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Budget Key Factor – all you need to know

A budget key factor or principal budget factor is described by the CIMA London terminology as: “a factor which will limit the activities of an undertaking and which is taken into account in preparing budgets”. The limiting factor is usually the level of demand for the products or services of the undertaking but it could be a shortage of one of the productive resources, e.g. skilled labour, raw material or machine capacity. In order to ensure that the functional budgets are reasonably capable of fulfilment the extent of the influence of this factor must first be assessed. As noted already all the functions in all organisations are interlinked. The target of one has influence on that of the other. If the sales department could sell only 50,000 units, it is no use of producing 1,00,000 units. If the production department has the capacity for 50,000 units, sales potential of 1,00,000 units is not of much consequence.

Deliberations in the budget committee would lead to a decision regarding steps to get over a limiting factor. If one limiting factor is got over, another may creap up. Thus, there is a possibility of varying limiting factors under different circumstances. Decision will have to be taken resulting in optimum production keeping in view the different limiting factors. The basic issue is an enquiry into the future. All probabilities under different circumstances are to be worked out to fix the target at the optimum level. This may sometimes involve lengthy mathematical calculations.

The following is a list of principal budget factors which will influence the targets:

  • customer demand,
  • plant capacity
  • availability of raw material, skilled labour and capital,
  • availability of accommodation for plant, raw materials and finished goods and
  • governmental restrictions.

If a limiting factor cannot be got over by any means, then the whole budget involving all functions will have to be built around that factor. For instance, if the production capacity is 50,000 units and it cannot be increased in the short run, all budgets, say, the sales budget and raw materials purchase budget, will have to be based on the production of 50,000 units. To achieve maximum profitability, a key factor must be overcome, if not, at least efforts should be made to minimise its adverse effect.

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