Module Strategic Management Accounting - Research Paper Example

STRATEGIC MANAGEMENT ACCOUNTING Part A Introduction Accounting helps a company keep a control and overview over expenditures and allows for the formulation of the budget that would allow the company to stay in business. As such, the practice of accounting is performed in a standardized manner and follows a set of procedures and approaches, so much so that most accounting initiatives are often described as being done according to a traditional method. Many industry experts have expressed their opinion that this traditional practice of accounting and budgeting would be done away with in the coming decades. From an overall perspective, the problem of traditional budgeting stems from two major deficiencies, which companies have yet to address in totality. One of the first issue with traditional budgeting is associated with accounting. Budgeting is performed to fulfill two major objectives. It helps serve the purpose of internal budgeting for every department and responsibility within the company and subsequently works to form the goal of determining the earnings and revenue per share. As such, the process of internal accounting in most companies is dependent on allocation of expenses. This top down approach, which has been followed for decades, is one of the prime reasons due to which most management resources in the companies stand to be underutilized and resort to being obstacles to the improvement of the budgeting process (Aaron Wildavsky, 2006). critics to this approach have instead advocated the use of a bottom up or activity based accounting model for effective budgeting. Another issue associated with traditional budgeting is the availability of systems that can help support the required change. To transform from an expense based to activity based budgeting, it is necessary for companies to determine the expected transaction volumes within the business. Simply projecting the expected and perceived volumes will not solve the purpose as most business managers tend to work in an edit mode rather than be creative in improving the efficiency and working of the business (Colin Drury, 2004). During the forthcoming discussion, the pros and cons of traditional budgeting will be discussed for the two companies in the question. While the company having a constant demand in a stable market will be known as ‘Company A’, the other company that operates in a very dynamic environment shall be known as ‘Company B’. Deficiencies in traditional budgeting Though traditional budgeting continues to be the most widely followed approach, several companies and institutions are moving to adapt to the bottom up method of management reporting. In general organizational environments, the management usually considers the annual budgeting process as one of the most unrewarding activity of the year despite the fact that it forms the basis of several major decisions in the company for the ensuing year. One of the important aspects of budgeting is the setting of a desired and achievable earnings per share target. Such a target is then discussed with analysts, consultants and shareholders. This target is also the determining factor for any compensation plans within the company. However, as one might have imagined, the management is not glad about performing a task that ultimately proves ineffective and sometimes contradictory to the plans they have created. The top management comprising the CEO is in contrast, more interested in creating a process that would get these managers more involved in determining the budget and still work within the confines of the expectations of shareholders and other stakeholders (Sven Röhm, 2007). In addition, the financial accountants and analysts who perform the task of determining and documenting the contents of the budget have a feeling that their suggestions and efforts have not been considered in the process. as a result of such colliding expectations and responsibilities that work together in budgeting, the traditional model of budgeting has become an outdated approach to solving the company’s quest to plan for the future and results in disruptions and intrusion into the day to day management on several instances owing to problems that are discovered or encountered, but could not be forecast during the budgeting period. Short term focus It is a well known fact that many books and reviews from several accounting experts have openly critics the American approach to budgeting that focuses solely on earnings during the current period and thereby lacks a proper vision for the long-term. This is equally visible in the financial markets where the pressure is on annual earnings and the media and shareholders are more interested in the quarterly earnings results. The industry has been so focused on fulfilling these short term approaches that the annual budgeting process tends to conquer the pressures involved within. Such a setting would not do much of a difference in the case of Company A, which operated in a stable and secure environment as it would not have much effort to put into determining any major changes within the forces of supply and demand, thereby helping it to rely on the traditional approach of quarterly performance and annual budgets. However, company B, which is operating in a constantly changing scenario, would be far placed if it were to merely look towards fulfilling the short term goals of investors and did not do much to anticipating the future market dynamics (Hassan Moeini, 2007). In fact, a lack of seriousness in this issue and absence of credible foresight is one of the reasons due to which financial giants such as Lehman Brother, which operate in some of the most volatile environments, could not foresee the looming danger, thereby leading to its bankruptcy in a matter of a few days, thus wiping out its century old legacy. Typical budgeting In the typical budgeting process, managers involved in budgeting meet once in a year and the task of budgeting extends only until the end of the coming year. Any forecasts made to support this budget traditionally limit themselves to within this one year period and work towards supplementing the budget information. As such, any forecasts are in effect working to achieving the targets of the coming year and not beyond it. However, as most market sectors such as the housing and oil sector have shown, any market tendency takes months and sometimes years to evolve and never really presents the complete true picture. Having said this, it is particularly difficult for companies operating in a dynamic market scenario to lay low and worry only about the next 12 months. In order to remain in a strong financial position, companies such as B should always work towards anticipating the market situation for a more prolonged period and be able to develop profitable strategies for all identifiable and foreseeable market scenarios. This also applied partially in the case of market A, as lack of even a basic amount of foresight beyond the typical annual year would prevent it from overcoming any adverse market conditions that could disrupt operations or flow of goods and services in a short time. As such, it is advised to do away with the practice of seamless transition (OECD, 2001). General Ledger Budgeting Traditional Budgeting is based on the use of the General Ledger approach, whereby a General Ledger (G/L) for short contains every basic financial information and details of every transaction performed within the company. Some of the pieces of information that a general ledger deals with range from direct revenue, expenses as also balance sheet amounts. People participating in preparing the budget generally tend to include such amounts that pertain to only their areas of responsibility. Though most of such people have the responsibility to major in a profitable manner, several of them do not achieve this budget wise. For instance, a typical budgeting scenario in a company would be to include all outstanding balances, employee expenses as also expenses incurred in travel and entertainment, which leaves out all direct expenses and revenue. The finance department then moves to add the benefits and occupancy, while the back office deals with budgeting these figures. However, the allocations by the back office are not taken into account while managing the business and this represent a major disconnect since work is being generated by the profit centers, which subsequently is processed in the back office. As such, disregarding the back office during the calculation of the budget is one serious deficiency under the traditional approach. Both the companies in question must do away with any such disconnect as ensuring profitability is all about bringing about a connectivity between various parts of the business and determining areas that can be made more profitable apart from minimizing any costs. As profit is the driving force behind the business, any company regardless of the nature of the market in which it operates would stand to benefit from doing away with such traditional practices (J. Kroon, 2001). The front and back offices Several departments such as the back office are often not considered to be a part of the profit earning engine of the company and therefore do not constitute the planning process. in such a situation, discrepancies in areas such as salary increases are bound to occur. For instance, a manager in could anticipate a salary increase of 5% for the coming year and enter 10% into the budget. During the review of the budget, the increase gets reduced to 7%, thereby leaving the managers satisfied over the 2% expected gain in their salaries. However, due to the disconnect mentioned above, there is no clear understanding if such an increase has been uniform with other ‘profiting’ departments in the company, thereby leading to a lack of clarity whether there are enough resources at hand to fulfill the demand. Such a situation can be controlled to a certain extent in the case of Company A, which would have a certain leverage in using the stable demand to firstly arrive at a proper conclusion over the expected increase in expenses and thus make a close estimate. The company B would have to consider several parameters such as the expected nature of the markets over a long period of time, the demand curve for every product, the extent to which market conditions would influence the pace of production and supply as also the level of control that the company can exercise over the pricing of its products. In these situations, it is very difficult to come to a proper estimate. One of the best ways to overcome and disagreements and deficiencies in companies operating in difficult market conditions would be to provide a range of such salary increases or any other budgeting parameters that would be measured against a combination of market parameters (Pedro Jacobi, 1999). Arriving at an agreeable solution in this direction would greatly help in improving the understanding between the various departments as well as with the external entities dealing with the company. Expense Allocations Expense allocations are practice that allows for the movement of expenses from the back to the front office wherein the revenue is recorded. Product managers and customer relationship managers are often frustrated with this practice due to the profitability information that they receive as they are unable to understand the validity of such allocations. Additionally, they cannot understand the accuracy of the sums that should have been charged. This leads to problems with the back office and a blame game ensues over allegations such as overspending and violating guidelines of allocation rules. The management therefore needs to have a clear oversight over the costs and the profit margins. It also needs to ensure customer profitability that in turn creates value for the product. The point being derived here is that prior to making any improvements to the process of planning and budgeting, it is necessary to correct the procedures involved in measuring the actual profitability as this enables the allocations of expenses through a more meaningful and elaborate expense calculation (James Edward Ward, 2001). This is extremely important in the case of company B as it needs to constantly keep a track of the sale of its products as well as determine the exact amount of costs and profits that are being made on a periodic basis. Without a proper estimation mechanism in place, there will be no clear correlation between production and sales and the management will be in no position to set the correct price levels that would ensure optimum profitability. Operating expenses Businesses today operate in a highly vulnerable and fluctuating environment and companies need to have appropriate adjustment mechanisms in place. Providing suitable budgeting solutions to all such requirements helps in allowing the customers to take benefit of these approaches as the companies are better places to offer the products at competitive prices. A company’s operating expenses are dependent directly on the manner in which its resources are positioned. But determining the expense of positioning these resources is the critical question at the time of devising the budget. Different expenses ranging from the salaries and benefits given to employees, the cost of space and equipment required to manufacture, the cost of distribution, expenses incurred in promotion and management as well as keeping track of all financial information through controlling and accounting are all important ingredients that go towards determining the operating expenses (Glenn Albert Welsch, 2005). The traditional approach The traditional approach does not provide a clear picture as it does not effectively consider all these aspects while determining the operational expenses of the organization. Additionally, allocating the entire value of these estimated expenses for the revenue period and not looking into the amount of work and contribution provided by each of these resources is one of the key deficiencies of the traditional budgeting approach that leads to the generation of false and incorrect estimates thereby leading to bad and inefficient decision making. Therefore, this aspect of traditional budgeting needs to be considered by companies that aspire to profit year after year. Part B Cash flows represent the flow of money into, out and around a business. It is the lifeline of any business and is the primary area of concern for any manager, whose task is to maintain a steady flow of capital and to use it to manufacture goods or provide services and earn profits through sales. The same goes for the XYZ Company that uses the cash from previous sales proceeds as well as the money sourced from creditors. The sale of goods is expected to produce a surplus that forms as profit and forms a part of the working capital of future production. In the case of XYZ Company, the managing director has to understand that the business cycle absorbs cash in two different areas. The first area where cash needs to be invested is the Inventory which encompasses the task of maintaining stocks of raw materials as well as the work in progress. The second part that absorbs cash from XYZ is the group of debtors who owe money to the company. likewise, the company generates cash from the creditors (or payables) as well as through equity and loans. Therefore, striking a proper balance between these 4 main ingredients in the working capital cycle are essential for ensuring the smooth conduct of the business (E. J. McLaney, Peter Atrill, 2005). Dimensions of working capital It is also important to understand that every component of the working capital received above is comprised of two major dimensions i.e., time and money. When the question is over managing the working capital, ‘time is money’. Thus, the speed with which money moves through the cycle determines the efficiency with which the capital cycle is being managed. One of the best ways to ensure faster access to cash is to speed up the collection of capital from debtors (Pauline Weetman, 2006). Additionally, maintaining minimum inventory levels will also minimize the amount of money that gets tied up in relation to the sales. By these ways, the business will be in a better position to generate more cash and will need to depend less on borrowed sources of income. Such a method would lead to a reduced amount of interest that would have to be paid to banks as a result of smaller loans thereby generating more cash at hand from lesser costs that can then be invested towards expansion or in new ventures (Carlos W. Moore, 2008). Apart from ensuring the improvement over movement of cash, it is also advised to look into the revising and improving over the terms of agreements with suppliers as required. This essentially means that the goal should be towards securing increased credit limits or a bigger credit. Achieving this would ensure the creation of free finance that would help fund production and sales in the future. Collecting receivables from debtors in a faster manner would help release the cash from the working capital cycle into the coffers of the company while refraining from improving on this would soak up all available cash that could prove to be a hindrance in funding operations in the future. XYZ Company may also find it tempting to pay for everything in cash in every expense incurred. For instance, it could prefer to pay in cash for purchasing fixed assets such as plant equipment, vehicles, office equipment, stationary, computers etc. however, opting to not make the payment is cash would put the company at a comparative advantage as it would be left with working capital for a longer duration. As such, in times when cash is tight, the company should consider alternative ways of financing the operations such as through loans and equity. Similarly, paying out dividends and expenses are deemed as cash outflows, which reduce the liquidity of the business (Diana R. Harrington, 2004). Thus, the company could come up with alternative ways of delivering such benefits to employees and investors to the greatest extent possible. The company could further enhance the pricing policy by offering products at competitive prices, which requires extensive market research and analysis. This can improve the gross profit margin in a significant manner and lead to better liquid profits. The company could also look into ways to increase the sales volumes as a higher sales volume would enable a greater amount of cash collection thereby improving the net cash flow. The managing director of XYZ is further advised to ensure that all capital expenditures are kept to a minimum by ensuring that any fixed assets are only purchased when deemed to be absolutely necessary (Karen Berman, 2006). This way, the XYZ Company can ensure that it keeps it net cash flows at an optimum level, thereby leading to a better management of the working capital cycle, which can lead to better prospects for the company. References 1. Aaron Wildavsky (2006), Budgeting and governing. New York: Transaction. 2. Carlos W. Moore (2008), Managing Small Business: An Entrepreneurial Emphasis. New York: Cengage. 3. Colin Drury (2004), Management and Cost Accounting. London: Cengage. 4. Diana R. Harrington (2004), Corporate financial analysis: decisions in a global environment. University of California. 5. Hassan Moeini (2007), Beyond Budgeting. Stockholm: GRIN Verlag. 6. James Edward Ward (2001), A Critical Evaluation of Traditional, Program, and Zero-base Budgeting Systems. University of Texas at Austin. 7. Glenn Albert Welsch (2005), Budgeting: Profit Planning and Control. New York: Prentice Hall. 8. Karen Berman (2006), Financial intelligence: a managers guide to knowing what the numbers really mean. Harvard Business Press. 9. J. Kroon (2001), General Management. Johannesburg: Pearson. 10. J. McLaney, Peter Atrill (2005), Accounting: An Introduction. New York: Pearson. 11. OECD (2001), OECD Journal on Budgeting. Organisation for Economic Co-operation and Development. 12. Pauline Weetman (2006), Financial accounting: an introduction. New York: Pearson. 13. Pedro Jacobi (1999), Challenging Traditional Participation in Brazil: The Goals of Participatory Budgeting. New York: Woodrow Wilson International Center. 14. Robert Lee (2004), Public budgeting systems. New York: Jones & Bartlett. 15. Sven Röhm (2007), Are Traditional Budgeting Practices Out of Kilter with Companies Competitive Environment. Stockholm: GRIN Verlag. Read More