New Making Finance Work
1. Richard’s Engineering Ltd produces hand tools for the Car Industry. Following are their Sales and Costs for the four-month period Jan to April:
Sales
Jan
Feb
Mar
April
50
40
60
90
Complete their Production Budget when opening stock of finished goods in January are 80 Units and 70 units a month are produced:
Production Budget proforma.
Month
Jan
Feb
Mar
April
Opening Stock
80
100
130
140
Produced
70
70
70
70
Less Sales
50
40
60
90
Closing stock
100
130
140
120
2. Presently Richard only produces the production budget. Write to Richard giving simple examples of each of the following budgets. Explain to Richard what each of the following budgets show and why they are useful to an organisation.
a. Materials Purchases budget
Answers:
In order to have a successful business procedure, Richard should also consider not only the Production budget but also the Material Purchases budgets. With this, Richard can make purchase material he needs to make the products that he will sell. Depending on how big the company is, for example, saving 30 cents on each piece could save the company millions the product may lose quality but the price doesn’t have to change.
b. Production Cost budget
With regards to production cost budget, similar to materials, machineries to be used should be planned well. Actually, machines are expensive but it save lots of money in the long run rather than paying workers also mass producing makes an abundance of what Richard needs but if the product doesn’t sell having a bunch of factories will run further into the ground.
Here are the suggested materials purchases and production cost budgets that Richard might consider:
BUDGETING PRODUCTION
AND MATERIALS PURCHASES
January
Sales
Company expects sales of 40,000 units in January. The company has an inventory of finished goods on hand at December 31 and desires a finished goods inventory at the end of January as follows:
40,000
Units
Units
Finished Products in Inventory on:
Dec-31
Jan-31
Units
24,000
22,500
Materials Requirements for Production
It takes three pounds of direct materials to make one unit of finished product. The company has an inventory of raw material at December 31, and desires an inventory of raw materials at the end of January as follows:
Pounds
Pounds
Dec-31
Jan-31
Raw Materials
Pounds
110,000
120,000
PRODUCTION (units)
Planned sales
40,000
Planned ending inventory of finished goods
22,500
Needs
62,500
Beginning Inventory of finished goods
(24,000)
Budgeted production ( in units)
38,500
RAW MATERIALS PURCHASE BUDGET
Materials Needed ( 3 pounds per unit produced)
115,500
Desired ending inventory of raw materials
120,000
Needs
235,500
Beginning Inventory of raw materials
(110,000)
Budgeted purchases of raw materials ( in pounds)
125,500
3. Explain the nature of budgets and their use in the long-term planning and strategy of an organisation.
Draw an overview diagram of the budgeting process and of budgets drawn-up by an organisation and explain how they interact with one another. Explain the different approaches to drawing-up budgets.
Use one of the budgets I have provided you with or one you have compiled and explain what each budget says about the organisation involved. (35 Marks)
Answers:
In budgeting, the focus is not only to prepare the budget, but more importantly to have a follow-up operation for budgeting and to act according to known data. In addition, budgets are also known as a financial expression of a company’s plan for a period of time. It is important in long term planning since it tells where and how the organization will spend money and where the money will come from to pay these expenses. Budgets also set limits. Imagine how chaotic an industry would be if everyone was allowed to spend as much as they wished on whatever they wanted. Besides setting limits, budgets also enables the assurance that the most important needs of a company are met first and less important needs are deferred until there are sufficient funds in which to pay for them.
Budgeting Process
It is important to know that budgets do not function well when treated as an isolated business procedure. In order to be successful in this approach, it is essential that the management associates the budgetary process to the other key business processes such as sales and marketing, public relations and advertising, and accounting.
The budget process is made up of activities that include the development, implementation, and evaluation of a plan for the provision of services and capital assets. An effective budget process includes several essential features, which includes, but are not limited to the following:
· The budget process incorporates a long-term perspective;
· The budget process establishes links to broad organizational goals;
· The budget process focuses the budget decisions on results and outcomes;
· The budget process involves and promotes effective communication with stakeholders;
· The budget process is based on a “team approach” for program managers and administrative management; and
· The budget process provides incentives to management and employees.
For large industry, the management should be aware that it is a good idea to spreadsheet all known revenue producing areas as well as to understand all of the expense categories. In this way, the management is able to start getting a grasp of its peak business periods as well as it’s off business periods. As a result, the company begins to get an understanding on which this work will be rendered.
In previous years, the organisation took budgeting so lightly that, until the year was nearly over, it suddenly realised that they had to put on a “hiring freeze”, until the financial people could figure out if they could pay the incoming bills. The financial situation got too bad that the organization started to make painful, but very predictable, across-the-board cost cutting measures.
Basically, there are many approaches of budget preparation that a certain organisation can use. One of these methods is the activity-based costing (ABC). Activity-based costing approach represents one capital budgeting technique for analysing an investment opportunities (Lewis, 1993). The purpose of activity-based costing (ABC) systems is to focus on the causes behind indirect costs. It is primarily a system of allocation. Activities rather than traditional departments are emphasized in order to isolate the cost drivers, which are the factors most likely to cause or contribute to the incurrence of costs. ABC systems are designed to be complementary with the technological changes in the business world due to enhanced global competition (Lewis, 1993).
This method allows the management to vary the underlying activity drivers in business operations and processes so as to identify the impact of different levels in the process itself. It is noted that managers have the potential to learn much more about the risks of investment when they are able to determine the uncertainties in the business processes, rather than the traditional overview approach. The traditional approach has typically focused upon highly aggregated revenue and cost items that are merely the result of business processes.
4. You work as an Accountant for Slade Ltd. Your manager has asked you to write a memorandum to the Managing Director, John Brown explaining the reasons for budgeting and the advantages of preparing a cash budget.
Answers:
Dear Mr. John Brown,
As the nature of financial management become more and more complex in this information and efficient communication era of international business, I know that managers like you face a wide array of challenges, opportunities and options you need to enhance the investing and financing activities of the organization as well as the inherent risks and circumstances of the decisions that will be made. As such, you need to keep operational expenses within budget to be able to devote the necessary financial resources to both exploration and marketing activities of the company. Financial management decisions that will supply for the internal and external business operations your company should be closely monitored to be able to control the flow of cash. Investing on profit-generating projects as well as training-specific programs for the human resources of the company will ensure extended success.
Actually, the budget serves as a financial plan that operates as a statement of revenue and expenses of your organisation. Budgets may then be used to look forward as a plan and/or look backward as a monitor. This is due to the limiting feature of the budget to the activities, which the organization may involve in. With budget goals, your organization can also check and verify expenditures that are appropriate. Furthermore, budgets give indications of the revenue flows.
I hope you’ll understand the need of budgeting and the advantages of preparing a cash budget in your organisation.
Thank you,
The Accountant
5. Obtain a set of PLC accounts and calculate the Gross profit percentage and the return on capital employed percentage. Explain what these ratios say about the company
Take a brief look at the chairman’s statement and briefly explain what is being said about the company’s performance.
Answers:
The following report is done for the purpose of analysing the performance of Shell Plc. The summary of the performance is based on the figures gathered from the companies’ financial statement for the year 2007. Furthermore, an evaluation will be given with regards to the company’s financial snapshots.
Table 1
2007 Shell Plc and BP Plc. Current Ratio and ROCE
Current Ratio
ROCE
Shell
2.35%
40.10%
Table 2 Shell Plc. Financial Details
Source: http://www.shell.co.uk
In financial report, gross profit margin is important as it reveals the profitability of a company’s core business. A company with a high gross profit has more money left over to pump into research and development of new products, a big marketing campaign, or better yet – to pass on to its investors. Investors should also monitor changes in gross profit percentages. These changes often indicate the causes of decreases or increases in a company’s profitability. For instance, a decrease in gross profit could be caused by an industry price war that has forced the company to sell its products at a lower price. Poor management of costs could also lead to a decreased gross profit. The gross profit on sales is computed by subtracting the turnover and cost of sales. Based from the figures in the financial statements, the gross profit for both companies shows constant progress. As seen in the figures, Shell plc is quite expressive. Actually, the yearly increase in the gross profit on sales of the company will enable them to invest on future business endeavours.
Apparently, Net profit margin is the proverbial bottom line. It measures the amount of profit a company makes after all of its income and all of its expenses. It also represents the total dollar figure that may be distributed to its shareholders. Net earnings are also the typical benchmark of success. Interest expense refers to the amount of interest a company has paid to its debtors in the current year. Meanwhile, income taxes are federal and state taxes based upon the amount of income a company generates. Net earnings are particularly important to equity investors because it is the money that is left over after all other expenses and obligations have been paid. It is the key determinant of what funds are available to be distributed to shareholders or invested back in the company to promote growth. The annual net earnings of the company were computed by subtracting the profit before tax, interest expenses and income tax. Based from the calculated results, the companies had significantly increased its net earnings through the years.
With regards to current ratio and ROCE, it is evident in the computations that Shell was in good position to meet its short-term debt. This means that Shell is bale to meet their current liabilities using their current assets (cash, inventory, receivables). The figures are not high so as to make the shareholders fear that the assets of the company are not working to grow the business, and not low so as to drive creditors away with respect to the level of risk present. Since these ratios are perceived as a sign of the company’s financial strength or weakness, the figures in the previous table shows the relative stability of the financial strength of Shell. A higher number would indicate stronger financial performance, and a lower one means weaker performance. Moreover, it is evident that as time passes, the return on capital employed by both companies fluctuates and cannot be pinpointed to one pattern. This is largely due to the differences in the focus on capital investment as business activities progresses. At one point in time, these firms may be very active in business investment and other periods, it may be not very keen on investing.
With regards to the chairman statement, even though the company shows growth for their previous years of performance, there are problems that might occur and that is because of the current global financial crisis and the company’s capability to allocate resources or funds are tightening because of the credit crunch. However these companies can still change the trend of economic crisis by doing some evaluation of their business strategies. It is suggested that Shell plc. should keep a close watch on its expenses for the coming years and to find alternative solution for increasing prices of raw materials and processes used for production and distribution.
Reference:
Lewis, R.J. (1993). Activity-Based Costing for Marketing and Manufacturing. Westport, CT: Quorum Books.
Credit:ivythesis.typepad.com
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