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In this report it gives an overall view of Udarata Tea Marketing Service Company, its existing management accounting practices and suggestions to improve company performance. Udarata tea marketing services is a company that form under Sole proprietorship business law a sole proprietor business in late 2003. Basically company buys tea from various tea auctions and plantations, blend it according to company’s recipes, packaging and distribute it through company distributions chain.
For Udarata Tea company accounting practices, it used Activity based costing for overhead costs, Accounting rate of return for investment decisions and working capital management for day-today activities of managing current assets and current liabilities. End of this report it will create a good idea in management accounting practices that Udarata Tea Company used and it helps to identify what are the drawbacks of each practices and suggestions for those practices.
- Company Profile
- Analysis of Management Accounting Practices of Udarata tea marketing Services
We chose Udarata Tea Service Company as our current management accounting practices of manufacturing firm. This is a 100% fully Sri Lanka owned company. Udarata Tea Marketing Service is a company which buys tea from auctioneers and selling. Company investments based on Net Present Value and consider about the risk. Company pricing strategy depends on cost + profit margin strategy. We are practicing the Inventory management and investment management. We calculate some relevant ratios for the measurement of the company performances. In this research we deeply analyze the investment decision making process and financial position of the company.
- Company Profile
Business Name:Udarata Tea Marketing Service
Vision:To provide quality products that exceeds the
expectations of the customers
Mission:To build a long term relationships with our
consumers and provide exceptional customer services by pursuing business through
innovation and new technology
Business address:95/3, North Pitipana, Homagama
General Business:Buy tea from auctions
Activities :Blend (mix) it with other flavours, Packing, Distribute
Business Products:Branding, Packed tea packets, Bottled tea, Tea bags
Products:Supreme tea, Catering tea, Gift tea, Black tea
Udarata Tea bags
3. Analysis of Management Accounting Practices of Udarata tea marketing Services
- Long term investment decision making process
There are two fundamental types of financial decisions that the finance team needs to make in a business investment and financing. The two decisions involved in how to spend money and how to borrow money. Recall that the overall goal of financial decisions is to maximize shareholder value, so every decision must be put in that context.
An investment decision revolves around spending capital on assets that will yield the highest return for the company over a desired time period. In other words, the decision is about what to buy so that the company will gain the most value.
To do so, the company needs to find a balance between its short-term and long-term goals. In the very short-term, a company needs money to pay its bills, but keeping all of its cash means that it isn't investing in things that will help it grow in the future. On the other end of the spectrum is a purely long-term view. A company that invests all of its money will maximize its long-term growth prospects, but if it doesn't hold enough cash, it can't pay its bills and will go out of business soon. Companies thus need to find the right mix between long-term and short-term investment.
The investment decision also concerns what specific investments to make. Since there is no guarantee of a return for most investments, the finance department must determine anexpected return.This return is not guaranteed, but is the average return on an investment if it were to be made many times.
The investments must meet three main criteria:
- It must maximize the value of the firm, after considering the amount of risk the company is comfortable with (risk aversion).
- It must be financed appropriately.
- If there is no investment opportunity that fills (1) and (2), the cash must be returned to shareholder in order to maximize shareholder value.
All functions of a company need to be paid for one way or another. It is up to the finance department to figure out how to pay for them through the process of financing.
There are two ways to finance an investment using a company's own money or by raising money from external funders. Each has its advantages and disadvantages.
There are two ways to raise money from external funders, by taking on debt or selling equity. Taking on debt is the same as taking on a loan. The loan has to be paid back with interest, which is the cost of borrowing. Selling equity is essentially selling part of your company. When a company goes public, for example, they decide to sell their company to the public instead of to private investors. Going public entails selling stocks which represent owning a small part of the company. The company is selling itself to the public in return for money. Every investment can be financed through company money or from external funders. It is the financing decision process that determines the optimal way to finance the investment.
Mainly Udarata tea is focused on Average rate of return and risk of the investment. When they invest in machines or vehicles mainly consider about the risk which occur because this is a sole proprietor business. They have limited ways to collect money so Company mainly target for long term investments which quickly recover and more profitable compare to other investments.
When consider about ARR It uses operating profit rather than cash flows. Some capital investments have high upkeep and maintenance costs, which bring down profit levels. Unlike NPV and IRR, it does not account for the time value of money. By ignoring the time value of money, the capital investment under consideration will appear to have a higher level of return than what will occur in reality. This is an issue consider about this business accounting practices so it’s better to use IRR or NPV to calculate capital investment decisions. When talking about financing this company have big amount of loan creditor because sole proprietor do not have shares to issue so they have borrowed from banks. ARR can be calculate by using following Formula.
ARR = Average Profit / Average Investment
- ACTIVITY BASED COSTING (ABC)
An accounting system that identifies the activities that a firm performs, and then assigns indirect costs to products. An activity based costing (ABC) system recognizes the relationship between costs, activities and products, and through this relationship assigns indirect costs to products less arbitrarily than traditional methods.
We can identify different activities that Udarata Tea Marketing Service use. Such as,
- Tea blending
- Quality Testing
- Machine Maintenance
- Product Developing
- Distribution Overheads
Cost Driver: It is a factor which causes a change in the cost of an activity.
According to Udarata Tea Marketing Services, we can select these cost drivers for different activities mention above.
- Tea Blending - Number of blend times
- Quality Testing - Number of items tested
- Machine Maintenance - Number of machine hours
- Product Developing - Number of times product developed
- Distribution Overheads - Number of distributions
By using cost drivers company can came out with cost driver rate. We can show it like this according to Udarata Tea Marketing Services.
- Tea Blending Rate = Total amount for tea blending activity
Number of blend times
- Quality Testing = Total amount for quality test
Number of items tested
- Machine Maintenance = Total amount for Machine maintenance
Number of machine hours
- Product Developing Rate = Total amount for Product Developing
Number of times product developed
- Distribution Overhead Rate = Total amount for Distribution Overhead
Number of distributions
ABC method can identify the advantages and disadvantages of Udarata Tea Marketing Service as follows,
- ABCprovides a more accurate cost per unit. As a result, pricing, sales strategy,performance managementand decision makingshould be improved.
- It provides much better insight into what drives overhead costs.
- ABC recognizes that overhead costs are not all related to production and sales volume.
- In many businesses, overhead costs are a significant proportion of total costs, and management needs to understand the drivers of overhead costs in order to manage the business properly. Overhead costs can be controlled by managing cost drivers.
- It can be applied to derive realistic costs in a complex business environment.
- ABC can be applied to all overhead costs, not just production overheads.
- ABC can be used just as easily in service costing as in product costing.
- ABC will be of limited benefit if the overhead costs are primarily volume related or if the overhead is a small proportion of the overall cost.
- It is impossible to allocate all overhead costs to specific activities.
- The choice of both activities and cost drivers might be inappropriate.
- ABC can be more complex to explain to the stakeholders of the costing exercise.
- The benefits obtained from ABC might not justify the costs.
- Other systems may need to be changed - for example, how variances are calculated.
- Working capital management of UDRATA Tea Marketing Services.
Working Capital management is a managerial accounting strategy focusing on maintaining efficient levels of both components of working capital, current assets and current liabilities, in respect to each other. Working capital management ensures a company has sufficient cash flow in order to meet its short-term debt obligations and operating expenses. (Investopedia.com.2015) The goal of capital management is to make sure that a firm is ready to continue its operations which it's sufficient ability to satisfy each maturing short debt and coming operational expenses.
Udarata Tea’s working capital management involves both current assets and current liability components. Example to those components are,
Current assets: Inventory management, Debtors management & Cash and Cash Equivalents management
Current liabilities: Trade and Other Payables management
Udarata Tea used to do ratio analysis to manage there working capital problems. Most of the times they analyze current ratio and working capital cycle to measure their liquidity and perform well in the future.
- Current ratio
Current ratio, also known as liquidity ratio and working capital ratio, shows the proportion of current assets of a business in relation to its current liabilities.it can measure by using following formula.
Current Ratio=Current Assets / Current Liabilities
Current magnitude relation may be a live of liquidity of an organization at an explicit date. It should be analyzed within the context of the trade the corporate primarily relates to. The underlying trend of the magnitude relation should even be monitored over an amount of your time. Generally, firms would aim to take care of a current magnitude relation of a minimum of one to make sure that the worth of their current assets cowl a minimum of the number of their short term obligations. However, a current magnitude relation of larger than one provides extra cushion against unpredictable contingencies which will arise within the short term.
Current ratio of Udarata Tea services:
Udarata Tea has manage their current ratio more than 1. That is a good practice they do in the firm and most of the time they has try to get that closer to 2. Importance of this is minimum levels of current ratio are typically outlined in loan covenants to protect the interest of the lenders within the event of deteriorating monetary position of the borrowers.
- Working capital cycle
The working capital cycle is the amount of time it takes to turn the net current assets and current liabilities into cash. The longer the cycle is, the longer a business is tying up capital in its working capital without earning a return on it. Therefore, companies strive to reduce its working capital cycle by collecting receivables quicker or sometimes stretching accounts payable. There are three components in working capital cycle. They are:
- Operation Cycle
- Cash cycle
The time between the purchase of an asset and its sale, and the sale of a product made from the asset. Operation cycle can be calculate by using fallowing formula.
Operation Cycle = Inventory Holding Period+ Debtors Holding Period
Operation cycle of Udarata Tea Marketing Services
= 23 Days
= 39 Days
Operation Cycle = Inventory Holding Period+ Debtors Holding Period
Operation cycle = 23 Days + 39 Days
= 62 Days
The time between an expenditure of money to make a product and the collection of accounts receivable from the sale of that product. Cash cycle can be calculate by using fallowing formula.
Cash Cycle = Operation cycle – Creditors payment period
Creditor payment period
= 9 Days
Cash Cycle = Operation cycle – Creditors payment period
=62 Days – 9 Days
Analyzing above data Udarata tea manage to maintain their operation cycle as 62 days. And their Cash cycle is 51 days. After analyzing these ratios have decided to maintain their inventory holding period less than 30 Days. That mean they decided to have quick sales and also get their raw material to manufacturing process quickly. Also their debtors holding period is 39 days and their creditors payment period is 9 days. Udarata tea firm use these ratios to conduct and maintain their process. And they get following advantages by using ratio analysis.
1. Judging Efficiency-Accounting ratios are important for judging the company's efficiency in terms of its operations and management. They help judge how well the company has been able to utilize its assets and earn profits.
2. Locating Weakness-Accounting ratios can also be used in locating weakness of the company's operations even though its overall performance may be quite good. Management can then pay attention to the weakness and take remedial measures to overcome them.
3. Formulating Plans-Although accounting ratios are used to analyze the company's past financial performance, they can also be used to establish future trends of its financial performance. As a result, they help formulate the company's future plans.
Suggestions for ABC Method
- In ABC system the method of implementation is complex, time consuming, and costly. So as an emerging company this system shouldn’t suitable for Udarata Tea Company. So company have to look for another method that’s requires less cost, less time and less implementations.
- Being only average costs for the accounting period, process cost cannot be considered to be very accurate for the purpose of detailed analysis, evaluation, and control of individual performance efficiency on a day-to-day basis.
- Costs obtained at the end of the accounting period are only historical and are not of much use for effective control unless standard process cost are used. This is, no doubt, true in respect of all other historical systems but the nature of process accounting with its departmental divisions makes this disadvantage more prominent.
- When different products come out of one and the same process, the common costs are prorated to the various products. Such costs of individual products are not reliable as they may, at best, be taken to be only approximations.
- For the purpose of calculation of unit costs of continuous processes, work-in-process is required to be determined at the end of an accounting period. This is done mostly on estimated basis which introduces further inaccuracies in costs.
Suggestions for Working Capital Management
- Considering the working capital management of Udarata tea marketing services they use ratio analysis and their current ratio is less than 2. So they have to pay attention to their Inventories and debtors and manage them carefully to have a better current ratio.
Suggestions for Investment Decision making
ARR It uses operating profit rather than cash flows. Some capital investments have high upkeep and maintenance costs, which bring down profit levels. Unlike NPV and IRR, it does not account for the time value of money. By ignoring the time value of money, the capital investment under consideration will appear to have a higher level of return than what will occur in reality. This is an issue consider about this business accounting practices so it’s better to use IRR or NPV to calculate capital investment decisions.
We have selected Udarata tea for our research which is based on Management accounting practices. There are so many management practices in world. We choose Working capital management, Investment decision making process and activity basic cost (ABC) and process. We have clearly explained throughout this report about these three process. We have examined pros and cons of those practices and how company practice it. And finally we have present suggestions. So as a conclusion the best methods and practices for Udarata tea marketing service has been presented here.
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