SUITABILITY OF BUDGETING

Suitability of Budgeting

Suitability of Budgeting

Introduction

A Budget is a plan expressed in financial terms.

C.I.M.A. defines a budget as 'A plan quantified in monetary terms, prepared prior to a defined period of time... to attain a given objective', A budget is normally for a relatively short period, e.g. 1 year.

Purposes of Budgeting

A number of purposes of budgeting have been identified. They include:

1. Planning.

2. Resource Allocation.

3. Co-ordination.

4. Control.

5. Communication.

6. Motivation.

7. Performance Evaluation.

Budgetary Control

This is a system which uses budgets as a means of controlling the activities of the organisation. It has three main aspects:-

1. Planning.

2. Co-ordination.

3. Control.

Planning

Budgetary planning is the process of preparing detailed, short-term plans for all the functions, departments and activities of the organisation. It is important that the short-term plans and objectives that make up the budget are related to the long-term plan and objectives of the organisation. The budget may be drawn up by preparing an overall budget for the organisation which is then broken down into more detailed budgets for the different parts of the organisation [the top-down approach] or by devising budgets for the various parts of the organisation and then bringing them together to build up the overall budget [the bottom up approach].

Extrapolations, Forecasts and Plans

In discussing budgetary planning it is important to distinguish between extrapolations, forecasts and plans.

An extrapolation is the continued projection of an existing trend.

A forecast will be based on an extrapolation, but is adjusted to take account of any known factors which will affect the trend.

A plan involves some intervention by the organisation in order to modify events in such a way as to make it more likely that the organisation's objectives will be achieved.

Co-ordination

It is vital that the plans of each department are related to each other and are integrated together to make a coherent whole e.g. it is no use planning for sales of 150,000 units if productive capacity is restricted to 120,000 units. Note the significance in this context of limiting factors and the principal budget factor.

The principal budget factor is the factor which acts as an over-riding limitation on the activities of the organisation. It might be sales, productive capacity, finance, shortages of materials, labour or energy. The principal budget factor can change over time. Identifying limiting factors is a key element in the co-ordination aspect of budgetary control.

The Master Budget

This is the overall plan for the business's financial activities, to which, therefore, its sectional plans must be related. For commercial organisations it will be normally in the form of a planned Income Statement, Balance Sheet and Cash Flow Statement.

The master budget is the key element in budget co-ordination as it summarises all the other plans and reveals any inconsistencies amongst them.

Control

As far as possible, actual Activity should be in line with the original plan and steps should be taken to restore Activity to the plan when there are deviations from it [although on occasions it will be necessary to adjust the plan to meet changing circumstances].

Control is exercised in organisations by the continual feedback of information ...