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Drury (2008) has defined management accounting as
“… the provision of information to people within the organisation to help them make better decisions and improve the efficiency and effectiveness of existing operations.”
Making the most effective and efficient decisions is one of the most vital things to do because this leads to a successful growth and profitability of the company. Various positions like the Board of Directors make these significant decisions every day in order to serve the shareholders’ interests and to make sure that the business will continue to run in the future. The decisions are made using competent management skills, different managerial experiences and whether the management chose to be a risk taker or a risk averse.
Edit 4U (E4U) is a family owned business who provides editing and layout service for magazines. The business was set up with the intention to be profitable and to compete with other businesses in the same field whilst the economy of Ireland is booming. As a starting business- problems and difficulties could not be avoided which is the reason why this report has been commissioned. The report will provide information and business advice to resolve problems that Mr. and Mrs. O’Sullivan is currently experiencing.
The key issues of the business will be analysed and examined to be able to give the right solutions and recommendations to Mr. Sean O’Sullivan. Different management accounting techniques would be endorsed in order to improve the performance of the business.
The key issues that have been found whilst the examining the business is as follows:
Pricing jobs or product costing is one of the key issues that Sean and Mary are currently facing. Sean does not know how to cost a service per editorial job which has led to inaccurate financial statements and false figure of revenue (Banker & Hughes, 1994).
A management accounting research by Brignall, et al (1991) have mentioned that product costing are used for ‘...inventory valuation, product pricing, mix decisions and for management planning and control’. It is essential that a business cost their service correctly because it helps the management make better decisions towards the profitability of the business. The cost-plus pricing could be an option that Edit 4U could use because this determines the selling price and costs of the service they offer. This is calculated based on Sean’s chosen profit margin for the company.
Moreover, Edit 4U could use a product costing system which helps to cost products/ services based on the demand for the job. Marginal costing, absorption costing and activity based costing are some of the costing methods that Sean could use to accurately price the editorial services that they offer to their clients.
The Activity Based Costing (Garg & Rafiq, 2002) method
`…aid strategic decision making, it act as a lens into the business process allowing resources to be efficiently allocated and to enable cost reduction and lastly, it is an allocation mechanism that transfer pricing internal and external to the organisation’.
This indicates that the basis of apportionment which a model is shown in Appendix 1should be considered to be implemented throughout the company because this will split up the costs that are allocated accordingly to its cost centres. The method ensures that costs are being driven by the right cost centres and they are precisely measured.
Enforcing a management accounting technique will result to a better service pricing based on the customization of each client (Caplan, 2014). However, in order to do these more information is needed from the business. For example, Sean should account for all the relevant costs because this will support him to choose the most efficient decision with regards to the future of the business. Alternatives should also be considered because this will act as insurance in case the first decision fails. In addition, more information like how much work is allocated to a customized editing service; the type of product mix that they are going to offer that could give high absorption rate and how much is the demand for their service. These are some of information that would be required from Sean and Mary to fully put a price on services that they offer. As well as providing additional information it is recommended that Sean and Mary use the customer profitability analysis (Epstein, 2000) which is shown in Appendix 2.
II.Planning and Control
The next key issue to be raised is the lack of separation between the household and the business’ expenses since Sean uses part of their home as an office. The Activity Based Costing will help Sean and Mary to apportion the cost more accurately with regards to the expenses used in the business. The lack of planning and control in the business could lead to poor decisions being made, poor cash flow, and they could be taking the business’ objectives to a wrong path (Lucey, 2009).
The Cost Volume Profit (Drury, 2013) analysis “examines the relationship between changes in activity and changes in total sales revenue, costs and net profit.” The analysis is a management accounting technique that determines how many products/ services can a business produce in order to breakeven. This means that the analysis could allow the management to find out how much services they can offer in order for the business to earn profit. The analysis is also used to draw the margin of safety that will show the range of units before the business will occur some loss. Using this kind of management accounting technique could prevent Sean from making the wrong decision for the company.
However, the analysis will not work if there is not enough information available which makes it impossible for the business to construct the cost volume profit analysis correctly (ACCA, 2014). Some of the information that will be needed to produce the analysis is the expected sales of the business, the variable cost, the fixed costs and the contribution per unit of the product.
Therefore, it is recommended that the business should continue on using the accounting system that they already have because this will ensure that the revenues and expenses are accurately accounted for. Moreover, this will make sure that the books remain balance and their VAT returns will be addressed correctly.
The last issue that will be analysed and discussed is the prospective business venture that Sean will enter with Fergus. There are numbers of concerns that would need to be resolved in order to make the right decision for Edit 4U’s business venture (Datar, et al., 2012).
The first concern is the loan that Fergus will borrow from Sean to pay for the printing and distribution costs. I would suggest to Sean to do a full background and credit check on Fergus before he agrees to do a business venture with him. The reason for this is that Sean needs to make sure that Fergus is a credible person and has a clean reputation amongst banks and building societies. If Fergus has a bad reputation as a businessman, then this could post great threats and risks to the business venture and could tarnish Sean’s business reputation. However, if Sean wants to pursue the business venture then he would need to enter into a contract with Fergus that contains all the conditions that Sean has with regards to any problems in the future regarding Fergus’ credibility. Sean will need to remember that even though they have a contract, he could not change the public’s opinions towards him if there was a scandal about the business venture.
The second concern would be the failure to budget the cash flows of the business. Budgeting is a management accounting technique which ensures that the cash out flow and inflow will be accounted (Russell, et al, 2001) C. Using this technique Sean and Fergus would be able to plan and make decisions about the future of the business and they can accurately know the costs and predicted revenues. If the business does not use any accounting technique then it will be difficult for the management to determine the performance of the business and they will not be able to meet their objectives.
Lastly, Sean should be aware on how many days their creditors are giving them because if the company fails to pay these creditors in time they will tend not to trust the company and discontinue doing business with Edit 4U. The worst case scenario is the company going to go on bankruptcy (Agarwala & Taffler, 2008). Using personal credit cards and overdraft facility as a capital is not the most efficient way to finance a business because this could lead to paying higher interest rates that will incur each month. In order to avoid missing the creditor’s days a management accounting technique called ‘accounting ratio’ should be practiced.
Patton has mentioned on his Accounting review in 1982 that ratio analysis could be very useful in areas like ‘analysis of business transactions in markets that may not be efficient; contractual limits based on accounting rations and performance prediction and risk evaluation in an efficient market’.
Some people might think that accounting ratios are not useful but in fact these ratios could guide the management of the company to whether the business is performing well and it could also reveal how many days their creditors would need to be paid and when they are going to receive cash inflows from their debtors.
However, if more information like the financial reports is available, it is possible for the company to fully analyse and see the performance of the company. The accounting ratio could help the company manage its cash flows effectively. Therefore, I would suggest for Sean and Fergus to use the ratio analysis technique whether they go ahead or not with the business venture.
CONCLUSIONS & RECOMMENDATIONS
After analysing and evaluating the key issues of Edit 4U, I conclude that Sean who started the business along with his wife Mary should use and implement a number of management accounting techniques in order for their business to be enhanced, to grow and to identify the costs efficiently.
As a management consultant, I would recommend for Mr. and Mrs. O’Sullivan to use the following: Activity Based Costing to cost the service that Edit 4U offers and to allocate the costs effectively to each cost drivers. The Profitability Analysis should be used to forecast the profitability of a project and the business. Cost Volume Profit (CVP) Analysis (CSUS, 2014) should be used to be able to know when the units of output and the amount of revenues breakeven. Budgeting and accounting ratios are used to analyse the business venture between Fergus and Sean. These management accounting techniques could give the two parties a better picture of the performance of the business. In addition, these techniques could give them the most important information needed to make decisions and forward their plan.
Therefore, after accounting the most important key issues, it has been identified that more information is needed from Sean with regards to the past records and past performance of the company in order to use the management accounting techniques and to get the most accurate results. The more accurate the results are from using these techniques, the more accurate the decisions are made for the company.