Budgetary control definition
/What is Budgetary Control?
Budgetary control is a system of procedures used to ensure that an organization's actual revenues and expenditures adhere closely to its financial plan. The system typically involves setting personal goals for managers that are based on the budget, along with a set of rewards that are triggered when the goals are attained. In addition, budget versus actual reports are routinely issued to anyone having responsibility for a line item in the financial statements; they are then expected to take action to correct any unfavorable variances. Further, the results of the business are closely monitored by a budget committee, which provides feedback to managers whenever actual results threaten to fall below expectations. The budget may even be loaded into the purchasing and payables software, so that purchases are immediately flagged if they exceed the budgeted amount.
Advantages of Budgetary Controls
There are multiple advantages to the use of budgetary controls, which is why they are installed in most larger businesses. Here are the key advantages:
Cost reduction. By adhering to a system of planned costs, managers can spot unfavorable variances and remediate them as soon as possible. Also, tight control over capital budgeting ensures that major cash outlays are only made on those fixed assets included in the underlying plan.
Goal clarification. The presence of budgetary controls is a good way to clarify with employees exactly what management believes to be the most important goals of the organization. This is because funds are directed at what are considered to be the most important goals, while funding is restricted elsewhere.
Performance measurement. A system of budgetary controls establishes a baseline of expected revenues and expenses, against which actual results can be compared. This represents a good tool for senior management, which can review budget-versus-actual reports to determine where the business is matching expectations and where it is not.
Profit enhancement. By maintaining tight control over costs, a system of budgetary controls keeps excess expenditures down, which tends to drive profits up. Further, budgetary controls tend to emphasize efficiency, which also tends to improve profits.
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Example of Budgetary Control
A small retail clothing store sets an annual budget to manage its expenses, forecast revenues, and achieve profitability. The business uses budgetary control to monitor its financial performance and ensure it stays aligned with its goals. The store owner prepares a budget at the beginning of the year, which contains the following items:
Sales Revenue: $500,000
Cost of Goods Sold (COGS): $250,000
Operating Expenses: $200,000 (including rent, utilities, salaries, advertising, etc.)
Net Profit Goal: $50,000
The store owner sets a monthly revenue target of $41,667 ($500,000 ÷ 12), as well as a cost of goods sold target of $20,833 and operating expenses of $10,667. Each month, the store compares actual performance against the budget. Here is an example of its budgetary control monitoring for February:
Actual Revenue: $38,000 (shortfall of $3,667)
Actual COGS: $19,000 (savings of $1,833)
Actual Operating Expenses: $18,500 (exceeded budget by $1,833)
This results in the following variance analysis:
Revenue Variance: $(3,667) – Revenue is lower than expected due to lower foot traffic.
COGS Variance: $1,833 – Savings achieved by negotiating better supplier rates.
Operating Expense Variance: $(1,833) – Overspending due to an unplanned marketing campaign.
The store owner takes corrective action by increasing promotional efforts to boost foot traffic and sales, delaying or minimizing discretionary expenses for the next month, and continuing to negotiate with suppliers for better rates or bulk purchase discounts.
By carefully monitoring its budget and taking corrective actions based on variance analysis, the store minimizes financial risks, optimizes resources, and increases its chances of achieving its profit goal for the year.