One of businesses most crucial financial process is setting the budget. The accuracy and efficiency in projecting how much the company would need to allocate and spend for the next 12 months of operation is important in terms of measuring if the company has enough to cover those expenses. In the events that the business does not have money, budgeting would enable them to find resource that will answer the deficiency issues. There are several problems that companies such as Competition Bikes Inc. may face in the budgeting process; one of those is over projection.
This is a common problem among companies because executives tend to dream big with hopes of higher revenue year after year. Over budgeting causes the company to over spend money on investments and operational needs. But when the annual financial statements reflected a bad sales performance that is when the company hits rock bottom especially when the funds were loaned. Other problems could be overlooked sales and withholding taxes, mismanaged advertising time lines and short-budgeting. All of which boils down to less profitable end that the company will suffer the consequences thereafter.
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For the budget projection presented by Competition Bikes Inc. consistency is apparent but accuracy is another question. The raw materials budget for the frame materials consist mainly of the fiber carbon sheet proved to need a little more checking. Each unit bike unit will be using 42 carbon fiber sheets and each one costs $9. Multiplying 42 sheets by 3,510 units will give us 147,420 multiply it again by $9 should come out as $1,326,780. However, the total budget for frame materials shows only $1,326,778. It is short by $2; therefore the projection is lower than it should be. Although it's just a matter of a couple of bucks, but it still makes a difference, because in order to keep an accurate financial statement, every single cent should be accounted for.
In the end any amount left not accounted from the budget to the yearly financial statement would accumulate and pose significant difference in the company's financial outcome. Another distinct area in the budget projection is on the quality control because among the overhead budgets, quality control has the highest budget among the rest coming up at $122, 850. It almost comes up almost double as compared to the cost of the other areas in the overhead budget. Although quality control is crucial in ensuring that the product encompasses industry standards it is still quite high almost the amount of money allocated for depreciation.
Budget projections of course works like a map that the business has to follow in taking financial steps. In any cases that the anticipated results from the projection were not achieved variations in flexible budget has to be evaluated to see how much the actual output compares to the budget projection and identify the weak points in the process. To define flexible budget, it is an adjustable budget that flexes according to the changes in activity. It is more complex than static budgeting which consistently remains at the same amount whatever the activity volume is. To apply that principle to Competition Bikes Inc. flexible budget, a decrease in volume in the actual production greatly affects the budget outcome which the variance has to be evaluated if favorable or unfavorable.
The original projection calls for a total of 3,510 units of bikes to be sold in order to achieve favorable revenue; however, the actual output of 3,400 products creates variances. Like for example a 3,510 units of bikes should create revenue of $5,247,450 which is the ideal amount for profitability. The actual output of 3,400 only makes $5,083,000 which is $164,450 or 3.13% short of the expectation. This might be a small percentage of short in sales but it makes a lot of difference. The variance in sales alone is unfavorable, but obviously the decreased in production units gained favorable amount of savings from the budget allocated for the materials. The variability appears that the favorable difference in overhead, selling expenses, direct labor and materials created a positive favorable output in the costs but it is not enough to get the contribution margin to get even at a favorable rate.
These variances resulted to a $45,142 negative on the operating income which is unfavorable for the business in general. On the other items in the flexible budget category, we realized that the short on actual output versus the standard creates an unfavorable outcome there are a lot of reason behind it. First of all, fixed expenses remains constant no matter what the output is. If depreciation for instance is fixed at $150,000 a year, it doesn't matter if the company was able to meet the desired production output or not they would still have to consider depreciation expenses as it is, no excuse to that. The same goes with the other fixed expenses such as Admin and selling expenses, they do not change in value even if the company only made half of the target output they would still need to pay the Admin salaries, executive compensation, utilities and services among others.
Except on research and development which appears to be moving together with the output change, of course if there's not much to make therefore no reason as well to spend too much time in research and development. That is why among the Admin fixed expenses, only research and development comes out with a favorable variance of $3,577. The variable cost however moves along with the changes in production output, since less production means less labor hours, overhead, materials and selling expenses. They can be identified as favorable, this means less output the more it is favorable for the variable cost and it means savings for the company. But that savings doesn't generate profit on matter how bug it was because the contribution margin in the first place is the only means of profit for the company, other than goes to the working capital. In a nutshell, the 110 short of production output provides a favorable $115,053 on variables costs but not on the fixed cost and that short on output decreases the profit probability.
In order to address the unfavorable variances, basically what the company have to do is to reach the originally projected production output as possible and one way to do that is to maximize production efforts, since labor budgets has been set prior to production and time and cost were calculated based on the normal rate, there shouldn't be any reasons why the output would come out less than what has been projected. If circumstances prevent the production line from completing the target, there should be adjustments made on the other items in the budget to make it more flexible. If 110 bike units is what it takes to complete the projected standard output of 3,510 units then adjustments on budget is not necessary but rather adjust the production time lines. If laborer works for 15 hours to complete a single unit, then it would be more feasible if CBI add another 1 hour to labor hours to meet the time needed to complete the short production of 110 units.
The cost on overhead, labor and materials will not be affected and will stay the same considering that the budget for the extra one hour is already covered by the variance based on the original output. Any cost that will incur in the process would be very minimal as compared to the losses that the company will face if they were not able to meet the projected output. In any case that the production line is undergoing an unavoidable circumstance, then further adjustments have to be made on the other areas of the budget items.
For example, the general Admin expenses is at $170,000 identified as fixed expenses. We need to itemize and decipher the components that makes up the general Admin expenses to see if there were items on that category that can be changed in relation to the changes in the output. Normally the general Admin expenses are made up of office supplies, petty purchases, incidental expenses among others. CBI can actually cut those expenses and implement a target cost-cutting measure. If $45,820 is what it takes to break-even on the operating income then might as well cut a few things out of the general Admin expenses until the negative variable was zeroed out.
By definition, management by exception means that the attention of the manager should focus on areas of the organization's plans that are working for some reason. It simply calls for the management to put aside things that are going smoothly and direct their time and effort on those that needs more attention. Not all variances are worth the time investigating because the difference between the actual from the anticipated output happens always every time. Variances do happen for some reason, like for example a hot summer season causes higher electricity bills because of intensified use of air-conditioning units or slow production due to the weather affecting the worker's output to be faster or slower. Such things happen randomly and they cause significant cost variances, but the managers have to decide whether it has to be investigated or not (Accountingformanagement.com. N.D.).
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To put this context into Competition Bike Inc. flexible budget data, it was mentioned earlier from A.2.a section that small variances appearing in the crucial areas of the budget items makes a big difference when accumulated together, however not all of them is worth the attention. If the variance like for example appears to be 10% of spending then that is the a sign that something is not right, but in relation to amount and size of the variance if the 10% difference is still within the bounds of normal expectation then it is safe to assume that it is not worth the effort of tracking down. Like for example, in CBI's contribution margin the variance between the standard outputs from the actual output is at $49,397, even though the difference is just 3.86% of the standard output, the amount itself is relatively high to be neglected.
The same goes with the variance in net sales whereas the standard output is $5,247,450 and the actual is $5,083,000, the difference is $164,450 and that is alarming although it only comprise 3.13% of the standard output. When fluctuations appears randomly normal in relation to the usual trend from time to time the company can expect that the cost is well under control, but in any case that an unusual changes happened relative to fluctuation's normal random levels occur then management have to revisit the budgeting items and go over each line to see what went wrong.
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