The management should use the economic order quantity (EOQ) method to carry out their stock control. Other methods such as just-in-time and optimised production technology are also available but since Stoddard is worry about the interruption towards the end of the accounting year, just-in-time method is not the best solution to this situation. On the other hand, optimised production technology is more suitable for production companies, this is not the best solution for Stoddard. Since we do not have any information on the cost of placing one order and the cost of storage, it is difficult to calculate the actual figure of the EOQ.
I would suggest the management of Stoddard to reduce their credit terms to their debtors to one month and to purchase the equipment on credit and to be paid the following month. I would also suggest the management to reduce the stock purchasing from £1500 each month to £750. The freehold property cash payment should be spread over a twelve months period and this can avoid a large amount of cash being spent in the beginning of the financial year.
On the following page, I have recalculated the cash budget with new amendments as I stated above, we can clearly see an improvement to the cash situation of Stoddard Ltd. Although the company is not making profit at present but it is more reliable to have a positive bank balance than relying on the bank overdraft.
Cash Budget for Stoddard Ltd for six months to 1 November 2001 (Amended)
Jun Jul Aug Sep Oct Nov
£ £ £ £ £ £
Cash inflows
Credit Sales 7350 8750 10150 11550 14000
Cash Sales 3150 _ 3750 _ 4350 _ 4950 _ 6000 _ 6000 _
3150 11100 13100 15100 17550 20000
Cash Outflows
Freehold Property (Mortgage) 5000 5000 5000 5000 5000 5000
Equipment 8000
Vehicle 4000
Purchases 33625 10125 11625 13125 15750
Wages & Salaries 1000 1000 1000 1000 1000 1000
Overheads 400 400 400 400 800 800
Commission to salesmen 525 625 725 825 1000 10400 48550 17150 18750 20750 23550
Cash flow (7250) (37450) (4050) (3650) (3200) (3550)
Opening Balance 80000 72750 35300 31250 27600 24400
Closing Balance 72750 35300 31250 27600 24400 20850
Behavioural implications of operating a budgetary control
A budgetary control involves the establishment of the budgets throughout the organisation by area managers who is aware of his/her budget objective knowing that his actual results will be measured in the budget period and compared with the budget figures.
F Wood (2002:520) stated that “When the budgets are being drawn up the two main objectives must be uppermost in the mind of top management, that is that the budgets are for Planning and Control.”
The budget is a useful way of setting out in detail the planned activities of the organisation for the coming period and relating them to the objectives of the organisation. It is vital in comparing actual performance to planned performance and enabling corrective action to be taken when deviations occur.
The budgetary control process places great emphasis on the location of responsibilities within a company. The recognition that performances can be traced to managers, supervisors and workers is an integral part of budgetary control, therefore, to distinguish clearly between controllable and uncontrollable costs. Controllable costs are those which can be traced to a particular person or group of persons. It would be unfair to hold a manager responsible for costs which are outside his or her control.
A Benedict & B Elliott (2001:484) suggested that an organisation should have a budget committee, which is formed by senior executives and managers who act in a collaborative manner. If members of the budget committee do not act in a collaborative manner, behavioural implications will arise out of implementing and operating a budgetary control system. The most common example is where the manager realises that he has not spent his entire budget for a particular item, then he made a purchase on unnecessary items on the basis that “If I don’t spend this amount this year, the company will cut down next year when I will really need the money.” In this case, the manager is acting on his own interest rather than implementing the control system in the result of this behaviour, the company has a lot of unusable and unnecessary equipments. Another example is where the manager turns down requests for overtime work because the budgeted overtime has already been exceeded. In result the job is not completed on time and the company may have to pay a large sum under a penalty clause in the contract.
From these two examples, we can see the behavioural implications have impacts on the effectiveness of the budgetary control system. A budgetary control report focuses on various areas of the business to compare the forecast and actual figure. If all budget managers are building in a hidden contingency of, say ten percent, and it turns out in the event that only a quarter or a third of them really need to use this slack, then the company has committed six to seven percent more resources than it need have.
We can argue that it is true that behavioural problems can lead to lack of objectivity in budgetary information, lack of motivation and consequent dysfunctional effects. However this should not be seen as a reason for not budgeting but as a reason to budget in such a way as to minimise the behavioural impacts. The first stage in doing so is recognising the existence of the possibility of such impacts. Measures can then be taken to minimise their effects.
Discuss how budgeting may be harmful to the achievement of business objectives
By involving managers in budget preparation we can create a communication channel, and managers at all levels are more likely to understand the justification for any changes in operations. In such case, instead of complaining, they might well become more constructive, and even innovative in their responses. However, there are advantages and disadvantages of budgeting in the dynamic business environment.
P Atrill & E McLaney (2002:132) suggested that budgets are seen as having five main benefits to the business – promote forward thinking and the possible identification of short-term problems, motivate managers to better performance, provide a basis for a system of control, help co-ordinate the various sections of the business and provide a system of authorisation. The advantages of budgeting are to help to control income and expenditure, helping to draw attention to waste, losses and inefficiency. It is also argued that budgeting could lead to better managerial planning and control because resources could be allocated more precisely to specific activities, and actual achievements could be monitored more effectively.
Other advantage is that performance can be analysed in figures to measure financial success/loss, and by hitting the targets can also be a way of motivating staff. Bear in mind these only apply to a well structured budget where the target is realistic, but there is no measurement or definition of a well structured budget. This can only be justified by an experience member of senior managers. T Hines (1990) cited that the managers who are responsible for particular budget areas should be aware of these responsibilities. As we have discussed this on the pervious page, there are behavioural implications arise out of implementing a budgetary control system, therefore it is almost impossible to judge whether or not the targets are set at a realistic figure.
Even though the budget targets are being set realistically and well structured, it is simply impossible for anyone to predict the future. For example, the New York 9-11 case happened out of the blue, no one would ever think of this type of terrorist attack would happen, and in result of this incident, the US markets fall dramatically. From this example we can see that this comply with the argument from P Atrill & E McLaney (2002:147) – “Budgets cannot deal with a fast-changing environment and that budgets are often out of date before the commencement of the budget periods.”
Budgeting can also put management on high pressure on archiving the short-term goals rather than the long-term goals. For example, the manager turns down requests for overtime work because the budgeted overtime has already been exceeded. In result the job is not completed on time and the company may have to pay a large sum under a penalty clause in the contract. In this case, although the manager may have met the budget target (short-term goal), but due to the incomplete production, it results in losses for the company or the customer will simply go else where (long-term goal). This does not only affect the company’s profit, but also its reputation. As we can see from the example, individual managers’ goals are being more important than overall company aims, it can focus too much management attention on the achievement of short-term targets rather than aiming for the long-term success.
Preparing budget is a time consuming task, management needs to have many meetings and discussion before they can draw up a well structured budget. Again we can see this is mainly focus on the individual managers’ goals (by setting up the budget on time) rather than focusing on the more important tasks, such as how the company can increase their sales level, how can they improve their existing production to attract more customers etc. By the time the budget is drawn up, it may be out of date and need new amendments, which again, the manager needs to spend more time of adjusting the budget.
P Atrill & E McLaney (2002:148) also argue that “Budgeting encourage incremental thinking by employing a ‘last year plus x per cent’ approach to planning. This can inhibit the development of ‘break out’ strategies that may be necessary in a fast-changing environment.” Although budgeting can identify and eliminate the unnecessary costs, but cost cutting do not fit with overall strategy. As we mentioned before, things can still go wrong no matter how methodical or well intentioned everybody may be. Incremental approach to budgeting is fairly widespread, it is a logical approach to planning for the next year in that it starts with the current or latest year. The approach bases the next year’s budget on the previous year’s actual figures, plus an allowance for inflation, and a percentage deduction to encourage cost reduction. The incremental approach has the advantage of being relatively simple and therefore cheap to implement. This is useful in companies where activity and resource levels do not change much. Of course, where inefficiencies and imperfections have existed in previous years they are then compounded on a continuing basis into the budgets of future years.
Faced with the need to anticipate sending requirements in an uncertain future, it is unsurprising that most people want to ‘play safe’. Research has shown that building some ‘slack’ into budget is widespread. But what makes good sense for the individual budget manager may be damaging for the company as a whole. Managers are only human and can be tempted to do all sorts of things they should not. Top management are also faced with the problem of not always having the necessary information to challenge effectively the estimate produced by lower management. For example, just think of the consequences of this: a manager may add 10% to the proposed budget expenditure in anticipation of being cut down later, senior management cuts it down by only 5%. It takes only a few budget managers to do this and the company will soon be suffering. If four managers require £100 000 each but bid for £110 000 each and receive £105 000 each, the company will be wasting £20 000.
In conclusion, the intention of budgeting is to provide budget managers with a powerful incentive to make company priorities their own, to seek out and deliver economies, driving down costs while maintaining or boosting performance. By rewarding relatively objective budgetary performance, organisational performance can be improved. This may work to some extent, but it can also produce a further twist in the spiral of distrust, self-protection, deception and cynicism. When pressure to achieve budgetary targets frequently requires managers to make false economies, to withhold co-operation from other department, and to avoid expenditures by imposing even greater costs on other people’s budgets, then clearly something has gone wrong. Furthermore, there is the issue of information and uncertainty. Senior managers do not know what sorts of saving are possible, or what levels of service would be associated with different levels of expenditure. They may have hunches and rough ideas, but they cannot be certain, perhaps by spending considerable time or resources finding out themselves.
Reference
Atrill P & McLaney E, (2002), 3rd edition, Management Accounting for Non-specialists, Pearson Education Ltd, Essex
Benedict A & Elliott B, (2001), Practical Accounting, Pearson Education Ltd, Essex
Hines T, (1990), 2nd edition, Foundation Accounting, Checkmate Publications, Clwyd
Wood F & Sangster A, (2002), 9th edition, Business Accounting 2, Pearson Education Ltd, Essex
Bibliography
Atrill P & McLaney E, (2002), 3rd edition, Management Accounting for Non-specialists, Pearson Education Ltd, Essex
Benedict A & Elliott B, (2001), Practical Accounting, Pearson Education Ltd, Essex
Davidson I & Mallin C, (1993), The Business Accounting & Finance – Blueprint, Blackwell Publishers, Oxford
Dyson J, (2004), 6th edition, Accounting for Non-accounting Students, Pearson Education Ltd, Essex
Hines T, (1990), 2nd edition, Foundation Accounting, Checkmate Publications, Clwyd
Wood F & Sangster A, (2002), 9th edition, Business Accounting 2, Pearson Education Ltd, Essex
