MAPM5029 Management Accounting And Performance Management

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MAPM5029 Management Accounting And Performance Management

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MAPM5029 Management Accounting And Performance Management

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Course Code: MAPM5029
University: Greenwich School Of Management

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Country: United Kingdom

Question:

TimberTreat Ltd. is a new company, which will be incorporated on 1 January 2019. The company will manufacture one product. TimberTreat Ltd. will buy and pay for office equipment costing £2,400 in January 2019. The equipment will be depreciated by 25% per annum. Depreciation is not included in the overhead details given. Direct materials will be purchased during the month they are required for production and paid for during the following month. Monthly production is planned to meet expected sales demand for the following month. All sales will be on credit terms, with customers paying two months later. TimberTreat Ltd. will issue 20,000 ordinary shares of £1 at par for cash on 1 January 2019. An overhead absorption rate of £5 per direct labour hour has been calculated for the variable production overheads. Variable distribution costs of £2.50 per unit sold will also be incurred.

Write a memorandum to the shareholders to accompany the budgets that:
 

1.Evaluates the use of budgets in the modern business world.
 
2.Analyses the figures shown in the cash budget.
 
3.Suggests ways in which the cash budget could be improved

Answer:

Part a
Importance of budgeting in modern business world:
In the today’s era, the businesses have become quite complex to operate due to the changes that takes place in the business environment. Therefore, the role of budgeting has achieved significant importance especially for the business segments. Budgeting is regarded as the integral process of financial planning of the business as it involves estimation of expenses or costs as well as anticipation of incomes or revenues which are going to occur in the course of business in particular period as covered by budgets.
Budgets are the formal and comprehensive statements that work as the map to reach at the desired goals and objectives of the business.  Budgets help the organisation by providing them the standards or benchmarks against which actual results of business is compared to measure its performance and to enable the managers of business to develop the corrective measures to improve the performance in the future periods. Budgets are the operational guides of the strategic plan of the business (Jensen, 2003). Not only the planning function of business is supported by the budgeting practices but also it facilitates controlling functioning by supporting the effective and efficient use most valuable resources of the business. The process of budgeting involves estimation of all the possible expenses and income of the business that are probable to occur in the time covered by the budgets (Tran, 2012).
In the modern world, where businesses are getting complex day by day, it is becoming very important to anticipate the future business conditions so as to avoid any sort of unforeseen problems. A budget is prepared keeping in mind the overall goals and targets of the business and quantifies them into something that is tangible or achievable. Further, the process of budgeting promotes effective communication and coordination between the top management personnel and employees of the company so that all the strategies and plans could be converted into real actions (Chen, 2003).
To achieve the success in the financial terms, it has become necessary to plan carefully all the financial affairs. These financial plans are usually regarded as the budgets. In general, budgets take various forms and serves various functions by offering the basis to set the targets for the sales,  manage inventory, investing surplus funds or borrowing the required quantum of funds and so on (Hope &  Fraser,  2003).
Though it is correct to say that no budget can guarantee success to any organisation but it is the fact that budgets help in avoiding the failures as they work as the key tool for the translation of general plans into more specific goals and objectives that are action-oriented (Stratton, 2015). Through the use of budges the managers communicate the desired results out of business performance by appropriately allocating the resources to all the areas where they are required to achieve such desired results.
In the highly competitive business environment, it is quite essential for the organisations to use their limited and valuable resources in the most effective ways. Such practices for effective utilisation of those resources can only be undertaken when there is a clear idea of as to how much resources needs to be allocated to what department so that organisational success and growth can be achieved smoothly (Israel & Kihl, 2005).
Budgeting process  help in seeking the required funds for the business by allowing the providers of finance to analyse the future performance of the business of such entity by examining the budgetary statements submitted by the concerned parties. Once budgets are prepared for the subsequent period it becomes easy for the business organisation to persuade the potential investors to invest their surplus monies in its business. Budgets allow the finance providers to study in details the future perspective of business of the entity asking for loans, before lending considerable sum of monies to them. Further, budgets allow the managers to clearly identify the areas where maximum resources must be deployed so as to generate maximum returns out of business. If there is no planning function undertaken beforehand, then it may create confusions among the employees of the organisation who are working to turn the desired results into actual results. Furthermore, the budgets also provides the competitive edge over the rival firms operating in the industry as it allows the managers to formulate such strategies and policies on the basis of the standards  which can allow it to perform better than the average expectations (Parker & Kyj, 2006).
A budget that it is carefully framed enables the business managers to continuously track the performance of the business as to whether their business is capable of offering them the desired results. Budgeting processes not only support the short term business planning but also it facilitates the long term strategic planning of the business in every aspect such as setting the level of operating costs to be incurred or the potential expansion. Budgetary statements also allow the identification of business areas which have the scope of further improvement and investment (Principles of Accounting, 2018).
Therefore, it can now be concluded that a budgeting process that is carried in details enables the managers of business to regularly prepare the comparative reports and provide the status updates to the line level managerial persons so that they can adopt the changes required in their functioning and roles. Also, the effective monitoring of budgets helps in quickly coping with the environmental changes through the change in the strategies wherever necessary.
Part b
Analysis of cash budget prepared for the business of Timber Treat Ltd.:
As Timber Treat Ltd. has started its business as a manufacturing concern, it has to make capital investment in the acquisition of machineries and equipment which has resulted in the outflow of cash for the business. Further, since the business is an entirely new venture, it is quite obvious that the company would have required funds before commencing the core manufacturing activities of the business. In order to acquire the machineries and to arrange funds for the purchase of raw materials as well as to meet the cost of production and selling the output of the business, Timber Treat has chosen the share capital financing as a source of its finance.
The cash budget of the Timber Treat Ltd. is depicting a considerable amount of cash balance at the closing of the year i.e.  31st December, 2019. It contains all the cash flows that have taken place in the current year. Firstly, the company has issued a share capital £ 20000 and this has resulted a cash inflow of £ 20000. Further, the business has made sales on the credit basis under which the cash from the sales have been recovered in the 3rd month of the sales. As the company could not make any sale in the month of January due to the incorporation of its business in the same month, the sales were initiated from February. However, the collection for sales were started from the month of sales and thus the collection from the sales of November and December could not be collected in the same year. Rather such sales will be collected in the month of January and February of next year.
Further, the cash collected from the sales made during the course of business have been used to make payment of various expenses such as production expenses, administrative expenses and selling and distribution expenses. Also, the company had to purchase required amount of raw material to produce the quantities which was expected to be sold in the next month. Moreover, Timber Treat Ltd had to acquire an equipment of £ 2400 to take up the production process of the business. This has also resulted in the outflow of cash from the business of the company (Hilton & Platt, 2013).
The overhead cost of business includes various expenses as discussed above and along with such expenses, it also includes depreciation expense on the equipment which was purchased at the start of the business in the current year. However, since the depreciation is a non-cash expenditure of business, it does not result in any outflow of cash from the business and hence it does not form part of cash budget (Horngren, 2002). In the present case of Timber Treat, the depreciation of £ 600 (i.e. 2400 * 25%) is not included in the payment section of the cash budget. But, the same is taken into account while calculating the net profits of the business.
The closing cash balance of each month has become the opening balance as it is assumed that the managers of the company has carried forward the closing month cash balance of business to the next month to use the same for the business purpose only without withdrawing even a single penny for their personal use.
In the month of March, the closing cash balance had become negative and this shows that the business had no sufficient cash inflows and cash balances to meet the cost of business and therefore it is assumed that the company has availed the facility of cash credit or overdraft.  Resultantly, the negative balance of March month had become the opening balance of April. However, since the company had made sufficient cash collection for the sales made in February, it did not have to face the cash crunch in the April month as well as in the further months.  Moreover, the company has made payment for its purchase of raw materials in the month following the month in which such raw materials were purchased by it. Therefore, the cash budget for the year ending 31st December, 2019 does not contain the payment of cash for the purchase of raw material in the month of December and it will be paid in the January of the next year.  
Part c
Further recommendations to improve cash budget:
The closing cash balance of Timber Treat Ltd. as at the year-end 31st December, 2019 is £ 355760 and this is quite lesser than the net profits of the company as depicted by the income statement prepared for the year ending on 31st December 2019. The reason for such variation in the net profits of the company and its overall cash flows is the basis of accounting. The accounting of Timber Treat Ltd is carried on the accrual basis and hence all the transactions that have been entered into during the current year have been reported, irrespective of the cash payment or collection of such transactions (Zimmerman & Yahya-Zadeh, 2011).  The cash budget for the current year has further scope of improvement by reducing the cash collection from the trade customers of the business. The company must introduce new policies to reduce the credit allowance time on the sales by offering them various kinds of discounts and other schemes so that collection from sales can be made more quickly to instil the system of proper cash management. Further, the company must purchase the requisite raw material in bulk quantity in order to avail the discounts from their suppliers for the bulk purchases. It will not only reduce the ordering cost but also the purchase price of raw material will also be reduced (Drury, 2013). Alternatively, Timber Ltd. could also ask its suppliers to provide a credit allowance of at least two months so that proper balance of cash collection and payment can be made while taking up the purchases and sales transactions under the business. Further, instead of purchasing the equipment by making the full payment, the company must make the instalment payments for such equipment as the cost of such equipment is quite large and it has already resulted in the outflow of significant amount of cash from the business. The chunk payments for such equipment purchase will allow the company to maintain a sufficient balance of cash in the business (Garrison, 2010).
References:
Chen, Q., 2003. Cooperation in the budgeting process. Journal of Accounting Research, 41(5), pp.775-796.
DRURY, C.M., 2013. Management and cost accounting. Springer.
Garrison, R.H., Noreen, E.W., Brewer, P.C. and McGowan, A., 2010. Managerial accounting. Issues in Accounting Education, 25(4), pp.792-793.
Hansen, D., Mowen, M. and Guan, L., 2007. Cost management: accounting and control. Cengage Learning.
Hilton, R.W. and Platt, D.E., 2013. Managerial accounting: creating value in a dynamic business environment. McGraw-Hill Education.
Hope, J. and Fraser, R., 2003. Beyond budgeting. Harvard Business School Press, Boston.
Horngren, C.T., Bhimani, A., Datar, S.M., Foster, G. and Horngren, C.T., 2002. Management and cost accounting. Harlow: Financial Times/Prentice Hall.
Israel, C.A. and Kihl, B., 2005. Using strategic planning to transform a budgeting process. New Directions for Community Colleges, 2005(132), pp.77-86.
Jensen, M.C., 2003. Paying people to lie: The truth about the budgeting process. European Financial Management, 9(3), pp.379-406.
Parker, R.J. and Kyj, L., 2006. Vertical information sharing in the budgeting process. Accounting, Organizations and Society, 31(1), pp.27-45.
Principles of Accounting, 2018. Importance of Budgets. Available at: < https://www.principlesofaccounting.com/chapter-21/budgets/ > Accessed on: 31.07.2018.
Stratton , L., 2015. Importance of Budgets in Strategic Planning. Available at: < https://www.portebrown.com/Consulting-Blog/importance-of-budgets-in-strategic-planning>  Accessed on: 31.07.2018.
Tran, T.T., 2012. The role of budgeting in corporate performance management. Available at: < https://blog.trginternational.com/bid/155570/the-role-of-budgeting-in-corporate-performance-management> Accessed on: 31.07.2018.
Zimmerman, J.L. and Yahya-Zadeh, M., 2011. Accounting for decision making and control. Issues in Accounting Education, 26(1), pp.258-259

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