Last Name, First Name
Flexible Budget
The budgetary plan for the company is not appropriate. For the years 8 and 9, the sales projections indicate that the company simply used the prior year's performance as their budget for the following year. This approach is known as static budgeting (the budget for year 9 is a near facsimile of year 8). This is normally done by companies and is amended based on the following year's projections. However, the company's managers failed to be realistic for year 9 projections, bringing the optimism from year 8 into their budgeting for year 9 despite market intelligence information indicating a slightly depressed market for year 9. According to information received by the company, the global economy will be sluggish from year 9 to 11 thus requiring a re-evaluation of the operating budget for the year.
The company's performance in terms of cash management is also a serious issue. Through an examination of the accounts receivables (AR) for the company, the company has projected an Accounts Receivable Turn-over of about 8.33 for year 8 and the company's managers want to retain this ratio for year 9 (as shown below). However, the company's closest competitor has an AR that is considerably lower. This means that management is too lax in giving credit to its clients. Because AR is 12% of the total revenues of the company, this is a significant cash resource that is not being managed better by the company. In a sluggish economic year where sales projections are forecasted to be slower, the management of assets including cash is critical for better performance of the company.
Similarly, the company should try to manage its cash relationship with its suppliers. The company's accounts payable has increased to 1.52 times from 1.3 times from year 8. The company has moved to try to get better payment terms from its suppliers and should continue beyond year 9.
Management has not done anything to up profitability and this is a concern for the company. The Gross Margin Rate of the company is at a 27% rate while the competitor's GP margin is a higher 32%. This means that the company can try and lower down its direct operating costs to improve the overall profitability of the company. Management seems to be too lax to consider this as well and is thus a serious management concern. An examination of the budget uncovers the following variances:
- Net sales – decreased by 130 thousand
- Advertising and transportation expenses – increased by 6 thousand
- Admin salaries – increased by 1 thousand
- General admin costs – increased by 2 thousand
- Profitability – decreased by 38 thousand
Studying the variances based on the budget presented by the company shows that the company's managers are not doing enough to ensure improved financial performance. The budgets seem to have been made without consideration of the market information provided to the company. For one, net sales are projected to be lower due to the slowing down of the global economy. The company's managers did not take this into consideration on two accounts. One, they projected higher bike sales (higher number of units sold). Second, the company did not make changes to its budgets to achieve higher sales volumes. For instance:
- Favourable variance (decreased spending) for pushing sales mean that management thinks it could reduce the direct cost of selling yet achieve higher sales volume in a bearish economy. This simply will not happen. Money should be spent effectively to make more money and the company is thinking that it will achieve its sales targets complacently.
- Increase in GAE and management compensation despite the projected decrease in profitability. This simply means that management is not performing well. Managers are paid to make sure that the shareholders’ interests are kept, and that is primarily an enlargement of their financial returns from their investments. Managers should take this into consideration in steering the company and the variances shown in the company's budgets indicate that management has not performed well enough to ensure shareholder wealth optimization.
Management by Exceptions
Management by exception is an approach wherein managers are concerned with only specific areas that have relatively higher variances that lead to high divergence from preferred results. Management experts believe that managers should be concerned with future strategies thus reducing the time devoted to measurements and individual appraisals, which are required on a periodic basis. With MBE, managers devote time to issues and act on it when necessary. MBE is effective in areas that are characterized by massive activities thus allowing managers to concentrate only on critical items. Variance analysis and MBE go hand in hand and is effective for production situations, such as those of Competition Bikes.
The process form MBE is straightforward. Managers look at the largest variances in a company’s operations, examine its impacts and then decide, on an ad hoc basis, on what to do. Variables that show significant movements are analysed and acted upon efficiently. Whether the variance is negative or positive is then related to the goals of the organization, which managers fully are aware of. This makes the detection of necessary actions easier for both the managers and the rank and file employees since clear directives will always be the result of MBE and variance analysis.
Management by exception will help the managers know the severity of most variances and ensures that there will only be corrective actions in order to limit the variance to a specific low difference between planned results and budgeted results. This concept allows managers to be involved in other more pressing issues apart from accounting. Moreover, not all variances should undergo investigations. This is because almost all variables will undergo variances. This will always occur. Putting management to the task of investigating all variances wastes a lot of their time and efforts which could be used for strategic planning. Managers will look at variances of concern in terms of their size, when they are unusual, when they involve a huge amount of money, and above a certain rule of thumb/ unique standard.
