Hospitality Management
Budgetary Control

Budgetary control methods

 

a) Budget:

A formal statement of the financial resources set aside for carrying out specific activities in a given period of time.· It helps to co-ordinate the activities of the organisation.

An example would be an advertising budget or sales force budget.

b) Budgetary control:

A control technique whereby actual results are compared with budgets.· Any differences (variances) are made the responsibility of key individuals who can either exercise control action or revise the original budgets.

Budgetary control and responsibility centers;

These enable managers to monitor organizational functions.

A responsibility center can be defined as any functional unit headed by a manager who is responsible for the activities of that unit.

There are four types of responsibility centers:

  1. Revenue centres: Organisational units in which outputs are measured in monetary terms but are not directly compared to input costs.

  2. Expense centresUnits where inputs are measured in monetary terms but outputs are not.

  3. Profit centresWhere performance is measured by the difference between revenues (outputs) and expenditure (inputs). Inter-departmental sales are often made using “transfer prices”.

  4. Investment centresWhere outputs are compared with the assets employed in producing them, i.e. ROI.

 

Advantages of budgeting and budgetary control

There are a number of advantages to budgeting and budgetary control:

  • Compels management to think about the future, which is probably the most important feature of a budgetary planning and control system. Forces management to look ahead, to set out detailed plans for achieving the targets for each department, operation and (ideally) each manager, to anticipate and give the organisation purpose and direction.· Promotes coordination and communication.

  • Clearly defines areas of responsibility. Requires managers of budget centres to be made responsible for the achievement of budget targets for the operations under their personal control.

  • Provides a basis for performance appraisal (variance analysis). A budget is basically a yardstick against which actual performance is measured and assessed. Control is provided by comparisons of actual results against budget plan. Departures from budget can then be investigated and the reasons for the differences can be divided into controllable and non-controllable factors.

  • Enables remedial action to be taken as variances emerge.

  • Motivates employees by participating in the setting of budgets.

  • Improves the allocation of scarce resources.

  • Economises management time by using the management by exception principle.

 

Problems in budgeting

Whilst budgets may be an essential part of any marketing activity they do have a number of disadvantages, particularly in perception terms.

  • Budgets can be seen as pressure devices imposed by management, thus resulting in:
    a) bad labour relations
    b) inaccurate record-keeping.

  • Departmental conflict arises due to:
    a) disputes over resource allocation
    b) departments blaming each other if targets are not attained.

  • It is difficult to reconcile personal/individual and corporate goals.

  • Waste may arise as managers adopt the view, “we had better spend it or we will lose it”. This is often coupled with “empire building” in order to enhance the prestige of a department.

  • Responsibility versus controlling, i.e. some costs are under the influence of more than one person, e.g. power costs.

  • Managers may overestimate costs so that they will not be blamed in the future should they overspend.

 

Characteristics of a budget

A good budget is characterized by the following:

  • Participation: involve as many people as possible in drawing up a budget.

  • Comprehensiveness: embrace the whole organisation.

  • Standards: base it on established standards of performance.

  • Flexibility: allow for changing circumstances.

  • Feedback: constantly monitor performance.

  • Analysis of costs and revenues: this can be done on the basis of product lines, departments or cost centres.

 

Budget organization and administration:

In organizing and administering a budget system the following characteristics may apply:

a) Budget centres: Units responsible for the preparation of budgets. A budget centre may encompass several cost centres.

 

b) Budget committee: This may consist of senior members of the organisation, e.g. departmental heads and executives (with the managing director as chairman). Every part of the organisation should be represented on the committee, so there should be a representative from sales, production, marketing and so on. Functions of the budget committee include:

  • Coordination of the preparation of budgets, including the issue of a manual

  • Issuing of timetables for preparation of budgets

  • Provision of information to assist budget preparations

  • Comparison of actual results with budget and investigation of variances.

 

c) Budget Officer: Controls the budget administration The job involves:

  • liaising between the budget committee and managers responsible for budget preparation

  • dealing with budgetary control problems

  • ensuring that deadlines are met

  • educating people about budgetary control.

 

d) Budget manual:

This document:

  • charts the organisation

  • details the budget procedures

  • contains account codes for items of expenditure and revenue

  • timetables the process

  • clearly defines the responsibility of persons involved in the budgeting system.

 

Budget preparation

Firstly, determine the principal budget factor. This is also known as the key budget factor or limiting budget factor and is the factor which will limit the activities of an undertaking. This limits output, e.g. sales, material or labour.

 

a) Sales budget: this involves a realistic sales forecast. This is prepared in units of each product and also in sales value. Methods of sales forecasting include:

  • sales force opinions

  • market research

  • statistical methods (correlation analysis and examination of trends)

  • mathematical models.

 

In using these techniques consider:

  • company’s pricing policy

  • general economic and political conditions

  • changes in the population

  • competition

  • consumers’ income and tastes

  • advertising and other sales promotion techniques

  • after sales service

  • credit terms offered.

 

b) Production budget: expressed in quantitative terms only and is geared to the sales budget. The production manager’s duties include:

  • analysis of plant utilisation

  • work-in-progress budgets.

If requirements exceed capacity he may:

· subcontract
· plan for overtime
· introduce shift work
· hire or buy additional machinery
· The materials purchases budget’s both quantitative and financial.

 

c) Raw materials and purchasing budget:

  • The materials usage budget is in quantities.

  • The materials purchases budget is both quantitative and financial.

 

Factors influencing a) and b) include:

  • production requirements

  • planning stock levels

  • storage space

  • trends of material prices.

 

d) Labour budget: is both quantitative and financial. This is influenced by:

  • production requirements

  • man-hours available

  • grades of labour required

  • wage rates (union agreements)

  • the need for incentives.

 

e) Cash budget: a cash plan for a defined period of time. It summarises monthly receipts and payments. Hence, it highlights monthly surpluses and deficits of actual cash. Its main uses are:

  • to maintain control over a firm’s cash requirements, e.g. stock and debtors· to enable a firm to take precautionary measures and arrange in advance for investment and loan facilities whenever cash surpluses or deficits arises

  • to show the feasibility of management’s plans in cash terms

  • to illustrate the financial impact of changes in management policy, e.g. change of credit terms offered to customers.

 

Receipts of cash may come from one of the following:

  • cash sales

  • payments by debtors

  • the sale of fixed assets

  • the issue of new shares

  • the receipt of interest and dividends from investments.

 

Payments of cash may be for one or more of the following:

  • purchase of stocks

  • payments of wages or other expenses

  • purchase of capital items

  • payment of interest, dividends or taxation.

 

Zero base budgeting (ZBB)

After a budgeting system has been in operation for some time, there is a tendency for next year’s budget to be justified by reference to the actual levels being achieved at present. In fact this is part of the financial analysis discussed so far, but the proper analysis process takes into account all the changes which should affect the future activities of the company. Even using such an analytical base, some businesses find that historical comparisons, and particularly the current level of constraints on resources, can inhibit really innovative changes in budgets. This can cause a severe handicap for the business because the budget should be the first year of the long range plan. Thus, if changes are not started in the budget period, it will be difficult for the business to make the progress necessary to achieve longer term objectives.

One way of breaking out of this cyclical budgeting problem is to go back to basics and develop the budget from an assumption of no existing resources (that is, a zero base). This means all resources will have to be justified and the chosen way of achieving any specified objectives will have to be compared with the alternatives. For example, in the sales area, the current existing field sales force will be ignored, and the optimum way of achieving the sales objectives in that particular market for the particular goods or services should be developed. This might not include any field sales force, or a different-sized team, and the company then has to plan how to implement this new strategy.

The obvious problem of this zero-base budgeting process is the massive amount of managerial time needed to carry out the exercise. Hence, some companies carry out the full process every five years, but in that year the business can almost grind to a halt. Thus, an alternative way is to look in depth at one area of the business each year on a rolling basis, so that each sector does a zero base budget every five years or so.