Benefits of the System of Budgetary Planning and Control at Fitness Fitness First Group - Assignment Example

Reading Header: STRATEGIC ACCOUNTING FOR DECISION-MAKING Your institution: Your name: Course name: Course instructor: January 18, 2010 REQUIREMENTS Question 1: Key financial ratios for the most profitable club in the Fitness First group The key financial ratios for the most profitable club in the Fitness First group for the financial period ending 30/09/2009. Table A 1 Operating Profit Operating Assets 36% 2 Operating Profit Sales 10% 3 Sales Operating Assets 3.6 x £278=£1000.8 4 Expenses Sales 90% 5 Sales Fixed Assets 39.4 x £254=£10007.6 6 Sales Current Assets 41.7 x £24=£1000.8 7 Sales Stock 181.8 x £5.5=£999.9 8 Sales Debtors 153.85 x £6.5=£1000 9 Sales Bank 83.3 x £12=£999.6 10 Current Ratio 1.8:1 11 Quick Ratio 1:1 12 Gearing Ratio 15% a) Calculation of 12 ratios for Fitness First (Pontypridd) to allow comparison between profitability and performance for financial period ending 30/09/2009. Answer 1a: Key Financial Ratios for Pontypridd 1 Operating Profit Operating Assets 23.8% 2 Operating Profit Sales 7.6% 3 Sales Operating Assets 23.8% 4 Expenses Sales 29.42% 5 Sales Fixed Assets £ 288.43 6 Sales Current Assets £ 30.3 7 Sales Stock £ 4.85 8 Sales Debtors £ 8.48 9 Sales Bank £ 16.97 10 Current Ratio 2:1 11 Quick Ratio 1.167:1 12 Gearing Ratio 2% Answer 1b: Critical analysis/comparison of Fitness First Pontypridd and the most profitable club highlighting areas of weakness and strengths. Introduction There exist varied types of ratios that have been utilized by Pontypridd and other corporations currently and the commonest being the Profitability and liquidity ratios. Profitability ratios involve P/E ratio which is the current market price per share divided by the current earnings per share. These ratios are influenced by the company’s sales growth and earnings, the performance volatility or risks, company dividend policy, company debt-equity structure management quality, and a several other factors. The performance ratios of one corporation should be compared with those of other firms belonging to the same industry (Kelting & John, 1999). Comparison The operating profits and assets of Pontypridd is recorded at 23.8% while that of the most profitable firm is at 36% hence in comparison, Pontypridd needs to put more efforts to bridge the gap. It should institute incentives that would motivate generation of extra profits especially in services department by motivating staff to provide better services to attract more clients. The operating profits to sales for the benchmark is 10% while that of Pontypridd is only 7.6% hence it indicates that Pontypridd has to double its efforts to maximize on its sales capacity to increase profits. The Sales to Operating Assets for the most profitable firm is given at 0.12 while that of Pontypridd is at 0.238 which shows that Pontypridd is at right track but should only improve on its operating assets holding to beat the target. The expenses to sales of the most profitable firm are at 0.9 while Pontypridd is at 0.29 which is very low therefore the firm should devise means of reducing its costs and expense. The sales to fixed asset is at £1007.6 for the most profitable firm while the Pontypridd ratio is at £ 288.43 which is alarmingly very low (Timmons & Jeffrey 1998). While sales to current assets on the other hand for the same firm is at £30.3 against a backdrop of £1000.8 for the most profitable firm hence Pontypridd needs to reviews its operations to match industry standards. Sales to stock for Pontypridd is at £ 4.85 as compared to £999.9 for its top competitor hence it should analyze advance methods of stock handling to reduce wastages and overstocking expenses. The sales to debtors for the top competitor is recorded at £1000 while for Pontypridd is at £8.48 which is almost 10 times less. Sales to bank for Pontypridd is at £16.97 while for the most profitable in the industry is at £999.6 while for the current ratio, Pontypridd is at 2:1 while the top competitor is at 1.8:1. The current ratios indicate that Pontypridd has extra current liabilities while the moat profitable firm has more current assets than current liabilities. The quick ratio for Pontypridd is at 1.167:1 while the top competitor has recorded quick ratio of 1:1. It means top competitor can easily raise cash for its operations as compared to Pontypridd. Finally the gearing ratio for the most profitable is at 15% while Pontypridd is at 2% (Kelting & John, 1999). Conclusion Issues that Pontypridd Manager, Street Alison, should give attention when analyzing financial ratios include the reference point that should be identified in order to be meaningful and also facilitate comparison with historical values of the same firm, ratios of competitor/similar firms and those of industry standards. These ratios should also be viewed as indicators to paint picture of firm’s position though they are subjects to limitations of accounting methods. Hence Pontypridd should still improve of its accounting ratios in order to match performance with those of competitors in the industry (Timmons & Jeffrey 1998). Question 2 Report to Alison Street critically commenting on the profit centers using table 1 figures, tables b & c to allocate and apportion expenses to cost centers and calculate profitability of each profit centre. Table B Split of Revenue between Profit Centre’s for Financial Year 2009 Table C Division of Asset Value within the Sports Centre Cost Centre Asset Value 1 30% 2 10% 3 2% 4 5% 5 40% 6 5% 7 3% 8 5% 100% Answer a: Allocation and apportionment of expenses to cost centers & profit calculation Income/Expenses (£) Centre 1 Centre 2 Centre 3 Centre 4 Centre 5 Centre 6 Centre 7 Centre 8 TOTAL Revenue 500,000 120,000 0 240,000 250,000 150,000 60,000 330,000 1,650,000 Rates & Insurance 75,000 25,000 5,000 12,500 100,000 12,500 7,500 12,500 250,000 Fuel & Power 43,750 8,750 10,000 2,000 18,750 6,250 6,500 4,000 100,000 Repairs & Maintenance 22,500 7,500 1,500 3,750 30,000 3,750 2,250 3,750 75,000 Chemicals 25,000 5,000 0 0 0 0 0 0 30,000 Security 21,875 4,375 5,000 1,000 9,375 3,125 3,250 2,000 50,000 Cleaning Materials 10,937.50 2,187.50 2,500 500 4,688 1,562.50 1,625 1,000 25,000 Salaries 95,000 30,000 175,000 35,000 45,000 25,000 35,000 60,000 500,000 Salary related costs 23,750 7,500 43,750 8,750 11,250 6,250 8,750 15,000 125,000 Depreciation 12,000 4,000 800 2,000 16,000 2,000 1,200 2,000 40,000 Snack Bar supplies 0 0 0 0 0 0 0 100,000 100,000 Licensed Bar 0 0 0 80,000 0 0 0 0 80,000 Head office overheads 45,454.50 10,909 0 21,818.20 22,727.40 13,636.40 5,454.50 30,000 150,000 Total Expenses 375,267 105,222 243,550 167,318 257,790 74,074 71,530 230,250 1,525,000 Profit 124,733 14,779 -243,550 72,682 -7,790 75,926 -11,530 99,750 125,000 Answer b: Alison’s report According to the figures derived from the profit and loss account of each cost center it is evident that cost centers 1, 2, 4, 6, 8 are profitable. Cost center 1 is the most profitable with a revenue level of 500,000 and a profit of 124,733. This is 25% in operating profit over the sales. On the other hand there is a cost center which is operating is big loss, that is cost center 3. This center has got no revenue but it operates at expense level of -243,550. This cost center is the most expensive to run because it brings nothing back to the company (Kelting & John, 1999). The other cost centers have the following ratios of profit to the revenues: Center 2: 12.3%, Center 4: 30.3%, Center 5:-3.1%, Centre 6: 50.6%, Centre 7: 19.2% and Centre 8: 30.2%, while the profit revenue ratio of the whole department is 7.5%. Another key issue we should note from these results is that there are varied ratios on the cost centers. The main reason may be due to different roles played by each centre. For example we highly expect the administration to incur expenses but no revenues are likely to be generated by this center (Hamilton & Brian, 1999). Cost center 6 is the one with the highest rate of return based on the revenue it generates. By this realization the management can take a step of increasing the level of revenue generated by either marketing or additional facilities. But this decision is based on the condition that the additional costs do not exceed the revenue and it is within the reach of the department. Also the management would consider investing in center 4, 8, or 7. Finally it is not always a good policy to expect every cost center to make profit. This is due to the fact that some sections of the business are meant to offer support to the profit making centers. For example, accounting section is meant to offer administrative support to the rest of the department and doing business without accounting services will lead to lack of coordination and direction of the whole organization. Question 3 Critical analysis of the benefits that could result from the introduction of a system of budgetary planning & control at Fitness Forever/ Pontypridd Fitness First would benefit greatly from budgeting as it would enable it to plan, monitor, communicate, organize, control, evaluate and plan a head o time on what to achieve and how to attain it. As far as planning is concerned, budgets would enable the company to develop both long, medium and short term plans as pertains to all its areas of operations involving financial management, human resource management and services provision management. Budgeting would allow Fitness First to improve on its corporate governance through improved communication as it would enable every company to institute mangers for every cost centre who would, for successful business growth, communicate their ideas not only to head office and other managers, but also to their staff members. Budgeting would also improve employee motivation levels since budgeting would ensure that all the key people in the company are not left out, since, ideally everyone has to be involved. Budgeting, on the other hand, would also facilitate proper company organization, and this has to be conducted at every level of the organization. Managers/ people on the higher hierarchy would have to delegate the tasks to their employees through proper budgeting and planning. Performance/management control over workforce would also be enhanced through detailed budgeting in order to rectify any deviations from the set standards. The management would also carry out proper company evaluation made possible through budgeting since it’s very important to compare the budget to the actual results attained and assess how efficiently the budget was implemented. CIMA/ Institute of Cost and Management Accountants defines Budgetary control as, "The establishment of budgets relating the responsibilities of executives to the requirements of a policy, and the continuous comparison of actual with budgeted results, either to secure by individual action the objective of that policy, or to provide a basis for its revision". Critical analyses of benefits that Pontypridd/ Fitness Forever could gain from introducing budgetary planning and control system in its operations include the fact that it would compel management to engage in future control and planning processes hence would be able to set out detailed plans in order to achieve targets for its operations, departments, and also enable managers to anticipate and grant direction and purpose to the organization. Budgeting and planning would also promote communication and coordination among the managers/departments, since it would define areas of responsibilities clearly. It would require budget managers to be responsible to achieve set objectives in operations which they control directly. Budgeting, planning and control would also provide platform for conducting performance appraisal regarded as analysis of variance since it’s a yardstick against which to measure and assess actual performance and hence control would be provided upon comparison of actual and the target budget plan. Reasons for discrepancies are investigated and isolated into uncontrollable and controllable factors. Budgets also enable remedial actions to be conducted upon emergence of variances and also this would motivate employees when allowed to take part to drafting of budgets. Budgets also improve resource allocation which is always limited at same time economizing top level management time through utilization of principle of management by exception (Hamilton & Brian, 1999). Some of the features of good budget involve provision of feedback to managers through constant performance monitoring; allow analysis of costs and revenues to be performed on basis of departments, cost centers, and product lines. Budgets also allow for flexibility in the changing circumstances/environment while at same time providing standards/bases upon which to establish performance standards. They also embrace whole organization comprehensively while allowing participation of many people/stakeholders during its drawing (Schilit W. & Keith. 2000). Academic experts and observations have it that managers behave in a conservative manner when they are required to draft budgets to be utilized as future achievement forecasts. They would generally underestimate sales and overstate costs since this would cater for their interests to incorporate slack into the targets. They also build slack in good years and convert it to reported profit in bad periods. They would also manipulate profits upward at times to promise better performance in future hence budgets might help stakeholders censure such mangers should they fail to hit the optimistic targets painted. Budgets are also used as basis of setting standards of performance and rewards for instance status, bonus, and enhanced prospects of promotion which often intertwine with budget attainment. Since corporations are complicated/complex, tasks are interdependent hence there are many performance dimensions which are not easily quantifiable and not in financial terms certainly hence misunderstandings are common here since budgets are may have narrowed specifications as regards organizational outcomes which are acceptable/desired (Hamilton & Brian, 1999). The roles of non-financial information in management control context have continued to improve and are essential in operational, managerial, and strategic control. These controls have often been supported by non-financial measures for reasons of both timeliness and relevance it has been common to utilize measures of performance to evaluate material wastages, efficiency, throughput and several other operational aspects by the use of quantitative financial measures in addition to those of non-financial. This through budgeting would provide useful complement and opportunity for Generation of perspective that is balanced in accordance to performance of organization. Budgets do have a number of disadvantages especially in terms of perception as much as it’s essential for marketing activities. Managers see budgets as pressure devices imposed from above hence may result in bad labor relations, conflicts at departmental level, inaccurate keeping of records, and blames by departments accusing each other should targets fail to be attained. It is also challenging to have corporate and individual goals reconciled together while at same time wastes may easily arise as managers adopt don’t care attitude and may also start empire building to enhance departmental prestige. The controlling versus responsibility also pose a challenge since some cost are under influence of several individuals for example the power costs, while also overestimation of costs may be done by managers in order to avoid being blamed should future costs become higher (Barr & Stephen, 1998). The characteristics below may apply in administration and analyses of budget systems and include the budget centers which entail units that responsible for budget preparation and it encompasses cost centers. The budget committee involve senior organizational members like heads of departments, CEOs chairmen, MDs and all organizational parts should be represented on the budget committee like from marketing, sales, production etc. it functions include coordination of budget preparation, issue of timetables for budget preparation, provide information that assist budget preparation, make comparison of actual with set targets and also investigate variances. The budget officer on the hand controls administration of the budget liaising between budget mangers and committee, handle control of budgetary problems, ensure that deadlines are attained, and also educate user on controls instituted by the budget. Question 4 Report for Dan Brennan on long term sources of finance to consider during expansion of the Fitness First group highlighting the relative advantages and disadvantages of each potential source and the issues which should be considered in the relative percentage of each source. Question 4 There are two main categories of sources of long term finance which Dan Brennan should consider when thinking about possible future expansion of the Fitness First group. This report also highlights the relative advantages and disadvantages of these potential finance sources including the issues that should be considered in the relative percentages of these particular sources. These two main categories are the debt/external source and equity/internal capital sources of finance. Equity capital refers to the sale of shares to investors who take ownership interest on the business and are entitled to sharing profits. This capital is not repayable and therefore does not burden the business at any time because profits are only payable if the business is in a position to do so. The major disadvantage of equity capital is that the owner is relieved the power of control over the business since he becomes a co-owner with the provider of the finances. Debt capital on the other refers to borrowing of finances either from financial institutions or friends. This money is repayable within the agreed period and it poses a burden of repayment to the business. The advantage with this source is that the lender does not take ownership control over the business. Debt capital can be classified in a number of sources: Loan from commercial banks: these are the most visible and widely used to finance business projects on a short term and medium term basis. They charges interest for the money extended as loan. They also require collateral for money lent in order to avoid the risk of losing money in case of default in payment by the borrower. This source is more advantageous if the owner of the business want to retain the ownership control. Leasing companies: by leasing equipment from a leasing company would reduce the need of more capital. Everything in a business premises can be acquire through leasing. This method is generally more expensive than bank financing and it is only limited to items that the leasing company has on offer and one cannot be able to select the items he desires. In most cases on is required to buy the equipment upon expiry of a given period of time. The advantage with this method is that one is able to use the equipment that could not afford under if only were to be acquired by cash (Barr & Stephen, 1998). Loan from commercial finance companies: when one is unable to secure a loan from a bank, commercial finance companies are the best alternative. The reason they are more preferable is they tend to look more on the ability of the borrower to pay, and they put more weight on the quality of collateral than the future projections of profits. The disadvantage with them is they tend to charge more on interest rates than commercial banks. Trade credit: suppliers may offer credit facilities to the business and help[ to acquire some of the items in the business though without money at a given time. It is important to note discounts offered by the suppliers to take advantage of them. It is very crucial to establish good credit policies for the business to avoid. It is not prudent to establish dependence on one supplier on credit because if payment problem arises it is difficult to run the business for one major source of supplies will have been affected. This source is the most effective for short term source of capital. The problem with it is that it cannot be used for long term commitment and expansion program. Life insurance policies: insurance policies can be used as a source of capital by borrowing up on the security of the policy. The advantage with this type of financing business is normally lower rate of interest as compared to other debt financing. The problem with it is one should have paid substantial premiums since one cannot exceed his total premium contribution. Additionally the loan extended will reduce the value of the policy and in case of death or accident the loan is paid first before one is compensated. Consequently it is very crucial for any business to balance between equity financing and debt financing. Balancing these sources is affected by various factors. These may include: 1. availability of debt financing 2. availability of collateral to acquire debt capital 3. willingness of owners to share ownership interest 4. performance of the business in the last periods 5. Current leverage levels. Relative advantages and disadvantages There exist no obligation to repay hence a break to small firms struggling with liquidity problems as contrasted with the debt capital sources whereby bank loans including other debt financing forms provide stringent penalties for defaults by businesses to make interest payments and the monthly principal. Equity is also more acceptable at early stages of the business than the debt capital since equity financiers are often interested in taking chances in new ideas than providers of debt. Debt providers require security hence they would always consider the track records of the business hence unsuitable for commencing businesses. Also for equity, investors would always be willing to provide advice and contacts for the small business owners hence Dan Brennan should consider acquiring additional equity than debt (Barr & Stephen, 1998). The main disadvantage of equity capital is the founders have to give up some business control which debt capital doesn’t have to. Investors may also disagree on the corporation’s strategic direction including the daily operations hence posing challenges to the entire business. Also sale of equity like the initial public offers are very expensive and complex to administer since they would always require complicated legal proceedings/filings including lots of paperwork for compliance with regulations by capital markets. This would necessitate need to enlist accountants and attorneys (Schilit W. & Keith. 2000). Question 5 Alison’s forecast for profit and Loss Account for the first 6 months: Table 4 Forecast Profit & Loss Account for 6 month Period 01/10/09 – 31/03/10 Assumptions £ £ Revenue + 5% 866,250 Expenses Rates & Insurance + 3% 128,750 Fuel & Power + 1% 50,500 Repairs & Maintenance 0 37,500 Chemicals + 10% 16,500 Security + 2% 25,500 Cleaning Materials 0 12,500 Salaries + 3% 257,500 Salary related costs + 3% 64,375 Depreciation 0 20,000 Snack Bar Supplies + 5% 52,500 Licensed Bar Supplies + 5% 42,000 Head Office Overhead + 2% 76,500 784,125 Profit £ 82,125 Answer: Construction of a budgeted Profit and Loss Account for the period 01/10/09 – 30/09/10 using table 4 as base: Adjustments: a) £ 866,250 * 1.02 = £883,575 b) £ 128,750 * 1.01 = £130,037.50 c) No change d) £ 16,500 * 1.10 = £18,150 e) £ 25,500 * 1.13 = £28,815 f) £ 257,500 * 1.04 = £267,800 £ 64,375 * 1.04 = £66,950 g) No change h) No change i) £ 76,500 * 1.04 = £79,560 j) No change Forecast Profit & Loss Account for the period 01/10/09 – 30/09/10 Revenue: £ 886,250 + £ 883,575 = £1,769,825 Rates & Insurance: £ 128,750 + £ 130,037.50 = £258,787.50 Fuel & Power: £ 50,500 Repairs & Maintenance: £ 37,500 Chemicals: £ 16,500 + £ 18,150 = £34,650 Security: £ 25,500 + £ 28,818 = £54,318 Cleaning Materials: £ 12,500 Salaries: £ 257,500 + £ 267,800 = £525,300 Salary related costs: £ 64,375 + £ 66,950 = £131,325 Depreciation: £ 20,000 Snack bar supplies: £ 52,500 Licensed bar supplies: £ 42,000 Head office overheads: £ 76,500 + £ 79,560=156,060 Adjusted Forecast Profit & Loss Account for the period 01/10/09 – 30/09/10 Assumptions £ £ Revenue + 2% 1,769,825 Expenses Rates & Insurance + 1% 258,787.50 Fuel & Power 0% 50,500 Repairs & Maintenance 0% 37,500 Chemicals + 10% 16,500 Security + 13% 54,318 Cleaning Materials 0% 12,500 Salaries + 4% 525,300 Salary related costs + 4% 131,325 Depreciation 0% 20,000 Snack Bar Supplies 0% 52,500 Licensed Bar Supplies + 5% 42,000 Head Office Overhead + 4% 156060 1,357,290.5 Profit £ 412,534.5 References Barr & Stephen (1998) "Where Cash is Anything but Trash." CFO: The Magazine for Senior Financial Executives. Gladstone & David. (1998), Venture Capital Handbook, Prentice Hall. Hamilton & Brian, (1999), Financing for the Small Business, U.S. Small Business Administration. Kelting & John (1999), "Innovative Financing Solutions." Acquisitions Monthly. Schilit W. & Keith. (2000), The Entrepreneur's Guide to Preparing a Winning Business Plan and Raising Venture Capital. Prentice Hall. Timmons & Jeffrey (1998), A. Planning and Financing the New Venture. Brick House Publishing Company. End of Assignment Read More