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Managing Financial Principles and

Techniques

Contents
3. Be able to participate in the budgetary process of an organisation.......................4
3.1 select appropriate budgetary targets for an organisation.................................4
3.2 participate in the creation of a master budget for an organisation...................7
3.3 compare actual expenditure and income to the master budget of an
organisation.......................................................................................................... 11
3.4 evaluate budgetary monitoring processes in an organisation.........................14
4 Be able to recommend cost reduction and management processes for an
organisation.............................................................................................................. 16
4.1 recommend processes that could manage cost reduction in an organisation. 16
4.2 evaluate the potential for the use of activity-based costing...........................18

3. Be able to participate in the budgetary process of an


organisation
3.1 select appropriate budgetary targets for an organisation
In the modern business it is vital for organisations to maintain a appropriate budgetary control
system to carry out its business in an efficient and effective manner and to survive in the
business. More specifically cost and revenue targets needs to be set in an effective manner so
that such companies are able to obtain a competitive advantage over the other companies.
The XYZ Company is in the process of preparing its annual budget for the financial year 2012
and has prepared the following budget.
XYZ manufacturing company budget for the financial year 2012
2010
Actual
14,375
8734
5641
1325

2011
Actual
15820
9520
6300
1458

2012
Budgeted
18193
10758
7435
1603

expenses
Administrativ

537

550

e expenses
Other

268

3511

Revenue
Cost of Sales
Gross profit
Selling
&

Variance

2373
1238
1135
146

15
13
18
10

565

15

275

270

(5)

(2)

4017

4997

980

24

1004

1249

245

24

3013

3748

1225

41

distribution

administrative
expenses
Profit before
tax
Taxation

@ 878

25%
Profit after tax

2633

Revenue
Over the two year period the revenue of the company has grown by 10% annually and therefore
taking into consideration the past trend and the future opportunities by the management the
revenue is expected to increase more that previous years. According revenue is expected to be
grown by 15% compared to previous years.
Cost of sales
Even though the revenue has increased by 10% in the past cost of sales has increased only by
9% due to the improvement taken place in the organisation and due to the economies of scales
experienced by the company. Therefore with the aim of further improving these benefits the
company has budgeted a 13% increase in cost of sales which will further improve the gross
profit margin.
Gross profit margin
With the increase in the revenue and the increase in the cost of sales lower than revenue the
company is expected to increase the gross profit margin in the financial year 2012.
Selling and Distribution expenses
The company expects to increase the selling and distribution expenses same as previous years
by 10%. Though the revenue is expected to increase only by 15% selling and distribution
expense in expected to increase only by 10% by improving efficiency and the effectiveness of
the marketing activities.
Administrative expense
The company is targeting to maintain the same administrative expenses level in the current year
by way of cost reduction activities to compensate the expenses increased due to the general
inflation prevail.
Other expenses
The company expects to maintain same level of other expenses by means of cost reduction
activities.
Profit after tax

The company is expecting a increase in the profit after tax by 41% compared to the previous
year by increasing sales and increasing the efficiency and effectiveness of manufacturing
process.

3.2 participate in the creation of a master budget for an


organisation
The master budget of the organisation comprise following budgets.

Budgeted income statement


Budgeted cash flow
Budgeted balance sheet

Budgeted income statement


The company prepares its budgeted income statement as follows,
XYZ manufacturing company budget for the financial year 2012
2010
Actual
14,375
8734
5641
1325

2011
Actual
15820
9520
6300
1458

2012
Budgeted
18193
10758
7435
1603

expenses
Administrativ

537

550

e expenses
Other

268

3511

Revenue
Cost of Sales
Gross profit
Selling
&

Variance

2373
1238
1135
146

15
13
18
10

565

15

275

270

(5)

(2)

4017

4997

980

24

1004

1249

245

24

3013

3748

1225

41

distribution

administrative
expenses
Profit before
tax
Taxation

@ 878

25%
Profit after tax

2633

Budgeted cash flow


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The budgeted cash flow statement of the company for the financial year 2012 is as follows,
XYZ manufacturing company budget for the financial year 2012
2010
2011
Cash balance at the beginning

2012

Actual

Actual

Forecasted

625

450

796

Add Receipts
Collection from customers

10,750

14,750

17,350

Total cash available

11,375

15,200

18,146

Direct material

3,345

3,755

4,506

direct labour

2,300

2,530

3,036

manufacturing overhead

2,893

3,434

4,121

selling

1,300

1,430

1,716

537

555

570

2,000

500

1,500

800

1,100

1,250

Total disbursements

13,175

13,304

16,699

Excess or

(1,800)

1,896

1,447

Less: Expenses

and

distribution

expenses
Administrative expenses
Purchase of Property Plant &
Equipments
Tax

Deficiency over

disbursements
Financing
Borrowings

2,500

2,000
8

payments
Interest
Total financing
Cash balance at the end

1,000

500

250

100

200

2,250

(1,100)

450

796

1,300
147

It is assumed that the customer collection will be taken place in the same manner which took
place in the past two year of 2010 and 2011.
Further a capital expenditure of 1500 is expected in the year of 2012 to ensure that the
manufacturing facilities are operates in most effective and efficient manner using cutting edge
technology that the industry has.
All the other manufacturing related expenses such as direct material, direct labour and
production overheads are assumed to pay as an when they incur.
Operating expenses such as selling and distribution expenses, administrative expenses also
paid when they incurred.
Accordingly a borrowing of 2000 is expected to bridge the gap between the available cash
balance and required cash balance.
At the financial year end 147 cash balance is expected to prevail with the company.

Budgeted balance sheet


The companys budgeted balance sheet is drawn as follows,
2010
Actual

2011
Actual

2012
Budgeted

10350

10500

12,500

Non current assets


Property

Plant

&

equipments
Current assets
9

trade receivables

2300

1893

2,789

inventory

750

847

2,194

450

796

147

3500

3536

5133.2

Total assets

13850

14036

17630

Share capital

6500

6500

6,500

reserves

1000

4013

7,761

Borrowings

2500

1500

2,500

350

2023

869

10350

14036.08

17630

cash

and

bank

balance

current liabilities
Trade payable

Total
liability

equity

and

The budgeted income statement, budgeted cash flow statement and budgeted balance sheet for
the financial year 2012 has prepared in a consistent basis.

3.3 compare actual expenditure and income to the master


budget of an organisation
2010

2011

2012

2012

Variance
10

Revenue

14,375

15,820

18,193

18,668

475

Cost of sales

8,734

9,520

10,758

11,043

286

Gross Profit

5,641

6,300

7,435

7,624

189

Selling & distribution

1,325

1,458

1,603

1,647

44

537

550

565

590

25

Other expenses

268

275

270

290

20

Profit before tax

3,511

4,017

4,997

5,097

100

Tax @25%

(878)

(1,004)

(1,249)

(1,274)

(25)

Net profit after tax

2,633

3,013

3,748

3,823

75

expenses
Administrative
expenses

Revenue
The actual revenue of the company for 2012 was 18,668 while the budgeted amount was
18,193 which is an increase of 475 than budgeted. This has resulted in the significant increase
in the volume due to the higher demand prevailed for certain product categories backed by the
weather condition.
Cost of sales
Cost of sales has increased by 286 than those budgeted due to the increase in the demand for
certain product which is evidenced by the increase in revenue. However gross profit of the
company remains in the same position of 41% as budgeted. Though the company expected to
increase the cost of sales to be increased by 13% actual increase accounted to 16% due to the

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Certain lapses faced by the manufacturing facilities. Furthermore certain direct manufacturing
expenses such as electricity and overhead costs also increased along with the increase in
revenue.
Gross profit
Gross profit also increased by 189 than budgeted for the financial year 2012. However the
gross profit margin shows flat at 41% with the budgeted while it has improved by 1% from
previous year of 40%.
Selling and distribution expenses
Selling and distribution expense was amounted to 1647 while the budgeted expense was stood
at 1603 which shows a increase of 44 than budgeted. This is mainly due to the increase in sales
volume and this has resulted in slight increase in distribution expenses of the company.
Moreover sales commission expense has also increased due to the increase in the revenue.
Administrative expenses
Administrative expense were budgeted at 565 where as actual amount was stood at 590.
Accordingly administrative expense has increased by 25 than budgeted. This is mainly due to
the increase in the salary expenses resulted in due to the new recruitments taken place in the
company.
Other operating expense
Other operating expenses also increased slightly by 20 compared with actual other operating
expense.
Profit before tax
The profit before tax has increased 100 than budgeted amount due to the increase in the sales
volume. However the company was unable to obtain the full benefit from such increase due to
the increase in the cost of sales and several other operational expenses.

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3.4 evaluate budgetary monitoring processes in an


organisation
Budgetary monitoring is a process whereby the organisations sets the budgets to their
organisations and continuous monitoring of the performance of the organisation compared with
the budget to evaluate whether the operations of the organisation is taken place in an effective
and efficient manner.
The objectives of the budgetary control system is as follows,

Determining the goals and objectives of each department of the organisation


Assigning roles and responsibilities to each and every employee so that such individual

is aware what he is expected to contribute to the organisation.


Providing a basis for which performance of the company can be compared and identify

any deviations take necessary actions on that on timely manner.


Ensuring that all available resources are used in efficient and effective manner.
Providing basis for revision of current policies to face to the future.

The following advantages can be obtained through a budgetary monitoring and control system,
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Budgetary control system helps the management of the organisation to carry out its

operational activities in an efficient and effective manner.


Budgetary control is a efficient tool to control the companys expenses.
Budgetary control can be used as a yardstick or measurement base to evaluate the

performance of the individual staff of the organisation.


Budgetary control system helps to identify the deviations from the actual output and

expected output and to identify the possible reasons for deviations.


Budgetary control system helps to increase efficient and effective utilisation of resources
in the organisation such as production materials, skilled labours, production machinery

etc.
Budgetary control system helps the organisation to identify the current trends and to

formulate future policies based on such information to operate effectively.


Budgetary control helps the organisation to implement standard costing system to the

organisation in an efficient and effective manner.


By implementing a budgetary control system it encourage employees of the organisation
to concentrate on the cost when performing activities within the organisation.

Budgetary control system has following limitation/ disadvantages

Budgets are based on estimates of the future activities and therefore such estimates can

be wrong and budgets may not be able to achieve giving a wrong picture.
Budgetary controls may affect to the quality of the product and services of the

organisation due to the high concentrate on the expenses of the production activities.
Budgetary control can gives a wrong impression that achieving budgets of the

organisations will solve all the problems faced by the compay


Implementation of a budgetary control system may be high cost and in some instances it

may not be cost effective.


The management may focus on the achieving budget targets rather than achieving the

goals and objectives of the organisation.


Management may do under budgeting to show that the performance of the company is
improved

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4 Be able to recommend cost reduction and management


processes for an organisation
4.1 recommend processes that could manage cost reduction in
an organisation
Company can reduce costs in various of ways. And these will ultimately helps the organisations
to achieve its goals and objectives.
The cost reduction techniques includes following steps,

Identify the areas where the cost can be saved


in this step the company needs to critically evaluate its cost structure and identify the
areas where they can reduce the cost in more efficient and effective manner.
Quantify the cost savings
in this step the company needs to quantify the amount of cost that they can reduce
which they identify in the first step. This helps to identify the most effective areas and

concentrate more on such area.


Test cost reduction process before implement
At this step the organisation needs to consider whether the quantified costs can be
reduces in actual scenario and they need to evaluate the impact of such reduction to the
other processes such as quality of the product, impact to the brand name from such

reduction etc.
Implement the cost reduction activities
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The company must implement the cost reduction activities in the areas where they have
identified in the previous steps. Due attention needs to be given to the areas where there

is a effective cost reduction is available.


Ensure that cost reduction has taken place
Once the process has implemented the management needs to make sure that the
targeted cost reduction has taken place.
With regard to specific costs that has a significant impact on the company can use

following techniques and method to reduce the cost


Company can enter in to long term supplier contracts with suppliers which helps the

company to obtain more favourable payment terms and attractive discounts.


The company can use several suppliers to purchase goods and thereby reduce or

eliminate the bargaining power of the suppliers and obtain the most favourable prices.
To minimise the wastage in the production process the company can use the latest

cutting edge technology in its manufacturing facilities.


To reduce the finance cost the company may grant discount to customers who settle

their dues on time.


The companies can discuss with suppliers to obtain more favourable credit periods.

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4.2 evaluate the potential for the use of activity-based costing


Activity Based costing
Activity Based Costing (ABC) is a relatively new management accounting model which is a
mechanism whereby assigning costs of production based on the activities involved in the
production process and the resources utilized by such activity (The Economist.com,2011). ABC
is an alternative to traditional management costing techniques.
According to the ABC technique, company needs to,
Identify the activities involved in the production process.
Allocate the cost to each activity based on the resource requirement
Allocate the cost of each activity to each product based on the requirement of such
activity by such product.
If company uses Activity Based Costing method to compute its unit cost, it will be able to do a
effective pricing of the products since this method computes the cost of the product based on
the activities involved in the production process instead of using a single basis such as machine
hours or labor hours utilized by each product which are used in traditional techniques.
Activity based costing has following advantages

Activity based costing gives more accurate information about the product cost rather

than other cost accounting techniques.


Under activity based costing overhead costs can be understand in a better manner.
Activity based costing method is a simple costing method which can be understood by

everyone.
Activity based costing take in to account unit cost rather than the total cost of the product

and by this cost drivers can be easily identifiable.


Activity based costing can be used to implement performance management methods

such as scorecards.
Activity based costing can be used for benchmarking.
By using activity based costing the organizations can identify losses incurred in the
production process and is able to identify activities or processes which will not add value

to the production process


Results obtained from Activity based costing can be used for other modern management
techniques such as six sigma

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Activity based costing asses the cost of individual activities based on its utilisation of
resources.

Activity based costing has following disadvantages

Implementing activity based costing system to the organization can be involved high cost
as such costing system needs significant amount if resources such as sophisticated

computerized system, skilled labour etc


Once the system is implemented the cost incurred to process the data is high.
Accordingly in order to obtain the information data needs to be collected, validated,

checked and feed to the system which incur high labour cost
Activity based costing system produce various information which are significantly
difference from information generated by other costing techniques. Owing to this reason
the management may tend to use information provided by existing costing technique.
Further when evaluating the performance of the management information produced by
existing costing technique may used. Therefore the management will pay their attention

on existing costing technique rather than the activity based costing


Activity based costing method produce data which can be misinterpreted easily by
managers. Thus due attention need to be given when interpreting information and

making decisions
Activity based costing is not in line with the Generally Accepted Accounting principles
GAAP) which leads to prepare another set of accounts to comply with Generally

Accepted Accounting principles


Practical implementation of Activity based costing is challenged due to the serious
challenges faced by the company

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