Introduction
This paper highlights a global firm, Pepsi, not to discuss how it outperformed Coca Cola in a recent Forbes press release () but more interestingly how it controls its budget. However, this can have some implications to this century-old realized achievement. The assignment will discuss the financial situation of Pepsi based on its 2003, 2004 and 2005 financial information ( 2006 financial statements). This will be followed by reviewing and evaluating how Pepsi improve its budget control in recent years and how it affects its financial performance. Lastly, expectations on the future of the firm’s budgeting control are discussed.
The Financial Situation of Pepsi
Based from the consolidated statement of income, net revenues increase in 2005 at billion marking a constant billion rise per year since 2003. This means that the firm continues to achieve its objective for stable growth considering that its cost of sales for 2005 has increased by 0 million compared to previous years. The revenue stability is also caused by the deferment of any restructuring and merger strategy for the current year. By doing so, the company has concentrated its efforts to improve its business-level strategy and enhance customer value. In addition, the global firm prevents excessive costs of change adjustment and implementation which would have both organizational and financial adversities.
There are four major subsidiaries for Pepsi; namely, Frito-Lay North America, PepsiCo Beverages North America, PepsiCo International and Quaker Foods North America. Although it is known for its beverages division, its snack division Frito-Lay took the crown away from the beverages particularly in North America with billion more revenues for the past three years including 2005. Divesting the pasta subsidiary of Quaker Foods in 2003 suggests how the firm strategically withdraws inefficient operations because Quaker revenue contribution consistently increases 0 million from 2003 to 2005. The divestiture strategy on inefficient operations does not only provide the firm with positive net gain in the sale but also redeem its long-term growth efforts. The operating profit of Frito-Lay is the highest among the divisions at 38% for 2005. Accordingly, Quaker and PepsiCo North America suggest efficiency as their net revenues are non-proportional with their operating profits contributions; namely, 5% against 8% and 28% against 30% respectively. Astonishingly, the highest net revenue contributor at 35%, PepsiCo International resulted to only 24% operating profit contribution. This financial highlight shows how smaller subsidiaries outweighs net financial performance of bigger ones.
Based from its statement of cash flows, its operating activities provided .9 billion in cash compared to .1 billion in 2004 which is greatly affected by lower taxes paid. This brings into the spotlight the importance of auditing functions to evaluate the wealth maximizing capability of financial statements. However, the increase is held down by pension plan contributions that reached 3 million compared to last year’s 8 million. This would suggest that the firm may test other human resource incentives for motivation probably at short-term stage. General Motors is facing solvency difficulties because its diminishing profits cannot cover its pension plans forcing it to sell some of its major subsidiaries like its financial service arm.
Further, investing activities are largely dedicated for capital spending from 2003 and 2004 at around constant .3 billion. The capital spending in 2005 has increased to 0 million which was basically funded by its sale of PBG stocks that reached 4 million. This account is idle for the last two years which implied that such strategy is intended for aggressive investing activities. In addition, the sale of property, plant and equipment also is increased for the current year which also submitted to the purpose of PBG sale. To enforce Frito-Lay position, it also invested in snack ventures in Europe which is done only in 2005. Portfolio investments is also active for the year at 5 million compared to 2004 ( million) and 2003 ( million). This means that the firm is facing higher risk because it does not control these associates. In effect, close coordination with its fund managers is needed to maximize its returns with minimal risk associated with such investment. For the past three years, the firm is consistently investing in short-term investments at 0 million level. This can be an ideal amount to support and rationalize the risk of capital spending which in nature are long-term investments.
The financing structure of the firm shows how its proceeds from long-term debt issuances reduced in 2005 at million compared to 4 million. There can be no hard conclusions for this as its can suggest that maturity dates are not yet due. An important consideration, however, is if the firm can shorten its maturity dates in order for its cash flow maintain its upbeat standing. In contrast to this, it has able to pay a mere 7 million for the current year in long-term debt compared to 2 and 641 in 2004 and 2003 respectively. In effect, it has strategically situate itself in a position that it would not enjoy continuous cash inflow with its long-term receivable but also associated with minimal outflows in its opposite obligations. On the other hand, cash dividends paid remained rising at a constant rate for the last three years while share repurchases for both common and preferred stocks remained in constant amounts. This is an indication that the firm has substantial control in its financing strategies backed up by its ability to pay the short-term return requirements of its shareholders.
Based on the consolidated balance sheet, the current assets of the firm increase by .5 billion from 2004 to 2005 which balanced the increase in long-term assets. If observed, the majority of accounts in the asset portion reflected a consistent increase which means that the firm is fairly stable and solvent. On the other hand, its current obligations settled at billion while long-term debts are at .3 billion. This position is very risky for the firm since it only has a .5 billion in current assets to cover its billion current liabilities. However, the firm continuously receives positive credit rating from Moody’s and Standard and Poor’s which maintained their access to global financial markets. In the equity side, issued common stocks for the year remained the same from 2004 with issuance worth million. Retained earnings are surprisingly increased by billion despite of the increased dividend pay-out mentioned earlier. In effect, the income-generation of the firm should not be undermined which could also suggest why it has able to receive positive credit ratings and borrow short-term debts despite minimal current assets.
Income per common share (basic) amounted to irregular swings from 2004 increase of .38 to 2005 decrease of .02. Income per common share (diluted), on the other hand, resulted to the same direction with 2004 increase of .36 and 2005 decrease of .02. Aside from the implication that the firm’s basic and diluted earnings per common share are similar, it had to make contingent strategies to minimize negative speculations about its income generating capability. This results to increasing dividend per share from 2003 to 2005. By doing so, the firm is in the position to be a business aggressive although the fact that 2005 return on invested capital reduced to 22.7% compared to past years of 27% level may adversely affect the risk-taking decisions of its shareholders. The pressure of performing well in earnings, however, is mitigated by stable long-term debt at billion level for the past two years coupled by increasing total assets since 2003. In effect, it is able to maintain share prices in manageable level and even reaching a 3-year record at the end of 2005 fourth quarter stock price closing at .
Financial Situation Summary
Financial Account
Performance
Net Revenue
Positive
Cost of Sales
Moderately Negative
Frito-Lay
Positive
PepsiCo North America
Moderately Positive
PepsiCo International
Moderately Negative
Quaker
Moderately Positive
Operating Activities
Positive
Tax Payments
Positive
Pension Payments
Moderately Negative
Capital Spending
Moderately Positive
Sale of Stocks
Moderately Positive
Sale of Property, Plant and Equipment
Moderately Positive
Portfolio Investments (Non-Control Associate)
Moderately Negative
Short-term Investments
Positive
Long-term Debt Proceeds
Moderately Negative
Long-term Debt Payments
Positive
Cash Dividends
Positive
Share Repurchases
Positive
Current Assets
Positive
Long-term Assets
Moderately Positive
Current Liabilities
Negative
Long-term Liabilities
Negative
Retained Earnings
Positive
Income Per Common Share (Basic/ Diluted)
Moderately Negative
Dividend Per Share
Moderately Positive
Return on Invested Capital
Negative
Long –term Debt
Moderately Positive
Total Assets
Positive
Share Price
Positive
The Nature of Budget Control
In general, budget control is central to the key management areas of an organization; namely, planning, monitoring, controlling and evaluation. Specifically, the quantitative approach to budgeting makes the process to create accountability on the part of decision-makers ( 2000). On the contrary, other benchmarking/ targeting activities that merely result on qualitative characteristics of the goals do not only eradicate the opportunity for measuring the output but more importantly lessen the accountability attached to each decision-maker. Budgeting and budget control preserves the objectives of the firm/ strategy, guides the execution of plans and makes results measurable for comparison/ analysis. For example, the statement that “sales department aims to increase sales growth by 2% next month” connotes accountability than excluding the parameters 2% and next month. Thus, budgeting should be prerequisite to budget control to be able to have something to control to. Otherwise, the objective value of budget control will be worthless as managers would tend to insert their own subjective criteria.
The fundamental purpose of budget control is to create and maintain accountable decision-makers/ implementers within the organization ( 2000). Since it uses before-strategy-implementation inputs (probably historic data) to come-up with realistic and optimal strategy, actual strategy implementation is expected to adhere and lead to the intended goals. Failure to comply would result to two-sided adverse effects against the organization; namely, low revenues and high expenses. The budget for every department of the firm is bargained and ultimately given in order for the inputs skim down to outputs. With such continuous occurrence, the firm might face bankruptcy. The role of budget control is to prevent this from occurring by affecting budget preparation, rationalizing results of a financed strategy, monitoring periodic performance and evaluating the actual results with the pre-determined ones.
Pepsi’s Budget Control: Improvements through the Past Years
Software utilization. In 2001, the firm’s Middle East and North American divisions had applied oracle e-business suite and technology products ( 2006). This resulted to improved financial controls since there were also improvement in the efficiency of sales reporting, tracking of sales promotions, inventory control and settlements. The technology allows the firm to monitor and measure business needs as they emerge, thus, appropriation of the pre-determined budget tends to be more contingent not fixed. Budget control should be emphasized in these regions especially in the Middle East to protect the firm’s rare market leadership against Coca Cola. As a result, both its internal (manufacturing) and external customers (distributors) including suppliers are benefited from faster creation of financial data that aid in decision-making. This is because the technology is complemented in shortening the firm’s monthly financial closing by up to 20 days. As decision-making requires financial inputs to rationalize decision alternatives, the firm has provided an efficient working and contracting environment among its business partners.
Seeking consultancy services. It is a smart and useful move for the firm to expose its organizational problems with an outsider. By doing so, biases and lesser motivation to study and improve key business areas would be possible. As the saying goes, “Mirrors are deceptive.” As a result, the firm took the services of PA Consulting Group for a task to reduce its billion operating costs ( 2002). The problem posted a budget-out-of-control problem to the firm that places them below industry’s best practice when it comes to budgeting. Since the firm managers are operating in a volatile and demanding environment, the Group suggested a fast framework model in order to offset the inability of these managers to timely access relevant information essential to an effective decision-making. The new business model was tried in the US and Canadian operations that resulted not only to productivity gains but also cost reductions by as much as 20% within weeks. The program included productivity tracking, staff and resource scheduling and staff appraisal requirements. The success of the Group’s advice had impressed the officials of the firm that will likely resort to the aid of the former in the future.
Dissolution of ineffective partnerships. In 2002, the firm’s Sichuan factory in China was filed to be dissolved due to loose of control of Pepsi over the venture ( 2002). The firm had accused the government-held partner of looting in favor of vacations and expensive cars which ultimately provided local managers with greater control. Local managers were also indicted to bar Pepsi auditors to enter the factory and inspect account standings. In effect, check-and-balance was not possible in the present structure which made budget control a difficult and lapse-sided condition for the firm. Resources, even though not confirmed, are not allocated optimally from the mere absence of audit. This had cause the firm to throw accusations just to give rationale behind the audit barring. The financial and organizational including business strategies were diminished by the happening. The socio-political background of local managers served as the bottleneck (that even referred Pepsi as practitioner of commercial hegemonism) that led the firm to drop one of its key factories in exploiting the large customer base available in the country. The decision, however, emphasized the importance of budget control and budget monitoring in consolidating corporate/ global results in which the firm should integrate into one financial system.
Financial Situation after the Improvements
Improvements
Results
Software Utilization
Ø Revenue targets and cost limitations are manageable
Ø Operating activities are efficient and wealth-maximizing
Ø Tax and pension payments will be on-time
Ø Capital spending can be minimized without altering returns by favoring more important operational needs
Ø Short-term liabilities and other payments are paid when due without hurting credit rating due to questions on solvency
Seeking Consultancy Services
Ø Divisions/ subsidiaries can maximize their revenue potential and minimize their operating costs
Dissolution of Ineffective Partnerships
Ø Maximize investing potentials both direct and portfolio investments
Ø Improving the rationale behind selling stocks
Ø Share repurchases can be conducted with rigid planning
Future Expectations: From Bad to Good and Good to Better
Apply decentralized treasury function. When each department/ division budget is centralized, the financing and investing strategies will be consistent to the overall strategy of the firm ( 1999). This will also result to larger volumes of cash that might reduce bank charges and interest rates. As the firm has higher interest expense that interest income for the last three years amounting at 0 million to 0 million, the economies of scale of a centralized treasury might alleviate some of the negative financial accounts of the firm due to this cost saving strategy. However, cost leadership strategy cannot maximize the revenue potential of a firm and its growth ( 2003). Decentralized treasury function allows the company to be flexible and more responsive to its global operations, reduce bureaucracy hence obtain efficiency and performance evaluation of local managers ( 1999). More importantly, these characteristics will sustain the differentiation strategy of the firm which intends to maximize its revenue and growth potential.
In considering strategic and tactical outcomes, decentralized treasury will make different country subsidiaries independent to its headquarters. This may have implications on its own pricing strategy which involve economic factors in their specific location. In a similar case, centralized advertising budget (in which Pepsi is known to highlight celebrity figures) may not be effective in other cultures due to local taboos. The scandals of Madonna and Michael Jackson that received demerit and criticism from the Catholic Church also suggested that global promotions in general and use of known celebrities in particular would not always stimulate demand rather result to unintended de-marketing. The substantial budget provided to these celebrities that might as well distributed across different geographical subsidiaries to maximize their use.
Lastly, the performance of different country subsidiaries will be evaluated more objectively while the performance appraisal of the headquarters will be more enforceable. Unlike centralized treasury which is volatile to pass-over accountability, decentralized structure gives subsidiaries their freedom to choose their goals, create and implement their own strategies to achieve them and use the budget the headquarters approved. The electric motors and computer support systems manufacturer Emerson had succeeded in using the same application to its global units that impacted its 30-year continuous growth in profit and stock value ( 1998). The budgeting model of Emerson allows its business managers to plan, execute and deliver their goals using their own creativity with minimal headquarter intervention unless a major concern. When applied to the firm, managers will see their budgets and budget utilization as the reflection of their reputation as well as the reputation of their subsidiaries.
Use performance-based budgeting. This is the component required for a decentralized treasury to function effectively. When the organization is decentralized, competition can exist among divisions and subsidiaries to maximize their budget request and ceiling at the beginning of the next operations. When this happens, it is probable that motivation can vanish when one division feels that their performance is trailing far behind of its peer division. However, when performance evaluation and budget provision is based on the mission of a specific division and their pre-determined results, competitive and de-motivation tendencies can be prevented. Performance-based budgeting requires a division/ subsidiary to cost each of their activity/ project and determine the intended results after implementation ( 2001). When this is accomplished, decentralized structure within the global firm can be easily deployed since each division has a goal in mind with less regard to peer competition.
Conclusion
Pepsi’s current financial situation is observed to have specific loopholes and sub-optimal performance particularly in financial accounts such as cost of sales, portfolio investments, debts and PepsiCo International. However, with the introduction of budget control techniques, the firm has able to cut down on costs, establish weal-maximizing investments, avoid excessive debts due to efficiency, and improve division/ subsidiary output. In this view, it can be said that Pepsi is one organization who benefit so much from budget control. Further, this implies the vitality of financial approach to a global firm profitability and long-term growth. As illustrated, if the firm continued its Sichuan (China) venture, it will loose tract on subsidiary performance that connotes financial inaccuracy. As numbers do not lie because they have their exact values, decisions that can be derived from such condition are tantamount to integrate inaccuracies to the whole organizational units. Lastly, it is also suggestive that decentralized treasury coupled with performance based budgeting can enhance the viability of budget control to be able for Pepsi to compete in a duopoly global cola market.
Bibliography
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