The purpose of this report to identify the problems that may arise in motivating staff to achieve higher levels of operating efficiency and different approaches to budgeting which could be used to improve the current system.
Definition of a Budget
"A budget is a quantitative expression of a plan of action for defined period of time. It may include planned sales volumes and revenue, resource quantities, cost and expenses, assets, liabilities and cash flows".(Lucey,2006,p.415). A budget could be seen as a guide to achieving the goals of an organisation. A current survey has shown that top companies, be it financial or non- financial companies sees it as a vital tool for co-ordination, planning and control. In order words, it helps firms to stay on track, and in that manner; the top managers will be able to see where they are and where they are heading towards.
Problems with incremental Budgeting
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Incremental Budgeting also known as conventional budgeting, "a type of budget which bases next year's budget on the current year's result plus an extra amount for estimated growth or inflation next year."(CIMA, 2005 p.301)
According to Hope and Fraser (2003), who said that the use of budgets could result into different problems and are part of a fixed performance contract (Robin H,Jeremy F 2003).That is, budgets are seen as annual exercise since it is based on targeted costs and sales. Budgets have been criticized for its use in motivating managers. Budget should be motivating, that is, it should be encouraging in such a manner that staffs and managers will want to work very hard in the attainment of the set goals.
According to Hope and Fraser (2003), an incremental budgeting approach makes staffs and managers feel undervalued. They often feel this way because it is imposed on them, they feel underestimated and are not capable of handling situations all by themselves, thereby demotivation sets in. Top down budgeting could be seen as demotivating, because, the budget is imposed on them. Managers may not want to take responsibility if anything goes wrong. A budget should rather be bottom- up, that is, participative, as this will have an effect on the behaviour of manager and it could improve the possibility of the organisation goals being achieved.
Keeps to the same condition or state of affairs/obstructs change: that is, the culture of the organisation is maintained, keeps to the way things have always been done based on past performances. It promotes a more laid back attitude from mangers and staffs because there is nothing to challenge them to think ahead and be creative. Incremental budgeting approach is based on past performance, it doesn't recognise the economy is changing, and different ideas that can be developed to help organisations gain efficiency. In comparison with Beyond Budgeting by Hope and Fraser, more strategic and confidence building measure is encouraged in order to cope with the competition most businesses face as a result of changing market today.
Budget supports departmental barriers rather than promote knowledge sharing and ideas Hope and Fraser (2003). Budgets are supposed to be bring people together under one umbrella, in terms of communication and so on, but in this case staff sees it as a competition against other department, because they are given details of targeted sales for the year.
Alternative approaches to Budgeting
There is no ideal budgetary control, the best approach adopted by an organisation have to correlate with what type of service is provided.(Hussey,J and Hussey R,1999)Researches have shown that the system of budgeting adopted by some organisations tends to either motivate or demotivate staffs.
Zero-based budgeting: this method of budgeting was developed in the United Sates. It is defined as "a method of budgeting that requires all costs to be specifically justified by the benefits expected."(Lucey 2006,p.436).
Acivity Based Budgeting: This approach which is mostly applied to service sectors and indirect costs in a manufacturing environment. This technique focuses on the output of a process relatively to the input.(Scarlet B,2009). Four steps in activity based budgeting are
"Determine the budgeted cost of performing each unit of activity
Always on Time
Marked to Standard
Determine the demand for each individuals activity.
Calculate the costs of performing each activity
Describes the budget as costs of performing various activities." Horngren, C.et al(2005),pg 504.
These steps concentrates on the cost of activities involved in the production and sale of product and services. Advantages of this technique are
It gives a clearer knowledge of the connection between costs and the level of activity, compared to traditional approach which does not trace costs to the level of activity and consumption of resources .It helps in better allocation of resources and identifies problems associated in capacity issues. Since Langdale Ltd is willing to remain competitive, it will be able to identify the cost involved in the supply of its products, like distribution, publishing, printing, by doing this it will be able to identify which department needs to be improved more than the other, the resource to be allocated to better its products and decision making in general. It helps to improve staffs and managers performance, because they can easily understand the budget from a functional point of view rather than financial terms. Thus, improving manager's responsibility, as they are accountable for activity under their department. However,
It is also known as bottom-up budgeting. "A budgeting system in which, all budget holders are given the opportunity to participate in setting their own budgets."(Scarlett B,2009.p 238) Budget holders who are in charge of the day to day activities have a hand in the compilation of the budget.
Arguments for this approach are as follows:
Morale and Motivation is improved: because managers are given the opportunity to set budgets themselves, they will want to work hard to achieve the target they have set. They will also be able to act in their own interest and that of the organisation thereby, achieving higher level of operating efficiency.
Specific resource requirements are included: since budget is set by lower managers based on their view, they tend to give the specific resource needed to achieve the budget, because they will not want to be held accountable if anything goes wrong, hence, the cut in the use of resource.
Sharing of ideas and knowledge is promoted among different manager: in contrast to the conventional approach, this approach brings managers together from different levels to discuss what each one feels can be done to remain competitive, as the top managers are counting on them to come up with the budget.
However, the disadvantage is that, an easily attainable budget may be set by managers, by doing so, the organisations target might not be reach. Also, due to the budget been set by lower level managers, the target might not be achieved as they are unqualified.
W 1) Sales (units)
2500 x £700 = £1,750,000
W2) Learning rate
y = cumulative average time per unit
a = time for the first unit
x = cumulative output in units
b = the learning factor
b is calculated as log r/log 2
b= log 0.8/log2 = -0.3219
y = 400 x 1600^-0.3219
y = 400 x 0.093023
= 37.21 (2 decimal places)
To make 1600 units
y = 1600 x 37.21hrs
y = 59536hrs (nearest hrs)
b = -0.3219
y = 400 x 1599^-0.3219
y = 400 x 0.093042
= 37.22(2 decimal places)
To make 1599 units
y = 1599 x 37.22hrs
y = 59515hrs (nearest hrs)
Total time 1600units - total time to make 1599 units
59536hrs - 59515hrs =21hrs
£6 per labour hour
59536hrs x £6 = 357216
900 units remaining
900units x 21hrs x £6 = 113400
W4) variable overheads
£2 per labour hour
59536hrs x £2= 119072
900 units remaining
900units x 21hrs x £2 = 37800
W 5) direct material
£680,000 for the year
Craig Ltd Cash flow statement
Sales (2500units x £700 selling price)
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Net cash flow
The cash flow statement above shows Craig Ltd's inability to meet their targeted net cash flow of £450,000 by £7488 (£450000- 442512) .There are different measures Craig Ltd could take to improve their net cash flow. These are analysed below:
Reduce rate of learning: as seen above in the calculation, if the rate of learning can be reduced to say 70%, this will have an impact on the incremental time. For instance, in the calculation above, the incremental time to make the second batch using 85% learning rate is lower than that of 95%.
Reduce labour hours: Semi skilled labour can be employed to help reduce labour costs. That is, a little training can be given to employees, since they are a bit skilled .if labour rate per hour can be reduced, this will in turn reduce the total labour cost and thus increase our cash flow.
Increase credit terms: negotiation can be made with suppliers, to help increase credit days. By increasing the days it takes to pay suppliers more cash will be available in the cash flow, this cash can be used to run their day to day operations. Also, discounts given by the suppliers of materials should be taken advantage of, in order to reduce the cost of materials.
Variable Overheads: variable cost per unit should be noted i e management needs to make sure that variable cost per unit doesn't increase at higher rate. If this increases it will affect total variable cost and have negative impact on sales revenue.
Increase selling price: to help improve cash flow, average selling price can be increased to £720, while other factors like material, labour, number of unit is constant at 2500 units. This is illustrated below, to show the effect of the increase in selling price.
Revised cash flow statement based on selling price increase
Sales revenue (2500units x £720)
Variable overheads *
Net cash flow
Note: labour and variable overheads figures are taken from the workings above.
In this case, the target of £450,000 is reached by increasing the selling price by 2.9% (700-720) = 20/700 x 100%. The effect of the increase in selling price