The management team relies heavily on the information provided by the management accountants to make critical decisions based on the performance of the business. Management accounting focuses on marginal analysis, constraint analysis, capital budgeting, trend and forecasting analysis of the company. Therefore, through information on the business metrics, the management can make decisions on production volume, budgeting and even pricing decisions. The report will analyse the role of management accounting in planning, decision-making and control for manufacturing organisations. Furthermore, the report will also focus on the financial ratio analysis of Camden Limited with a focus on the return on equity and capital employed, current ratio, inventory turnover and the number of days’ purchases in trade payables for the last two years.
2. Role of Management Accounting
2.1 Role of Management Accounting in Planning and Control
Production and Sales forecasting techniques are the most commonly used planning methods in management accounting (Turner, 1997). The role of planning cannot be underestimated in any organisation. Manufacturing organisations value planning since it determines product readiness and operational efficiency. The Cost Volume and Profit Analysis is the most common forecasting technique for planning by the manufacturing organisations. Organisations that do not forecast their operations either under produce or oversupply into the market resulting in losses. Hence, by engaging in the cost volume profit analysis, the organisation has visibility on the number of units which they need to produce for them to break-even. Moreover, through forecasting, the production team will be knowledgeable about the exact quantity of units in demand by the customers in the market. As a result, by getting accurate figures on the demand units, the organisation prevents any production losses due to the pilferage of goods.
Profitability and growth are the two critical goals for any company. It is the role of management accountants to make decisions internally that drive the goals (Kocran, Dechow and Sun, 2013). Controlling involves budgeting and forecasting firm operations in a way that ensures that company goals and objectives are attained. Moreover, it requires one to monitor, measure, evaluate as well as correct actual results in favour of the company’s plans (Fry, Steele and Saladin, 1998). Nevertheless, it is important to realise that management accountants can only be able to perform this function after critically analysing the expenses and revenue of the organisation.
The control aspect in management accounting is enhanced through budgets. The budgeting process is critical to the management team to improve control since the revenue and costs budgets ensure that the organisation remain on track. The revenue budgets give insights to the management team especially with regards to ensuring that they achieve the revenue targets that have been set. The costs budgets, on the other hand, ensure that the production department minimises on costs to maximise revenue.
2.2 Role of Management Accounting in Decision Making
Management accounting as a decision-making tool is quite integral especially in the operations of manufacturing firms. In essence, it acts as a source of cost information that can be used in making decisions. First and foremost, the techniques of product costing enable managers to obtain a systematic means of determining costs incurred in the production of products (Freedman, 2018). Product costing data can also be used in valuing inventory as well as in generating external reports. Moreover, it is through product costs that selling prices can be determined hence monitoring the performance of manufacturing. Managers can choose between process costing and job-order costing depending on the nature of the product being manufactured by the firm.
Furthermore, manufacturing firms can perform variance analysis through management accounting. Variance analysis is instrumental in determining the magnitude of the difference between budgeted and actual production hence minimising any future wastage of inputs (Davila and Wouters, 2006). It is a systematic way for managers to split differences arising from expected production costs into quantity as well as price variances.
Manufacturing firms can determine whether to buy or make a product with the help of management accounting. It is essential for such firms to decide whether or not it is economical to build a product or purchase preassembled components of the product. Differential cost analysis technique can be used by management accountants to analyse such decisions. Managers are therefore able to make unprejudiced make or buy decisions.
3. Financial Ratios for Camden Limited
3.1 Return on Capital Employed
The ratio is critical to the investors as it is a measure of the net profit generated from the capital that is employed by the business (Barnes, 1987). Capital drives the activities of the business hence investors and other stakeholders are keen to ensure that the funds are invested efficiently to generate the maximum return which is required.
The ratio is calculated as below;
Return on Capital Employed (ROCE)= Earnings Before Interest " Taxes/Capital Employed (Barnes, 1987)
The Capital employed is derived by subtracting the current liabilities from the total assets. The computation for Camden Limited for 2016 and 2017 is as shown below;
Year
2016
2017
£'000
£'000
Gross Profit
1350
1500
Operating Expenses
-600
-675
Earnings Before Interest " Taxes
750
825
Total Assets
4470
8070
Current Liabilties
-645
-2220
Capital Employed
3825
5850
Return on Capital Employed
0.1961
0.1410
3.2 Return on Owner’s Equity
The ratio focuses on analysing how much return the investors generate based on the equity that they have invested (Kocran, Dechow and Sun, 2013). The ratio is different from the return on working capital because it simply focuses on the issued share capital less any debt that the company has. The formula for calculating the ratio is as shown below;
Return on Owner’s Equity= Net Profit/Shareholders Equity (Barnes, 1987)
Shareholder’s Equity is determined by the difference between Total Assets and Total Liabilities. The computation for Camden Limited for 2016 and 2017 is as shown below;
Year
2016
2017
£'000
£'000
Net Profit
1350
1500
Total Assets
4470
8070
Total Liabilities
2145
5220
Shareholders’ Equity
2325
2850
Return on Owner's Equity
0.5806
0.5263
3.3 Current Ratio
The current ratio is a liquidity ratio which provides the investors with the view on whether the company can meet the current obligations as and when they arise (Kocran, Dechow and Sun, 2013). The higher the ratio, the greater the ability of the company to meet the short-term obligations. As a result, the healthy ratio is between 1.5 and 3.
The current ratio is calculated as below;
Current ratio=Current Assets/ Current Liabilities (Barnes, 1987)
The computation for Camden Limited is as shown below;
Year
2016
2017
£'000
£'000
Current Assets
1515
2070
Current Liabilities
645
2220
Current Ratio
2.35
0.93
3.4 Inventory Turnover
Sales is very critical for manufacturing organisations since it determines whether the products being manufactured are being consumed. As a result, the Inventory Turnover Ratio provides insights to the management team on how many times the company has sold and replaced inventory during the period under review (Kocran, Dechow and Sun, 2013). As a result, a company which is performing well should have a higher inventory turnover ratio signifying a strong demand for their products.
The ratio is calculated as shown below;
Inventory Turnover=Cost of Sales/Closing Inventory (Barnes, 1987)
The calculation for Camden Limited for 2016 and 2017 is as shown below;
Year
2016
2017
£'000
£'000
Cost of Sales
3900
5250
Closing Inventory
450
4500
Current Ratio
8.67
1.17
3.5 No. of Day’s Purchases in Trade Payables
Prompt payment of suppliers is a key determinant to the efficiency of the supply chain since when the suppliers are paid promptly their commitment to the process is improved (Turner, 1997). As a result, the ratio reveals how long the company takes to settle the vendors and suppliers from the time the invoice is received (Kocran, Dechow and Sun, 2013). Thus, the ratio is calculated in days and the desired industry expectation is to pay the suppliers 30 days from the date the invoice is received.
Moreover, the ratio reveals how a company manages its cashflows especially with regards to an accounting period. The ratio is calculated as shown below;
Year
2016
2017
£'000
£'000
Trade Payables
570
2100
Cost of Sales
3900
5250
No. of Day's Purchases in Trade Payables
53.35
146.00
4. Commentary on Camden Limited’s Results
4.1 Return on Capital Employed
The Return on Capital Employed has dropped from 19.61% in 2016 to 14.10% in 2017. The level of efficiency has fallen by 5.51%. In 2016, for every pound of working capital employed by the investors, the business generated 19.61 cents in profit. However, in 2017, for every pound of working capital invested the company has only generated 14.10 cents in profit. As a result, the profitability of Camden Limited has dropped by 5.51 cents for every pound invested. The capital investment increased in 2017; however, the company has not generated the required level of profit causing the decline. As a result, the investors should not invest in Camden Limited due to the 5.51% decrease in Working Capital.
4.2 Return on Equity
The return on equity for Camden Limited dropped from 58.06% in 2016 to 52.63% in 2017 signifying a 5.43% drop. As a result, in 2017, Camden Limited has only been able to generate 52.63 cents in revenue for every pound of equity invested as opposed to 58.06 cents in 2016. The decline has been caused by an increase in shareholder’s equity which did not yield a corresponding increase in revenue hence causing the drop. As a result, due to the declining profitability, it is not advisable for the investors to invest in Camden Limited.
4.3 Current Ratio
The current ratio is healthy when it ranges between 1.5 and 3. Camden Limited’s current ratio has dropped from 2.35 in 2016 to 0.93 in 2017. The company was at a healthy financial position in 2016, and they were able to meet their current obligations since the ratio was above 1.5. However, in 2017, the ratio of 0.93 signifies the company has a high gearing ratio, and their current assets cannot cover their liabilities. From a liquidity point of view, the company is not best placed to meet their short-term obligations due to the massive increase in their current liabilities. As a result, the investors should not invest in Camden Limited since the company is in a struggling liquidity position.
4.4 Inventory Turnover Ratio
Camden Limited has been struggling to sell its products in 2017. The company’s inventory turnover ratio was at 8.67 in 2016 which reveals that the company sold and replaced its inventory more than eight times in 2016. However, the inventory turnover ratio has dropped by 7.5 to 1.17 revealing that Camden Limited is struggling to sell its inventory. The cause of the current drop could be attributed to the reduced demand in the market for Camden’s products. Moreover, the products could be high priced or of low quality hence being unattractive to the customers (Turner, 1997). The drop in the turnover ratio reveals the low sales power in the organisation. As a result, the investors should not invest in Camden Limited.
4.5 No. of Day’s Purchases in trade payables
Camden Limited was taking 53.35 days to pay their suppliers and vendors once they had received the invoices in 2016. However, in 2017, the number of days increased to 146 days. The expectation in the industry is to pay suppliers 30 days once the invoice has been received. However, Camden Limited has been holding invoices for a more extended period meaning the suppliers are disgruntled due to the late payments. The current situation has been caused by cashflow issues since organisations that do not struggle with cashflows pay their suppliers promptly. As a result, the investors should consider and not invest in Camden Limited.
5. Conclusion
In conclusion, the report has analysed the role of management accounting in planning, control and decision making. The different functions of management accounting such as budgeting, forecasting, cost volume profit analysis together with make or buy decision process ensure that these functions are achieved. The second part of the report has analysed the financial statements of Camden Limited with a focus on the Return on Capital Employed, Return on Equity, Current Ratio, Inventory Turnover ratio and the number of Day’s Purchases in Trade Payables. These ratios have been analysed for both 2016 and 2017. Camden Limited has experienced a decline in 2017 for all the ratios which has revealed the poor financial health of the organisation. As a result, the investors should not consider investing in the organisation.
References
Barnes, P. (1987). The Analysis and Use of Financial Ratios: A Review Article. Journal of Business Finance " Accounting, 14(4), pp.449-461.
Davila, T. and Wouters, M. (2006). Management Accounting in the Manufacturing Sector: Managing Costs at the Design and Production Stages. Handbooks of Management Accounting Research, pp.831-858.
Freedman, J. (2018). Why Management Accounting Is Important in Decision-Making. [online] Smallbusiness.chron.com. Available at: https://smallbusiness.chron.com/management-accounting-important-decisionmaking-53947.html [Accessed 15 Aug. 2018].
Fry, T., Steele, D. and Saladin, B. (1998). The use of management accounting systems in manufacturing. International Journal of Production Research, 36(2), pp.503-525.
Kocran, A., Dechow, P. and Sun, Y. (2013). The use of financial ratio models to help investors predict and interpret significant corporate events. Australian Journal of Management, 38(3), pp.4-8.
Turner, J. (1997). The Impact of Materiality Decisions on Financial Ratios: A Computer Simulation. Journal of Accounting, Auditing " Finance, 12(2), pp.3-7.
