Charles Company Financial Analysis - Case Study Example

Business Finance: Case Analysis Introduction Charles Ltd has been analysed by financial planners and post analysis the company’s financial managers prepared a budget that showed that there was a significant need to enhance the company’s efficiency on almost all frontiers to ensure that finances were efficiently utilised and the resources were used to the best of their capabilities. The plan also set estimates for a higher production capacity but however, concerned functional departments did not find the budget acceptable. The paper explores the reason behind such non acceptability of the budget planned by financial managers at Charles Ltd and draws the behavioural reasons behind the failure of management in getting their budget accepted by various departments. It moves forward to analyse the plan and performs a variance analysis to find out how the budget could be flexed in order to accommodate a better and more acceptable plan in the scenario where huge deviations from the plan existed. It then concludes in suggesting measures to the management by which such behavioural issues in budget acceptance could be addressed and the new plan could be made acceptable throughout the organization (Stede, 2000). Drawbacks of the Budgetary Control System in Practice The budgetary control system analyses the Management Accounting as a Behavioural Process more than simply a financial process. The budgeting process at Charles ltd was not accepted by the departments primarily because of several behavioural issues that can be highlighted from the provided case. The case suggests a great deal of evidence whereby practical implementation of budgets calls for addressing behavioural issues more than making the budget acceptable within the organization. In case of Charles Ltd., the managers found it difficult to make their budgets accepted across departments of the company. After the 3 month period, they found large variances of actual production from planned estimates. Janet, a supervisor at Department D thought that the plan was some paperwork that did not require her attention and also the report prepared was unfair to for their team with several inaccuracies (ICSA, 2005). 1. The managers lack of concern acts as major criteria for non acceptance of financial plans by departments. Such lack of concern arises from lack of communication between the concerned departments while formulation of budgetary estimates. The managers need to be well aware of the production techniques and usage requirements and also understand efficiency norms and standards for various inputs. Only after due consideration of the interrelated production processes can the budget plan well at the departmental and hence the managerial level. Janet’s comment on unfairness and inaccuracy of financial report reflects that the financial plan or the budget was prepared without due consideration of the departmental issues and production related concerns. The figures were prepared without proper groundwork which includes understanding production capacities and techniques, problems associated in production line, uncontrolled inefficiencies and drawbacks and such other issues the contribute to production figures (Cotts and Rondeau, 2004). 2. Financial managers need to improve communication between the concerned departments. Such communication helps to identify the loopholes and also areas of concern where efficiency hits a rock. Lack of communication also contributes in helping management to make their employees understand the importance and relevance of budgetary planning. Communication becomes necessary to make people aware of organisational goals and why such goal setting calls for planning and adherence to plans. It was lack of communication between concerned teams that called for non - adherence to financial plans and preparation of faulty budget. 3. As a result of the present budgetary situation, non acceptance by departments might lead to mismanagement of department’s production plans where each department has a different target set for itself and things get distorted. 4. Unfairness observed in budgets might lead to complete lack of confidence in financial planning system and lack of knowledge of departmental functioning would lead to each department preparing their own financial plans. Such situation might have serious implications on inter department functioning and control. 5. Faulty revenue and production estimates portray a collared picture of the organization. Unrealistic budget preparation might lead to lack of confidence of investors in the company’s management and this in turn might affect its existence. Even the workers might feel a lack of confidence in the company when the even the financials do not appear sound. This might act as a major factor that de-motivates employees and leads to employee attrition. 6. When funds are allocated to different departments, it is made sure that these funds are sufficient to meet the needs of the overall organizational goal. However, when such funding is done inappropriately such that one or more departments face lack of funds to carry out production process, the entire production system might come to a standstill. Also, departments with excess of funds might use the funds available to them inefficiently thereby raising production costs. In order to attain better financial management, management accountants and financial planners should necessarily have the ground technical knowledge about different departments of the company and use and implement such knowledge while preparing financial plans. Along with this, it has been accepted by and large that accountants and financial planners must also have the ability to drive and motivate behaviour in such a manner that employees act in favour of their financial plans. Behavioural alignments become necessary for acceptance and implementation of budgeted plans and targets. Such alignment also calls for goal setting such that attainment of organizational objectives is also seen as attainment of personal goals by the employees and in reality; such achievement does contribute to employee’s betterment as well (On Target Direct, 2013). Variance Analysis Charles Ltd has sales of £9 million per year. The plan was reviewed at the end of three months to see whether the actual production was following the budgeted estimates. The concern produces a single product and the figure reached 90,000 units for a period of 3 months ending August of the year under consideration. The following table lays down the actual production performance against the planned estimates based on standard costing system of accounting. Particulars Actual Planned Variance Raw materials 130,500 133,000 Direct labour 153,000 152,000 Fixed production overheads 115,300 125,400 Machine hours 27,200 28,500 Variable production overheads 96,300 100,700 Total Cost 522,300 539,600 17,300 Sales 922,500 950,000 27,500 The figures above represent a major change in all areas of production planning. It is observed that production targets were higher and so were costs except for labour costs which were over expended (Hately, 2012). The analysis above shows that total costs weighed higher by £17,300 from the actual performance. This does not mean that costs were efficient or money was not spent. It is to be realised that in order to increase production capacity by 5000 units from 90,000 to 95,000, the company was incurring an additional cost of £17,300. The budget figures apparently show that there has been a rise in investment in all major areas of production costs except for a decrease in labour requirements for the additional; 5000 unit production. However, such a belief becomes misguiding and real results can be observed in the analysis below. The notes to budget stated that there was a need to increase production and sales volume by reducing the cost of production and increasing the number of units produced. For this, the new budget planned for an overall downsizing of labour requirements from 153,000 people to 152,000 people. Per unit reduction of labour was even more drastic. Per Unit actual labour used = 153,000/90000 = 1.7 Per unit projected labour to be used = 152,000/95000 = 1.6 The budget planning team also designed a budget which called for a far more efficient utilisation of raw materials and variable production overhead. Per unit availability of raw material was reduced from 1.45 units to 1.4 units in the planned budget. Similarly per unit variable overheads had seen a fall from 1.07 per unit of good to 1.06 per unit of production in the new budget. Machine hours devoted to production of a 5000 unit rise was more or less same. Such reductions in labour, variable overheads and raw materials in achievement of budgeted targets were compensated by an increase in investment in fixed production overheads. There was a rise in fixed production overheads from 1.28 unit hours per produce to 1.32 unit hours per unit of goods for a total of 95000 units. The budget prepared by the finance managers at Charles Ltd is highly stringent and is not accepted well by various departments of Charles Limited. The expenses mentioned in the budget call for efficiency in almost every area of production activity. However, a new budget is prepared for the next period below that shall accommodate the variances and also encompass the planned targets (IBP, n.d). Proposed Budget The new budget proposed below takes into account the actual production units and the planned budget spending together and put forward a flexible budget. This new budget highlights where the actual spending take a toll on profits and bring actual profits much reduced from the budgeted profits. Flexed Budget according to sales volume kept at 90000 units. Particulars Flexible Budget Actual Variance Raw Materials 126000 130,500 -4,500 Direct labour 144000 153,000 -9,000 Fixed production overheads 114452 115,300 -848 Machine hours 27000 27,200 -200 Variable production overheads 95400 96,300 -900 Total Cost 506852 522,300 -15,448 Sales 922500 922500 0 Profits 415648 400200 15,448 As per 3 month figures, the new budget figures provide an additional savings in cost by £15,448 which thereby get turned into additional profits figures keeping the sales prices and production figures unchanged. The expenditure on raw materials available per unit is reduced to 1.4 units and this brings raw material costs down by £4,500 from £130,500 to £126,000. Similarly, the budget estimated view that there is a need to cut back on labour and lay off a few by enhancing the efficiency of others and maintaining the same level of production. Labour is reduced by £9,000 and contributes majorly towards savings in costs. For machine hours, the planned budget estimated that better utilisation of machines could enhance productivity by using lesser costs. For this, the machine hours were reduced from 27200 to 27000 hours by 200 hours. Fixed production overheads changed per unit of machine hours used and a reduction in machine hours in the planned budget where production is increased by 5000 units because the fixed cost to reduce by 848 units based on planned estimates in the new budget. Hence fixed production overheads were reduced from 115,300 to 114,452 units. Under variable costs of production, lesser variable costs were allowed on per unit of produce in the planned budget. As per planned estimates, if production units were kept same, the variable overhead costs were reduced by 900 units from 96,300 to 95,400. If budgeted estimates were considered in the actual production activity then a production of 90,000 units would invite a reduction in costs by £15,448. This would in turn enhance profits to the tune of £15,448. The new budget is prepared estimating that production is going to remain at 90,000 units for the next period. It aims at reducing costs on almost all frontiers to ensure that production is carried out in an efficient manner such that higher profits are attained by a reduction in costs and not by increasing sales volume (Berry, n.d.). Measures to control behavioural implications Management accountants cannot afford to avoid the behavioural implications of the budgetary process. It is essential that all staff within the organizations views the importance and implications of the budgetary plan as seen by the financial management. It is suggested in principal that the sole purpose of the budgetary process is to ensure that individuals have the necessary information about organizational goals and budgetary targets. It also has to ensure that individuals are motivated towards the achievement of the task of attainment of budgeted targets. To highlight the steps that managers need to pursue in order to work towards budget acceptance and its implementation at the departmental level, effective decision making process requires 1. The organizational goals are in tune with the budgeted targets and both are known to the different concerned levels and departments of the organization. 2. The management and financial planners are well aware of the capacity and scope of performance of various departments. This is essential to ensure that out of proportion targets are not set by the financial managers. 3. There exists a proper communication between departments and the financial management such that problems and possibilities are discussed between the concerned teams. Goal setting and financial planning should be an outcome of such decision process. 4. Employees are motivated to the task of decision making such that they see attainment of organizational goals as means of attainment of personal goals. This also implies that there must be goal congruence between the individuals need and the organizational needs (Financial Management Development, 2012). 5. After the budgeting process is over, it is essential that the leader is able to communicate the results to the concerned divisions of the company. In order to have appropriate reaction being taken over the deviations, the manager has to ensure that goal congruence is well in place so that employees have the motivation to take action against goal deviations. 6. The managers should be available for communication and should be able to understand employee feedback. 7. It is also the task of financial planners to ensure that whatever data they furnish are useful to all concerned. For this, financial planners have to ensure that they plans and financial statements help managers and supervisors to use them for they action oriented plans and decisions. The data should be such that individuals and supervisors feel that such statements are essential for making their decision and also acts in the best interests of the company. It also facilitates their course of action. The statements should be viewed as encouragement by managers and staff such that achievements of these goals are seen as attainment of their personal interests. These include performance at work, recognition for superior performance and self actualisation (Cimaglobal, 2012.). Conclusion In most organizations that have the best of technology and the most efficient systems in place, managers often fail to achieve their planned targets primarily because they are naive on the behavioural management aspect of their job role. More often than this, is the problem where financial planners are completely unaware of existence of such a problem within their organization. Such an attitude either does not contribute anything to the organizational goal attainment from the financial planner point of view or it becomes a reason for undesirable implications on the attitudes of employees that have deterrent impacts of organizational goals. Hence it is important to realise that accounting role is also responsible for goal setting through the process of budgeting, communication and coordination of activities through data flow within the company, providing a tool for decision making for managers at various levels and a means of receiving proper and formal feedback about the consequences of the decision making process (Alpern Rosenthal, n.d.). Reference List Alpern Rosenthal., n.d. The Importance of Budgeting. [online] Available at: [Accessed 23 December 2013]. Berry, T., n.d. Plan vs. Actual, Part 3: Understanding Variance Analysis. [online] Available at: [Accessed 23 December 2013]. Cimaglobal., 2012. Performance Operations. [pdf] Cimaglobal. Available at: [Accessed 23 December 2013]. Cotts, D. G. and Rondeau, E. P., 2004. The Facility Managers Guide to Finance and Budgeting. New York: AMACOM Div American Mgmt Assn. Financial Management Development., 2012. Budgetary Control and variance Analysis. [pdf] Financial Management Development. Available at: < http://www.financialmanagementdevelopment.com/Slides/handouts/213.pdf> [Accessed 23 December 2013]. Hately, H. O., 2012. Understanding Variance Analysis. [pdf] Certified Public Accountants. Available at: [Accessed 23 December 2013]. IBP., n.d. Why are Budgets Important. [online] Available at: [Accessed 23 December 2013]. ICSA., 2005. Medium Term Management Control. [pdf] Available at: [Accessed 23 December 2013]. On Target Direct., 2013. Management Accounting: Roles and Challenges ahead. [online] Available at: [Accessed 23 December 2013]. Stede, W. A. V., 2000. The relationship between two consequences of budgetary controls: budgetary slack creation and managerial short-term orientation. [pdf] Accounting, Organizations and Society. Available at: < http://elmu.umm.ac.id/file.php/1/jurnal/A/Accounting,%20Organizations%20and%20Society/Vol25.Issue6.Aug2000/2991.pdf> [Accessed 23 December 2013]. Read More