TOPIC 6: BUDGET AND BUDGETARY CONTROL

Budget
A budget is a plan expressed in monetary or other terms which govern the operation of a business over a
predetermined period of time.
It is a detail plan of operations for a specific period of time and is prepared for the effective utilization of
resources, which will help in achieving the set objectives. Whereas most budgets (e.g. sales budget, labour
cost budgets) are expressed in terms of money, some are expressed in terms of units or percentages
A personnel budget may be expressed in terms of numbers of employees to be replaced or engaged over a
period of time
A sales budget invariably shows the budgeted value of sales, number of covers or the budgeted rate of room
occupancy

Budget Control
It is a means of control by which responsibility for various budgets is assigned to the managers concerned
and a continual comparison is made of the actual results with the budgeted results / figures and if there is a
variance, an inquiry and corrective action follows

Therefore a budget is the plan on which a system of budgetary control is based. The budget sets standards of
performance (targets) for the managers of a business while budgetary control is a means of ensuring that the
objectives set for the managers are fulfilled

Budgetary control is the use of the comprehensive system of budgeting to aid management in carrying out its
functions like planning, coordination and control.
This system involves:
 Division of organization on functional basis into different sections known as a budget centre.
 Preparation of separate budgets for each “budget centre”.
 Consolidation of all functional budgets to present overall organizational objectives during the
forthcoming budget period.
 Comparison of actual level of performance against budgets.
 Reporting the variances with proper analysis to provide basis for future course of action.

Objectives
The main objectives and advantages of budgeting are as summarized below: -
 The budget is a detailed plan of action which guides and regulates the progress of a business (improved
planning)
 Budgeting results in a better coordination of all activities of a business
 The budget sets standards against which the performance of those responsible may be measured and
assessed (clearer standards of business performance)
 Budgeting is an important method of expense and revenue control; it establishes clear lines of cost
responsibility and promotes cost consciousness (improved control of income and expenditure)

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 Budgeting ensures an economical utilization of the resources of a business and thus helps to maximize
profits (clearer lines of cost and profit responsibility)

For effective running of a business, the management must know:

 Where it intends to go i.e. organizational objectives
 How it intends to accomplish its objective i.e. plans
 Whether individual plans fit in the overall organizational objective. i.e. coordination
 Whether operations conform to the plan of operations relating to that period i.e. control

Formulation of the Budget

Budget Committee
Where there is a system of budgetary control in operation there is always constituted a budget committee.
This consists of: -
 A senior executive of the business (managing director / general manager) acts as the chairman
 Several managers (food and beverage manager, executive chef, executive house keeper, banqueting
manager)
 An accountant who acts as the secretary of the budget committee

Before any budgets are drawn up the budget committee must decide how the overall system of budgeting will
fit into the existing structure of the business
This entails: -
 A review of the organizational structure of the business
 A definition of each managers authority and responsibility
 After preliminary work, various departments and other budgets set appropriate targets expressed in terms
of
- Turn over
- Profit margins
- Operating ratios and
- Cost limits

Main Function of the Budget Committee

1. Prepare budget proposals (draft budgets) for submission to board of directors.
When preparing budget proposals, the budget committee will take into consideration the following: -
a) Past performance – entails a thorough analysis of past income, expenditure, trends in income and
expenditure, etc.
b) Current trends – this necessitates a review of the current position with regards to the items mentioned in
(a) above
c) Other information – would include a consideration of the prosperity of the particular sector of the
hospitality industry, the condition of the local industries, the degree of unemployment, if any, the degree
of competition.

2. Choose an appropriate budget period; in most cases this will be a one calendar year.

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 All businesses whether large or small have budgets covering a period of one year. Where the budget year
runs from January to December, work on the following years budget will start early in October to that
the budget proposals are ready for submission to the board of directors early in December

3. Choose an appropriate review period also referred to as control period

An essential part of budgetary control is the continual comparison of the actual with the budgeted results.
Budget reports will be submitted at various intervals i.e. (one week, one month, quarterly, biannual and
annual reports)

Types of Budgets
Budgets are prepared to check the availability of finance according to the demand of project while budgetary
control is also essential tool of management to control cost and maximizes profits.
A budget is a quantitative statement, for a defined period of time, which may include planned revenues,
expenses, assets, liabilities and cash flows; it provides a focus for the organizations, aids in the co-ordination
of activities and facilitates control

The following are the essential of a budget:

 It is prepared in advance and is based on future plan of action
 It relates to a future period and is based on objectives to be attained.
 It is a statement expressed in monetary or physical unit prepared for the formulation of policy

General Classification of Budgets

a) On the basis of functionality; Sales budget, Production budget, Material budget, Labour budget,
Manufacturing overhead budget, Administrative expenses budget, Selling and distribution budget, Cash
budget

b) On the basis of flexibility; Fixed budget, Flexible budget

c) On the basis of period / time; Long term, Short Term

There are several kinds of budgets used in hospitality establishments and are based on the following
classifications: -
1.) From the point of view of the subject matter budgeted for; we may distinguish: -
 Capital budgets
 Operating budgets

2.) From the point of view of the comprehensives of budgets for; we may distinguish: -
 Master budgets
 Departmental budgets

3.) From the point of view of the level of sales assumed; we may distinguish: -
 Fixed budgets
 Flexible budgets

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1. On the Basis of Period / Time
 Long Term Budget - A systematic and formalized process for directing & controlling operations for
period extending beyond one year
Long-term budgets are prepared for those organizations, which deal in regular product line. Here
organizations are not suppose to change their proceedings in short time periods.
Examples include; sales budget, fixed budget
These are prepared for those organizations, which deal in regular product line and organizations are not
suppose to change their proceedings in short time periods
 It evaluates future implications associated with present decisions
 Market trends, change in demographics, national income, etc. play important role in preparing
long term budget
 It proves useful in forecasting and evaluation of an organization over period of time

 Short Term Budget - May cover periods of 3 – 12 months depending upon nature of business; budgets
are prepared for short time periods which work for seasonal product line
 Should be long enough to allow completion of a season or all aspects of a business
 The period should coincide with financial accounting period to facilitate evaluation of
performance e.g. A budget allocated to manufacturing of lots for spring- summer season,
Fashion Retailing, etc

Short-term budgets are prepared for small time periods which work for seasonal product line. Here products
may change in near future.
Examples include; production budget, flexible budgets

2. According to Function
 Sales Budget - Sales budget is the primary budget; it is the most important budget upon which all the
other budgets are built up
It is the most important budget to prepare and the other budgets are prepared on the basis of sales
budget
It is most important because it affects the accuracy of most other budgets thus if budget sales are forecast
inaccurately, budgeted variables and semi variable costs will also be inaccurate. Similarly the cash budget
which is obviously affected by the volume of sales will be inaccurate
 It forecast on quantities and values of sales to be achieved in a budget period
 In this budget the in-charge or expert forecast the future expected sales of the firm.
 The sales manager is responsible for the accuracy of the budget.
 Sales forecasting: Developing a sales budget requires forecasting future sales, which depends upon
the following 4 main factors:
 Past performance - is information concerning past performance (a) actual sales of previous
periods; (b) sales mix; (c) trends in sales and sales mix
 Current trends – is information about present conditions within industry and sales territory
(a) trends in sales and sales mix; (b) bookings reserved for accommodation, banquets etc
 Limiting factors: (a) where the increase in sales is considered inadequate, limiting factors
should be identified and dealt with accordingly

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  Other information - data concerning the industry and general business conditions (a)
condition of local industries ; (b) state of employment and prosperity in the locality
concerned; (c) political situation, government policy etc and their effect on future turnover

 In preparation of sales budget the following should be taken into consideration;

- Past sales
- Sales man estimates
- Plant capacity
- Raw material
- Orders in hand
- Seasonal fluctuations
- Competition etc.

Example 1
Production budget, selling and distribution, etc. are affected by sales budget e.g.
Q1 Q2 Q3 Q4 Yearly Sales

Sales 120 130 150 165 565

Price / unit 20 22 25 27

Total sales 2400 2860 3750 4455 13465

Example 2
Omega Pearl Restaurant is a large, licensed establishment and budgets its sales a year in advance; actual sales
are reviewed in the light of the budgeted figures at the end of each 4-weekly period. The sales of the
restaurant for the past 3 years has been as follows;

Analysis of Past Sales

1993 (£) 1994 (£) 1995 (£)
Restaurant sales 179,500.00 186,500.00 190,200.00

% increase on the previous year 7% 4% 2%

Bar sales 91,000.00 95,500.00 102,200.00

% increase on the previous year 4% 5% 7%

Sundry sales 30,500.00 32,000.00 34,000.00

% increase on the previous year 5% 5% 6%

Total Sales 301,000.00 314,000.00 326,400.00

% increase on the previous year 6% 4.3% 4%

The following supplementary information is also made available.

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 (a) Restaurant sales – the rate of increase in this section of the turn over if falling off. This is due to
the limited dining room space available. It is thought that, in the circumstances, little increase in
sales is possible
(b) Bar sales – the turnover has been rising satisfactorily but in view of the limiting factor restricting
restaurant sales a higher rate of increase cannot be expected
(c) Sundry sales – this is expected to increase at least as in 1995

Determination of Sales Target

Having due regard to the past trends in sales and all other relevant factors, the following sales target are set
for 1996
(a) Restaurant sales – it is decided that that these ought to be increased by 4%. In view of the limited
space available the increase in sales is to be achieved through increased prices. This end, all restaurant
prices are to be revised yearly in the year
(b) Bar sales – these ought to show an increase of 7% on the previous year
(c) Sundry sales – in view of the past trend, an increase of 7% should be aimed for

Thus the budgeted sales for 1996 are therefore as shown below;
1993 (£) 1994 (£) 1995 (£) 1996 (£) The budgeted
sales for each 4-
weekly period
Restaurant sales 179,500.00 186,500.00 190,200.00 197,800.00 197,800.00/13
104/100*190200
=197808 = 12,215.00
% increase on the 7% 4% 2% 4%
previous year
Bar sales 91,000.00 95,500.00 102,200.00 109,350.00 109,350.00/13
107/100*102200
=109354 = 8,411.00
% increase on the 4% 5% 7% 7%
previous year
Sundry sales 30,500.00 32,000.00 34,000.00 36,380.00 36,380.00/13
106/100*34000
=36040 = 2,798.00
% increase on the 5% 5% 6% 7%
previous year
Total Sales 301,000.00 314,000.00 326,400.00 343,530.00 26,400.00

% increase on the 6% 4.3% 4%

previous year

At the end of each 4-weekly period, the actual sales would be compared with budgeted sales and any
discrepancies (variance) would then be investigated and the necessary corrective action would be taken
The following is a monthly sales report based on the figures given above

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 Pearl Omega Restaurant

Monthly sales report for four weeks ended 28th January, 1995

To: Managing Director

General Manager

From: Catering Controller

Budgeted Sales (£) Actual Sales (£) Variance (+ or -)
Restaurant sales 15,200.00 14,400.00 -800.00
Bar sales 8,400.00 8,500.00 +100.00
Sundry sales 2,800.00 2,950.00 +150.00
Total 26,400.00 25,850.00 -500.00

NB: Only a small partial revision of restaurant prices has taken place; a complete revision is called for

 Production Budget - It is stated in physical units

It specifies the number of units of each product that must be produced to satisfy the sales forecast
It involves planning the level of production which in turn involves the answer to the following questions:
(a) What is to be produced?
(b) When is it to be produced?
(c) How is it to be produced?
(d) Where is it to be produced?
After preparing sales budget the next budget will be production budget.
In this budget works manager prepare schedule of production by breaking large production in small units to
fulfill the target production.
A properly operated budgets leads to inventory control, improved maintenance of production schedules
and production targets.

Example 1
Suppose, if the estimated opening stock is 5000 units and estimated sales are 25000 units and closing stock of
the product is 3000 units the estimated production will be: -

Sales + Closing stock – Opening stock = Estimated production

25000 + 3000 – 5000 = 23000 units

Example 2
The number of units to be produced can be formulated using:

Units to Produce = Budgeted sales + Desired closing inventory of finished goods – Beginning inventory of
finished goods

e.g.
Budgeted sales = 70,000
Desired closing finished goods inventory = 20,000
Beginning finished goods inventory = 40,000

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Units to be produced = (70,000 + 20,000 – 40,000) = 50,000

Schedule of production is prepared by breaking large production in small units to fulfill the target production.
A properly operated budget leads to
 Inventory control
 Improved maintenance of production schedules and production targets.

 Cost of Production Budget - It summarizes the materials budget, labor budget and the factory
overhead budget
This budget is an estimate of cost of output planned for a budget period and may be classified into three
budgets: -
a. Material Cost Budget
b. Labour Cost Budget
c. Overhead Cost Budget / Factory Overhead

(a) Material Budget - In the production budget material is the first requirement to be considered and are
basically divided into two categories i.e.
 Direct and
 Indirect material.

Direct materials budget: It specifies the cost of direct materials used and cost of the direct materials
purchased.
It helps in developing purchasing and delivery schedule
Helps to meet production targets
Material budget includes the preparation of estimates of different types of the raw material needed for various
products and purchasing raw material in required number at a required time.
The following are factors to be taken under consideration;
- Requirement of raw material
- Company’s stocking policies
- Price trend, and
- Cost of raw material

(b) Labour Budget - Labour is an important factor in every production organization. It plays an important
role in converting raw material into finished product.
It is evolved in relation to the budgeted volume of sales.
When an increase in sales is budgeted for it is necessary to establish how much of the increase can be dealt
with by the existing staff of the establishment
A labour cost budget cannot be realistic unless it is based on a detailed analysis of the staffing of each
department vis-à-vis the budgeted turnover
There exist two types of labour: -
 Direct and
 Indirect labour.

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In this budget company has to budget the required number of hours and the expected pay scales of the
employees. This budget gives information about personnel specifications for the job for which workers are to
be recruited, the degree of skill and experience required and rates of pay.

Direct Labor Budget: Labour requirement budgets are prepared on basis of production budget.
It must disclose: - Grade of labor along with cost (wages)
- Period of training to enable production budget to be achieved
- Casual labour and authorized overtime
- Proposed changes in staffing, rates of pay and grading of staff
- Staff meals, holiday pay and other labour costs

Summary
This budget gives information about personnel specifications for the job for which workers are to be
recruited, the degree of skill and experience required and rates of pay

(c.) Factory / manufacturing Overhead Budget: Prepared on basis of chart of accounts which reflects
different accounts expense and details of cost center or departments
This budget gives the works overhead expenses to be incurred in a budget period to achieve the production
target. The cost of indirect material, indirect labouretc can be calculated with the help of this budget.
For making proper control especially in larger establishments tend to have separate budgets for the various
component parts of overhead expenditure i.e. it can be divided into departmental overhead budget such as
maintenance, office and administration costs, marketing etc.
The overhead cost budget is also evolved in relation to the budgeted sales therefore it must clearly distinguish
between fixed overheads (rates, depreciation of premises, licenses etc) and variable and semi-variable
overheads (gas, electricity, telephone, laundy, cleaning materials etc) thus variable expenses are estimated on
the basis of the budgeted output because these expenses are bound to change with the change in output.
This budget gives the work overhead expenses to be incurred in a budget period to achieve the production
target.

Example on Production Cost budget

Material Usage budget Product A Product B Total Budgeted production 50,000 80,000 Direct materials
requirements Product A X 5 Product B X 8 Direct materials usage (kg) 250,000 480,000 Cost per kg Rs. 1 Rs.
1.50 Cost of Direct materials used Rs. 2,50,000 Rs. 7,20,000 Rs. 9,70,000

 Purchase Budget - This budget provides information about the materials to be acquired from the
market during the budget period.

 Personnel Budget - This budget gives an estimate of the requirements of direct labour essential to meet
the production target.
This budget may be classified into: -
a. Labour requirement budget
b. Labour recruitment budget

 Research &Development Budget - A tool for planning and controlling research and development
costs

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 This budget provides an estimate of expenditure to be incurred on research & development during the
budget period. A R&D budget is prepared taking into consideration the research projects at hand and
new research & development projects to be taken up.

 Helps in coordination with company’s other plans and projects

 Helps allocation of funds for R&D by coordinating company’s immediate and long-term plans
 Helps in planning staff and equipment requirements for R&D
 It contains details of cash inflows and cash outflows for the budget period of some other specific
period.
 It indicates effect on cash positions of seasonal requirements, unusual receipts and slowness in
collecting receivables
 Indicates availability of cash
 Shows availability of excess funds for short term investments
 Helps in planning bond redemptions, income tax installments and payments to employees

 Administration Expenses Budget - The budget covers the expenses incurred in framing policies,
directing the organization and controlling the business operations.
In administration expense budget an estimate of expenses is prepared regarding central office and of
management salaries and the most important items covered in this budget include: -
 Office salaries
 Depreciation of office equipments
 Telephone
 Printing and stationery
 Insurances, bank charges and audit fees

The budget may be prepared at department level for effectiveness in budgeting system with the past
experience and anticipated changes taken into consideration.
As with all other budgets, the office and administration budget will distinguish between fixed and variable
costs.

 Selling and Distribution Budgets -This expense is related to the selling and distribution of material. In
this budget experts have to plan for the expected selling and distribution expenses of the firm.
Certain items of selling and distribution costs includes cost of transportation, salesman salaries etc.

 Capital Expenditure Budget - This is an important budget providing for acquisition of assets
necessitated by the following factors:
(a) Replacement of existing assets.
(b) Purchase of additional assets to meet increased production
(c) Installation of improved type of machinery to reduce costs.

These are budgets dealing with the assets and the capital funds of a business and more specifically they
are budgets in respect of matters such as; capital expenditure on new fixed assets, cash, debtors, stock;
the raising of fresh capital by the issue of shares or debentures
The most common of such budgets is the cash budget

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 Cash Budget - Predict the inflow and outflow of cash during the budget period and is prepared from
the various operating and capital budgets. Cash sales, credit collection and other receipts in cash
payments are considered.
Particulars of cash payable over the budget period will be extracted mainly from the operating (expense)
budgets and budgets in respect of any planned acquisition of fixed assets
This budget gives an estimate of the anticipated receipts and payments of cash during the budget period.
In cash receipt we consider cash sales, credit collection and other receipts in cash payments for
example; we consider cash payments, tax payable, dividend payable etc. Without cash organizations
cannot work so prediction thus cash is very important.
A cash budget makes provision for a minimum cash balance which will be available at all times; may be
prepared monthly, weekly even daily to meet requirements
Short range: Prepared annually and is in correspondence with annual profit plan.
 Indicates cash inflows and outflows as generated by annual profit plan

Long range: Does not disclose detailed estimates of revenue and expenses. It is prepared according
to:
 The timing of the capital expenditure projects
 The timing of long range profit plan

Differences between Cash budgets and Operating budgets

Cash budgets may look similar to operating budgets because they use much of the same information,
however;
 Operating budgets forecast income, expenditure and the level of profits over the coming years
whereas cash budgets are concerned only with the actual receipt and payment of cash
 Depreciation for example will never feature in a cash budget because no cash changes hands, it is
however a legitimate expense in an operating budget
 In cash budgeting, receipt of cash will not always coincide with the sale of goods nor with
payment of cash with the purchase of goods (it depends on the terms of credit)

Example 1
Forecast Receipt of Cash
The following is the forecast sales budget for a restaurant for 6 months starting January

January February March April May June

Forecast £ £ £ £ £ £
Sales 4,000.00 5,000.00 6,000.00 7,500.00 6,000.00 6,500.00

Past experience has shown that 40% are for cash and 60% are on a credit basis with cash from the above
sales being received as follows: -
Expected Receipt of Cash

Cash sales 40% Straight away

Credit sales 1 50% after 4 weeks
Credit sales 2 10% after 6 weeks

Total sales 100%

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 Using the above information, you are required to complete the cash received section of the cash budget
statement for April, May and June

Proceed as shown below: -

Cash budgets for 3 months ending 30th June
(Forecast cash receipts only)
April (£) May (£) June (£)
Cash Receipts
Sales
Cash 3,000.00 2,400.00 2,600.00
Credit 1 3,000.00 3,750.00 3,000.00
Credit 2 500.00 600.00 750.00
Total Cash received 6,500.00 6,750.00 6,350.00

The figures in the solution above were calculated as follows: -

It shows pattern of cash receipts and payments
(£) April (£) May (£) June (£)

Cash 40% from 7,500.00 3,000.00

April
40% from May 6,000.00 2,400.00

40% from June 6,500.00 2,600.00

Credit 1 50% from 6,000.00 3,000.00

March
50% from 7,500.00 3,750.00
April
50% from Feb 6,000.00 3,000.00

Credit 2 10% from 5,000.00 500.00

April
10% from 6,000.00 600.00
March
10% from 7,500.00 750.00
April

 Master Budget - It is the summary or total budget package for a business firm; The master budget is the
aggregation of all lower-level budgets produced by a company's various functional areas, and also
includes budgeted financial statements, a cash forecast, and a financing plan
 It can be called end product of budget making process

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  It reveals the top management’s goals of revenues, expenses, net income, cash inflows and
financial positions
 Takes the macro view of business and coordinates with production, raw materials, manpower
and other resources with production targets
 It cuts across divisional boundaries to coordinate firms’ diverse activities
 The operating budgets constitute the building block used to complete the master budget

A master budget may be a budgeted profit and loss account, incorporating all income and all expenditure of a
business.
It may also be a budgeted balance sheet incorporating all assets and liabilities of a business.
It is a summary budget incorporating all components of a functional budget and which is finally approved,
adopted and employed”. Thus a master budget is a summary of all functional budgets in capsule form
available in one report.

 Departmental Budgets - These are concerned with a particular department of a business.

Examples include; banqueting budgets, maintenance budget, rooms division budgets, food and beverage
budget

 Performance Budget - These days budgets are established in such a way so that each item of
expenditure is related to specific responsibility centre and is closely linked with the performance of that
standard.

 Marketing Budget - In smaller establishments any marketing and sales promotion expenditure would be
included in the overhead cost budget.
In larger business: hotels rather than restaurants, the marketing will involve a large amount of expense
and include amongst others
 Salaries of the marketing staff
 Cost of press and television advertising
 Cost of printing brochures and other promotional materials
 Other expenditures i.e. office expenses, travel, entertainment
 Maintenance Budget - Whilst most smaller hospitality establishments include maintenance cost in a
total expense budget or overhead cost budgets, larger units tend to have a separate maintenance budget.
A well prepared maintenance budget will accomplish the following two functions;
 It will predetermine the maintenance costs
 It will show the sequence of the work to be done over the budgeted period

The following key points will inform budgeted maintenance cost;

 The state of the premises, kitchen plant, furniture and other equipments
 The standard of comfort which is necessary to provide with regards to the type of customer
catered for
 The current availability of funds

The following costs have to be taken into account;

 Maintenance materials and supplies include items such as paints, wall paper, electrical
components, loose tools and other supplies required by the maintenance department

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  Maintenance labour cost includes all wages and salaries payable to the maintenance staff and
 Other costs i.e. depreciation of maintenance department’s equipment, stationery, office supplies

3. According to Flexibility
 Fixed Budget - This is the rigid budget and it is drawn on the assumption that there will be no change in
the budgeted time period. A fixed budget will be helpful only when actual level of activity is equal to
budgeted level of activities
It is defined as a budget which is designed to remain unchanged irrespective of the level of the volume of
output or turnover attained or irrespective of activity actually attained.
 It is based on single level of activity
 It compares data from actual operations with single level of activity reflected in budget
 Fixed budget is good for performance measurement, if output can be estimated within close limits

 Flexible Budget - It is prepared for a range, for more than one level of activity and is also called a
variable budget
A flexible budget predetermines costs in relation to several possible volumes of sales. It also gives
different budgeted costs for different levels of activities.
Is one “which, by recognizing the difference in behavior between fixed and variable costs in relation to
fluctuations in output, turnover or other variable factors such as number of employees, is designed to
change appropriately with such fluctuations”.

Important Features of Flexible Budget:

 It covers a range of activity
 It is easy to change with variation in production levels
 It facilitates performance measurement and evaluation

Advantages of Flexible Budgeting:

 Accurate budgeting: Output factor is considered during preparation, since cost of goods may
fluctuate from time to time
 Coordination: Production is planned in relation to expected sales, materials and labor are acquired to
meet expected production requirements
 Control tool: Comparison between the budgeted costs and actual costs form basis for analyzing cost
variances and fixing responsibility for same. This motivates managers to feel themselves motivated in
controlling costs for which they are responsible.

A flexible budget gives different budgeted costs for different levels of activities. This budget is applicable
where;
 Activity levels vary from period to period.
 The business is new and it is difficult to predict
 The industry is influenced by change in fashion, where there are changes in sales

Responsibility Accounting
Responsibility accounting fixes responsibility for cost control purposes by establishing responsibility centres
namely: -
(a.) Cost centre
(b.) Profit centre

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 (c.) Investment centre

Principles of responsibility accounting are as follows:

 Fixation of targets for each responsibility centre
 Actual performance is compared with the target
 The variances therein are analyzed so as to fix the responsibility of centres
 Taking corrective action.

Conclusion:
 Preparation of budgets is the first step in the budgetary control system.
 Implementation of budgets is the second phase.
 But preparation and implementation of budgets alone will not achieve much unless a comparison is
made regularly between the actual performance and the budgeted performance.
 Continuous and proper reporting makes this possible.
 To ensure the success of budgetary control system, proper follow up action has to be taken
immediately for the reports submitted.

The Limiting Factor

The first step in the preparation of a budget is to forecast the volume of sales (as this affects most of other
parts of the budget).
The forecast volume of sales will: -
 Determine the level of all variable and semi fixed costs
 Affect the cash position of the business which in turn may determine the amount of capital expenditure
planned for the period

When forecasting the future volume of sales it is important to remember what is known as the limiting
factor (also referred to as the ‘key factor’, ‘governing factor’, and ‘principal budget factor’
A limiting factor - is the factor that limits the volume of sales and makes a further increase in sales
impossible

Limiting Factors
The following limiting factors will be found operating in hospitality establishments
(a) Accommodation Availability – this operates in residential establishments namely hotels, motels,
hostels, etc Once all the accommodation available has been let it is impossible to increase the volume of
sales except by raising prices
(b) Seating Capacity – this applies particularly to restaurants where the seating capacity is fixed; also to
banqueting sales, and insufficient seating capacity may well result in loss of potential sales
(c) Insufficient Capital – in a multiple catering business an expansion of sales through the acquisition of
further units may be impossible due to insufficient capital

(d) Shortage of Efficient Labour – many hospitality establishments could increase their sales by improving
the efficiency of their labour. Thus the speed with which cash is taken by the cashier in a self service
restaurant has an important bearing on the volume of sales. Similarly the speed with which waiters serve
customers can affect the volume of sales considerably.

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 The abilities of the chef and other kitchen staff are equally important with this respect

(e) Shortage of Efficient Executives – more important than even the shortage of efficient labour.
Inefficient management makes an expansion of sales difficult through bad organization, unimaginative
menu planning and failure to take advantage of any opportunities to increase sales that may present
themselves

(f) Management Policy – An increase in sales may be impossible as a result of the deliberate policy of a
business. Thus restaurants may discourage the ‘wrong’ type of customer; a hotel may refuse to accept
coach tour business, football teams etc

(g) Consumer Demand – This is a limiting factor in the operation of which is most difficult to remove.
Consumer demand may be limited in several ways: by the prices charged, through completion, as a result
of a fixed potential demand e.g. in industrial canteens.
When an increase in sales proves difficult, it is important to identify the limiting factor(s). The nature of
the limiting factor will then indicate the most appropriate method of dealing with the problem

Capital Budgeting
Capital budgeting is a decision situation where large funds are committed (invested) in the initial stages of the
project and the returns are expected over a long period of time. These decisions are related to allocation of
investible funds to different long-term assets. Capital budgeting is a continuous process and it is carried out
by different functional areas of management such as production, marketing, engineering, financial
management etc.

Basic Features of Capital Budgeting

b. Capital budgeting decisions have long-term implications.
c. These decisions involve substantial commitment of funds.
d. These decisions are irreversible and require analysis of minute details.
e. These decisions determine and affect the future growth of the firm.

Capital Budgeting Decisions Involves the following three steps

i. Estimation of costs and benefits of a proposal or of each alternative.
ii. Estimation of the required rate of return, i.e., the cost of capital
iii. Selection and applying the decision criterion

Estimation of Cash Flows

 The costs and benefits for a capital budgeting decision situation are measured in terms of cash flows.
 An important point is that all cash flows are considered on after tax basis.
 The rule is that all financial decisions are subservient to tax laws.
 The cash flow from the project are compared with the cost of acquiring the project.

The cash flows may be grouped into

 Relevant and
 Irrelevant cash flows as follows:

(a) Relevant cash flows Irrelevant cash flows

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 i. Cost of new project Sunk cost
ii. Scrap value of old / new plant Allocated overheads
iii. Trade-in-value of old plant Financial cash flows
iv. Cost reduction / savings
v. Effect on tax liability
vi. Incremental repairs
vii. Working capital flows
viii. Revenue from new proposal
ix. Tax benefit of incremental
x. Depreciation

Budget methods

Main contents

• Incremental budgeting vs. Zero-based budgeting

• Top down budgeting vs. bottom up budgeting

Incremental budgeting and Zero-based budgeting

Incremental budgeting definition: Prepared based on the current period’s budget with some added amounts
regarding inflation or planned increases in sales and costs

Advantages:

• Simple to prepare and understand

• Consistent basis

• Better co-ordination between budgets

Disadvantages:

• Totally ignore the impact of changes

• No incentive in development and innovation

• Encourages spending up to the budget

• This approach is not recommended as it fails to take into 4 account changing circumstances

Zero-based budgeting
It is also referred to as priority based budgeting. It is a cost benefit approach budgeting where it is assumed
that the cost allowance is Zero for any item until the manager responsible justifies its existence in terms of
costs and benefits.

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CIMA definition: A method of budgeting whereby all activities are re-evaluated each time the budget is set.
It is concerned with alternative means that established activities have been compared with alternative uses of
the same resources.

It takes away the implied right of existing activities to continue receiving resources unless they can be shown
to be the best use of such resources.
Stages of Implementation
1. Definition of decision package.
This is the comprehensive description of the organizations functions or activities.
2. Evaluation and ranking of packages.
This is on benefit basis.
3. Resource allocation according to priorities.

Advantages
1. More efficient allocation of resources.
2. Focus attention on values for money and makes clear relationship between input and output.
3. Develops a questioning altitude and makes it easier to identify obsolete, inefficient and less cost effective
operations.
4. Leads to greater staff and management knowledge of operations.

Disadvantages
1. Time consuming.
2. High skills required.
3. May encourage wrong impression that all decisions must be made through budgets.
4. Short – term benefits may be emphasized to the detriment of long-term benefits.

TOPIC 7: Food and beverage production, planning and

control

Production Planning
Production is the transformation of raw materials to finished goods.
Planning looks ahead, anticipates possible difficulties and decides in advance as to how the production, best,
be carried out.
Control phase makes sure that the programmed production is constantly maintained.

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