The Problems of Martin Kimble Plans Business Operations - Case Study Example

MK Plans report Table of Contents Introduction 3 Methodology 3 Interpretation of variance 5 Results 6 Comparison of budgeted and actual income ment and balance sheet 6 Calculation of variance 8 Conclusion 9 Recommendation 10 References 12 Introduction MK plans is a sole proprietorship firm that is run by Martin Kimble. It is a nascent company and is currently in its second year of trading. It deals in producing high quality brochures and offers planning services to its client. Its clientele mainly comprises sports clubs and small and medium rural businesses. The report aims to identify the problems of MK plans business operations. It aims to compare the actual and the budgeted data of MK plans. The data includes income statement and the balance sheet of the company. The variance of the budgeted and the actual statements are calculated and the problems leading to such variances are identified. Budgeting helps a company to plan its expenses in advance and restricts a company to incur excess costs. It is an effective tool to evaluate the performance of the company. It allows companies to finance its own funds for its future projects. It can range for a period of one month to one year. Budgeting for a longer time span is critical as it requires high level of precision in forecasting the market. Budgeting for shorter time period is easy as the expected market fluctuations i.e. wage rate, raw material prices, power rates, transportation costs, etc do not vary that much, unlike for longer periods. Forecasting for a longer time horizon is difficult as it is unpredictable to gauge the price trends and externalities (Hopkins, 2012). Methodology The budgeted financial statements i.e. income statement and balance sheet are used to compare it with the actual statements for 2011. It then calculates the variances observed in the financial statements and then identifies the problems leading to such variance. There are mainly two types of budgeting techniques namely incremental budgeting and zero based budgeting. Since Mk plans is a new company it has used zero based budgeting to forecast its financial statements. Zero based budgeting is done by grouping various business activities and then forecasting the expenditure levels for the period of budgeting. The business activities are direct and indirect which are further grouped into manufacturing, administration, non financial, selling and distribution activities. Zero based budgeting also includes the forecasted levels of earnings i.e. gross profit and net profit. It can either forecast the growth rate or the absolute value of the expected earning level. These activities are then considered for forecasting the future levels and are also called decision packages. It follows a three step process in its implementation. In the first stage the entire business operations are grouped based on its activity level as discussed above. The second stage involves ranking the business activities on decreasing level of priority. This helps the company to identify in which activities to allocate more funds and in which activities to allocate fewer funds. The third stage involves allocating resources based on the activity rankings in stage two. It does not consider the earlier activity levels and starts from zero or scratch, unlike in incremental budgeting where the earlier levels are considered for future forecasting (Clowes and Scriven, 2010). Zero based budgeting eliminates inefficient business activities and superfluous spending that give companies greater flexibility and leverage to better analyse and forecast future levels of earnings and spending. It is considered to be dynamic tool as it considers the market changes from the current year to the next year. It ensures better allocation of resources. Though it offers more benefit to a company it still faces many challenges which have led to the adoption of incremental budgeting technique. Zero based budgeting favours MK Plans owing to its small scale of operations. It becomes very complex if a company has many business activities. It requires precision in identifying the business activities and ranking them according to the priority of the benefits. Wrong ranking of priorities will lead to ineffective allocation of funds, resulting in excess expenditure. Zero based budgeting requires an effective information system as it requires sufficient information. Budgeting requires internal and external data. Internal data requires the various business activities like manufacturing, administration, selling, distribution, earning level and investment. External data includes market information like changes in government regulation, market characteristics, labour, supplier and customer bargaining power (Debarshi, 2011). Interpretation of variance Martin Kimble’s company MK Plans witnessed adverse variances for its direct and indirect activities that led to high level of variances for its gross profit and net profit. Variances for MK plans were categorised in two parts adverse and favourable. Adverse variance implied negative variance and favourable variance implied positive variance. Though its sales witnessed a positive variance but its high level of adverse variance in cost of sales led to the negative variance in its gross profit margin. It sales saw an increase from its budgeted level owing to additional orders from a local charity that made its payment to MK plans in full amount and on time. Martin Kimble owing to his high quality of brochures and services used best materials that led to the adverse variance of the total cost of sales. The negative variance in gross profit coupled with the variance of the indirect costs led to negative variance of net profit of MK Plans. It witnessed adverse variances of its indirect costs on account of rent charges, bank charges, equipment leases and telephone charges. Additional equipment installation has led to negative variance of lease charge. It is assumed that additional equipments and other indirect charges were met by additional bank borrowings that led to increased interest charges. New equipments led to more space requirement that resulted in additional rent expenses (Drury, 2007). Advertising charges were reduced owing to its brand loyal customers and word of mouth promotion. The local charity owing to Martin’s quality brochures and plans, have recommended him for his services to other charities. This allowed MK plans to spend less in its advertising expenses (Ferrell and Hartline, 2012). Apart from the income statement variances MK plans also witnessed adverse variances in its balance sheet items. Debtors had an adverse variance owing to delayed delivery of brochures to Martin’s clients. Martin wanted to deliver high quality of work to his customers that took much of time. Owing to delayed delivery Martin gave discounts to its customers that contributed to its lower earnings. He did not follow up with his customers who made delayed payments this led to adverse variance in debtors. Negative variance was also observed in bank balances. This was mainly because of additional borrowings made for new equipment leases and other additional working capital requirements. Delayed payments from debtors led to late payments to MK plans vendors. Additional drawings from business led to negative variance in total drawings of MK Plans. Drawings were made owing to Martin’s personal expenses (Spurga, 2004). Results Comparison of budgeted and actual income statement and balance sheet MK Plans Actual Income statement For the year ended 31st Dec 2011 Budgeted Income statement for the year ended 31st Dec 2011 Particulars Amount (£) Amount (£) Amount (£) Sales 38500 37000 Less: cost of sales 25000 19000 Gross profit 13500 18000 Less: Expenses Rent 5400 5000 Bank charges 1200 0 Advertisement 2000 3000 Equipment lease 3250 2950 Insurance 1500 1500 Telephone 1000 14350 750 Net profit -850 4800 Table 1: Actual and budgeted income statement for 2011 MK Plans Actual Balance Sheet For the year ended 31st Dec 2011 Budgeted Balance sheet for the year ended 31st Dec 2011 Particulars Amount (£) Amount (£) Amount (£) Fixed Assets 0 0 Current Assets Debtors 11350 6300 Bank -1400 7500 9950 Current liabilities Creditors 8300 5000 Net current assets 1650 Total net assets 1650 Networth Owners capital 10000 Add: net profit -850 4800 Less: drawings 7500 -8350 6000 Balance sheet total 1650 Table 2: Actual and budgeted balance sheet for 2011 The above two tables represent the actual and budgeted income statement and balance sheet of MK plans for the year ended 31st December 2011. From income statement year ending 31st December 2011 (figures in GBP), actual sales stood at 38500 and budgeted stood at 37000. Cost of sales stood at 25000 and the budgeted figures stood at 19000. Gross profit was 13500 while its forecasted figure was 18000. The total indirect expenses stood at 14350 against its budget of 13200. The budgeted net profit was 4800 while the actual figure stood at -850. From the balance sheet of MK Plans (figures in GBP), budgeted and actual fixed assets stood at 0 as MK plans has no investment in long term assets. Budgeted and actual debtors and bank stood at 11350 and -1400 against its budgeted figures of 6300 and 7500. Actual figures for creditors stood at 8300 compared to its budget of 5000. Drawings for the year ended 31st December 2011 stood at 7500 against its budgeted value of 6000 (Sagner, 2010) Calculation of variance MK Plans Income statement Variance Value (£) Causes Sales 1500 FAV Marginal increase in sales was witnessed due to the order of local charity. The charity paid in full and on time. Cost of sales 6000 ADV Martin Kimble is a perfectionist and uses high quality brochures and plans for his clients. This led to increased level of costs. Gross profit 4500 ADV High cost of sales resulted in such adverse gross profit figures. Rent 400 ADV Variance in rent expenses is attributed to additional equipment leasing. Bank Charges 1200 ADV In adequate working capital has led to increased borrowing from banks, resulting in adverse variance in bank charges. Advertising 1000 FAV MK Plans service quality led to word of mouth promotion along with its brand loyal customers that led to lower actual advertising expenses. Equipment Leasing 300 ADV Additional leasing of equipments for producing high quality brochures led to higher leasing expenses. Insurance 0 No variance was witnessed for insurance charges. Martin has not taken any additional personal insurance or equipment insurance for 2011. Its insurance charge was fixed at £1500. Telephone 250 ADV Follow ups with suppliers and customers have led to increased telephone charges. Net profit 3950 ADV Negative variance in gross profit and indirect expenses has led to adverse net profit figure for the year ended Dec, 2011. Table 3: Income statement variance MK Plans Balance Sheet Variance Value (£) Causes Debtors 5050 ADV Martin owing to his high quality of service has led to delayed delivery. He did not follow up when his customers defaulted or delayed in payment. Bank 8900 ADV The adverse variance was highly because of additional borrowing owing to inadequate working capital and new equipment leasing. Creditors 3300 ADV Delayed payments from debtors led to delayed payments to suppliers. He did not receive enough funds from his debtors to pay of his short term liabilities. Drawings 1500 ADV His personal expenses also grew to an extent of £1500 that led to adverse variance in drawings of his firm. Table 4: Balance sheet variance Conclusion MK Plans is a new company in the industry. Need for timely performance evaluation Capital constraint Limited customer segment Delayed order delivery Quality and time trade off Use of high quality materials for producing brochures Local competition Limited clientele Though MK Plans is a new company in the industry of brochure printing and services it should not limit its market scope by catering to only few segments. Its clientele is limited to only sports club and rural business. It should consider other types of business. It has to balance its trade off between time and quality of services. It currently uses high quality materials for its brochure printing which adds to its increased level of cost and delivery time. This leads to MK plans giving discounts to retain its customers and also delayed payments from its customers that negatively impacts the working capital cycle (Chorafas, 2002). It lost its high commission clients to local companies which deliver brochures at cheap rates and faster than MK plans. It has limited financing sources that led to increased borrowing from banks that led to adverse variances of bank charges. In adequate current assets have led to high leverage of MK plans that led to adverse variances in total expenses, resulting in negative variance of net profit. Martin Kimble spends less time evaluating his business performance that leads to delayed identification of the problems facing the company (Cox and Fardon, 2008). Martin moved to second year of trading without analysing the performance of his company. This led MK plans to a new period without evaluating its risks properly. This might prove to be another bad year for Martin. Martin paid no heed to the requirement of human capital as he needs a team which will constantly monitor the company’s performance. There is lack of process diversification at MK plans i.e. Martin Kimble does all the work himself that affects the overall productivity of his company that led to lower levels of earnings (Mathur, 2007). Recommendation Requirement of additional capital Proper working capital management Newer and cheaper source of procuring raw materials Expanding markets and clientele Advertising activities Requirement of human capital Martin Kimble requires additional capital apart from its initial capital of £10000 which he received from his grandfather’s will. This leads to additional borrowing that adds to the total debt of the company. It should foster efficient working capital management practices. Budget variances showed how indirect and direct expenses grew over its forecasted levels that were financed by bank credit that led to higher interest charges. It should try to improve the quality time trade off. Owing to its quality services it takes substantial time that leads to delayed delivery. This affects the receipt cycle of MK Plans. As a result this affects its payment period of its vendors. It should try to reduce the collection cycle and increase the payment cycle to enjoy better liquidity (Matz, 2011). Its cost of sales owing to high quality material corroded its gross profit margin that led to significant variances. It should try and procure better inputs for its brochure production at cheaper rates. It can leverage its bargaining power by availing special discounts from its suppliers. This will help Mk Plans with better economies of scale that will reduce it’s per unit cost of production. This will also lead to competitive advantage (Pandey, 2009). It faces local competition from companies that offer better products at cheap rates and in less time. It should try and engage in better marketing activities like increasing its market exposure through effective ads. MK plans caters to a confined clientele group it should try and reach out newer markets and customer classes like educational institutions, restaurant chains, retail stores, etc (Hutt and Speh, 2012). Moreover it requires manpower to expand its scale of operations. Martin Kimble alone does most of the work and should try to divide the total work in smaller jobs to increase the overall efficiency of the company. Following this it will not only help him to leverage operational efficiency, but will also improve his company’s earning potential (Periasamy, 2009). References Chorafas, N., D., 2002. Liabilities, Liquidity, and Cash Management: Balancing Financial Risks. New Jersey: John Wiley & Sons. Clowes, R. and Scriven, V., 2010. Budgeting: A Practical Approach. Australia: Pearson Higher Education AU. Cox, D., and Fardon, M., 2008. Management of finance. Worchester: Osborne Books. Debarshi, B. 2011. Management Accounting. New Delhi: Pearson Education India. Drury, C., 2007. Management and Cost Accounting. London: Cengage Learning EMEA. Ferrell, O., C., and Hartline, M., 2012. Marketing Strategy. Ohio: Cengage Learning. Hopkins, R., 2012. Practical Cash Management, Budgeting, Forecasting and Analysis. Indiana: Booktango. Hutt, M., Speh, T., 2012. Business Marketing Management. Ohio: Cengage Learning. Mathur, B., S., 2007. Working Capital Management And Control: Principles And Practice. New Delhi: New Age International. Matz, L., 2011. Liquidity Risk Measurement and Management. USA: Xlibris Corporation. Pandey, M., I., 2009. Financial Management. Noida: Vikas Publishing House Pvt Ltd. Periasamy., 2009. Financial Management. New Delhi: Tata McGraw-Hill Education. Sagner, J., 2010. Essentials of Working Capital Management. New Jersey: John Wiley & Sons. Spurga, C., R., 2004. Balance Sheet Basics: Financial Management for Non-financial Managers. USA: Penguin Group. Read More