The Analysis of HK Cooperation Company - Report Example

Page Table of Contents Contents Page Number Introduction What is Wrong with Our Company’s Budgeting Process Some Suggestions in Improving Our Budgeting Process 2 Cutting Costs and Expenses to Meet Budget 3 Standard Cost and Variance Reporting System 3 Conclusion 4 Introduction Budgeting has always been the tool used by companies and managers to plan, to execute and to monitor the results of operations of the company. Although the process is tedious and can take a long time, it is a very important element in financial management and in the overall success or failure of any company (Adaptive Planning, 2005, p. 1). A good budget helps management communicate its goals to its personnel and control the direction of the company’s operations. The budget is also important for the management and the employees because it provides a benchmark that they can use to assess if they are performing as expected. Lastly, a budget is important because it is used by the management to monitor the results of operations and to take any corrective actions when such a need arises. Another concern very much applicable to a manufacturing company like ours is the proper implementation of a standard cost and variance reporting system. According to Gene Siciliano (2003, p. 134), the power of this system lies in the analysis of the differences or variances and utilizing the results of such analysis to ensure that the managers change what they are doing, all for the long-term profitability of the company. The standard cost and variance reporting system is important because it helps management measure the efficiency of each department; it aids management in pinpointing where exactly the deviations occur and in taking corrective measures accordingly; it controls costs and, lastly, it aids management in making the right decisions on which areas need to be addressed (Globusz Publishing, n.d.). HK Corporation (the Company), like a lot of companies, has its own budget and standard cost system. However, in the last few years, we have been unable to meet our budgeted targets for sales and net income before income tax making the budget fail in its goal to control our operations. I believe that our budgeting process has contributed to our failure to achieve our targets. This report that I am submitting shows why I believe this is the case. My report also contains some suggestions or recommendations on how our budgeting process can be revised to solve its problem and how we can improve on our standard costs and variance reporting systems. What is wrong with Our Company’s Budgeting Process? First of all, the top-down approach has led to inadequate allocation of resources and dissatisfaction among the managers. In fact, most often than not, after the director of finance and the other managers met to thresh out the problem areas in the budget, we see our managers often left dissatisfied with the process. With dissatisfaction, there is the danger of loss of motivation, which can influence managers not to perform in the Company’s best interests (Jensen, 2001). With inadequate allocation of resources, some of our departments are to efficiently perform their functions and to positively contribute to the over-all results of the Company. Secondly, our steadfast belief that the targets should be inflexible has caused the other areas of our budget to be adjusted, thus, failing to check if these two initial targets are unrealistic in the first place. Instead of revising the unrealistic targets, we are revising the other areas of the budget to follow these two targets, resulting to an over-all unrealistic and unreliable budget. Thirdly, our budget is generally considered inflexible. As Ali pointed out, the annual budget is written in stone. We don’t have any policy or procedure to review and verify if the budget is still realistic or if its needs to be adjusted during the year. Lastly, our budgeting process (and the resulting reporting process) lacks proper communication and coordination. Our managing director does not coordinate with the concerned managers in coming up with the two important targets. When a standstill occurs, the concerns from the managers are not considered when breaking off such a standstill. The report given is almost a month old, making its information almost useless to the analyzing managers. The managers do not receive the type of reports they need to better analyze their departments’ performances. Some Suggestions in Improving Our Budgeting Process First of all, the level of interaction in our various departments during the budgeting process should be increased. Instead of a top-down approach, we could consider using a variety of approaches. We can implement a top-down approach for strategies, objectives and expectations but the actual plan to meet these goals (i.e., the budget) should start from the bottom to the top (Adaptive Planning, 2005, p. 3). Second, let us view all targets as flexible. If there are inconsistencies in the areas covered by the budget, we should resolve these matters with a view of retaining the most realistic target possible. Third, we should eliminate the ‘written-in-stone’ characteristic of our budget. Instead, we should consider implementing a rolling forecast or budget. According to Loren Gary (2003), a rolling forecast may contain only a few items such as sales, costs, profit, cash flows and capital investment but this is already enough to ensure that the managers will focus more on the long-term perspective or issues of the company, which are actually necessary for our Company’s success. Lastly, our level of communication and coordination should be improved. Other than the first recommendation, we should consider revamping our reporting process to produce more useful reports at the shortest possible time. Cutting Functional Areas when Sales Volume Falls Below Budget One critical thing I’ve noticed is that, since our main targets are our sales and net income before income tax, a sales target that is not met will mean that our actual costs and expenses are cut so that these would also fall below budgeted amounts to maintain the same net income before income tax. However, I would like to point out that cutting costs should not always be the solution when sales target is not met. Doing so might actually be detrimental to the long-term financial future of our Company as there may be a need for the Company to actually increase some of its costs (such as marketing costs) in order to increase actual sales in the future. Standard Cost and Variance Reporting System Other than our budgeting process, our standard cost and variance reporting systems leave also much to be desired. As a matter of fact, Ali’s biggest gripe is that his department’s production activities vary from month to month; yet, the results are compared to a budget that is set on stone. Ali feels that the performance report, in particular, is hampering his analysis because it does not provide him useful information to help him handle his people, as well as the machines and the materials used by his department. He also feels negative about the report because it does not take into account sudden spikes in the operations, such as the rush order they made the previous month because of lack of supplies. Adam, on the other hand, is uncertain as to where rush orders for supplies will be found in their latest performance results. He does not know where he will find such spikes in the report given to them. He also feels frustrated because he knows he will be charged with the negative variances that resulted from activities that were beyond his control. A properly implemented standard cost and variance reporting system can only bring about many benefits to our Company. One major benefit is that it “coordinates all functions…towards the achievement of a common goal (Lal and Srivastava, 2009, pp. 805 – 806). It enables our managers to better assess the performance of the company as actual costs can be compared to standard costs, plus the analysis can be broken down further into which component (labour, materials, overhead, units, etc.) actually caused the difference. The continuous and deep analysis of what caused the variance “leads to the discovery of inefficiency and the early organization of remedial activity” (Pizzey, 1989, p. 224). Lastly, reasonable and attainable standard costs can actually motivate one to work (Oliver, 2000, p. 219). In our Company’s case, we can improve our standard costing and variance reporting system by ensuring that the budget actually includes the standard costs at different levels of production and different product – mixes. The standard costs should be more realistic and reflective of the thoughts, plans and projections of the production manager, and not come from having to fit the production budget with the sales target. The variance reports included in the actual performance report should show or capture the unusual spikes or activities during the month. The managers of the departments affected by these unusual activities should not be penalized for the resulting negative variances (which is what Ali and Adam were afraid of). Lastly, the variance report should actually show how the labour hours, the materials and the equipment usage actually affected the variances. Inclusion of these important matters in the variance report will help address Ali’s concern that he is not receiving relevant data to make an informed analysis on his department. Conclusion It would seem that our budgeting and standard cost and variance reporting systems and the resulting performance evaluation are proving to be hindrances in achieving our desired results. We should, therefore, consider improving these systems. The recommendations found in this report are just some of the steps that we can take to improve our budgeting process and our standard cost and variance reporting system. Ensuring that these systems will become more responsive to the needs of the managers and the employees is a step towards harnessing the huge benefits that our Company can gain from these systems in the future. Bibliographies Adaptive Planning (2005). Best Practices for Budgeting, Forecasting and Reporting. Retrieved from: http://www.adaptiveplanning.com/docs/AP_Best_Practices_Kit_01.pdf. Gary, L. (2003). Why Budgeting Kills Your Company. Retrieved from: http://hbswk.hbs.edu/item/3623.html. Globusz Publishing (no date). Chapter 4: Standard Costing. Retrieved from: http://www.globusz.com/ebooks/Costing/00000014.htm. Jensen, M. (2001). Why Corporate Budgeting Needs to Be Fixed. Retrieved from: http://hbswk.hbs.edu/item/2647.html. Lal, J. and Srivastava, S. (2009). Cost Accounting. New Delhi: Tata McGraw-Hill Publishing Company Limited. Retrieved from: http://books.google.com.ph/books? id=1KklpFKeT6EC&printsec=frontcover#v=onepage&q=&f=false. Oliver, L. (2000). The Cost Management Toolbox: A Manager’s Guide to Controlling Costs and Boosting Profits. New York: AMA Publications. Retrieved from: http://books.google.com.ph/books?id=affD1a1OlqUC&pg=PA216&lpg=PA216&dq=advantages+of+standard+costing&source=bl&ots=QJhjPANU78&sig=RE-k9pIQHhPmJiX MieMLjHiOh4M&hl=tl&ei=L-QXS5rfN4uUkAWT5ozSAw&sa=X&oi=book_result& ct=result&resnum=4&ved=0CBUQ6AEwAzge#v=onepage&q=&f=false. Pizzey, A. (1989). Cost and Management Accounting: An Introduction for Students. London: Paul Chapman Publishing Ltd. Retrieved from: http://books.google.com.ph/ books?id=QAYsaQXik48C&printsec=frontcover#v=onepage&q=&f=false. Siciliano, G. (2003). Finance for Non-Financial Managers. New York: The McGraw – Hill Companies, Inc. Retrieved from: http://books.google.com.ph/books?id= KirYlKS3ZygC&printsec=frontcover#v=onepage&q=&f=false. Read More