What is Budgetary Control in Management Accounting? Best Notes for BBA, MBA

Budgetary control is a crucial financial management tool that helps organizations plan, monitor, and control their financial resources effectively. By setting predefined budgets, companies can track performance against goals, identify variances, and make informed decisions to optimize their operations. Understanding the meaning of budgetary control, its key objectives, the benefits it offers, and the limitations it presents is essential for businesses looking to maintain financial discipline and achieve long-term success.

In this guide, we’ll delve into these aspects to provide a comprehensive overview of budgetary control and its significance in modern business management.

Introduction to Budget: 

A budget is a financial plan that helps you decide how to spend your money wisely. Imagine receiving ₹10,000 as pocket money each month. If you spend it all on movies, snacks, and clothes, you might not have enough left for important things like school supplies or saving for something special. A budget helps you plan in advance how much money you should allocate for each of these things.

In businesses, a budget works similarly. Companies create budgets to plan how they will spend their money, helping them avoid overspending in one area and not having enough for other important needs. For example, a company might decide to spend ₹5,00,000 on marketing, ₹3,00,000 on salaries, and ₹2,00,000 on new equipment over the next year.

What is Budgetary Control? 

Budgetary control is like having a strict parent who makes sure you stick to your budget. Let’s go back to the pocket money example. If you plan to save ₹2,000 out of your ₹10,000 pocket money but find yourself tempted to spend it on a new video game, budgetary control is the self-discipline that reminds you to stick to your plan.

In a business context, budgetary control means the company regularly checks and compares its spending with the budget. If they plan to spend ₹5,00,000 on marketing but are close to overspending, they will either cut back or find savings elsewhere. This control ensures the company doesn't run out of money or overspend, helping them achieve their financial goals.

So, in simple terms, a budget is your spending plan, and budgetary control is the practice of making sure you stick to that plan.

Essentials of Budgetary Control

1. Creating a Budget
   • What it Means: Before spending money, a business creates a detailed plan showing how much money will be allocated to different areas.
   • Example: A small business might set aside ₹2,000 for office supplies, ₹5,000 for marketing, and ₹3,000 for utilities each month.
2. Monitoring Spending
   • What it Means: Regularly check actual expenses against the budget to see if the business is staying within its limits.
   • Example: Each month, the business checks if it has spent ₹2,000 on office supplies as planned or if the actual amount is higher or lower.
3. Analyzing Variances
   • What it Means: Looking at differences between the budgeted amount and actual spending to understand why they occurred.
   • Example: If the business spent ₹2,500 on office supplies instead of ₹2,000, they analyze why there was an extra expense, such as unexpected costs.
4. Adjusting Plans
   • What it Means: Making changes to future budgets or spending plans based on the analysis to improve financial management.
   • Example: If the business finds it consistently overspends on marketing, it might adjust its budget or find ways to reduce marketing costs.

Objectives of Budgetary Control

1. Ensure Efficient Use of Resources
   • Objective: To make sure money is used wisely and not wasted.
   • Example: A company wants to ensure that every rupee spent on advertising brings in more customers, thus making sure the money is well spent.
2. Control Costs
   • Objective: To prevent overspending and keep costs within the set budget.
   • Example: A factory sets a budget of ₹50,000 for raw materials. Budgetary control helps ensure they don’t spend more than this amount.
3. Achieve Financial Goals
   • Objective: To help businesses reach their financial targets and goals.
   • Example: If a business aims to save ₹1,00,000 for expansion, budgetary control helps them track savings and manage expenses to reach this goal.
4. Improve Financial Planning
   • Objective: To provide a clear picture of financial performance and help in better planning.
   • Example: By reviewing past budgets and actual spending, a business can make more accurate budgets for the future.
5. Enhance Decision Making
   • Objective: To provide useful information that helps in making better financial decisions.
   • Example: If a company sees that it is consistently under budget in one area, it might decide to reallocate those funds to another area needing more investment.
6. Promote Accountability
• Objective: To ensure that everyone responsible for spending stays within the budget and is accountable for their financial decisions.
• Example: Each department in a company has its budget and is responsible for sticking to it. If a department overspends, they need to explain why.

Steps in Budgetary Control

1. Set Clear Objectives

Know what you want to achieve, like saving a certain amount of money, increasing sales, or controlling expenses.

Example: Suppose a small café wants to increase its monthly profit. The goal is to save INR 10,000 more than last month by cutting down on unnecessary expenses and boosting sales.

2. Prepare a Budget

Create a detailed plan of how much money you expect to earn and spend over a period.

Example: The café owner creates a budget for the next month. They estimate:

• Sales revenue: INR 1,50,000
• Cost of ingredients: INR 40,000
• Staff salaries: INR 30,000
• Rent and utilities: INR 20,000

The total planned expenditure is INR 90,000, so the expected profit would be INR 60,000.

3. Implement the Budget

Put your budget plan into action by spending money according to the budget and ensuring all departments follow it.

Example: The café starts buying ingredients, paying staff, and covering other expenses as outlined in the budget. The owner also keeps an eye on sales to ensure they match the projections.

4. Monitor and Compare

Regularly check actual spending and income against the budget to identify any deviations

Example: Halfway through the month, the café owner notices that ingredient costs are higher than planned, and sales are lower. They compare these figures with the budget to understand the differences.

5. Analyze Variances

Investigate differences between the budgeted and actual figures to understand why these differences occurred.

Example: The café's ingredient costs were higher due to a price increase from suppliers, and sales were lower because of unexpected weather conditions. Analyzing these reasons helps in making adjustments.

6. Take Corrective Actions

Make necessary changes to spending or revenue strategies based on the analysis.

Example: The café owner decides to find alternative suppliers with better rates and plans special promotions to boost sales for the rest of the month.

7. Review and Adjust

At the end of the budget period, review the overall performance and adjust the budget for the next period based on what was learned.

Example: After the month ends, the café owner reviews the entire budget performance. They see that the promotions helped increase sales, and they plan to include these strategies in the next month’s budget.

Types of Budgets

Budgets are essential tools for managing finances. They help individuals and organizations plan how to spend and save money. Budgets can be classified in various ways based on different factors. 

1. Based on Coverage

Comprehensive Budget: This budget covers all aspects of finances. For example, if you’re planning a wedding, a comprehensive budget would include expenses like venue rental, food, decorations, and attire. It gives you a complete view of all costs involved.

Partial Budget: This budget only covers specific areas. For instance, if you only want to budget for the food and decoration of a party, you would create a partial budget focusing solely on those expenses.

2. Based on Capacity

Operating Budget: This budget deals with day-to-day expenses. Think of it like your monthly grocery bill. If you spend ₹5,000 on groceries, ₹2,000 on transportation, and ₹1,000 on utilities, your operating budget helps you track these regular costs.

Capital Budget: This budget is for big, long-term investments. For example, if you’re saving to buy a car or build a house, you’d use a capital budget to plan and manage these significant expenses. If you plan to buy a car costing ₹5,00,000, a capital budget helps you save and allocate money for this purchase over time.

3. Based on Conditions

Flexible Budget: This type of budget can be adjusted based on changes in conditions. Suppose you’re running a small business. If your sales increase, a flexible budget helps you adjust your spending on supplies and marketing accordingly.

Static Budget: This budget remains fixed regardless of changes in conditions. For instance, if you plan a fixed amount of ₹10,000 for a vacation and stick to it even if you find cheaper or more expensive options, you’re using a static budget.

4. Based on Time Periods

Short-Term Budget: This budget covers a short period, usually one year or less. For example, if you plan to save ₹20,000 over the next six months for a new laptop, you’re creating a short-term budget.

Long-Term Budget: This budget spans a longer period, usually more than a year. For instance, if you’re saving ₹1,00,000 annually to build a house over the next five years, you’re working with a long-term budget.

Preparation of Flexible Budgets

A flexible budget is a financial tool that adjusts for changes in the level of activity. It helps businesses understand how costs behave with varying levels of production or sales. Let’s break it down in a simple way with an example.

What is a Flexible Budget?

Imagine you run a small bakery. You prepare a budget for the month, but you know that your sales can vary—some days are busy with many customers, while other days are quiet. A flexible budget helps you adjust your budget based on the actual number of customers or sales you experience.

Why Prepare a Flexible Budget?

1. Better Planning: It allows you to plan for different levels of activity, not just one fixed amount.
2. Cost Control: Helps you see how changes in sales or production affect your costs.
3. Performance Evaluation: Assists in comparing actual performance against what was budgeted, taking into account changes in activity.

How to Prepare a Flexible Budget

1. Identify Key Variables: Determine what factors affect your costs and revenues. In our bakery, these might be the number of cakes baked and sold, and the cost of ingredients.
2. Create a Base Budget: Start with a fixed budget based on a standard level of activity. For example, you might budget for 500 cakes in a month with associated costs.
3. Estimate Costs and Revenues for Different Levels: Create different scenarios based on possible sales volumes. For example:
   • Low Activity: Budget for 300 cakes.
   • Medium Activity: Budget for 500 cakes.
   • High Activity: Budget for 700 cakes.
4. Calculate Variable Costs: These costs change with the number of cakes baked. For example, if the cost of ingredients is ₹20 per cake, the cost for 500 cakes would be ₹10,000 (₹20 x 500).
5. Add Fixed Costs: These costs remain the same regardless of how many cakes you bake. Suppose you pay ₹5,000 for rent and ₹2,000 for utilities each month.
6. Prepare Flexible Budget Statements: Create a budget statement for each level of activity:
   • A. Low Activity (300 cakes):
     • Variable Costs: ₹6,000 (₹20 x 300)
     • Fixed Costs: ₹7,000 (₹5,000 rent + ₹2,000 utilities)
     • Total Costs: ₹13,000
   • B. Medium Activity (500 cakes):
     • Variable Costs: ₹10,000 (₹20 x 500)
     • Fixed Costs: ₹7,000
     • Total Costs: ₹17,000
   • C. High Activity (700 cakes):
     • Variable Costs: ₹14,000 (₹20 x 700)
     • Fixed Costs: ₹7,000
     • Total Costs: ₹21,000
7. Compare Actual Performance: At the end of the month, compare your actual costs and sales to the flexible budget. If you baked and sold 600 cakes, adjust your budget to see how your costs should have been if you were operating at that level.

Example in Practice

Suppose at the end of the month, you baked 600 cakes, and your actual costs were ₹18,000. Compare this with your flexible budget for 600 cakes (which might be between the costs of 500 and 700 cakes). This helps you understand if you were efficient or if there were unexpected costs.

Benefits of a Flexible Budget

1. Adaptability: Adjusts to actual performance, making it more accurate than a static budget.
2. Insightful Analysis: Provides a clear picture of how changes in activity affect costs and revenues.
3. Improved Decision Making: Helps you make informed decisions based on real-time data.