What is principal budget factor?

The principal budget factor is the factor that limits the activities of functional budgets of the organisation.
The early identification of this factor is important in the budgetary planning process because it indicates which budget should be prepared first.

In general sales volume is the principal budget factor. So sales budget must be prepared first, based on the available sales forecasts. All other budgets should then be linked to this.

Alternatively, machine capacity may be limited for the forthcoming period and therefore machine capacity is the principal budget factor. In this case the production budget must be prepared first and all other budgets follows it.

Failure to identify the principal budget factor at an early stage could lead to delays later on when managers realize that the targets they have been working with are not feasible. 

In case of one limiting factor, we shall need to apply the concept of Marginal costing. In this we initially allot the limiting resource on the basis of highest contribution per limiting factor.
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