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United Consultancy is a service based company that provides consultancy to the F&B industry. The overall performance from the year's budget ending 31st August 2012 has made a great impact towards the directors and has seen how big a margin the variance has been compared to the budgeted sum. The surplus of the profit garnered has simplified the overall budgeting process while limiting the focusing on how best the company can reinvent its financial operations to properly reflect the changes and how it can further enhance itself to be a competitive market player.
With concerns from the consultants to further address the issue on the simplicity of the budget used in the company, we are hereby going to take a look at the practice of United Consultancy and if there is a possible solution to further improve on the way the board of directors get the budget and properly realign the companies goals and directions to keep it at an edge.
Fixed Budgeting and United Consultancy
Current approach adopted by United Consultancy is fixed budget. A fixed budget is a budget that is prepared on the basis of specified criteria that does not allow for any changes or variations in the activity that might occur at any time within the period covered by the budget.
For United Consultancy, this means that the fixed budget is drafted from a calendar or operational year/months, and is not changed at any time within the year, even when there are changes in the levels of business activities that takes place. There will be no changes even when the company takes a sudden increase in profits or dive in its sales figures.
The fixed budget used is a different budgeting approach compared to a variable or flexible budget, with a flexible budget there are allocations for adjusting specified line of items based on the levels of revenue generated over the duration of the year.
In contrast a fixed budget is laid out carefully to be fixed for the entire period. This approach ensures that each department within the company is able to identify how much they have to spend at the start of a period and how much allowances remains after any given point during the budgeting period.
The fixed budget is a financial plan that do not allow the change irrespective of the change from the plan in actual levels of activity that occurs, since United Consultancy experiences does experience a certain variations from their expected activity levels over the period encompassed by the budget, the amount of the budget is very certainly different from the actual results. Points to consider is the situations in which a fixed budget can be likely to track closely to the actual results are when:
Costs are largely fixed, so that expenses do not change as revenues fluctuate
The industry is not subject to much change, so that revenues are reasonably predictable
The company is in a monopoly situation, where customers must accept its pricing
In comparison most companies that uses fixed budgets, which indicates that the routinely deal with large variances between actual and budget results. A possible way for United Consultancy to mitigate the disadvantages of a fixed budget is to combine it with a continuous budget whereby you add a new budget period into the end of the budget as soon as the recent budget period has concluded, by this practice, United Consultancy could gradually incorporate the most actual results of the period into the budget.
Another way to mitigate the effect of a fixed budget is to shorten the time frame it covers. For example, United Consultancy may budget can be made to only encompass a 3 month period, after which management formulates another budget that goes on for the 3 months after that.
Consultants pros & cons in United Consultancy
At United Consultancy services employs consultants to provide services to its clients. A consultant can be an experienced individual that has been trained to analyze and advice a client in order to assist the client in making the best possible choices. Strategic consultants may even help the clients to evaluate and develop a business plan to meet the company's strategic goals.
Peter Block (), Defines a consultant as someone who has influence over an individual, group or an organization, but who has no direct authority to implement changes. He further defines that to contrast a consultant with a surrogate manager or a person who 'acts on behalf of, or in place of a manager'. The major difference that should be identified is that a consultant never makes the decision for the individual or group but a surrogate manager does make these decisions.
A consultant is usually an expert or a professional the specified field and has a wide knowledge on the subject matter. The role of consultants outside the medical field (where the term is most commonly used) can be classified under two general categories:
Internal Consultant - someone who operates within an organization but is available to be consulted on areas of specialism by other departments or individuals (acting as clients); or
External Consultant - someone who is employed externally (either by a firm or some other agency) whose expertise is provided on a temporary basis, usually for a fee. As such this type of consultant generally engages with multiple and changing clients.
In the case of United Consulting we have our consultants as part of the external consultants that targets the clients to provide their area of expertise that in return generate income for the company. The consultants also serve as a dual purpose whereby they are able to give internal advice to United Consultancy to address certain issues if they arise.
The Advantages and Disadvantages of Consultants
To understand further the impact of consultants in Untied Consultancy, we would need to further understand the pros and cons of having such individuals:
Advantages to consider:
Access to a unique skill set that is nonexistent in the company. Provides a different point of view towards a certain set of objectives and can provide invaluable feedback and suggestions for process improvements.
Advantage: Intelligent advice.
The consultants provide "Expert" advice and can provide "miracle" solutions towards a problem. Clients engage our services to get different aspects of empowering their business.
Advantage: Outsider perspective.
Ellen J Langer suggest that the usage of consultants as an outsider to imagine a different point of view towards a solution as the current employees of the company may already be adapted to the behavior thus a change of perspective or "think outside the box" view can shuffle changes in the company.
Engaging consultants at the start of the project can normally save the organization lots of money down the road, proper processes and design as advice by the consultants can ensure companies do not adopt bad practices and avoid failures.
Disadvantage to consider:
The cost to hire a consultant can be expensive, but without a counsultant, certain processes can be simplified and empowered to the employee to perform them at a better pace thus saving time and saving valuable resources in the long run.
The 'enigma' factor whereby the advice given by the consultant might not be as valuable due to the consultants not knowing the whole scenario or direction of the organization thus unable to give proactive advice to the clients.
No knowledge of in-house procedures:
Consultants don't know your business or your organization and procedures as well as you do. They have to go through a learning period the first time you engage them.
What's behind the charges?
Consultants cost more than in house employees because they can't work on a full time schedule, they are seek out as they provide their services and can be engaged to perform duties of employees while providing their expertise on how to further improve the company's performance.
Rates differ by length of engagement
Short-term engagements will usually command a higher hourly rate than long-term work. Long-term work represents less "bench time" and thus lowers the contractor's expenses.
Limitations of current budget spreadsheet:
Chargeable consultancy hours
Administration staff salaries
Motor and travel costs
Printing, postage & stationery
Premises and equipment costs
Based on the given budget data the as above, there is a few limitations stated as below:
Should group together fixed and variable cost so that can see clearly
Currently all the fixed and variable cost is merged all together and is difficult for someone to properly differentiate the difference for each individual costing
Variances should disclose + or (-)
From the sample, we can see that the current variance is determined by the value of the number but not showing out if it's a positive or negative figure.
Why Fixed Budgets Work
One of the best reasons for a company to engage a fixed budget is the variance analysis. The variance analysis will inform the respective individuals on how much the company is over or under its original planned budget; via percentage or dollars. Even for new business, it is easier to plan for years ahead when there is a comparison between what was expected and what actually happened. In the coming years, there can be adjustments in the budget either up or down depending on the variance percentages. Fixed budgets work best when the business owner has a reasonable amount of certainty what profits and expenditures will be like barring extraordinary circumstances.
Why Flexible Budgets Work
Flexible budgets are changes based upon volume; it provides a greater level of control. New setups need to keep a tight monitoring of cost, limiting certain flexible expenses to a percentage of volume to help accomplish this. A new business can vary a great deal from what was initially forecasted, and flexible budgets offer real-time view if a business expenses and revenues. The savvy business owners may not have time to go the trouble of generating a forecast for the fixed budget. The flexible budget trumps over this by having the forecast in one step.
Why flexed budget is useful
The functionality of a flexible budget is designed to change in response to the changes of the output levels or on circumstances changes in other relevant factors. Flexible budgets can be used to compliment the use of a fixed budget, they have a part to play and can be applied in more than one context. In the planning process, it is a significant tool that can be used to produce a range of estimates for different planning scenarios of sales, cost, market prices and etc.
The equal appropriate use of flexible budgeting is primarily for the purpose of control. When preparing a performance report it is important to take account of the difference of some cost with variable levels of output. The actual level of output can be different from those that have been planned in a fixed budget and the cost targets use for all the variable and semi variable cost should be adjusted accordingly.
Flexible budgeting takes into account how comparing the actual cost incurred for a certain output level with the budget developed. At a basic level, all budget variable and semi variable cost should be adjusted accordingly to take account of the actual output level. Fixed cost would not be expected to change in spite of the changing output. Flexible budget enables the changes to be captured accordingly and the variance depending on the output can be tailored accordingly to reflect the exact changes that is required at the particular point of time, though there can be a point of confusion for the operations as the target set for the year would appear to be a moving target.
Limitations of Flexible Budgeting
The usage of a flexible budget is an excellent way to resolve many difficulties that is inherent in a fixed budget. However there are also some numbers of serious issues from using a flexible budget, which are addressed below.
It might be hard to formulate or administer the flexible budget because many cost are not variables, instead of a fixed cost component that needs to be calculated and added in the budget formula. Time consumption in making calculations for formulas and flexible budgeting tends to include only small number of variable cost formulas.
Time delay when required to wait for a financial reporting to be closed, only then the revenue and other activities can be imported over to the budget model, extraction of the data and merger of the information. Only with that only can the financial statement that contains both actual and budget can be compared.
Lack of comparison between actual revenue since both numbers might be the same. The model is design to match actual expenses to expected expenses, not to compare the revenue level.
Some organizations have few variable cost for it to construct a flexible budget, instead they have mostly fixed overheads that does not change to any activity. In this scenario, there usage of a flexible budget is of no use since it will not be much different from a fixed budget.
In brief is that a flexible budget requires additional time to construct, slows down the issuance of financial statements, does not measures revenue variances and may not be applicable under certain type of budget models. These are serious issues that tend to limit its usages.
How the spreadsheet software can be used to setup the flexed budget
A flexible budget calculates the different levels of spending for variable cost, pending on the changes of the amount of the actual profit or other activity. The usage of a spreadsheet to input the actual revenue or activities measurable into the flexible budget once an accounting period has been closed, and from there it should generates a budget that is specific to the inputs. From there a base comparison can be done on versus actual information for control purposes.
Steps taken to construct a flexible budget are:
Classify all fixed expenses and separate out them in the budget model.
Establish the degree to which all variable costs change as activity measures change.
Generate the budget model, where fixed costs are "hard coded" into the model, and variable costs are acknowledged as a percentage of the relevant activity measures or as a cost per unit of activity measure.
Enter actual activity measures into the model after an accounting period has been completed. This updates the variable costs in the flexible budget.
Enter the resulting flexible budget for the completed period into the accounting system for comparison to actual expenses.
To create a flexible budget that ranges in level of sophistication. Here are several variations on the concept:
Basic flexible budget.
Easiest form where the budget changes those expenses directly with revenue. There is a typical percentile built into the model that is multiplied by the actual revenue to arrive at what expenses should be recorded as stated revenue level. In the case of United Consultancy, the cost for hours can be used rather than the percentage of total consultancy collection.
Intermediate flexible budget.
Expenses vary depending on the activity measured than revenue. The telephone expenses may vary with the changes in the headcount. If so, the integration other such activities can be considered into the flexible budget model.
Advanced flexible budget.
Expenses can only vary from the certain ranges of revenue or activities; those outside the range, a different proportion of expenditure may be applied. An advance flexible budget will change the proportions of the expenses if the measurement are based on exceed their target ranges.
In short, a flexible budget gives a company a tool for comparing actual to budgeted performance at many levels of activity.
Based on the given budget, a easier to comprehend budget is as above whereby it identifies the fixed and variable cost accordingly.
* Insert amounts only in yellow highlighted cells
** A positive variance is favorable to the company; it means the actual cost is lesser than expected. Likewise for negative variance
Changes done for comparison to initial spreadsheet.
Segregate both Fixed and Variable Costs.
Assumed that fixed cost for the next period is the same as actual fixed cost
User to input data in yellow highlighted cells
Variable cost is computed by formulae based on percentage of revenue.
Percentage is based on actual percentage for last period.
- You need to explain clearly whether the zero based budgeting is suitable for United Consultancy (for each justification, the example should be provided)
Zero Based Budgeting and United Consulting
Developed in the early 1960's by Peter Pyrrh, Zero based budgeting is an attempt to fix the set limits of incremental techniques. It presumes that the budget could be recompiled from the first start; from a zero base and focuses on the activities and programs rather than the units or departments.
Zero based budgeting was further defined by Jones and Pendlebury stating that 'Zero based budgeting in its purest form is precisely what its name implies; the preparation of operating budgets from a zero base even though the organization might be operating more or less as in previous years the budgetary process assumes that it is starting anew'.
The concept is applied to new services that genuinely are built from a zero base. In addition zero based budgets can be used to subjective areas such as repairs, maintenance, hardware where service priorities are set corporately without using reference from the last year's budget. The budget should indicate their requirements for resources such as a fund that can be allocated based on the cost benefits or similar evaluative analyses. The const benefit approach is an attempt to ensure value for money, it questions long standing assumptions and servers as a tool for systematically checking and abandoning any unproductive projects.
The characteristics of ZBB are:
Involves all managers in the budget process
Justifies the resource for current and proposed activities
Assessment of alternative methods to achieve objectives
Activities or cost should not be vectored into the plan even though they are featured in current or previous ones.
ZBB is best used to discretionary and support services whereby it has great potential application towards the public sector. With discretionary cost such as advertising or traning; management can have some options to the value the need to budget for the activity. There are no optimum relationship between input (cost) and output (revenue). They are not determined by previous commitments. In effect management is free to set the quantity of service they will be willing to provide and there are no set methods to determine the right amount to be spent in particular methods.
Key stages are to determine implementation of Zero Based Budgeting
define the scope of implementation;
identify decision units;
prepare decision packages (an analysis of a discrete area of activity);
In the case of United Consultancy stand point, the usage of ZBB would be favorable as the focus on the budget will constitute more towards the evaluation of services rendered from the total outcome of the budget. It would be a good way for management to evaluate the value of service offered and how much is required to either sustain or be required to improve upon through changes or training.
Advantages of Zero-Base Budgeting
Points to consider when evaluating Zero Based Budgeting for United Consultancy:
Requires management to identify alternative ways to each activity (in-house vs outsourcing); as well as the different levels of expenditure. Thus forcing the development of alternatives; the management can consider the process or other ways that the business can be carried out.
Management must match the expenses to activities; it reduces the possibility of an artificial inflated budget on the departments side and it is easy to pin point
Can be used as a debate platform from management to push through corporate views and missions as well as how it can be achieved
Eliminate non-key activities.
Forces reviews on management to identify what activities are critical to the organization. By doing so, management can target non-key operations for termination or outsourcing
Management are forced to set focus on the various clear goals of their departments that can otherwise be defined poorly
Can be used to show if there are similar activities carried out my different departments; leading to consolidation of the work or consideration ways for management to re-center the work
Regular basis reviews are more likely to have the management have a periodic review of the company
Overall corporate missions and objectives can end up with focused targets of proper funding on areas where the allocation is most needed.
In short, many of the advantages of zero-base budgeting focus on a strong, introspective look at the mission of a business and exactly how the business is allocating its resources in order to achieve that mission.
Disadvantages of Zero-Base Budgeting
The main downside of zero-base budgeting is the exceptionally high level of effort required to investigate and document department activities; this is a difficult task even once a year, which causes some entities to only use the procedure once every few years, or when there are significant changes within the organization. Another alternative is to require the use of zero-base budgeting on a rolling basis through different parts of a company over several years, so that management can deal with fewer such reviews per year. Other drawbacks are:
Required a large amount of analysis, meetings and reporting, all of which requires additional manpower to handle the process.
Some departments may twist their reports in order to ensure their budgets will not be reduces.
Hard to determine or justify certain expenditure areas of a business that is unable to produce tangible results.
Management would require significant amount of time to review the requirements of a zero based budget
Consideration for training of management to ensure comprehension of budgeting process which can take time
Time and effort it takes to create a zero based budget makes it less feasible for management to revise the budget on a constant basis
- for each of the advantage and disadvantage, you need to provide example.