Budgeting in the Sports Industry - Case Study Example

Managing Financial Resources in the Leisure and Sports Industries Task Budgeting Budgeting in the Sports Industry – possible risks In order to understand the possibly use of budget as a control tool in the sports industry, we should primarily refer to the general characteristics of the particular industry. Regarding this issue it is noticed by Hums et al. (1999, 51) that ‘the sport industry is an extremely diverse industry, including segments such as professional sport, intercollegiate athletics, health and fitness, recreational sport and facility management’. In this context, the managers of the firms that operate in the particular industry should use a series of tools in order to appropriately monitoring all the particular aspects of the organization’s operation. Cost control should be considered to be a significant part of organizational activities in all firms operating within the sports industry. The application of capital budget planning within modern organizations has been extensively explored by researchers around the world. The level of applicability of this procedure by modern firms should be however strongly criticized as it has been found to be limited. As an example, while monitoring a series of firms operating in the Hong Kong’s construction industry Lam et al. (2001) found that just few of the firms involved in the survey were using capital budget planning in order to control their costs. More specifically, it was revealed that ‘less than half of the respondents undertook any form of capital budget planning while the most common form of capital budget planning was a review of the minimum rate of return’ (2001, 569). As for the sports industry, the application of capital budgeting as a tool for cost control has not been particularly explored. However, particular issues that could have an impact on the profits and the costs involved in the operation of firms in the sports industry have been analytically examined. The application of specific economic models regarding the monitoring of costs and profits of the firms operating in the sports industry has been also reviewed. In this context, Kesenne (2007, 519) found that the Walrasian Equilibrium model and the Nash Equilibrium model could possibly used as tools of cost control in firms within the sports industry. Other economic models have been also proved to be appropriate for the measurement of costs related with the activities of firms operating in the sports industry. The computable general equilibrium (CGE) is a characteristic example among these economic models applicable in the sports industry (see also the relevant study of Dwyer et al., 2006). Another issue that is also highlighted is the fact that the profits generated from ‘business travelers visiting events’ (Solberg et al., 2002, 151) should be taken into account when measuring the profits of firms operating in the sports industry. In accordance with the above, budgeting can be used as a tool for cost control in the sports industry however there are certain risks, like: a) problem with identifying the revenues (as explained above many parts of sports events or of the activities of firms operating in the sports industry could be regarded as sources of profits), b) problem when deciding on the appropriate method of cost control (not all economic models are appropriate for cost control in the specific industry, the examples mentioned above prove the validity of this assumption) and c) problem with the timing related with the estimation of costs (sports events and sports activities are characterized by complexity and they are usually not completed in just one phase). Parts of budget A budget usually involves in the following issues/ stages: 1) Design of strategy that will be followed for the cost control 2) Distinguishing costs in categories: fixed, variable, direct and indirect 3) Choose of the appropriate costing technique 4) Allocation of responsibility for the successful planning and monitoring of the budget Other parts/ stages could be also added to the above ones, in accordance with the firm’s needs and its market characteristics. Variance analysis In order to understand the use of variance analysis as a cost control tool in the sports industry we should primarily present its main characteristics. In this context, it should be mentioned that ‘a variance is the difference between an actual result and an expected result; the process by which the total difference between standard and actual results is analysed is known as variance analysis; when actual results are better than the expected results, we have a favourable variance (F); if, on the other hand, actual results are worse than expected results, we have an adverse (A)’ [2]. In accordance with the above in order to apply the variance analysis in the sports industry, an appropriate and precise estimation of costs and profits in the long term could be completed in advance (in order to have a comparable amount after estimating a firm’s costs). Task 2 Project Appraisal The Association of Rugby is willing to purchase a machine for its Treatment Center in order to offer a specialize therapy to the athletes that have suffered an injury. The ‘life’ of the machine is expected to be 6 years. Because this machine is going to be used by the teams that are members of the Association by paying a specific amount as an indicative offer to the Association for this type of support, its use is expected to generate revenues for the Association. These revenues will be approximately 40,000/ year for the 6 years that it will be used. On the other hand, the operating expenses are expected to be approximately 25,000/ year. The Association has a tax rate of 20% while the discount rate is 10%. The cost of purchase of this machine is £80,000. The Net Present Value of this project should be calculated taking into account the fact that the Association has revenues from other sources (its common activities) while a significant number of assets are also administered by the Association. As an alternative, the Association could buy a machine offered to a cheaper price but with less annual income expected, the cost of its operation would be also less. More specifically, the cost of this machine would be £60,000, its life would be 10 years, and the annual profit from its operation would be approximately 30,000 while the expenses involved would be approximately 10,000. The Association has to choose between these two machines available in the market. The Net Present Value of the two machines should be calculated and the results would lead to a valid assumption regarding the most profitable investment for the Association. Step 1 Machine A Cost of Asset £80,000   Discount Rate: 10%   Life of Machine: 6 Years Tax Rate: 20% Tax Rate: 20% Annual Expenses 25,000/ year Annual Profits 40,000 Machine B Cost of Asset £60,000   Discount Rate: 10%   Life of Machine: 10 Years Tax Rate: 20% Tax Rate: 20% Annual Expenses 10,000/ year Annual Profits 30,000 Step 2 Net cash flows related with the operation of machine A: Year Machine Cost Revenues Expenses After Tax Net Cash Flows Present Value 0 (80,000)       (80,000) 1   40,000 25,000 12,000.00 11636.36 2   40,000 25,000 12,000.00 9917.35 3   40,000 25,000 12,000.00 9022.55 4   40,000 25,000 12,000.00 8219.17 5   40,000 25,000 12,000.00 7453.41 6   40,000 25,000 12,000.00 6779.66 Total net present value: £ (26971.5) In accordance with the above figure, since NPV is greater than zero, the particular purchase is expected to add value to the firm. This purchase would be accepted only after comparing the two figures (NPV of both purchases) after having estimated the NPV for the machine B. Net cash flows related with the operation of machine B: Year Machine Cost Revenues Expenses After Tax Net Cash Flows Present Value 0 (60,000)       (60,000) 1   30,000 10,000 16,000.00 14545.45 2   30,000 10,000 16,000.00 13223.14 3   30,000 10,000 16,000.00 12030.07 4   30,000 10,000 16,000.00 10958.90 5   30,000 10,000 16,000.00 9937.88 6   30,000 10,000 16,000.00 9039.54 7 30,000 10,000 16,000.00 8247.42 8 30,000 10,000 16,000.00 7476.63 9 30,000 10,000 16,000.00 6808.51 10 30,000 10,000 16,000.00 6201.55 Total net present value: £ (-38522.55) It is clear that the purchase of machine B would cause financial damage to the firm (NPV Read More