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Managing Financial Principles and
Techniques
Contents3. Be able to participate in the budgetary process of an organisation........................................................4
3.1 select appropriate budgetary targets for an organisation.................................................................4
3.2 participate in the creation of a master budget for an organisation...................................................7
3.3 compare actual expenditure and income to the master budget of an organisation........................11
3.4 evaluate budgetary monitoring processes in an organisation.........................................................14
4 Be able to recommend cost reduction and management processes for an organisation.......................16
4.1 recommend processes that could manage cost reduction in an organisation.................................16
4.2 evaluate the potential for the use of activity-based costing............................................................18
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3. Be able to participate in the budgetary process of an organisation
3.1 select appropriate budgetary targets for an organisation
In the modern business it is vital for organisations to maintain a appropriate budgetary control
system to carry out its business in an efficient and effective manner and to survive in the
business. More specifically cost and revenue targets needs to be set in an effective manner so
that such companies are able to obtain a competitive advantage over the other companies.
The XYZ Company is in the process of preparing its annual budget for the financial year 2012
and has prepared the following budget.
XYZ manufacturing company budget for the financial year 2012
2010 2011 2012Variance %
Actual Actual Budgeted
Revenue 14,375 15820 18193 2373 15
Cost of Sales 8734 9520 10758 1238 13
Gross profit 5641 6300 7435 1135 18
Selling &
distribution
expenses
1325 1458 1603 146 10
Administrative
expenses
537 550 565 15 3
Other
administrative
expenses
268 275 270 (5) (2)
Profit before
tax
3511 4017 4997 980 24
Taxation @
25%
878 1004 1249 245 24
Profit after tax 2633 3013 3748 1225 41
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Revenue
Over the two year period the revenue of the company has grown by 10% annually and therefore
taking into consideration the past trend and the future opportunities by the management the
revenue is expected to increase more that previous years. According revenue is expected to be
grown by 15% compared to previous years.
Cost of sales
Even though the revenue has increased by 10% in the past cost of sales has increased only by
9% due to the improvement taken place in the organisation and due to the economies of scales
experienced by the company. Therefore with the aim of further improving these benefits the
company has budgeted a 13% increase in cost of sales which will further improve the gross
profit margin.
Gross profit margin
With the increase in the revenue and the increase in the cost of sales lower than revenue the
company is expected to increase the gross profit margin in the financial year 2012.
Selling and Distribution expenses
The company expects to increase the selling and distribution expenses same as previous years
by 10%. Though the revenue is expected to increase only by 15% selling and distribution
expense in expected to increase only by 10% by improving efficiency and the effectiveness of
the marketing activities.
Administrative expense
The company is targeting to maintain the same administrative expenses level in the current year
by way of cost reduction activities to compensate the expenses increased due to the general
inflation prevail.
Other expenses
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The company expects to maintain same level of other expenses by means of cost reduction
activities.
Profit after tax
The company is expecting a increase in the profit after tax by 41% compared to the previous
year by increasing sales and increasing the efficiency and effectiveness of manufacturing
process.
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3.2 participate in the creation of a master budget for an organisation
The master budget of the organisation comprise following budgets.
Budgeted income statement
Budgeted cash flow
Budgeted balance sheet
Budgeted income statement
The company prepares its budgeted income statement as follows,
XYZ manufacturing company budget for the financial year 2012
2010 2011 2012Variance %
Actual Actual Budgeted
Revenue 14,375 15820 18193 2373 15
Cost of Sales 8734 9520 10758 1238 13
Gross profit 5641 6300 7435 1135 18
Selling &
distribution
expenses
1325 1458 1603 146 10
Administrative
expenses
537 550 565 15 3
Other
administrative
expenses
268 275 270 (5) (2)
Profit before
tax
3511 4017 4997 980 24
Taxation @
25%
878 1004 1249 245 24
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Profit after tax 2633 3013 3748 1225 41
Budgeted cash flow
The budgeted cash flow statement of the company for the financial year 2012 is as follows,
XYZ manufacturing company budget for the financial year 2012
2010 2011 2012
Actual Actual Forecasted
Cash balance at the beginning 625 450 796
Add Receipts
Collection from customers 10,750 14,750 17,350
Total cash available 11,375 15,200 18,146
Less: Expenses
Direct material 3,345 3,755 4,506
direct labour 2,300 2,530 3,036
manufacturing overhead 2,893 3,434 4,121
selling and distribution
expenses
1,300 1,430 1,716
Administrative expenses 537 555 570
Purchase of Property Plant & 2,000 500 1,500
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Equipments
Tax 800 1,100 1,250
Total disbursements 13,175 13,304 16,699
Excess or Deficiency over
disbursements
(1,800) 1,896 1,447
Financing
Borrowings 2,500 2,000
payments 1,000 500
Interest 250 100 200
Total financing 2,250 (1,100) 1,300
Cash balance at the end 450 796 147
It is assumed that the customer collection will be taken place in the same manner which took
place in the past two year of 2010 and 2011.
Further a capital expenditure of 1500 is expected in the year of 2012 to ensure that the
manufacturing facilities are operates in most effective and efficient manner using cutting edge
technology that the industry has.
All the other manufacturing related expenses such as direct material, direct labour and
production overheads are assumed to pay as an when they incur.
Operating expenses such as selling and distribution expenses, administrative expenses also
paid when they incurred.
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Accordingly a borrowing of 2000 is expected to bridge the gap between the available cash
balance and required cash balance.
At the financial year end 147 cash balance is expected to prevail with the company.
Budgeted balance sheet
The company’s budgeted balance sheet is drawn as follows,
2010 2011 2012
Actual Actual Budgeted
Non current assets
Property Plant &
equipments
10350 10500 12,500
Current assets
trade receivables 2300 1893 2,789
inventory 750 847 2,194
cash and bank
balance450 796 147
3500 3536 5133.2
Total assets 13850 14036 17630
Share capital 6500 6500 6,500
reserves 1000 4013 7,761
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Borrowings 2500 1500 2,500
current liabilities
Trade payable 350 2023 869
Total equity and
liability10350 14036.08 17630
The budgeted income statement, budgeted cash flow statement and budgeted balance sheet for
the financial year 2012 has prepared in a consistent basis.
3.3 compare actual expenditure and income to the master budget of an organisation
2010 2011 2012 2012 Variance
Revenue 14,375 15,820 18,193 18,668 475
Cost of sales 8,734 9,520 10,758 11,043 286
Gross Profit 5,641 6,300 7,435 7,624 189
Selling & distribution
expenses
1,325 1,458 1,603 1,647 44
Administrative
expenses
537 550 565 590 25
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Other expenses 268 275 270 290 20
Profit before tax 3,511 4,017 4,997 5,097 100
Tax @25% (878) (1,004) (1,249) (1,274) (25)
Net profit after tax 2,633 3,013 3,748 3,823 75
Revenue
The actual revenue of the company for 2012 was 18,668 while the budgeted amount was
18,193 which is an increase of 475 than budgeted. This has resulted in the significant increase
in the volume due to the higher demand prevailed for certain product categories backed by the
weather condition.
Cost of sales
Cost of sales has increased by 286 than those budgeted due to the increase in the demand for
certain product which is evidenced by the increase in revenue. However gross profit of the
company remains in the same position of 41% as budgeted. Though the company expected to
increase the cost of sales to be increased by 13% actual increase accounted to 16% due to the
Certain lapses faced by the manufacturing facilities. Furthermore certain direct manufacturing
expenses such as electricity and overhead costs also increased along with the increase in
revenue.
Gross profit
Gross profit also increased by 189 than budgeted for the financial year 2012. However the
gross profit margin shows flat at 41% with the budgeted while it has improved by 1% from
previous year of 40%.
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Selling and distribution expenses
Selling and distribution expense was amounted to 1647 while the budgeted expense was stood
at 1603 which shows a increase of 44 than budgeted. This is mainly due to the increase in sales
volume and this has resulted in slight increase in distribution expenses of the company.
Moreover sales commission expense has also increased due to the increase in the revenue.
Administrative expenses
Administrative expense were budgeted at 565 where as actual amount was stood at 590.
Accordingly administrative expense has increased by 25 than budgeted. This is mainly due to
the increase in the salary expenses resulted in due to the new recruitments’ taken place in the
company.
Other operating expense
Other operating expenses also increased slightly by 20 compared with actual other operating
expense.
Profit before tax
The profit before tax has increased 100 than budgeted amount due to the increase in the sales
volume. However the company was unable to obtain the full benefit from such increase due to
the increase in the cost of sales and several other operational expenses.
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3.4 evaluate budgetary monitoring processes in an organisation
Budgetary monitoring is a process whereby the organisations sets the budgets to their
organisations and continuous monitoring of the performance of the organisation compared with
the budget to evaluate whether the operations of the organisation is taken place in an effective
and efficient manner.
The objectives of the budgetary control system is as follows,
Determining the goals and objectives of each department of the organisation
Assigning roles and responsibilities to each and every employee so that such individual
is aware what he is expected to contribute to the organisation.
Providing a basis for which performance of the company can be compared and identify
any deviations take necessary actions on that on timely manner.
Ensuring that all available resources are used in efficient and effective manner.
Providing basis for revision of current policies to face to the future.
The following advantages can be obtained through a budgetary monitoring and control system,
Budgetary control system helps the management of the organisation to carry out its
operational activities in an efficient and effective manner.
Budgetary control is a efficient tool to control the company’s expenses.
Budgetary control can be used as a yardstick or measurement base to evaluate the
performance of the individual staff of the organisation.
Budgetary control system helps to identify the deviations from the actual output and
expected output and to identify the possible reasons for deviations.
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Budgetary control system helps to increase efficient and effective utilisation of resources
in the organisation such as production materials, skilled labours, production machinery
etc.
Budgetary control system helps the organisation to identify the current trends and to
formulate future policies based on such information to operate effectively.
Budgetary control helps the organisation to implement standard costing system to the
organisation in an efficient and effective manner.
By implementing a budgetary control system it encourage employees of the organisation
to concentrate on the cost when performing activities within the organisation.
Budgetary control system has following limitation/ disadvantages
Budgets are based on estimates of the future activities and therefore such estimates can
be wrong and budgets may not be able to achieve giving a wrong picture.
Budgetary controls may affect to the quality of the product and services of the
organisation due to the high concentrate on the expenses of the production activities.
Budgetary control can gives a wrong impression that achieving budgets of the
organisations will solve all the problems faced by the compay
Implementation of a budgetary control system may be high cost and in some instances it
may not be cost effective.
The management may focus on the achieving budget targets rather than achieving the
goals and objectives of the organisation.
Management may do under budgeting to show that the performance of the company is
improved
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4 Be able to recommend cost reduction and management processes for an organisation
4.1 recommend processes that could manage cost reduction in an organisation
Company can reduce costs in various of ways. And these will ultimately helps the organisations
to achieve its goals and objectives.
The cost reduction techniques includes following steps,
Identify the areas where the cost can be saved
in this step the company needs to critically evaluate its cost structure and identify the
areas where they can reduce the cost in more efficient and effective manner.
Quantify the cost savings
in this step the company needs to quantify the amount of cost that they can reduce
which they identify in the first step. This helps to identify the most effective areas and
concentrate more on such area.
Test cost reduction process before implement
At this step the organisation needs to consider whether the quantified costs can be
reduces in actual scenario and they need to evaluate the impact of such reduction to the
other processes such as quality of the product, impact to the brand name from such
reduction etc.
Implement the cost reduction activities
The company must implement the cost reduction activities in the areas where they have
identified in the previous steps. Due attention needs to be given to the areas where there
is a effective cost reduction is available.
Ensure that cost reduction has taken place
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Once the process has implemented the management needs to make sure that the
targeted cost reduction has taken place.
With regard to specific costs that has a significant impact on the company can use
following techniques and method to reduce the cost
Company can enter in to long term supplier contracts with suppliers which helps the
company to obtain more favourable payment terms and attractive discounts.
The company can use several suppliers to purchase goods and thereby reduce or
eliminate the bargaining power of the suppliers and obtain the most favourable prices.
To minimise the wastage in the production process the company can use the latest
cutting edge technology in its manufacturing facilities.
To reduce the finance cost the company may grant discount to customers who settle
their dues on time.
The companies can discuss with suppliers to obtain more favourable credit periods.
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4.2 evaluate the potential for the use of activity-based costingActivity Based costing
Activity Based Costing (ABC) is a relatively new management accounting model which is a
mechanism whereby assigning costs of production based on the activities involved in the
production process and the resources utilized by such activity (The Economist.com,2011). ABC
is an alternative to traditional management costing techniques.
According to the ABC technique, company needs to,
Identify the activities involved in the production process.
Allocate the cost to each activity based on the resource requirement
Allocate the cost of each activity to each product based on the requirement of such
activity by such product.
If company uses Activity Based Costing method to compute its unit cost, it will be able to do a
effective pricing of the products since this method computes the cost of the product based on
the activities involved in the production process instead of using a single basis such as machine
hours or labor hours utilized by each product which are used in traditional techniques.
Activity based costing has following advantages
Activity based costing gives more accurate information about the product cost rather
than other cost accounting techniques.
Under activity based costing overhead costs can be understand in a better manner.
Activity based costing method is a simple costing method which can be understood by
everyone.
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Activity based costing take in to account unit cost rather than the total cost of the product
and by this cost drivers can be easily identifiable.
Activity based costing can be used to implement performance management methods
such as scorecards.
Activity based costing can be used for benchmarking.
By using activity based costing the organizations can identify losses incurred in the
production process and is able to identify activities or processes which will not add value
to the production process
Results obtained from Activity based costing can be used for other modern management
techniques such as six sigma
Activity based costing asses the cost of individual activities based on its utilisation of
resources.
Activity based costing has following disadvantages
Implementing activity based costing system to the organization can be involved high cost
as such costing system needs significant amount if resources such as sophisticated
computerized system, skilled labour etc
Once the system is implemented the cost incurred to process the data is high.
Accordingly in order to obtain the information data needs to be collected, validated,
checked and feed to the system which incur high labour cost
Activity based costing system produce various information which are significantly
difference from information generated by other costing techniques. Owing to this reason
the management may tend to use information provided by existing costing technique.
Further when evaluating the performance of the management information produced by
existing costing technique may used. Therefore the management will pay their attention
on existing costing technique rather than the activity based costing
Activity based costing method produce data which can be misinterpreted easily by
managers. Thus due attention need to be given when interpreting information and
making decisions
Activity based costing is not in line with the Generally Accepted Accounting principles
GAAP) which leads to prepare another set of accounts to comply with Generally
Accepted Accounting principles
Practical implementation of Activity based costing is challenged due to the serious
challenges faced by the company19
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