Budget as an Instrument Budget as an Instrument of Controlof Control

P. GURU PRASADP. GURU PRASAD

FACULTYFACULTY

INC GUNTURINC GUNTUR

BudgetsBudgets Budgets are business plans that are stated in Budgets are business plans that are stated in

quantitative terms and are usually based on quantitative terms and are usually based on estimations.estimations.

These plans aid an organization in the These plans aid an organization in the successful execution of strategies. successful execution of strategies.

Due to the uncertainties in the business Due to the uncertainties in the business environment and / or due to wrong estimation, environment and / or due to wrong estimation, there may be significant deviations between there may be significant deviations between the a c t u a l s and the plans.the a c t u a l s and the plans.

Budgeting as a control tool, provides an action Budgeting as a control tool, provides an action plan for the organization to ensure least plan for the organization to ensure least deviationsdeviations

learning experiencelearning experience

Managers should participate in the Managers should participate in the budgeting process to ensure budgeting process to ensure consistency in the overall adherence consistency in the overall adherence to corporate goals. Budgeting helps to corporate goals. Budgeting helps mangers to enhance their learning mangers to enhance their learning experience. Learning takes place as experience. Learning takes place as they plan and later, compare a c t u a they plan and later, compare a c t u a l s with plans. Investigating the l s with plans. Investigating the reasons for deviations, further adds to reasons for deviations, further adds to their learning experiencetheir learning experience

Importance of BudgetsImportance of Budgets

Budgets are used to give an overview of Budgets are used to give an overview of the organization and its operations. They the organization and its operations. They are useful in resource allocation whereby are useful in resource allocation whereby resources are allocated in such a way resources are allocated in such a way that the processes which are expected to that the processes which are expected to give the highest returns are given give the highest returns are given priority.priority.

Budgets are also used as forecast tools Budgets are also used as forecast tools and make the organization better and make the organization better prepared to adapt to changes in the prepared to adapt to changes in the environmentenvironment

Importance of BudgetsImportance of Budgets

Budget preparation requires the participation Budget preparation requires the participation of managers from different functions / of managers from different functions / departments. This helps in integrating the departments. This helps in integrating the tactical and operational strategies of the tactical and operational strategies of the departments with the corporate strategy of departments with the corporate strategy of the organization.the organization.

Budgets act as a means to verify the progress Budgets act as a means to verify the progress of the various activities undertaken to achieve of the various activities undertaken to achieve the planned objectives. The verification is the planned objectives. The verification is done by comparing the a c t u a l s against done by comparing the a c t u a l s against standardsstandards

Importance of BudgetsImportance of Budgets

They help in the delegation of They help in the delegation of authority and allocation of authority and allocation of responsibility and accountability to responsibility and accountability to more people in an organization. They more people in an organization. They thus promote division of labor, which thus promote division of labor, which , in turn, promotes the process of , in turn, promotes the process of specialization. Functional specialization. Functional specialization leads to the overall specialization leads to the overall efficiency of the organizationefficiency of the organization

Steps in Budget FormulationSteps in Budget Formulation Creating a budget department or appointing a Creating a budget department or appointing a

budget controllerbudget controller Developing guidelines for budget preparationDeveloping guidelines for budget preparation Developing budget proposals at Developing budget proposals at

department/business unit leveldepartment/business unit level Developing the budget for the entire Developing the budget for the entire

organizationorganization Determining the budget period and key Determining the budget period and key

budgets factorsbudgets factors Benchmarking the budgetBenchmarking the budget Budget review and approvalBudget review and approval Monitoring progress and revising the budgetsMonitoring progress and revising the budgets

Budgeting procedures at Ford Motor Budgeting procedures at Ford Motor CompanyCompany

Ford motor company is one of the Ford motor company is one of the leaders in the global automotive leaders in the global automotive industry. It is based in Dearborn, industry. It is based in Dearborn, Michigan, and has a presence in 200 Michigan, and has a presence in 200 markets in six continents.markets in six continents.

Ford’s financial budget consisted of both Ford’s financial budget consisted of both financial and non-financial objectives financial and non-financial objectives that are set for the organization. It that are set for the organization. It included the sales volumes to be included the sales volumes to be achieved, the time frame, and the types achieved, the time frame, and the types of financing to be adopted.of financing to be adopted.

Budgeting procedures at Ford Budgeting procedures at Ford Motor CompanyMotor Company

Two types of budgets were prepared: Two types of budgets were prepared: one is the yearly budget which was one is the yearly budget which was detailed, and the other, a budget for a detailed, and the other, a budget for a period of five to ten years which was period of five to ten years which was not detailed. The financing from not detailed. The financing from external sources needed to achieve the external sources needed to achieve the sales volumes was estimated. sales volumes was estimated. Production costs including overhead Production costs including overhead costs were computed to calculate the costs were computed to calculate the profitability that could be achieved.profitability that could be achieved.

Budgeting procedures at Ford Budgeting procedures at Ford Motor CompanyMotor Company

Ford had over 2,000 cost centers and the Ford had over 2,000 cost centers and the head of each cost center was responsible head of each cost center was responsible for preparing the budget for that center. for preparing the budget for that center. In addition to this, the cash flow budgets In addition to this, the cash flow budgets were prepared. The budgets were then were prepared. The budgets were then reviewed by ford’s board of directors. reviewed by ford’s board of directors. Achievement of budgets was the Achievement of budgets was the financial control used by Ford. It also financial control used by Ford. It also emphasized the importance of achieving emphasized the importance of achieving and improving the budgeted costsand improving the budgeted costs

Rolling Budgets at CiscoRolling Budgets at Cisco

Cisco systems, inc, established in 1984, is Cisco systems, inc, established in 1984, is based in San Jose, California, USA. It is one of based in San Jose, California, USA. It is one of the world’s leading providers of products and the world’s leading providers of products and solutions in the areas of routing, switching, solutions in the areas of routing, switching, and other computer networking equipment.and other computer networking equipment.

In Cisco, a combination of traditional and In Cisco, a combination of traditional and rolling budgets and financial forecasts was rolling budgets and financial forecasts was used. At the beginning of the financial year, used. At the beginning of the financial year, an annual budget was fixed under the an annual budget was fixed under the supervision of the top management with supervision of the top management with information provided by the lower levels of information provided by the lower levels of management being used for the purpose.management being used for the purpose.

Rolling Budgets at CiscoRolling Budgets at Cisco

It was called as “plan of record” and was It was called as “plan of record” and was fixed for that particular year. Every quarter, fixed for that particular year. Every quarter, the management for the rest of the year.the management for the rest of the year.

In addition to these budgets with quarterly In addition to these budgets with quarterly reviews, the finance group of the company reviews, the finance group of the company developed rolling financial budgets – on a developed rolling financial budgets – on a monthly basis – for the next twelve months. monthly basis – for the next twelve months. By factoring in the ever-changing By factoring in the ever-changing environment , these budgets helped the environment , these budgets helped the management to decide on capital expenditure management to decide on capital expenditure projects, revise the manpower plan, update projects, revise the manpower plan, update the inventory policy, etc. these budgets also the inventory policy, etc. these budgets also helped the company to provide guidance to helped the company to provide guidance to investors on expected revenues and profitinvestors on expected revenues and profit

Master BudgetMaster BudgetThe master budget is also known as The master budget is also known as

the financial plan. Master budgets the financial plan. Master budgets form the basis of the control systems form the basis of the control systems in organizations. The master budget in organizations. The master budget has two components: the operating has two components: the operating budget and the financial budget. The budget and the financial budget. The operating budget includes the sales operating budget includes the sales budget, cash collections from budget, cash collections from customers, purchases budget, customers, purchases budget, disbursements for purchases, disbursements for purchases, operating expense budgets. operating expense budgets.

Master BudgetMaster Budget

The master budget may take the form of The master budget may take the form of a profit and loss account and a balance a profit and loss account and a balance sheet at the end of the budget period. It sheet at the end of the budget period. It shows the gross and the net profits and shows the gross and the net profits and the important accounting ratios. the important accounting ratios. Sometimes more than one master Sometimes more than one master budget has to be prepared before the budget has to be prepared before the final one is agreed upon. It is the duty of final one is agreed upon. It is the duty of the budget committee to approve the the budget committee to approve the master budgetmaster budget

Types of Types of BudgetsBudgets

CharacteriCharacteristicsstics

ExamplesExamples

Appropriation Appropriation budgetbudget

A ceiling is set for A ceiling is set for certain discretionary certain discretionary expendituresexpenditures

Based on the Based on the management decisionmanagement decision

Training, advertising, Training, advertising, sales promotion and sales promotion and R&DR&D

Flexible budgetFlexible budget A static amount is A static amount is established for established for discretionary and discretionary and committed fixed costs committed fixed costs and a variable rate is and a variable rate is determined per unit of determined per unit of activity for variable costactivity for variable cost

The static part: Salaries, The static part: Salaries, depreciation, property depreciation, property taxes, and planned taxes, and planned maintenance. The maintenance. The flexible part : direct flexible part : direct material, direct labor, material, direct labor, and variable and variable overhead .sales overhead .sales commissioncommission

Capital budgetCapital budget Decisions regarding Decisions regarding potential investments potential investments are made using are made using discounted cash flow discounted cash flow techniquestechniques

New plant and New plant and equipmentequipment

Master budgetMaster budget A comprehensive plan A comprehensive plan is developed for all is developed for all revenue and revenue and expenditureexpenditure

All revenue and All revenue and expenditures for any expenditures for any organizationorganization

Master budget

Operating Budgets

Financial Budgets

sales Direct material

Direct labor

Closing inventory

Cost ofGoods sold

Income statement

production Factory over head

Selling and Administrative

budgets

Capital budgets

Budgeted Balance

sheet

Cash budgets

Components of the MasterComponents of the Master BudgetBudget

Zero-Based BudgetingZero-Based Budgeting

It was put into practice first time by It was put into practice first time by Peter Phyrr at Texas Instruments , a Peter Phyrr at Texas Instruments , a world leader in digital signal processing world leader in digital signal processing and analog technologies based in the and analog technologies based in the US, in 1969.US, in 1969.

A traditional budgeting process is a A traditional budgeting process is a yearly process and uses the budget of yearly process and uses the budget of the previous year as a starting point to the previous year as a starting point to devise the current year’s budget. devise the current year’s budget. However, this process results in However, this process results in discrepancies.discrepancies.

Zero-Based BudgetingZero-Based Budgeting

For example, if there are inaccuracies in For example, if there are inaccuracies in the previous year’s budget, they are the previous year’s budget, they are carried forward to the next year, or, if carried forward to the next year, or, if the activities do not show a major the activities do not show a major impact on the budget, they are impact on the budget, they are continued even if they are not continued even if they are not contributing to the performance of the contributing to the performance of the organization.organization.

On the other hand, in ZBB the base is On the other hand, in ZBB the base is taken as zero and the budget is devised taken as zero and the budget is devised as for a new venture. as for a new venture.

Zero-Based BudgetingZero-Based Budgeting

In ZBB , the responsibility centers are In ZBB , the responsibility centers are called decision units and the process and called decision units and the process and activates involved in each decision unit activates involved in each decision unit are called decision packages. The ZBB are called decision packages. The ZBB process involves the following steps:process involves the following steps:

Decision unit identificationDecision unit identification Decision package developmentDecision package development Evaluation and grading of decision Evaluation and grading of decision

packagespackages Resource allocationResource allocation

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