Budgetary control refers to how well managers utilize budgets to monitor and control costs and operations in a given accounting period. In other words, budgetary control is a process for managers to set financial and performance goals with budgets, compare the actual results, and adjust performance, as it is needed.
You can think of a budget like a report card in school. It shows how well you performed in that subject during the school year. The budget process does the same thing. Management can set goals and evaluate the progress.
There are typically four steps in any budgetary control process that managers follow. First, a budget needs to be created. To put it simply, a company performance budget is really just a set of financial goals that management wants to achieve. These could be sales or spending goals.
Second, after the budget is created, management needs to compare, analyze, and interpret the actual performance results with the budgeted goals. Management typically uses a budget report for this comparison.
Third, after the comparison has been made, managers need to improve the under performing operations and continue to strengthen the favorable ones. The budget report easily allow managers to focus on unfavorable operations because all areas that meet the budget are marked with an F for favorable variance while the poorly performing areas are marked with a U for unfavorable variance.
The fourth and final step usually occurs at the end of an accounting period. After management has a chance to look over the entire last period, they can start making plans for the next year. For example, they will most likely review the original budget that was created and why certain goals were set. Then they will compare the actual with the budgeted performance over the entire period. Lastly, management will focus on how they tried to correct the problem operations and develop a plan to fix them in the next period.
A budget report is an internal report used by management to compare the estimated, budgeted projections with the actual performance number achieved during a period. In other words, a budget report is designed to compare how close the budgeted performance was to the actual performance during an accounting period.
Since budgets are financial goals based on estimates and future projections, they are often inaccurate and can differ largely from the actual financial performance of a company. During an accounting period managers often compare the budgeted numbers that were prepared at the beginning of the period to the actual numbers they are incurring. This serves two main purposes.
First, managers can correct problems occurring in the business to make the performance more inline with the financial goals in the budget. Second, they can evaluate how realistic and accurate their predictions were. If their predictions were way off during the period, they can adjust their next budget accordingly.
The budget report is used to compare both sets of data. An example budget report typically follows the same formatting as an income statement. The sales and revenues are listed first followed by the cost of goods sold, selling expenses, general and administrative expenses, other expenses, and finally a net operating income number.
There are usually two columns listed side by side for the budgeted numbers and the actual performance results for the period. Often there is a third column added to list the variances. Favorable variances occur when the actual numbers are better than the budgeted numbers. These are marked with an F in the margin.
Unfavorable variable are just the opposite. When actual numbers are worse than budgeted number, a U written in the margin identifying the poor results in that area. Depending on the operation, manager, and company these budgets can be reviewed on a monthly, weekly, or even daily basis.
Budgeting is extremely important in the business world. There are all kinds of different budgeting strategies that help management decide when to buy new assets, expand operations, or repair old machines. Needless to say, every company that operates effectively follows some sort of budget.
Business budgets are usually forecasted by management based on future predictions. In other words, a company's management sits down and discusses financial strategies based on the current performance of the business. They try to estimate what the future revenues and expenses will be for the business if they follow a given strategy. Sound familiar? It's just a basic budgeting process.
After a certain amount of time has passed, the company's management has to evaluate how well it has stuck to its budget or forecasted numbers. This is where the variances come into play. Since it is almost impossible for management to 100% accurately determine the company's future earnings, the budgeted, projected numbers are usually different than the actual numbers. A favorable variance is when the actual performance of the company is better than the projected or budgeted performance. A favorable variance could be caused by anything. Expenses might have dipped down because management was able to work out a special deal with a supplier. Revenues might have went up because a few large unexpected sales came in. All of these things help produce a favorable variance in the budgeted forecast and the actual business performance.
Unfavorable variances are just the opposite. An unfavorable variance is when a company forecasts for a certain amount of income and does reach it. Say they estimated that there would be $10,000 of profit for the quarter and they only got $7,500. That's an unfavorable variance and no one wants one of those.
An unfavorable variance occurs when the difference between actual revenues and costs compared with the budgeted revenues and costs results in a lower net income. In other words, management's budgeted and projected revenues and expenses resulted in a higher net income than the actual net income.
Most companies prepare budgets to help track expenses and achieve financial performance goals. There are many different forms of budgets as well as planning strategies, but most budgets start the same way. Management analyzes the past performance of the company and estimates future performance based on expected market and economic changes. Then management projects a budget and goals for the upcoming year.
As with most estimates, budgets are rarely completely accurate. Some budgets and goals are achieved and others are not. When a budget is achieved the budgeted revenue and expenses are the same as the actual revenue and expenses.
Sometime companies don't achieve their budgets and the actual expenses are higher than the estimates or the projected revenues are lower than the estimates. The difference between these estimates and the actual revenues and expenses is considered an unfavorable variance because higher expenses and lower revenues result in lower net income than expected.
Other times companies not only achieve their budgeted number, they exceed them. The difference between the actual and budgeted numbers that results in more net income than expected is considered a favorable variance. Companies with favorable variances often have spending surpluses and additional money for future periods.