting or projecting a future course of action that is implied in budgeting is essentially a planning process. Comprehensive budgeting forces the management to develop a network of objectives and policies and plans for all the phases of operations of the enterprise.
2. Means of Coordination:
Budgeting is also used for coordinating the activities of the various divisions of business. While preparing budgets, information must certainly be required relating to divisions and activities in the enterprise. A sales budget, for instance, cannot be prepared without knowing about production programme of the enterprise. The very act of preparing budgets, therefore, demands coordination. The process of integrating various budgets into a master budget also highlights the importance of coordination implied in budgeting.
3. A Basis for Control:
Control represents the most widely known use of budgeting. Events can be compelled to conform to plans only when there are predetermined objectives and standards. Budgeting forces management to lay down objectives, goals and plans in numerical terms. It thus provides the yardstick for the measurement of performance so essential for effective control. Budget reports analyse the deviations and also suggest corrective actions. Thus, budgeting is also used as an aid to managerial control.
4. Budget to Control Cost:
Individual budget for each operation or department helps the management to know separately the cost for each of them and thus exercise effective control over cost.
The departmental manager who notices substantial deviations from budgeted costs for operations under his control, feels compelled to curtail the extra expenditure and think very seriously about controlling the cost.
5. To Increase Efficiency in the Field of Production:
Very often than not, budgetary control necessitates preparation of separate production budget and thus, helps determine progress and efficiency of the production.
6. To Determine Capital Requirements:
Budgeting is also employed to determine capital requirement of the enterprise. This is possible through computing financial flows at different phases of all the operations of the enterprise as reflected in various budgets.
7. To Encourage Research and Development:
Budgeting also aims at encouraging research and development. Comparison of actual performance with the budgeted goals and plans and thorough analysis of deviations particularly of key factors provide a sound basis for research and development.
8. To Increase Utility of Cost Records:
Budgeting entails considerable use of cost information and records. Thus, budgetary control adds meaning to cost records and increase their utility.