Managing Financial Principles and Techniques

Contents
3. Be able to participate in the budgetary process of an organisation......................................................... 4 3.1 select appropriate budgetary targets for an organisation.................................................................. 4 3.2 participate in the creation of a master budget for an organisation ................................................... 7 3.3 compare actual expenditure and income to the master budget of an organisation ....................... 11 3.4 evaluate budgetary monitoring processes in an organisation ......................................................... 14 4 Be able to recommend cost reduction and management processes for an organisation....................... 16 4.1 recommend processes that could manage cost reduction in an organisation ................................. 16 4.2 evaluate the potential for the use of activity-based costing ............................................................ 18

3. Be able to participate in the budgetary process of an organisation

3.1 select appropriate budgetary targets for an organisation
In the modern business it is vital for organisations to maintain a appropriate budgetary control system to carry out its business in an efficient and effective manner and to survive in the business. More specifically cost and revenue targets needs to be set in an effective manner so that such companies are able to obtain a competitive advantage over the other companies. The XYZ Company is in the process of preparing its annual budget for the financial year 2012 and has prepared the following budget. XYZ manufacturing company budget for the financial year 2012 2010 Actual Revenue Cost of Sales Gross profit Selling distribution expenses Administrative 537 expenses Other administrative expenses Profit tax Taxation 25% Profit after tax 2633 3013 3748 1225 41 @ 878 1004 1249 245 24 before 3511 4017 4997 980 24 268 275 270 (5) (2) 550 565 15 3 14,375 8734 5641 & 1325 2011 Actual 15820 9520 6300 1458 2012 Budgeted 18193 10758 7435 1603 Variance 2373 1238 1135 146 % 15 13 18 10

Revenue Over the two year period the revenue of the company has grown by 10% annually and therefore taking into consideration the past trend and the future opportunities by the management the revenue is expected to increase more that previous years. According revenue is expected to be grown by 15% compared to previous years. Cost of sales Even though the revenue has increased by 10% in the past cost of sales has increased only by 9% due to the improvement taken place in the organisation and due to the economies of scales experienced by the company. Therefore with the aim of further improving these benefits the company has budgeted a 13% increase in cost of sales which will further improve the gross profit margin. Gross profit margin With the increase in the revenue and the increase in the cost of sales lower than revenue the company is expected to increase the gross profit margin in the financial year 2012. Selling and Distribution expenses The company expects to increase the selling and distribution expenses same as previous years by 10%. Though the revenue is expected to increase only by 15% selling and distribution expense in expected to increase only by 10% by improving efficiency and the effectiveness of the marketing activities. Administrative expense The company is targeting to maintain the same administrative expenses level in the current year by way of cost reduction activities to compensate the expenses increased due to the general inflation prevail. Other expenses 5

The company expects to maintain same level of other expenses by means of cost reduction activities. Profit after tax The company is expecting a increase in the profit after tax by 41% compared to the previous year by increasing sales and increasing the efficiency and effectiveness of manufacturing process.

3.2 participate in the creation of a master budget for an organisation

The master budget of the organisation comprise following budgets. Budgeted income statement Budgeted cash flow Budgeted balance sheet

Budgeted income statement The company prepares its budgeted income statement as follows, XYZ manufacturing company budget for the financial year 2012 2010 Actual Revenue Cost of Sales Gross profit Selling distribution expenses Administrative 537 expenses Other administrative expenses Profit tax Taxation 25% 7 @ 878 1004 1249 245 24 before 3511 4017 4997 980 24 268 275 270 (5) (2) 550 565 15 3 14,375 8734 5641 & 1325 2011 Actual 15820 9520 6300 1458 2012 Budgeted 18193 10758 7435 1603 Variance 2373 1238 1135 146 % 15 13 18 10

Profit after tax

2633

3013

3748

1225

41

Budgeted cash flow The budgeted cash flow statement of the company for the financial year 2012 is as follows, XYZ manufacturing company budget for the financial year 2012 2010 Actual Cash balance at the beginning 625 2011 Actual 450 2012 Forecasted 796

Add Receipts

Collection from customers

10,750

14,750

17,350

Total cash available

11,375

15,200

18,146

Less: Expenses

Direct material

3,345

3,755

4,506

direct labour

2,300

2,530

3,036

manufacturing overhead

2,893

3,434

4,121

selling expenses

and

distribution

1,300

1,430

1,716

Administrative expenses

537

555

570

Purchase of Property Plant &

2,000

500

1,500 8

Equipments

Tax

800

1,100

1,250

Total disbursements

13,175

13,304

16,699

Excess or

Deficiency over

(1,800)

1,896

1,447

disbursements

Financing

Borrowings

2,500

2,000

payments

1,000

500

Interest

250

100

200

Total financing

2,250

(1,100)

1,300

Cash balance at the end

450

796

147

It is assumed that the customer collection will be taken place in the same manner which took place in the past two year of 2010 and 2011. Further a capital expenditure of 1500 is expected in the year of 2012 to ensure that the manufacturing facilities are operates in most effective and efficient manner using cutting edge technology that the industry has. All the other manufacturing related expenses such as direct material, direct labour and production overheads are assumed to pay as an when they incur. Operating expenses such as selling and distribution expenses, administrative expenses also paid when they incurred. 9

Accordingly a borrowing of 2000 is expected to bridge the gap between the available cash balance and required cash balance. At the financial year end 147 cash balance is expected to prevail with the company.

Budgeted balance sheet The companys budgeted balance sheet is drawn as follows, 2010 Actual Non current assets 2011 Actual 2012 Budgeted

Property equipments

Plant

& 10350

10500

12,500

Current assets

trade receivables

2300

1893

2,789

inventory

750

847

2,194

cash balance

and

bank

450

796

147

3500

3536

5133.2

Total assets

13850

14036

17630

Share capital

6500

6500

6,500

reserves

1000

4013

7,761

10

Borrowings

2500

1500

2,500

current liabilities

Trade payable

350

2023

869

Total liability

equity

and

10350

14036.08

17630

The budgeted income statement, budgeted cash flow statement and budgeted balance sheet for the financial year 2012 has prepared in a consistent basis.

3.3 compare actual expenditure and income to the master budget of an organisation

2010

2011

2012

2012

Variance

Revenue

14,375

15,820

18,193

18,668

475

Cost of sales

8,734

9,520

10,758

11,043

286

Gross Profit

5,641

6,300

7,435

7,624

189

Selling & distribution expenses

1,325

1,458

1,603

1,647

44

Administrative expenses

537

550

565

590

25

11

Other expenses

268

275

270

290

20

Profit before tax

3,511

4,017

4,997

5,097

100

Tax @25%

(878)

(1,004)

(1,249)

(1,274)

(25)

Net profit after tax

2,633

3,013

3,748

3,823

75

Revenue The actual revenue of the company for 2012 was 18,668 while the budgeted amount was 18,193 which is an increase of 475 than budgeted. This has resulted in the significant increase in the volume due to the higher demand prevailed for certain product categories backed by the weather condition. Cost of sales Cost of sales has increased by 286 than those budgeted due to the increase in the demand for certain product which is evidenced by the increase in revenue. However gross profit of the company remains in the same position of 41% as budgeted. Though the company expected to increase the cost of sales to be increased by 13% actual increase accounted to 16% due to the Certain lapses faced by the manufacturing facilities. Furthermore certain direct manufacturing expenses such as electricity and overhead costs also increased along with the increase in revenue. Gross profit Gross profit also increased by 189 than budgeted for the financial year 2012. However the gross profit margin shows flat at 41% with the budgeted while it has improved by 1% from previous year of 40%. 12

Selling and distribution expenses Selling and distribution expense was amounted to 1647 while the budgeted expense was stood at 1603 which shows a increase of 44 than budgeted. This is mainly due to the increase in sales volume and this has resulted in slight increase in distribution expenses of the company. Moreover sales commission expense has also increased due to the increase in the revenue. Administrative expenses Administrative expense were budgeted at 565 where as actual amount was stood at 590. Accordingly administrative expense has increased by 25 than budgeted. This is mainly due to the increase in the salary expenses resulted in due to the new recruitments taken place in the company. Other operating expense Other operating expenses also increased slightly by 20 compared with actual other operating expense. Profit before tax The profit before tax has increased 100 than budgeted amount due to the increase in the sales volume. However the company was unable to obtain the full benefit from such increase due to the increase in the cost of sales and several other operational expenses.

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3.4 evaluate budgetary monitoring processes in an organisation

Budgetary monitoring is a process whereby the organisations sets the budgets to their organisations and continuous monitoring of the performance of the organisation compared with the budget to evaluate whether the operations of the organisation is taken place in an effective and efficient manner. The objectives of the budgetary control system is as follows, Determining the goals and objectives of each department of the organisation Assigning roles and responsibilities to each and every employee so that such individual is aware what he is expected to contribute to the organisation. Providing a basis for which performance of the company can be compared and identify any deviations take necessary actions on that on timely manner. Ensuring that all available resources are used in efficient and effective manner. Providing basis for revision of current policies to face to the future.

The following advantages can be obtained through a budgetary monitoring and control system,

Budgetary control system helps the management of the organisation to carry out its operational activities in an efficient and effective manner. Budgetary control is a efficient tool to control the companys expenses. Budgetary control can be used as a yardstick or measurement base to evaluate the performance of the individual staff of the organisation. Budgetary control system helps to identify the deviations from the actual output and expected output and to identify the possible reasons for deviations. 14

Budgetary control system helps to increase efficient and effective utilisation of resources in the organisation such as production materials, skilled labours, production machinery etc.

Budgetary control system helps the organisation to identify the current trends and to formulate future policies based on such information to operate effectively. Budgetary control helps the organisation to implement standard costing system to the organisation in an efficient and effective manner. By implementing a budgetary control system it encourage employees of the organisation to concentrate on the cost when performing activities within the organisation.

Budgetary control system has following limitation/ disadvantages Budgets are based on estimates of the future activities and therefore such estimates can be wrong and budgets may not be able to achieve giving a wrong picture. Budgetary controls may affect to the quality of the product and services of the organisation due to the high concentrate on the expenses of the production activities. Budgetary control can gives a wrong impression that achieving budgets of the organisations will solve all the problems faced by the compay Implementation of a budgetary control system may be high cost and in some instances it may not be cost effective. The management may focus on the achieving budget targets rather than achieving the goals and objectives of the organisation. Management may do under budgeting to show that the performance of the company is improved

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4 Be able to recommend cost reduction and management processes for an organisation

4.1 recommend processes that could manage cost reduction in an organisation

Company can reduce costs in various of ways. And these will ultimately helps the organisations to achieve its goals and objectives. The cost reduction techniques includes following steps, Identify the areas where the cost can be saved in this step the company needs to critically evaluate its cost structure and identify the areas where they can reduce the cost in more efficient and effective manner. Quantify the cost savings in this step the company needs to quantify the amount of cost that they can reduce which they identify in the first step. This helps to identify the most effective areas and concentrate more on such area. Test cost reduction process before implement At this step the organisation needs to consider whether the quantified costs can be reduces in actual scenario and they need to evaluate the impact of such reduction to the other processes such as quality of the product, impact to the brand name from such reduction etc. Implement the cost reduction activities The company must implement the cost reduction activities in the areas where they have identified in the previous steps. Due attention needs to be given to the areas where there is a effective cost reduction is available. Ensure that cost reduction has taken place 16

Once the process has implemented the management needs to make sure that the targeted cost reduction has taken place.

With regard to specific costs that has a significant impact on the company can use following techniques and method to reduce the cost Company can enter in to long term supplier contracts with suppliers which helps the company to obtain more favourable payment terms and attractive discounts. The company can use several suppliers to purchase goods and thereby reduce or eliminate the bargaining power of the suppliers and obtain the most favourable prices. To minimise the wastage in the production process the company can use the latest cutting edge technology in its manufacturing facilities. To reduce the finance cost the company may grant discount to customers who settle their dues on time. The companies can discuss with suppliers to obtain more favourable credit periods.

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4.2 evaluate the potential for the use of activity-based costing

Activity Based costing Activity Based Costing (ABC) is a relatively new management accounting model which is a mechanism whereby assigning costs of production based on the activities involved in the production process and the resources utilized by such activity (The Economist.com,2011). ABC is an alternative to traditional management costing techniques. According to the ABC technique, company needs to, Identify the activities involved in the production process. Allocate the cost to each activity based on the resource requirement Allocate the cost of each activity to each product based on the requirement of such activity by such product. If company uses Activity Based Costing method to compute its unit cost, it will be able to do a effective pricing of the products since this method computes the cost of the product based on the activities involved in the production process instead of using a single basis such as machine hours or labor hours utilized by each product which are used in traditional techniques. Activity based costing has following advantages Activity based costing gives more accurate information about the product cost rather than other cost accounting techniques. Under activity based costing overhead costs can be understand in a better manner. Activity based costing method is a simple costing method which can be understood by everyone. 18

Activity based costing take in to account unit cost rather than the total cost of the product and by this cost drivers can be easily identifiable. Activity based costing can be used to implement performance management methods such as scorecards. Activity based costing can be used for benchmarking. By using activity based costing the organizations can identify losses incurred in the production process and is able to identify activities or processes which will not add value to the production process

Results obtained from Activity based costing can be used for other modern management techniques such as six sigma Activity based costing asses the cost of individual activities based on its utilisation of resources.

Activity based costing has following disadvantages

Implementing activity based costing system to the organization can be involved high cost as such costing system needs significant amount if resources such as sophisticated computerized system, skilled labour etc

Once the system is implemented the cost incurred to process the data is high. Accordingly in order to obtain the information data needs to be collected, validated, checked and feed to the system which incur high labour cost

Activity based costing system produce various information which are significantly difference from information generated by other costing techniques. Owing to this reason the management may tend to use information provided by existing costing technique. Further when evaluating the performance of the management information produced by existing costing technique may used. Therefore the management will pay their attention on existing costing technique rather than the activity based costing

Activity based costing method produce data which can be misinterpreted easily by managers. Thus due attention need to be given when interpreting information and making decisions

Activity based costing is not in line with the Generally Accepted Accounting principles GAAP) which leads to prepare another set of accounts to comply with Generally Accepted Accounting principles

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Practical implementation of Activity based costing is challenged due to the serious challenges faced by the company

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