Management Accounting Models - Essay Example

Management Accounting Models Table of Contents Introduction 2 The Budgeting Process 3 The Inappropriate Budgeting Process of Management 4 The Revised Budgeting Process 7 9 The Costs of Functional Areas and the Decreasing Sales Volume 9 Conclusion 11 Reference 12 Bibliography 14 Introduction “Finance is the life blood of a business” (Thukaram, 2007, p.14). Business organisations of every kind, including the non profit making ones, try to ensure that they are financially sound since it alone attests their sustainability in the industry as well as in the society at large. Production of goods and services involve several primary operational activities which require a significant amount of expenditures for availing resources like raw materials, labours, machineries etc. Apart from such expenses; other activities like sales, logistics, human resources, research & development etc needs funding for successful completion of the entire business activities. Business finance is the term used to denote the funding activities for efficient conduct of business activities. Therefore, business finance is helpful in many ways. Firstly, it helps to procure enough flow of funding required in business. Secondly, it is important for maintaining and enhancing better management system by supplying the required amount of capital. Lastly, it is the foremost factor for obtaining adequate amount of profitability. The prime objective of a business is to generate profit by investing in projects. In order to fulfil the primary financial objectives, the decision makers of a company plan their financial activities. The planning of financial activities is known as budgeting and it is very vital for the smooth functioning of financial operations. A proper financial budgeting makes the entire operation efficient and effective. Budgeting plays a crucial role in the decision making process for a company. Oberlin states that “budgets are the link between plans and actions. They translate strategic plans into the financial resources necessary to implement the plan” (McClintock, 2000). Companies prepare many types of budgets like capital budgets, sales budgets, production budgets, cash budgets, inventory budgets etc for planning their operational activities. In fact, the budgets help the organisations to achieve the organisational and financial target on behalf of all the departments. This essay deals with a case study of Industrial Alternatives plc where the management has taken inappropriate decision while preparing its budgets which has led to a deadlock situation resulting in unachieved targeted sales volumes. The Budgeting Process Before discussing about the case study, it is important to identify the proper way of preparing the budgets for a company. Budgeting can be defined as “the process of identifying, gathering, summarizing and communicating financial and non-financial information about an organization” (Beavers, 2007). Estimating the future condition of the industry and the entire economy is the foremost aspect of budgeting. Budget is prepared for all types of profit making and non profit-making organisations. Its helps the organisations to set targets, according to the desired level of profit earning. The objective of developing budgets varies according to the management’s decision making style and the organisational goal. The management may either concentrate on the long term or short term goal but it must be reflected in the prepared budgets. Apart from setting the desired targets, budget is also necessary for controlling, motivating, communicating and evaluating the performances (Blocher, 2006, p.275). The Inappropriate Budgeting Process of Management The case study has as its subject the Industrial Alternatives plc, which is running its business on a basis of calendar year. According to the case study, the Industrial Alternatives plc has been able to achieve its targeted sales as per the pre-planned budgets. Going by its case study, it can be understood that the primary budgeting process is not appropriate for setting the sales targets. Other budgeting plans have also been prepared based on the targeted sales values and they too are not correctly designed. The case reveals several reasons for the company’s failure to achieve the targeted sales volumes. They are discussed below. The first blunder was made by the Chairman of Industrial Alternatives plc in setting the target for the sales volume for the coming calendar year in August. Before formulating any strategy, a company must scan its internal strength and weaknesses. The Chairman must consider the capacity of its entire department for achieving the desired sales. The availability of the necessary funding and resources must also be taken into account before setting the sales targets (Akintoye, 2008). For example, if the production capacity of any machine for a month is 100 units, the sales target cannot be 100 units or more. It is the responsibility of the Chairman to scrutinize all these important factors. Moreover, the available budgets of Industrial Alternatives plc were not enough to cover the required funds. The Chairman also neglected the external factors while setting the sales target. The external factors include the macro economic conditions and the industrial forces that determine the profitability and marker share. The process of industrial scanning provides an idea of the market demand in future. The competitive analysis helps to understand the strength of the existing and potential competitors. For example, the increase in the number of the competitors within an industry leads to the decrease of the market share and profitability. Budget is an inevitable part of strategic management and it helps to integrate the budgeting process by analysing the external factors (Xu, 2007, p.143). Another mistake done by the Chairman of Industrial Alternatives plc is that, before establishing the sales target, he did not consult with the managers of other departments like sales and marketing, manufacturing and administration departments. The Chairman must realize the requirement and demand of other operating departments which is easily understood through discussions and meeting with other managers. It is quite possible that the management of various departments have found the sales target illogical and unachievable and they are unsatisfied with the compromises in the prepared budgets. However, the managers also have not conveyed their dissatisfaction to the Chairman regarding the budgets. The overall situation led to such a deadlock where the Chairman, CFO and other managers could not communicate with each other. “The budgetary process is a complex persuasive communication act” (Stacks, 1992, p.81), hence the process of budgeting should be accompanied with proper communication framework. Lack of communication has resulted in the lack of cooperation among cross functional departments. Cross functional department is a modern concept where all the departments work together by sharing knowledge for achieving the desired goal. It is very important to know about the other departmental activities as each department are interlinked with each other. The problem is that the cross functional department have prepared their budgets without proper consultation with other departments. The Chief Financial Officer (CFO) of Industrial Alternatives plc has failed to understand the importance of the manufacturing department. He has used the sales budget by product line and projected marketing expenses to estimate the expenditure for administrating and manufacturing departments. Moreover, he has prepared budgets for administration before passing it to the manufacturing department. Ultimately, the amount allocated for the expenditure of manufacturing department became inadequate. Finally, all the departmental heads including the Chairman and CFO has increased the amount related to manufacturing by cost cutting down on the marketing and administrative expenses without decreasing the target sales volumes. The final blunder was made when the management without any proper research had adjusted the expenditure cost. The company has failed to achieve the target according to the prepared budget. The Chairman has appointed an expert consultant for analysing the overall situation. She inspected the budget and found that the sales budgets and other expenditure budgets were enough to achieve the desired sales volumes. Therefore, the basic problem with the entire situation is the unreasonable projection of sales volumes. The Revised Budgeting Process Developing a proper budget is one of the important tasks of the management. The budget must reflect the financial goal of a company. “A sound budget process communicates organisational goals, allocates resources, provides feedback and motivates employees” (Shim & Siegel, 2005, p.9). These are the primary features and advantages of a budget and to develop such features, it should follow proper steps. The management prepares a budget once in a year by predicting the future demand and business activities of the company. The business operations are carried out based on the pre-designed budget. Hence, to ensure efficient business activities, the budgets of the company have to be appropriate and relevant. The unfavourable condition of Industrial Alternatives plc is a shining example of what an inappropriate budget can do to the overall growth of a company. In order to revise the budgeting process for correcting the prevailing problems, the management should follow proper steps of developing a budget. At first, Industrial Alternatives plc should plan its budgeting process. In the planning process, a specified board of members must be mentioned who will be responsible for executing the budgeting process. The timeline for the desired level of the activities must be pointed out in the budgets. Next, the board of members responsible for executing the budgeting process must communicate this with other departments. The budget must figure out the area of responsibilities for each department. For example, the manufacturing unit must focus on reducing the overall production cost by maintaining the acceptable quality of the products. Thirdly, the budget for the Industrial Alternatives plc shows higher target sales volumes. Therefore, the budgets must project the expenditures for required labours, funds and other necessary resources. It will help to produce the desired level of production. Fourthly, before setting the desired sales and preparing the budget, the member of board for budgeting process must conduct a research (Nonprofits Assistance Fund, 2006). The research will scan the internal as well as the external environment of the company. This will help to develop a realistic and achievable budget for the entire department. The research will disclose the available resources, current income and expenses of the company. Once the members of the boards are over with all these activities, it should prepare a rough draft of the budget and this tentative draft of the budget must be reviewed by the committee or by an expert group of consultant. The consultant will focus on the areas of improvement of the prepared budgets. The members of board along with the group of consultant will rectify the probable errors in the budget to arrive at an error free budget. The project must get its final approval from the Chairman and Chief Financial Officer. The members of the board for the budgeting process must evaluate and update as per the requirement. The above mentioned steps for budget are the appropriate way of revising the budgeting process for the Industrial Alternatives plc. The company lacks the basic rule of the budgeting process and above discussion is helpful in rectifying the weaknesses of the company in preparing the budgets. However, in Industrial Alternatives plc there are also other problems that have led to the failure in achieving the target sales. Firstly, the Chairman must consider the opinions and views while setting the target sales for company. The Chairman sets the sales target according to his own perception and desired goal. However, this may not match with overall positioning of the company. The lack of communication is another major problem for the company. The Chairman must remove this barrier through an open discussion with other departments. The operational activities should be transparent so that it will be easier to comply with other departments. Every department Industrial Alternatives plc must contribute to the budgeting process. The Costs of Functional Areas and the Decreasing Sales Volume The preparation of budget must include all departmental expenditures so that the necessary adjustments can be made according to the requirements. As the sales volume decreases, the target profit margins also decreases but the expenses in other functioning department remains same. The budget of Industrial Alternatives plc should focus of the specific objectives of the company. However, the Chairman and management of other departments have failed to develop specific goal in the budgets. The major problem with its budgeting process is that the Chairman has set the target sales volume without any relevant assumptions and finally it has led to the decreasing sales volumes. The Chairman has assigned a consultant for reviewing the whole process operation to figure out the reasons for the failure to achieve the sales target. The consultant has found the product line for the sales budget adequate. Moreover, the allocated amount for the cost and expenses is also adequate for the target sales volumes. The consultant’s conclusions have raised a question against the Chairman’s decision that whether he has set the target sales volume on a realistic basis. In case the target sales volumes are unrealistic and unachievable, the profit margins cannot be increased by implementing cost cutting measures in other functional areas. Reducing the expenses and cost of product will not affect the production level. Moreover, the quality of the product may be affected due to the use of cheap raw material. Cutting down the expenses and cost of the products will not affect the level of the production and will lead to the increase in the inventory and handling costs of finished goods. The timeline of the budgets are fixed i.e. for one year and allotted cost, the desired level of production is fixed. The fixed costs cannot be reduced further as the budgets are already prepared with very little margin for the fixed cost budgets. The variable cost depends on the level of the production and to produce the desired level, the company has to incur the required variable expenses. However, if the targeted sales volumes can be reduced for a particular time period, then the cost will automatically reduce. In this case, the costs of other functional areas are expected to cut down the costs for the decreasing sales volumes. The cost for the functional areas can also be cut down by exercising control on the expenses and cost within each functional department. The cost can be reduced by delaying the discretionary costs if the entire operational activities are not affected seriously. The budgets can also be prepared considering the flexibility in the operational activities. In such case, the amount allocated for the expenses should be more than the targeted sales and hence the cost of the functional areas can be easily cut down to increase the profit margins. The above discussions have pointed out the manner in which the expected cost can be reduced in the functional department when sales volume falls below budget. However, in case of the present condition of Industrial Alternatives plc, it will not be possible to cut down the cost without reducing the level of production. In order to increase the profit margins, the company should reduce the sales target and the production level. It will help to reduce the overall cost of production. Conclusion The budgeting process of the company is important for the smooth functioning of business and other operational activities. The budgeting process of a company involves planning and estimating the income and expenses based on targeted sales volumes. In this process, it is very important to analyse the internal and external environment of the company as well as its industry for setting the sales target. Besides, cross functional communication is also very essential for an efficient budgeting process. The Chairman of Industrial Alternatives plc has followed an inappropriate method for setting the targeted sales volume. Moreover, allocation of the budgeted cost for the functional expenditures has been done according to the targeted sales volume. The company has failed to achieve sales as per the budget. The primary reason for such failure is that the Chairman has developed the target sales and estimated net income before tax without conducting any proper research or discussing it with other functional departments. Reference Akintoye, I.R. (2008). Budget and Budgetary Control for Improved Performance: A Consideration for Selected Food and Beverages Companies in Nigeria. [Pdf]. Available at: http://www.eurojournals.com/ejefas_12_01.pdf. [Accessed on September 05, 2010]. Beavers, A.R. (June 08, 2010). Managerial Accounting: The Budgeting Process. [Pdf]. Available at: http://www.laney.peralta.edu/Projects/30604/Business%201B%20-%20Managerial%20Accounting//Chapter_20.pdf. [Accessed on September 05, 2010]. Blocher. (2006). Cost Management: A Strategic Emphasis. Tata McGraw-Hill. McClintock, M. (2000). MIS FINANCE AND BUDGETING ISSUES IN SMALL PUBLIC AND PRIVATE INSTITUTIONS. [Pdf]. Available at: http://net.educause.edu/ir/library/pdf/EDU0022.pdf. [Accessed on September 05, 2010]. 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