The Effectiveness of Budgetary Control Systems in Cleaning Services for London - Case Study Example

Effectiveness of Budgetary Control System Cleaning Services for London Company Table of Contents Table of Contents 0 0Introduction 1.1Aims of theInvestigation 1 1.2Purpose of Budgetary Control 1 1.3Overview of Main Activities 2 1.4Current Budgeting Method 2 2.0Findings 3 2.1Budget Setting 3 2.2Controlling Budget 4 2.3Behavioural Issues 5 3.0Conclusions 6 3.1Evaluation of the Effectiveness of the Budgetary Control System 6 3.2Recommendations 6 REFERENCES 7 APPENDIX A 8 APPENDIX B 9 The Effectiveness of Budgetary Control Systems in “Cleaning Services for London” 1.0 Introduction The paper focuses on the operation of a service company – Cleaning Services for London. The company is a small cleaning business with two employees who do all the cleaning services. The business firm offers a wide range of cleaning services such as domestic, office, after builders, after parties, one-off and spring cleaning. It offers good prices and guarantees a perfect cleaning service. In cooperation with a carpet company, “Cleaning Services for London” also provides carpet cleaning. 1.1 Aims of the Investigation The aim of this paper is to investigate the financial operations of the company – Cleaning Services for London. It will include illustrating and evaluating the role of budgetary control in support to internal planning and decision making. It aims to create an effective budgetary control system for its operations, to identify cost behaviours and to propose a suitable recommendation for improvement. 1.2 Purpose of Budgetary Control Budget is a quantitative financial plan of operations. It identifies the resources needed in order to accomplish the organisation’s goals and objectives. It contains detailed plans and policies to be pursued in a future accounting period. It is continuous where one updates the budget for the year at the end of each month or each quarter. A continuous budget remains more relevant and more current. As a service company, “Cleaning Services for London” the operating budget includes purchase budget, human resources budget and sales budget. One of the major facets of budgeting is cost control. Budgets are the key to cost control. The purpose of budgetary control is to help master the financial aspects of the company’s operations and solve problems before they occur. Financial control is exercised by managers in preparing budgets for revenues and expenditures of an organisation in advance. Budgetary control facilitates the management and allocation of resources and funds in operating the business to achieve desired outcomes or to provide basis for revision of business objectives and plans. 1.3 Overview of Main Activities The activities of the company are categorized into two – revenue generators and cost drivers. These main activities summarise the operations of the company in financial terms where revenue generators are cash inflow of the company while cost drivers are expenses incurred in the operation of the business. The company generates revenues from three major cleaning services. These include domestic cleaning, one off services and carpet cleaning. The expenses of the company include wages, cleaning materials, advertising expenses as well as administrative costs such as telephone, internet and petrol uses. 1.4 Current Budgeting Method The company utilises a simple budget system in line with a business plan for one year. The manager who is responsible for the financial, marketing, administrative and operational matters uses cash flow forecasts as basis for the budget. The forecast shows the predicted movement of cash over a year. It is divided into months with a last column that sums up and averages the whole year. (See Appendix A) The revenue forecasts are based on historical data of the company’s previous performances. The forecasts consider the seasonality of the services of domestic, one-off and carpet cleaning. Cleaning services, like any other business, experience peaks and lows in the whole year of its operations. The budgeted expenses are based on several assumptions. Direct labour costs or wages are 15% of the total revenues. The costs of cleaning materials are 11% of the total revenues. Petrol expenses are fixed at £150 per month. Advertising costs are fixed at £580 each month. Telephone and Internet Costs are fixed at £80 and £21 each month, respectively. 2.0 Findings 2.1 Budget Setting Knowing what the business activities will cost and when such expenses will be incurred shall help the company in anticipating and preventing any unexpected surprises. Situations and circumstances that are not anticipated and predicted may lead to financial problems. The budget gives answers to questions such as: What revenues of domestic, one-off and carpet cleaning services will be needed in order to achieve the desired profit? How much shall the cost of the cleaning materials needed? How much of the advertising and marketing expenses shall be allocated based on the business plan? Does the company need to expand facilities or acquire new equipments? A summary of the budget is illustrated below. Cleaning Services for London Monthly Budget (2008) Total (YR 2008) Monthly Average Total Revenues 31100 2592     Variable Cost - Wages 4665 389 Variable Cost - Materials 3421 285 Fixed Cost - Advertising 6960 580 Fixed Cost - Petrol, Telephone, Internet 3012 251 Total Expenses 18058 1505     Net Income/Loss 13042 1087 2.2 Controlling Budget The company controls the budget using a static budget performance report and variance analysis. The static or fixed budget presents budgeted amounts at the expected capacity level of the business. The variance analysis is the difference of the actual performance from the forecasted performance. Below is an example of the static budget performance report of the company for three months. (See Appendix B for more details) Budget Performance Report (2008) September October November Budget Actual Var Budget Actual Var Budget Actual Var Total Revenues 2750 2745 5 2700 2670 30 2450 2386 64                   Variable Cost – Wages 413 462 -50 405 373 32 368 322 46 Variable Cost – Materials 303 326 -24 297 297 0 270 269 1 Fixed Cost – Advertising 580 580 0 580 490 90 580 670 -90 Fixed Cost - Petrol, Telephone, Internet 251 249 2 251 271 -20 251 225 26 Total Expenses 1546 1617 -71 1533 1431 102 1468 1486 -18                   Net Income/Loss 1204 1128 76 1167 1239 -72 982 900 82 2.3 Behavioural Issues The projected revenue is the most important line in the budget. The forecast should be a complete analysis of marketing research and sales performance. It is important that the forecasted data is accurate because this is the basis for the operations of the company and the projected cash inflow. The historical data of the sales performance of the company shows a seasonal behaviour. Anticipating the revenue generated with the season will create a favourable budget. Based on the sample budget performance report, the projected revenue is slightly higher than the actual revenue generated. The assumption on the variable cost of wages which is 15% of the total revenue is off the mark. The month of September has a negative variance which means that the wage expense is under-budget. The months of October and November, on the other hand, have a positive variance. This may indicate that the wages have a mix of variable and fixed costs. The assumption on the variable cost of cleaning materials which is 11% of the total revenue is on target for the three months except for September. This is unexpected and further analysis will be required to trace the root cause. The allocation of advertising cost is acceptable as it showed minimal or no variance at all. The allocation of fixed cost on petrol might be inaccurate. Petrol costs may have a mix of variable and fixed costs. 3.0 Conclusions 3.1 Evaluation of the Effectiveness of the Budgetary Control System Using a static budget and a simple variance analysis is not be adequate for the company’s budgetary control system. The cost variances indicated in the budget performance report may not illustrate an accurate occurrence and accomplishment. Some of the variances may be favourable on the company based on paper but will not be favourable on the actual operation. As an example, the static budget of expenses is based on the projected revenue of the month where the assumptions will apply. The actual revenue may be lesser than the forecasted value. A lesser revenue would mean lesser cleaning services. In turn, it should have a lesser budget in the expenses. However, the budget performance report does not follow such logic. From a control stand point, it makes no sense to try to compare costs at one activity level with costs at a different activity level. 3.2 Recommendations As discussed in the findings of the investigation and the evaluation of the existing budgetary control system, it is recommended that the company would adopt a different approach on budgeting. The recommended method is the flexible budget. A flexible budget is an effective tool that is extremely useful in cost control. It is geared towards a range of activity rather than a single activity. It is dynamic in nature where a series of budget can be developed for various level of activity. The idea of a flexible budget emphasizes an attempt to correctly measure the efficiency of the cost centres. Creating a flexible budget involves an expected range of activity for the period and an analysis of cost behaviour trends. The flexible budget separates costs by behaviour where mixed costs are broken into variable and fixed components. It effectively determines what costs will be incurred ad different levels of activity. Thus, variances between actual costs and budgeted costs are adjusted for volume increases and decreases before differences due to price and quantity factors are computed. REFERENCES Shim, J., & Siegel, J. (2005). Budgeting Basics and Beyond (2nd ed.). Hoboken, NJ: John Wiley & Sons, Inc. _________________ Word Count = 1965 APPENDIX A Monthly Budget (2008) Cleaning Services for London JAN FEB MAR APR MAY JUN JUL AUG SEP OCT NOV DEC TOTAL AVE Revenues     Domestic Cleaning 1200 1150 1300 1150 1200 1300 1150 1150 1300 1200 1150 1000 14250 1188 One-off Cleaning 700 650 700 650 600 700 650 600 700 650 600 500 7700 642 Carpet Cleaning 850 700 700 750 700 850 850 750 750 850 700 700 9150 763 Total Revenues 2750 2500 2700 2550 2500 2850 2650 2500 2750 2700 2450 2200 31100 2592     Expenses     Wages 413 375 405 383 375 428 398 375 413 405 368 330 4665 389 Cleaning Materials 303 275 297 281 275 314 292 275 303 297 270 242 3421 285 Petrol 150 150 150 150 150 150 150 150 150 150 150 150 1800 150 Advertising 580 580 580 580 580 580 580 580 580 580 580 580 6960 580 Telephone 80 80 80 80 80 80 80 80 80 80 80 80 960 80 Internet 21 21 21 21 21 21 21 21 21 21 21 21 252 21 Total Expenses 1546 1481 1533 1494 1481 1572 1520 1481 1546 1533 1468 1403 18058 1505     Net Income/Loss 1204 1019 1167 1056 1019 1278 1130 1019 1204 1167 982 797 13042 1087 APPENDIX B Budget Performance Report (2008) Cleaning Services for London September October November Budget Actual Var Budget Actual Var Budget Actual Var Revenues       Domestic Cleaning 1300 1200 100 1200 1200 0 1150 1156 -6 One-off Cleaning 700 800 -100 650 640 10 600 560 40 Carpet Cleaning 750 745 5 850 830 20 700 670 30 Total Revenues 2750 2745 5 2700 2670 30 2450 2386 64       Expenses       Wages 413 462 -50 405 373 32 368 322 46 Cleaning Materials 303 326 -24 297 297 0 270 269 1 Petrol 150 150 0 150 167 -17 150 135 15 Advertising 580 580 0 580 490 90 580 670 -90 Telephone 80 78 2 80 83 -3 80 69 11 Internet 21 21 0 21 21 0 21 21 0 Total Expenses 1546 1617 -71 1533 1431 102 1468 1486 -18       Net Income/Loss 1204 1128 76 1167 1239 -72 982 900 82 Read More