Budgetary Control System And Its Applications e521j

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Name of the project “BUDGETARY CONTROL SYSTEM AND ITS APPLICATIONS”, SUBMITTED BY, DEEPA MOHINANI .SUNIL KANCHAN ROLL NO. 33 UNDER THE GUIDANCE OF, PROF. DINESH MOTWANI In Fulfillment Of the Requirement for the Award of the Degree of Master of Commerce M.COM PART-1 J.W.SADHUBELLA GIRLS COLLEGE ULHASNAGR-1 University Of Mumbai ACADEMIC YEAR: 2013-2014

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DECLARATION

I,DEEPA MOHINANI the student of J.W.SADHUBELLA GIRLS COLLEGE M. Com Part 1, hereby declare that I have completed this project “BUDGETARY CONTROL SYSTEM AND ITS APPLICATIONS”,in the acedamic year 2013-1014. The information submitted is true and original to the best of my knowledge.

-------------------------Students Signature

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CERTIFICATE I, PROF.DINESH MOTWANI hereby certify that DEEPA MOHINANI of M.COM PART 1 Master of Commerce of J.W.SADHUBELLA GIRLS COLLEGE Ulhasnagar 421001 has completed the project entitled “BUDGETARY CONTROL SYSTEM AND ITS APPLICATIONS”,in the academic year 2013-2014under my guidance. The information submitted is true and original to the best of my knowledge.

PROF.DINESH MOTWANI

Signature

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J.WATUMALL. SADHUBELLA GIRLS COLLEGE UNIVERSITY OF MUMBAI CERTIFICATE This is to certify that ‗DEEPA MOHINANI‘ Master of commerce (semester 1) for the academic year 2013-1014 has completed the project on “BUDGETARY CONTROL SYSTEM AND ITS APPLICATIONS”,under the guidance of PROF.DINESH MOTWANI.

Prof.DINESH MOTWANI

Prof.Rajeshsingh

(Project Guide)

(Co-ordinator)

Dr.M.M.Hosalkar (Principal)

SIGNATURE (EXTERNAL EXAMINER)

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ACKNOWLEDGEMENT I take this opportunity to present a sense of gratitude towards my project guide PROF.DINESH MOTWANI for his excellent guidance and letting me know about the topic provided

“BUDGETARY CONTROL SYSTEM AND ITS APPLICATIONS”,and its need in todays world. His understanding and personal guidance have provided a good basis for my project.

I would also like to thank college authorities, our principal and co-ordinator sub guide for authorizing my project.

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METHODOLOGY This project is a mixture of theoretical as well as practical knowledge. Also it contains ideas and information imparted by the project guide.

Secondary data:The secondary data required for the project was collected from various kinds of websits the name of which are mentioned in bibliography.

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OBJECTIVES OF THE PROJECT  To study about the ―BUDGETARY CONTROL SYSTEM AND ITS APPLICATION‖.  To increase my knowledge on the innovative ideas made by ―BUDGETARY CONTROL SYSTEM‖.  To understand the present and future needs of ―BUDGETARY CONTROL SYSTEM‖.  To study about the different situations and settlements.  To know about the solution providing techniques.

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INDEX

1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12.

Introduction. Meaning and concept of budget. Process of budgetary control. Defination of budgetary control. Characteristics of budgetary control. Objectives of budgetary control. Advantages of budgetary control. Other Advantages. Limitations of budgetary control. Essentials of budgetary control. Steps in preparing budgetary control. Classification of budget. a. Functional budget. b. Master budget. c. Fixed budget. d. Flexible budget.

13. 14. 15. 16. 17. 18. 19.

Classification of Functional budget. Budget Preparation. What is the framework in which budget decesions are making. Recognizing the usefulness of budget principles. Identifying the responsibility within the budget system. Conclusion. Biblography.

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Budgetary Control system and Its Applications. INTRODUCTION: According to J.A. Scott, "it is the system of management control and ing in which all operations are forecasted and so far as possible planned ahead, and the actual results compared with for casted and planned ones."

BUDGET, BUDGETING AND BUDGETARY CONTROL A budget is a statement of financial resources that have been allocated for the conduct of particular activities for a three-, six- or 12-month time frame. Comparing budgets with actual operational results is referred to as budgetary control. Such budgetary control helps planning, coordination between departments, decision-making, monitoring of operating results and motivation of personnel to achieve business objectives. The principle is the same for small businesses as well as large. A budget is defined as the formal expression of plans, goals, and objectives of management that covers all aspects of operations for a designated time period. The budget is a tool providing targets and direction. Budgets provide control over the immediate environment, help to master the financial aspects of the job and department, and solve problems before they occur. Budgets focus on the importance of evaluating alternative actions before decisions actually are implemented. A statement of estimated annual receipt and expenditure whether, on capital or revenue of central government is prepared by the 9

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railway board. In other words it can be said that under (article 112) of constitution of India, the president will call upon astatement from Railways showing the estimated income and the out-lay amount that has tocross the Consolidated Fund of India. These statements are known as 'Budget'.A budget is a detailed plan of operations of some specific future period. It is ane s t i ma t e p r e p ar e d i n a d v a n c e o f t h e p e r i o d t o w h i c h i t ' a p p l i e s . I t a c t s a s a b u s i n e s s b ar o me t e r a s i t i s a c o mp l e t e p r o g r a m me r o f a c t i v i t i e s o f t h e b u s i n e s s f o r t h e p e r i o d covered.According to Gordon and Shilling law budget may be defined as "a predetermineddetailed plan of action developed and distributed as-a guide to current operations and as a partial basis for subsequent evaluation of performance. "The Chartered Institute of Management ants, London, defines a budget as "afinancial and/ or quantitative statement, prepared prior for a defined period of time, of the policy to pursued during that period for the purpose of attaining a given objective."

MEANING & CONCEPT OF BUGDET : .Budget refers to a plan relating to a definite future period of time expressed in monetary and/or quantitative . In relation to business, a budget is a formal expression of the expected incomes and expenditures for a definite future period.

Budgeting – The act and entire process of preparing budget is called budgeting. .

Budgetary controlit is a system of controlling costs through preparation of budget. Budgeting is the only part of the budgetary control. It is a system of controlling costs, which includes the preparation of budgets coordinating its departments and establishing responsibility, comparing actual performance with the budgeted and the acting upon results to achieve maximum profitability.

Process of Budgetary control  Establishing budgets of each function, departments of the organization. 10

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 Comparison of actual performance with the budgeted figures in a continuous basis.  Analysis of variance that is, comparision of actual performance with the budgeted performance to know the results there of.  Taking suitable remedial where necessary.  Revisions of budget time to time in view of changes in conditions.

Definition of 'Budget' An estimation of the revenue and expenses over a specified future period of time. A budget can be made for a person, family, group of people, business, government, country, multinational organization or just about anything else that makes and spends money. A budget is a microeconomic concept that shows the tradeoff made when one good is exchanged for another.

Definition of Budgetary Control: The establishment of budgets relating 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 firm basis of its revision or in simple words, budgetary control is implementing budgets and making managers responsible for implementing it.

What are its characteristics? A budget is a financial document or an action plan which is prepared and used to project future income and expenses. It outlines an organisation‘s financial and operational goals. It can also include non- monetary information with the monetary information. They need to be made and approved in advance of the year in which they are to be used or implemented. Following are the characteristics of a good budget: -It is expressed in quantitative or monetary . 11

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- It is prepared for a fixed period of time It is prepared before the period in which it commences. -Practical to implement. -It spells out the objects and the policies to be pursued in order to achieve the objective of the organisation. -Many people are involved in drawing up a budget. -Flexible enough to allow changes in the changing environment. -Prepared on the basis of established standards of performance. -Analysis of cost and revenues. -On the basis of budget report performance of the organisation is constantly monitored. Five Characteristics of an Effective Budget Must be realistic Should be flexible Should be evaluated regularly Must be a well planned and clearly communicated Should have a simple format

Objective of Budgetary Control: 1) Planning: A budget is a plan of the policy to be pursued during the defined period of time to attain a given objective. The budgetary control will force management of all levels to plan in time all the activities to be done during the future periods. 2) Co-ordination: The budgetary control coordinates the various activities of the firm and secures C-operation of all concerned so that the common objective of the firm may be successfully achieved. 12

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3) Control: Control consists of the action necessary to ensure that the performance of the organization conforms to the plans and objectives. Budgetary control makes control possible by continuous comparisons of actual performance will that of the budget so as to report the variations from the budget to the management for corrective action. 4)Motivation An agreed-to and reasonable budget serves to motivate managers to achieve business objectives. The linkage of personnel rewards to the budget process is an additional incentive for managers to accomplish departmental goals within pertinent financial constraints. 5)Resource Allocation A budget s the efficient allocation of scarce resources in that a budget controls the volume of goods and services that will be produced. The budget also is used to plan the cost of the output produced. The essential ingredients of a budget are: It is a plan for future action, in monetary .

Advantages of Budgetary Control  Budgeting compels managers to think ahead – to anticipate and prepare for changing conditions.  Budgeting co – ordinates the activities of various departments and functions of the business.  It increases production efficiency, eliminates waste and controls the costs.  It pinpoints efficiency or lack of it.  Budgetary control aims at maximization of profits through careful planning and control.  It provides a yardstick against which actual results can be compared. .It ensures that working capital is available for the efficient operation of the business.  Opposition from staff. Employees may not like to be evaluated and thus oppose introduction of budgetary control system. As such, inefficient 13

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managers may try to create difficulties in the way of introducing and operating this system.  Expensive technique. The installation and operation of a budgetary control system is a costly affair as it requires the employment of specialized staff and involves other expenditure which small concerns may find difficult to incur. However, it is essential that the cost of introducing and operating a budgetary control system should not exceed the benefits derived there from.  Reduces Costs: In the present day competitive world budgetary control has a significant role to play. Every businessman tries to reduce the cost of production for increasing sales. He tries to have those combinations of products where profitability is more.  Introduction of Incentive Schemes: Budgetary control system also enables the introduction of incentive schemes of remuneration. The comparison of budgeted and actual performance will enable the use of such schemes.  Maximization of Profit: The budgetary control aims at the maximization of profits of the enterprise. To achieve this aim, a proper planning and coordination of different functions is undertaken. There is proper control over various capital and revenue expenditures. The resources are put to the best possible.  Co-ordination: The working of the different departments and sectors is properly co-ordinate. The budgets of different departments have a bearing on one another. The co-ordination of various executives and subordinates is necessary for achieving budgeted targets.  Specific Aims: The plans, policies and goals are decided by the top management. All efforts are put together to reach the common goal of the organization. Every department is given a target to be achieved. The efforts are directed towards achieving come specific aims. If there is no definite aim then the efforts will be wasted in pursuing different aims.  Tool for Measuring Performance: By providing targets to various departments, budgetary control provides a tool for measuring managerial performance. The budgeted targets are compared to actual results and deviations are determined. The performance of each department is reported to the top management. This system enables the introduction of management by exception.  Economy: The planning of expenditure will be systematic and there will be economy in spending. The finances will be put to optimum use. The benefits 14

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derived for the concern will ultimately extend to industry and then to national economy. The national resources will be used economically and wastage will be eliminated.  Determining Weakness: The deviations in budgeted and actual performance will enable the determination of weak spots. Efforts are concentrated on those aspects where performance is less than the stipulated.  Corrective Action: The management will be able to take corrective measures whenever there is a discrepancy in performance. The deviations will be regularly reported so that necessary action is taken at the earliest. In the absence of a budgetary control system the deviation can determined only at the end of the financial period.  Consciousness: It creates budget consciousness among the employees. By fixing targets for the employees, they are made conscious of their responsibility. Everybody knows what he is expected to do and he continues with his work uninterrupted.

OTHERS:  Like other control methods, budgets have the potential to help organizations and their reach their goals. Budget control offers several advantages to managers. Some of these are:  The major strength of budgeting is that it coordinates activities across departments.  Budgets translate strategic plans into action. They specify the resources, revenues, and activities required to carry out the strategic plan for the coming year.  Budgets provide an excellent record of organizational activities.  Budgets improve communication with employees.  Budgets improve resources allocation, because all requests are clarified and justified.  Budgets provide a tool for corrective action through reallocations.  However, budgets control can also create problems.  These dysfunctional aspects of budgets systems may interfere with the attainment of the organization's goals. One generally accepted guideline for effective budgeting is to establish goals that are difficult but attainable. 15

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 Therefore, skilled managers who understand budgets and how to use them have a powerful control tool with which to attain departmental and organizational goals.

Limitations of Budgetary Control 







Budget plan is based on estimates. Budgets are based on forecasts and forecasting cannot be an exact science. Absolute accuracy, therefore, is not possible in forecasting and budgeting. The strength or weakness of the budgetary control system depends to a large extent, on the accuracy with which estimates are made. Thus, while using the system, the fact that budget is based on estimates must be kept in view. Danger of rigidity. A budget program must be dynamic and continuously deal with the changing business conditions, Budgets will lose much of their usefulness if they acquire rigidity and are not revised with the changing circumstances. Budget plan is based on estimates. Budgets are based on forecasts and forecasting cannot be an exact science. Absolute accuracy, therefore, is not possible in forecasting and budgeting. The strength or weakness of the budgetary control system depends to a large extent, on the accuracy with which estimates are made. Thus, while using the system, the fact that budget is based on estimates must be kept in view. Danger of rigidity. A budget program must be dynamic and continuously deal with the changing business conditions, Budgets will lose much of their usefulness if they acquire rigidity and are not revised with the changing circumstances. Opposition from staff. Employees may not like to be evaluated and thus oppose introduction of budgetary control system. As such, inefficient

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managers may try to create difficulties in the way of introducing and operating this system. Expensive technique. The installation and operation of a budgetary control system is a costly affair as it requires the employment of specialized staff and involves other expenditure which small concerns may find difficult to incur. However, it is essential that the cost of introducing and operating a budgetary control system should not exceed the benefits derived there from. OTHERS:  The major problem occurs when budgets are applied mechanically and rigidly.  Budgets can demotivate employees because of lack of participation. If the budgets are arbitrarily imposed top down, employees will not understand the reason for budgeted expenditures, and will not be committed to them.  Budgets can cause perceptions of unfairness.  Budgets can create competition for resources and politics.  A rigid budget structure reduces initiative and innovation at lower levels, making it impossible to obtain money for new ideas.  Budgeting involves cost and time to prepare. The benefits of budgeting must outweigh the drawbacks. A budget can be advantageous because it:  Communicates to managers what is expected of them. Any problems in communication and working relationships are identified. Resources and requirements are identified.  For example: The production department will manufacture based on the sales department's anticipated sales volume. The purchasing department will buy raw materials based on the production department's expected production volume. The personnel department will hire or lay off workers based on anticipated production levels. Executives are forced to consider relationships among individual operations and the company as a whole.  Provides a motivational device setting a standard for employees to achieve.  Management can make distasteful decisions and blame it on the budget..  Whilst budgets are widely used to in business, you should appreciate that they have some important limitations. In particular:

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 Budgets are only as good as the data being used to create them. Inaccurate or unreasonable assumptions can quickly make a budget unrealistic  Budgeting is a time consuming process – in large businesses, whole departments are sometimes dedicated to budget setting and control  Budgets can result in short term decisions to keep within the budget rather than the right long term decision which exceeds the budget  Managers can become too preoccupied with setting and reviewing budgets and forgetting to focus on the real issues of winning customers  Budgets can also create some behavioural challenges in a business  Budgeting has behavioural implications for the motivation employees  Budgets are de-motivating if they are imposed rather than negotiated  Setting unrealistic targets adds to de-motivation  Budgets contribute to departmental rivalry - battles over budget allocation  Spending up to budget: it can result in a ―use it or lose it‖ mentality - spend up to the budget to preserve it for next year  A ―name, blame and shame‖ culture can develop - but managers should be answerable only for variations that were under their control

Essentials of Budgetary control: 1) Establishment of budgets for each function and section of the organization. 2) Continuous comparison of the actual performance with that of the budget so as to know the variations from budget and placing the responsibility of executives for failure to achieve the desires results as given in the budget. 3) Taking suitable remedial action to achieve the desires objective if there is a variation of the actual of the actual performance from the budgeted performance. 4) Revision of budgets in the light of changed circumstance. ―There are certain steps, which are necessary for the successful implementation of budgetary control system. The proper organization is essential for preparation, maintenance and istration of budgets‖  There are certain steps, which are necessary for the successful implementation of budgetary control system. 18

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1st is organization for budgetary control. The proper organization is essential for preparation, maintenance and istration of budgets. A Budgetary Committee is formed, which comprises of the departmental heads of various departments. All the functional heads re entrusted with responsibility of ensuring proper implementation of their respective departmental budgets. The chief executive of the enterprise is the over all in charge. 2th place in budgetary control system is of Budget center. This part of the organization may be a department, section of a department or another part of the department. Actually budget is being prepared only for this part of the e organization. The establishment of budget centers is required for covering all parts of the organization. 3rd part of budgetary control system is Budget Manual. It is a document, which spells out the duties and also responsibilities of various executives concerned with the budget. It specifies relation amongst various functionaries. 4th part of budgetary control system is Budget Officer who is appointed by the chief executive. Budget Officer is empowered to scrutinize the budget prepared by different departments and to make change in them, if situations so demand. The actual performance of different departments is communicated to Budget Officer. He determines the deviations in the budget and the actual performance and takes necessary steps to rectify the deficiencies, if any. 5th part of budgetary control system is Budget Committee. In small-scale concerns the ant is made responsible for the preparation and implementation of the budget. In large-scale concerns a committee known as Budget Committee is formed. The of this committee are the heads of all departments of an organization. It is responsible for preparation and execution of budget. 1) Establishment of budgets for each function and section of the organization. 2) Continuous comparison of the actual performance with that of the budget so as to know the variations from budget and placing the responsibility of executives for failure to achieve the desires results as given in the budget.

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3) Taking suitable remedial action to achieve the desires objective if there is a variation of the actual of the actual performance from the budgeted performance. 4) Revision of budgets in the light of changed circumstances. Budget Period is another important part of budgetary control system. It is the length of time for which budget is prepared. This period depends upon the nature of budget i.e. sales budget, production budget, raw material purchase budget and the economic situation of the country, the length of trade cycle and the nature of demand for the product. The budget is prepared for all functional areas. 7th part of budgetary control system is Determination of Key Factor. Budget formation is an inter-departmental and inter-related activity. A proper coordination is necessary amongst different departments for the success of budgetary control system. A factor, which influences all other budgets, is known as principal factor or key factor.

Steps in Preparing Budgetary Control: In principle, the basic steps in a standard budget preparation system comprise the following: The first step in budget preparation should be the determination of a macroeconomic framework for the budget year (and ideally at least the next two years). The macroeconomic projections, prepared by a macroeconomic unit in the ministry of finance or elsewhere, should be agreed with the minister of finance. This allows the budget department within the ministry of finance to determine the global level of expenditure that can be afforded without adverse macroeconomic implications, given expected revenues and the level of deficit that can be safely financed. In a few countries, there are fiscal rules in place that may limit total spending or recurrent spending (e.g., the "golden rule").16

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The second step should be the allocation of this global total among line ministries, leaving room for reserves (a separate planning and a contingency reserve as explained below) to be managed by the ministry of finance. The third step should be for the budget department to prepare a budget circular to give instructions to line ministries, with the indicative aggregate spending ceiling for each ministry, on how to prepare their estimates in a way that will be consistent with macro objectives. This circular will include information on the economic assumptions to be adopted on wage levels, the exchange rate and price levels (and preferably differentiated price levels for different economic categories of goods and services). Step four is the submission of bids by line ministries to the budget department. Once received there needs to be an effective "challenge" capacity within the budget department to test the costing of existing and any new policy proposals. The fifth step comprises the negotiations, usually at official and then bilateral or collective ministerial level, leading finally to agreement. Finally, step six is Cabinet endorsement of the proposals for inclusion in the budget that will go to parliament. 1)Organisation for budgeting The setting up of a definite plan of organisation is the first step to be taken prior to beginning the real work of installing budgetary control. The responsibility of eachexecutive must be clearly defined. There should be no uncertainty regarding the point where the jurisdiction of one executive ends and that of another begins. 2)Budget manual The budget manual is a written document or booklet which specifies theobjectives of the budgeting organisation and procedures. The chartered institute of management ants, London defines it as ―a document which sets out, theresponsibilities of the persons engaged in, the routine of, and the forms andrecords required for, budgetary control.‖ Following are some important matterscovered in a budget manual:1)A statement regarding the objectives of the organisation and how they can be achieved through budgetary control.2)A statement regarding the functions and responsibilities of each executive by designation both regarding preparation and execution of budgets.3)Procedures to be 21

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followed for obtaining the necessary approval of budgets.The authority of granting approval should be stated in explicit .Whether one, two or more signatures are to be required on each documentshould also be clearly stated.4 ) T i me - t a b l e s f o r a l l s t a g e s o f b u d g e t i n g . 5)Reports, statements, forms and other records to be maintained.6)The s classification to be employed. It is necessary that theframework within which the costs, revenues and other financial sare classified must be identical both in the s and the budgetdepartments.There are many advantages attached to the use of budget manual. It is a formalrecord defining the functions and responsibilities of each executive. Themethods and procedures of budgetary control are standardised. There issynchronisation. There is synchronisation of the efforts of all which results inmaximisation of the profits of the organisation. 3)Responsibility for budgeting 1) Budget controller- the chief executive is ultimately responsible for the budget programme but it will be better if the large part of the supervisoryresponsibility is delegated as budget controller or director. The budgetcontroller or director should have knowledge of the technical side of the business and should report directly to the president.2) Budget committeethe budget controller will be assisted in his work by the budget committee. The budget committee will consist of heads of the variousdepartments such as production, sales, finance etc. with budget controller asits chairman. It will be the duty of the department will have his own sub-committee with executives working under him as its member. While the principles should be broadly familiar in most ministries of finance (and would even be considered out of date in those industrial countries with the most advanced budgeting systems), actual practices may fall a long way short. For example: In too many countries the budget department does not prepare a macro framework, nor even a first outline of the budget, let alone indicative ceilings by line ministry, before sending out the budget circular. In such cases, the circular is an istrative mechanism that initiates the budget-making process, usually providing a timetable for budget submissions--that is, estimates of financial requirements by line item and by line ministry or 22

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spending agency--but not giving them much guidance in the preparation of their estimates or overall spending limits. Thus, when preparing their budget requests, the ministries often merely add percentages, guided by an inflation projection in the circular, to their previous year's budget. With this "bottomup approach," line ministries are able to overstate their needs, exerting upward pressure on overall spending. Early in the preparation stage, that is before the budget circular is issued, those advising on the preparation of the budget should ask: Is the budget based on an aggregate level of general or central government expenditure, in cash , that is consistent with the macro framework, and any fiscal rules in place? Does the budget circular to the line ministries provide adequate guidance on preparing budget estimates? Does it include a guideline or limit for each line ministry on this total spending? Are there suitable reserves? Ideally, within the aggregate total there should be a planning reserve (not allocated in guidelines given to each line ministry), so the ministry of finance can assign extra resources later during budget negotiations for the most urgent priorities, without breaching the macroeconomic constraint. Moreover, after all final line ministry allocations have been made, there should still be a contingency reserve within the aggregate that will be held and istered by the ministry of finance to meet genuine contingency spending during the budget year.

Classification of budgets Classification on the basis of Function and Scope (i)Functional Budget, (ii) Master Budget Classification on the basis of flexibility (i)Fixed Budget, (ii) Flexible Budget

Functional Budget It is the one, which relates to particular functions of the business or organization. The types of functional budgets are 23

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1. 2. 3. 4. 5. 6. 7. 8.

Sales budget Production budget Raw materials budget Labour budget etc Cash budget Capital expenditure budget Purchase budget. Master Budget A functional budget is the budget that is achievable and is related to a specific unit or process or function or department of the organisation. I t is a group of related activities aimed at accomplishing a major service or program for which a unit of government is responsible. A functional budget is prepare for a process of function. By functional budgets, we mean budgets that relate to an area of an organisation that produces, or does, something. This is not necessarily to say that we are talking about manufacturing alone. We can have functional budgets in manufacturing, in commerce, in government. We can have functional budgeting in non profit making organisations too. The key principles of functional budget preparation are ·Understand the function, process or system you are budgeting · Find all of the data you need · Separate the values from the volumes.. . Check for interrelationships, understand and use them. · Check your arithmetic once you have prepared each budget

MASTER BUDGET: . Master or final budget is a summary budget which incorporates all functional budgets in a capsule form. It sets out the plan of operations for all departments in considerable detail for the budget period. . Master budget require the approval of the Budget Committee before it is put into operation. It may happen, sometimes, that a number of master budget have to be prepared before the final one is agreed upon. The budget generally contains details regarding sales (net), production costs, cash 24

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position, and key balances (e.g. debtors, fixed assets, bills payable, etc). It also shows the gross and net profits, and the important ing ratios . The master budget is a summary of company's plans that sets specific targets for sales, production, distribution and financing activities. It generally culminates in a cash budget, a budgeted income statement, and a budgeted balance sheet. In short, this budget represents a comprehensive expression of management's plans for future and how these plans are to be accomplished. It usually consists of a number of separate but interdependent budgets. One budget may be necessary before the other can be initiated. More one budget estimate effects other budget estimates because the figures of one budget is usually used in the preparation of other budget. This is the reason why these budgets are called interdependent budgets.

Advantages

and

Disadvantages

of

a

Master

Budget: Some advantages of a master budget are that it can give an idea of where a company wants to go and what it has to do in order to get there. It will also allow the company to realistically project future cash flows which in turn would help in getting certain types of financing. Some disadvantages of a master budget include the time involved in producing such a budget. This is primarily the reason a smaller company may not make a master budget if the company has a very small managerial staff.

Fixed and Flexible Budgets .Fixed Budget: A fixed budget is designed to remain unchanged irrespective of the level of activity. This budget is prepared on the basis of a standard of fixed level of activity. Since the budget does not change with the change of level of activity, it becomes an unrealistic yardstick in case the level of activity (volume of production or sales) actually attained does not conform to the one assumed for budgeting purposes. 25

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. The management will not be in a position to assess the performance of different heads on the basis of budgets prepared by them, because they can serve as yardsticks only when the actual level of activity corresponds to the budgeted level of activity. On of the limitation of fixed budget and its inability to provide for automatic adjustments when the volume changes, firms whose sales and production cannot be accurately estimated have given up the practice of fixed budget. Any budget in any functional area of an operation can be established as a fixed budget or a flexible budget. A fixed budget is established for a specific level of activity and is not adjusted to the actual level of activity attained at the time of comparison between the budgeted and actual results. Naturally, a fixed budget is established only for a short period of time where the budgeted level of activity is expected to be attained to the maximum possible extent. It is more suitable for fixed expenses, i.e. the expenses which have no relation with the level of activity. This budget does not indicate that it cannot be changed at all. It can be revised if the actual level of activity is likely to differ widely from the budgeted level of activity. A fixed budget cannot be used as an effective tool of cost control while computing the variations between the budgeted result and the actual result. The variance cannot be explained properly. Also, it is not possible to say whether the variance is due to the changes in the level of activity or due to the efficiency or inefficiency of the executive responsible for the execution of the budget.

Flexible Budget: It is designed to change in accordance with the level of activity attained. Thus, when a budget is prepared in such a manner that the budgeted cost for any level of activity is variable, it is termed as flexible budget. Such a budget is prepared after considering the fixed and variable elements of cost and the changes that may be expected for each item at various levels of operations A flexible budget is designed to change with the fluctuations in the level of activity and provides a basis of comparison for any level of activity actually attained. A flexible budget is more elastic and practical. It can be properly used as an effective tool for the evaluation of performance and cost control. It explains the variations between the budgeted and actual results. It also states the variations which are due to changes in the level of activity (which is beyond the control of operating executive) and which are due to the operational efficiency or inefficiency (for which the operating executive is responsible.) 26

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For the purpose of establishment of flexible budgets, it is necessary to classify the costs as fixed costs, variable costs and semi-variable costs. The fixed costs remain same at all levels of activity whereas the variable costs change directly in proportion to the level of activity. As far as the semivariable costs are concerned, each item of cost is examined and classified into its fixed and variable elements and a trend is established regarding the nature and behavior of each item of cost.

ZERO BASE BUDGETING .It is an alternative of traditional budgeting. The traditional budgeting is based on incremental and previous year figure use to take into consideration. But in Zero Base Budgeting figures are developed with zero as the base which means a budget will be prepared as if it is being prepared as a new for the first time. It is a method of budgeting where all activities are revalued each time a budget is set.Zero-based budgeting is an approach to planning and decision-making which reverses the working process of traditional budgeting. In traditional incremental budgeting (Historic Budgeting), departmental managers justify only variances versus past years, based on the assumption that the "baseline" is automatically approved. By contrast, in zero-based budgeting, every line item of the budget must be approved, rather than only changes.During the review process, no reference is made to the previous level of expenditure. Zero-based budgeting requires the budget request be re-evaluated thoroughly, starting from the zero-base. This process is independent of whether the total budget or specific line items are increasing or decreasing. The term "zero-based budgeting" is sometimes used in personal finance to describe "zero-sum budgeting", the practice of budgeting every unit of income received, and then adjusting some part of the budget downward for every other part that needs to be adjusted upward. Zero based budgeting also refers to the identification of a task or tasks and then funding resources to complete the task independent of current resourcing. Performance Budget:

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This whole framework points us to a newer way of budgeting, the performance-based budgeting. As explained by Carter (as quoted in ) ―Performance budgets use statements of missions, goals and objectives to explain why the money is being spent. It is a way to allocate resources to achieve specific objectives based on program goals and measured results.‖ The key to understanding performance-based budgeting lies beneath the word ―result‖. In this method, the entire planning and budgeting framework is result oriented. There are objectives and activities to achieve these objectives and these form the foundation of the overall evaluation. According to the more comprehensive definition of Segal and Summers, performance budgeting comprises three elements:  The result (final outcome)  The strategy (different ways to achieve the final outcome)  Activity/outputs (what is actually done to achieve the final outcome) Segal and Summers point out that within this framework, a connection exists between the rationales for specific activities and the end results and the result is not excluded, while individual activities or outputs are. With this information, it is possible to understand which activities are cost-effective in of achieving the desired result. As can be seen from some of the definitions used here, Performance-Based Budgeting is a way to allocate resources for achieving certain objectives, Harrison elaborates: ―PBB sets a goal, or a set of goals, to which monies are ―connected‖ (i.e. allocated). From these goals, specific objectives are delineated and funds are then subdivided among them.‖ Budget s a manager's efforts to monitor operations, identify variances and enact corrective action if necessary. It allows an evaluation of activities in of contribution to organizational objectives. Sales Budget Sales budget is a functional budget. The product wise as well as regional breakup of sales estimates are incorporated in the sales budget. The sales

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budgetbegins with the previous year actual and incorporates the likely changes

Production Budget The production budget is prepared based on the sales estimate incorporated inthe sales budget. The adjustments with respect to the opening and closing stockpositions that are policy decisions of the business are then made to prepare theproduction budget.

Purchase Budget The purchase budget is another functional budget that estimates thepurchase requirement of materials utilized in the production process. Thepurchase budget is based on the production budget and the standard materialconsumption requirement for the production estimates. Management Science-II Prof. R.Madumathi Expenditure Budgets Expenditure budgets may be drafted as fixed / flexible budgets. A fixed budget isone which is prepared keeping in mind one level of activity. It is defined as onewhich is designed to remain unchanged irrespective of the level of activityattained.In contrast, flexible budget is one which is designed to change in relation to the level of activity attained. Flexible budgets are prepared where the natureof business is such that it is difficult to predict the demand/sale of goods. Cash Budget A cash budget consolidates all the cash inflows and outflows for the business.The cash budget is also a functional budget. The cash budget helps the businessto plan the project purchases as well as to provide for the loan requirements. Thecash budgets also help in defining the repayment plans for short and long termloans of the business. Management Science-II Prof. R.MadumathiIndian Institute of Technology Madras The cash budget is based upon the business policy of holding a certain amountas cash. This is the desired opening cash balance for the business. Accordingly,the cash budget forecasts the loan requirements or short term investments thatare to be made with excess cash at any specific time. 29

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Budget Preparation A full understanding of the budget planning and preparation system is essential, not just to derive expenditure projections but to be able to advise policymakers on the feasibility and desirability of specific budget proposals, from a macroeconomic or microeconomic perspective. It is much easier to control government expenditures at the "upstream" point of budget preparation than later during the execution of the budget. Thus, fiscal economists and general budget advisors need to know: 

what is the framework in which budget decisions are made;



who is responsible for planning and preparing the budget;



what are the basic steps;



what are the typical weaknesses in procedures and how can these be overcome; and



how can changes in budget plans be programmed and targeted? Answers to these questions are set out in the subsections below. Budget planning and preparation are (or should be) at the heart of good public expenditure management. To be fully effective, public expenditure management systems require four forms of fiscal and financial discipline:

1. control of aggregate expenditure to ensure affordability; that is, consistency with the macroeconomic constraints; 2. effective means for achieving a resource allocation that reflects expenditure policy priorities; 3. efficient delivery of public services (productive efficiency); and 4. minimization of the financial costs of budgetary management (i.e., efficient budget execution and cash and debt management practices). Budget preparation is the principal mechanism for achieving items (1) and (2); item (3) typically features as an element of budget preparation only in industrial countries, while item (4) is essentially an issue in budget execution and cash management (see Sections 4 and 5). Moreover, no system of budget execution or cash planning (the subjects of Sections 4 and 5) can do more than mitigate the problems caused by poor quality or unrealistic budget preparation.

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What is the framework in which budget decisions are made? Budget preparation is a process with designated organizations and individuals having defined responsibilities that must be carried out within a given This process is normally established and controlled by a legal and regulatory framework. While generally sharing broadly common procedures, budget preparation (and execution) systems do exhibit differences depending on their historic origin. Given the common heritage of many countries, it is possible to identify four main patterns--francophone, Latin American, (British) Commonwealth, and transition economies. To understand the budget preparation process in a given country, it is important to: 

assess the basic soundness by judging the budget preparation system against certain internationally accepted standards or "budget principles";



know where to find the rules governing the budget preparation process; and



from those rules, identify who has the responsibility for what elements of the budget preparation process.

Recognizing the usefulness of budget principles Based on the objective macroeconomic assessment of available revenues and financing, ideally, the expenditure budget should aim to be comprehensive, transparent, realistic, policy-oriented, and allow for clear ability in budget execution. These concepts form a standard by which the soundness of budget systems can be judged (see Box 1).

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Box 1. Assessing the Soundness of the Budget The soundness of budget systems can be judged by the following: Comprehensiveness 

Is the coverage of government operations complete?



Are estimates gross or does netting take place? Transparency



How useful is the budget classification? Are there separate economic and functional classifications that meet international standards?



Is it easy to connect policies and expenditures through a program structure? Realism



Is the budget based on a realistic macroeconomic framework?



Are estimates based on reasonable revenue projections? How are these made, and by whom?



Are the financing provisions realistic?



Is there a realistic costing of policies and programs and hence expenditures (e.g., assumptions about inflation, exchange rates, etc.)



How are future cost implications taken into ?



Is there a clear separation between present and new policies?



How far are spending priorities determined and agreed under the budget process?

In most Organization for Economic Cooperation and Development (OECD) countries, comprehensiveness and transparency are achieved by deg a budget system with three key characteristics. Annuality. A budget is prepared every year, covering only one year; voted every year; and executed over one year. While maintaining the core concept of annual authorization, this principle has been modified at the preparation stage, such that most OECD countries now develop the annual budget within a multiyear perspective, through the preparation of medium-term revenue 32

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and expenditure frameworks. A very few are moving toward determining budget appropriations for more than one year at a time. Unity. Revenue and expenditure (as well as borrowing constraints) should be considered together to determine annual budget targets. The budget should cover all government agencies and other institutions undertaking government operations, so that the budget presents a consolidated picture of these operations and is voted on, as a whole, in the parliament. Universality. All resources should be directed to a common pool or fund, to be allocated and used for expenditures according to the current priorities of the government. In general, earmarking of resources for specific purposes is thus to be discouraged; but the case of extrabudgetary funds is considered in more detail below. These three characteristics are essential to ensure that, in budget preparation, all policy proposals for undertaking government expenditure will be forced to compete for resources, and that priorities will be established across the whole range of government operations. They are usually considered a prerequisite to meeting the first two of the four main goals of effective public expenditure management noted at the beginning of this Section: exercising the macroeconomic constraint of affordability on the total, and ensuring efficiency in the allocation of resources. These characteristics are typically enshrined in a legal and istrative framework regulating the budget process.

Knowing the rules Although the precise legal framework for central government budgeting varies from country to country, it is usually set out at several levels. The constitution is the highest in the legal hierarchy. Although it deals only with broad principles, the constitution may clarify three important aspects: (1) the relative powers of the executive and legislative branches with respect to public finances; (2) the definition of the financial relations between national and subnational levels of government; and (3) the requirement, for example, in Commonwealth systems, that all public funds be paid into designated s, and that these funds be spent only under the authority of a law. The organic law is usually the main vehicle for establishing principles of public financial management. These laws may take the form of a single law that guides budget preparation, approval, execution, control, and auditing (loi organique relative au budget in the francophone system; ley de 33

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istración financiera in the Latin American system), or there may be several general laws covering specific areas of public finance management (e.g., under Commonwealth systems) that may also relate to subnational levels of government. They are called "organic" because they relate to organizational matters and systems, and do not therefore require annual reenactment. Moreover, they can often be modified only under certain conditions, such as qualified parliamentary majority. Financial regulations. The organic budget law also gives to the government, or the minister responsible for public finance, the authority to issue detailed regulations and instructions (for instance décret portant réglement de la Comptabilité Publique in the francophone system, and decreto para la contabilidad pública in the Latin American system). These are often quite detailed. The constitution, the budget organic law, and financial regulations are permanent and form the legal framework within which the annual budget law, which includes the revenue and expenditure estimates for a given year, is prepared, approved, executed, and audited. The annual budget law can take different shapes depending on the system. In the francophone and Latin American systems, the coverage of the annual budget law (called budget or loi de finances in francophone countries and ley anual de presupuestos in Latin America) is rather wide, since it contains the amount and details of revenue and expenditure, the balance, and also any new tax legislation measures and some changes to spending. Under the Commonwealth system, both revenue and expenditure estimates are presented. Often the latter are further divided into recurrent and development estimates, sometimes presented as separate volumes. Typically, the presentation is detailed by institution and line item. By contrast, the annual budget in many transition economies has often been rather summary in format: prior to any recent reforms, budget estimates were presented by budgetary institution--typically only the major supervisory institutions and not their subordinate units--and broken down only by broad "functions," more or less the sectors used in the previous central planning framework.

Identifying the responsibilities within the budget system The powers assigned to the legislative and executive branches, and, within the executive branch, who does what, essentially define the responsibilities for preparing the budget (Box 2)

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. Box 2. The Framework that Regulates the Budget: What Do You Need to Know? The following summarizes some of the key questions on the overall budget preparation framework. What is the budget timetable? How are budgeting powers distributed between the executive and legislative branches? 

legislative power to propose spending



power of amendment



one vote--global vote on spending



executive powers to limit spending below appropriations How are budgeting powers distributed within the executive?



number of agencies involved; who does what?



agenda for setting budget negotiations; how is this determined?



structure of negotiations--who has veto power? How are activities funded?



revenue s



borrowed resources



extrabudgetary mechanisms



multiple funds



contingency funds



special funds Any legislative limits on:



expenditure?



deficit?

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

borrowing?



carryover of spending authority to next year? Any earmarking?



special or hypothecated funds



constitutional or legal commitments on specific public services (education, health)

For instance, when considering expenditure changes at the budget preparation stage, countries vary in the extent to which the parliament can change the budget, once it is submitted for their consideration. Many countries, for example, allow for the composition of the expenditure or revenue plans to be changed but not the global total; in others, particularly in a number of transition economies, new expenditure proposals--often poorly costed--can be put forward, approved by the parliament, and thus enter into the budget. Although those preparing the budget can help improve parliamentary understanding through discussions, the budget must ultimately be negotiated by the executive with the legislature.

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Conclusion A budget should be based on norms and standards. The budget should be coordinated, integrated, organized, systematic, clear, and comprehensive to accomplish optimal results. The budget preparation, review, and evaluation process must be facilitated. An orderly budgeting process will result in less cost, less man -hours, and minimization of conflict and turmoil. It will require less revision at a later date. The budget process must consider input -output relationships. The budget aids in anticipating problems before they become critical. Short-term budgets should be used for businesses subject to rapid change. A budget is a tool for planning and for "what-if" analysis. It aids in identifying the best course of action. As it is in the computer world—garbage in, garbage out—so it is with budgeting. If forecasts are inaccurate so will be the projections, resulting in bad management decisions to the detriment of the firm. A manager must be cautious when analyzing past experience. Unforeseen circumstances such as economic downturns and future innovations have direct inputs on current operations. A manager deviating from a budget target must explain why and, of course, is on the defensive. Without proper justification for missing targets, the manager may be dismissed.

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www.google.com www.wikipedia.com www.budgetarycontrol.com www.yahooindia.com

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