Budgets are important for the management of accounting systems within organizations. This is because most companies know their boundaries and would prefer to operate within their financial capacities. According to Klychoya, Faskhutdinova and Sadrieva (2014), budgets are necessary to allow organizations to prepare for the future. Depending on the organization’s strategic priorities, it is used to assign the resources retained. Proper budgets; cost justification, preparation, coordination, communication and assessment and monitoring are important to its performance.
Task 2a: East stands for variation on budgeted against actual results
Items April June 2016 Budget April June 2016 Actual Variance Sales 2,500,000.00 2,400,000.00 100,000.00 Cost of sales (625,000.00) (720,000.00) 95,000.00 Gross Profit 1,875,000.00 1,680,000.00 195,000.00 Operating Costs – Salaries 500,000.00 550,000.00 (50,000.00) Rent and rates 300,000.00 300,000.00 – Heating and Lighting 200,000.00 260,000.00 (60,000.00) Office Consumables 100,000.00 100,000.00 – Vehicle running Expenses 200,000.00 200,000.00 – Depreciation of Equipment 10,000.00 10,000.00 – Repairs and Maintenance 200,000.00 240,000.00 (40,000.00) Total Expenses (1,510,000.00) (1,660,000.00) 150,000.00 Operating Profit/Loss 365,000.00 20,000.00 345,000.00
Analysis: The difference between the actual and the budgeted figures is what makes a variance. According to Chen, Weikart and Williams, variance derived in each line of expense account should be identified and explained. And when they show genuine concern, a number of steps should be taken to correct or encourage them (p. 137). Eastlands plc intended to make sales worth £ 2,500,000 within the quarter but managed £2,400,000. Failing short by £100,000 is a pointer that something did not work. According to Walter and Skouken, the driver of any given organization is sales (p. 20). Inability to meet targets may overly affect the organization negatively. It may struggle in footing increases in Salaries and wages, heating and lighting, and repairs and maintenance by £ 50,000, £60,000, and £ 40,000 respectively. Consequently, the organization should be able to analyze why it used £720,000 to produce £2,400,000 since the budgeted figure was £ 625,000. The targeted profit of £ 365,000 was not made only realizing £20,000. Possible causes for the variance. Inability of the production department to manufacture enough items due to machine capacity which forced the market to accept less demanded. Labour, heating and lighting, and repairs and maintenance and salaries were underestimated which saw them shoot up.
When a revision is done
Items April June 2016 Budget April June 2016 Actual Variance Sales 2,500,000.00 2,600,000.00 (100,000.00) Cost of sales(72%) (625,000.00) (728,000.00) 103,000.00 Gross Profit 1,875,000.00 1,872,000.00 3,000.00 Operating Costs – Salaries 500,000.00 450,000.00 50,000.00 Rent and rates 300,000.00 310,000.00 (10,000.00) Heating and Lighting 200,000.00 195,000.00 5,000.00 Office Consumables 100,000.00 100,000.00 – Vehicle running Expenses 200,000.00 200,000.00 – Depreciation of Equipment 10,000.00 10,000.00 – Repairs and Maintenance 200,000.00 200,000.00 – (1,510,000.00) (1,465,000.00) (45,000.00) Operating Profit/Loss 365,000.00 407,000.00 (42,000.00)
Comparison: Produces the best result as profits that were initially budgeted at £365, 0000 shot to £407,000 which is what shareholders would want. There is decrease in salaries and wages, and Heating and lighting, while repairs and maintenance is what was budgeted for.
Task 2b): Success degree from informal report
Items April June 2016 Budget April June 2016 Actual Variance Assets Invested 10,000,000.00 10,000,000.00 Market 25,000,000.00 30,000,000.00 (5,000,000.00) Market penetration @ 10% 8% 0.02 Market penetration £ 2,500,000.00 2,400,000.00 100,000.00 Quality Customer complaints(days) 50.00 30.00 20.00 On time Deliveries 90% 95% -5% Profitability Gross Profit Margin 75% 70% 5% Operating Profit Margin 14.60% 0.80% 13.80% Return on Capital Employed 3.70% 0.20% 3.50% Solvency Current Ratio x:1 2.76 7.68 (4.92) Efficiency Net Asset Turn over 0.25 0.24 0.01 Stock Turn over days 45.00 30.00 15.00 Debtor payments 30.00 60.00 (30.00) Creditor payment 60.00 30.00 30.00 Working Capital Cycle 15 60 -45
Analysis of the performance indicators: A look at the market reveals an interesting scenario because an initial target of £25,000,000 was surpassed by £5,000,000.This shows that the overall market generally is responding positively to the products. Market penetration is important for a company intending to increase its revenue in an existing market. The organization intended to do so by at least 10% but fall short by 2% only managing 8%. Customer complaints days were targeted at 50 but this reduced to 30. Gone are the days when customers were loyal and would visit an organization severally with poor customer service. By reducing complaint days by 20 is a good indicator that the company is headed the right direction. On time delivery which was budgeted for at 90% also increased to 95%. This means that timely deliveries of services were enhanced much to the expectation of the organization.
Gross Profit Margin which was expected to yield 75% fell short by 5% .The organization should go to the drawing board and analyze cost drivers that did not make this possible and possible find ways of reducing them. The company budgeted for operating profits margin of 14.60% but managed only 0.8%. This was a very poor performance because they fell short with 13.8%. They should look into those expenses that ate into the profits and find ways of reducing them. Return on capital employed seeks to know the gains realized from the money invested. The targeted 3.7% only realized 0.2%. This return was way below average which the organization should check to establish if it is a worthy venture or not.
Current ratio shows the proportion of current assets a company is holding over current liability. The bigger the ratio, the better it is for the company. The organization budgeted for 2.76 but yielded 7.68 which is a plus for the company. Net asset turnover is a ratio of sales to net assets. It seeks to answer whether or not the net assets employed are speedily generating sales. The faster the sales, the more the cash the organization gets to enable it expand its operations. The target of 0.25 fell short by 0.01 which is not bad. Stock turnover days seek to know the number of days inventory should be held in the company before being sold. The organization budgeted for 45 days but stocks are only taking 30 days. This is a positive for growth.
Debtors_x0092_ payment days seeks to put limits within which all the sales that were made on credit should be paid. Customers are expected to pay for the services within 30 days but this extended to 60 days which is not good for the company. Creditors_x0092_ payment days puts a limit on credit terms between the organization and the suppliers. When organization negotiates to pay suppliers within 60 days but end up paying them within 30 days reduces the risk of having many debts which may be hard to clear in the future. It is a good practice. Working capital cycle is the number of days or times an organization may take to convert net current assets and liabilities into cash. The more the number of times this can happen the better for the organization. The organization budgeted for 15 times but ended up doing it 60 times. This is very positive for its growth.
Task 2c): Possible improvement strategies: Although the company is doing okay with regard it its stock turnover days, marketing strategies should be deployed by increasing sales team and forcing them to reach set targets. Doing electronic media advertising to enable them penetrate more markets is also important. A lot of work should be done on debtor payment days like recruiting receivables accountants who will collect money as per strict credit limits or by encouraging cash sales. Operating profit margin is greatly affected because _x0093_unnecessary expenditure_x0094_. Paying Sales and marketing team on commission or what is sold than monthly salaries would reduce costs.
Task 2d): Value added and Total Quality Management: Value addition and Total Quality Management is broad in relation to quality customer service. Total Quality Management (TQM) in Eaststand plc is important in ensuring customer satisfaction is attained as it adds value on the organizational practices. The organization fell short in Market penetration by 2%. TQM offers room for continual improvement. The organization should reflect back and be able to check those processes that did not function well with a view to improving them so that they close or exceed the 2% gap. Operating profit margins went way too low than the budgeted. TQM will ensure that those expenditures that drain the company are identified and a corrective measure is found so that they do not recur in future. Gross profit that fell short by 5% would have been caused as a result of items that undergo reprocessing. TQM would solve this because every stage in production would be checked and a correction gotten before work is concluded.
List of References (New Page)
Chen, G.G., Weikart, L.A. and Williams, D.W., 2014. Budget tools: Financial methods in the public sector. CQ Press.
Klychova, G.S., Faskhutdinova, М.S. and Sadrieva, E.R., 2014. Budget efficiency for cost control purposes in management accounting system. Mediterranean journal of social sciences, 5(24), p.79.
Walther, L.M. and Skousen, C.J., 2014. Budgeting: Planning for Success. Bookboon.