APC 309 Strategic Management Accounting Assignment

APC 309 Strategic Management Accounting Assignment Words: 3543

Module Title: Strategic Management Accounting Module Code: APC309 Individual assignment SUNDERLAND BUSINESS SCHOOL Date: 16/04/2011 Introduction: As Gowthope (2005, p. 148) said that: “A budget is a plan, expressed in financial and/or more general quantitative terms, which extends forward for a period into the future. Budgets are widely used in organisations of all types and sizes. ” –Budgeting actually refers to the process that, after the strategic plan of the business has been made, companies made a short term plan (usually one year) to meet the strategic purpose. Traditional budgeting has offered a lot of contributions in so many years? ractice; no one has a better summary of all advantage of traditional budget as (Umapathy, 1987, p. xxii): “I believe that budgeting provides managers with a wonderful opportunity to rejuvenate their organisations. There is no other managerial process I am aware of that translates qualitative mission statements and corporate strategies into action plans, links the short term with the long term, brings together managers from different hierarchical levels and from different functional areas, and at the same time provides continuity by the sheer regularity of the process. . So, many organisations use a „traditional budget? –the short term plan that meet the strategic purpose of the organisation- because of the easiness of preparation and its simplicity to coordinate budget across various departments. But it seems it is more and more unsuitable for the modern business. In this paper, I will give a brief induction for traditional budgeting; and then discuss the strengths and weaknesses of the traditional budgeting; last I will explain and evaluate the alternative approach that will be more accurate and work for today? dynamic markets. In the second part I will tackle the working capital concept by giving some ways to improve parts of Working capital in XYZ limited which is a medium sized manufacturing business. Today, reducing costs, improving quality, and saving time through all parts of an organisation are the mantra of executives in every industry. In their pursuit of those goals, however, they tend to overlook working capital productivity because it is an indirect measure.

They see it as a narrow financial calculation and miss its link to the overall systemic performance of an organisation. As a result, executives forfeit a powerful lens to track improvements across the company. Section 1: Budget and Budgeting: “Budget reflects a choice – not an easy choice, but the right choice. And when you think about it, the only choice. The choice to take the responsible, prudent path to fiscal stability, economic growth and opportunity. ” –George E. Pataki. An American politician.

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The use of budgets dates back to 1920 where it was used as a financial tool for business enterprises (Hofstede, 1968, p. 20). The budget is an indispensable management tool or as Horngren, T. et al, (2000, p. 178) said: “the most widely used accounting tool for planning and controlling organisations”. A budget is an estimated plan over a given period of time expressed in monetary terms for the allocation of funds and distribution of scarce resources through internal communication to get the planned activities done.

When used properly a well designed budget can be a helpful tool in decision-making, it can ensure the controlling process and performance measurements, facilitate communication, and can act as a motivational tool. (Highered. mcgrawhill, accessed 2011) “Budgeting may be defined quite simply as the process of compiling budgets and subsequently adhering to them as closely as possible” (Maitland, 2000, p. 1). Though budgeting process is complex, time consuming and requires a lot of decision-making (refer to Appendix, figure. for an outline of the budgetary process), it is an essential part of the strategic planning process that helps communicating the goals of the organization and facilitates, coordinates and controls various departments of the organization in order to steer the company to its desired goals, it involves the annual cycle to plan actions, better coordination and allocation of resources, and at the end measuring and controlling performance with regard to the plans agreed.

Traditional Budgeting Approach (TBA): There are various methods to prepare a budget. Here we are concerned with the traditional approach to budgeting known also as the incremental budgeting which involves basing next year? s budget on the current year? s results plus an extra amount for estimated growth or inflation (APC309 Workbook, 2008).

It is claimed that in many organisations the traditional budgeting remains widespread, and that 99% of European and US companies are using budgets and have no intention of abandoning them, it was also stated that over 60% of those companies claim that they are not highly satisfied with their current budgeting systems and are continuously trying to improve the budgeting process to meet the demands set for management in creating sustainable value (report: Better Budgeting, 2004, p. 2-3).

From this perspective it is obvious that traditional budgeting approach and budgets in general hold many benefits as well as problems. Implementing TBA on a static market: When implemented within businesses, such technique will be more suitable for firms where each year? s performance and activities are similar to the previous one and conditions are predictable, an active market that can take up large sales which do not change much in relation with changes in prices and where demand is slack.

If we take an example of a company „A? operating in a static market, let? s say that our company is selling „sugar?. So for such company using the TBA (Traditional Budgeting Approach) will be perfect and will work well because first, sugar is a necessary good so the market demand is steady i. e. the buying behavior of sugar does not change much, it is a food basic that people consume on a daily basis, the market demand in this case is predicted and quite unchanged, so „A? an constantly base its expenditures and estimated revenues on those of previous year and that makes it suitable for our company here to be using an annual budget based on historical data, thus, will make it easier to compare actual results with budgets and monitor organizational functions. Second, senior managers won? t be forced to spend an amount of time reviewing budgets. Again, focusing on the benefits of TBA we can say that this approach enhance controlling and is asy to prepare and understand, administratively unambiguous and simple to operate, so this method is cheap. It is probably the simplest method that ensures a quick and low preparation costs, however, I would insist on the point that for any business it? s good to provide and introduce change gradually, therefore, the only major weakness that would limit our company „A? is the fact that senior managers will never be able to have a general and overall picture of the performance, and also some people will be offended when it comes to supervision, humans tend o work at their lowest possible standards especially when there is lack of motivation and rewards, as a matter of fact the budgetary control touch on the culture of blame and mistrust, plus there is a fact that scarce resources will not be allocated effectively and efficiently so that would create an obstacle and prevent employees from performing at their best, and their creative spirit would then be stamp down. Implementing TBA on a dynamic market: “Fixed budgets don? t work today. A budget is a too static instrument and locks managers into the past – into something they thought last year that it was right.

To be effective in a global economy with rapidly shifting market conditions and quick and nimble competitors, organisations have to be able to adapt constantly their priorities and have to put their resources where they can create most value for customers and shareholders. ” Juergen H. Daum. (A management and executive adviser) As Juergen explained, budgeting tools that were created to serve businesses back in the manufacturing era where production costs and revenues were foreseeable will not be effective in today? s „information age? where the market is globalised.

This traditional annual budgeting system is not suitable or relevant in rapidly changing markets, many companies believe that budgets do not deal with intangible assets like brands and knowledge and fail to focus value (Davies T. and Boczko T. 2005 p. 408). In today? s global market where conditions and demands are unpredictable and hard to be determined in advance, an event like 9/11, the Arab? s revolution, and the earthquake that hit Japan will definitely change the way organisations do their businesses especially those big companies that are opened to the global market, in this matter, adopting a raditional budgeting approach will cause more damages. Considering a company „B? operating in a typical dynamic changing market let? s assume here that „B? is a hotel business where each year? s activities and number of tourists accommodated are completely different than the previous year and hard to be predicted, this kind of businesses system is changeable, adjusted constantly and boost employees to give their best with waking up their creativity spirits, our company „B? needs a full use of its potentials and should keep innovating in order to survive in its market and that would not be achieved if employees and managers are not motivated.

For „B? to become the success that all companies are striving to reach today, it has to avoid relying on historical performances or fix their employees performance on fixed budget to deliver the planned outcome, and if adopting any method of budgeting it should do so by designing it on a „bottom-up? basis. So, in a dynamic market a use of TBA would cause more problems to such companies. TBA is inaccurate for our company „B? where each year is very different to the previous one in terms of activities, cost, and market demand.

Here, I would suggest the use of the ZBB (Zero Based Budgeting) approach since the number of tourists change according to seasons and unexpected events worldwide, it will be beneficial to re evaluate all of the company? s activities from a zero base annually and respond to any condition changes within the environment each year. Thus, inefficient and inaccurate activities will be removed and any wasteful cost will be cut which means a better allocation of resources, also, this technique promotes the bottom-up of budgeting which will automatically lead to bring up the motivation of employees.

Nevertheless, the weakness of this method is that each pound spent must be justified, and if we have a big company which held too many activities, using a ZBB will generates more work that is hard to managed, and because decisions are made at the budget time, it will be difficult to react and deal with changes that might occur during the year, so here as a suggestion the company while performing the zero based budget may use a rolling budget every year. Furthermore, it will be challenging especially for private organisations that have indefinable activities and discretionary cost to be put into decision packages.

There were some argues about the traditional budgeting approach being as a barrier to change. For that Hope and Fraser (1997) suggested a new alternative process to budgeting which is termed as “Beyond budgeting approach”. They claimed that this approach will free people from the top-down performance contract and allows a use of knowledge and best allocation of resources to satisfy customers and beat competitors. This alternative way of budgeting is about the development of leadership principles and help decision making to be made.

The thing about it is that this model does not lead to change in some parts but require a systems transformation. (Refer to appendix, figure: 2 for a budgeting and beyond budgeting model). However, even with this model that will break managers free from the annual performance of budgeting, it has a disadvantage that it underpinned their organisation? s performance transformation. To alleviate all those limitations, companies must seek for alternatives approaches that combines and put in practice the benefits of each approach without forgetting to give priority to employees and managers? otivation, the human aspect behavior plays a crucial part in every business because success of any company nowadays rely on its number one asset which is the human labor (knowledge, know-how, expertise, experience….. etc. ). Section 2: Working Capital: Nowadays, the market requires companies to diversify its products and services within a short time delivery, so, companies are striving to keep on track with global markets? need and competition from other rivals in order to meet the customers? expectations and satisfy their needs. For that, companies will have to focus its resources and potentials to create the business? value, satisfy the shareholders and balance between its liquidity and profitability, this will be through improving all forms of cash flow and increasing their working capital productivity. In an article from (tutor2u, accessed 2011) working capital is: “The period of time which elapses between the point at which cash begins to be expended on the production of a product and the collection of cash from a customer” (Refer to appendix, figure. 3 for working capital cycle) Working capital is the concern of all firms; it is defined as the current assets minus the current liabilities (working capital = current assets – current liabilities).

While in the APC309 Workbook, (2008) it was said that: “Working capital required because the company has to pay for goods and services before recovering the money from customers, and represented by the difference between current assets and current liabilities. ” Company XYZ: a manufacturing business: Considering XYZ Limited, a medium sized manufacturing business. For such manufacturing businesses, XYZ needs to spend cash to purchase raw materials (inventories) and manufacture them. While waiting for the finished goods to be sold it needs to stock them.

After selling the goods it can incur some costs. And before receiving the revenue (cash) it waits for the cash receipts from the customers (accounts receivable) and can delay the payments to vendors (accounts payable). So, working capital is an important source of cash throughout the business cycle. (Refer to Appendix, figure. 4 for a diagram of the Working capital cycle in manufacturing firms). Improving XYZ’s working capital: Focusing on working capital will help XYZ? s manager to create lasting value, examine the organisation? productivity and efficiency, and XYZ will become stronger. Starting with the following formula: (working capital = current assets – current liabilities) to analyze the operating cycle of XYZ in order to improve its working capital. Liquidity assessment: cut-down the operating cycle. Shorten XYZ? s operating cycle and cash holding costs by maintaining a cash balance, this would be done through a trim of the stock on hand – the XYZ company however should pay attention not to be in short of stock which will affect it badly and will be unable to meet its customers? emand-, also, make a consignment of stock obtained, lowering the time needed to manufacture the goods and selling them, and a cut down of cost which will definitely increase their cash. Stock when necessary: reduce inventories. Inventory surplus is one of the ways to neglect any cash sources, so in order to boost cash flow; XYZ would better reduce production time and its inventories and lowering them to avoid over production. By a reduction in inventories meaning made a consignment of stock, managing the supply chain and varying the goods manufactures.

Also, to increase profitability, XYZ can benefit from cutting costs through this reduction in both inventories and warehouse space needed. Accounts receivable funding: get paid now. Until the customer pays XYZ, the sale is not considered as achieved. The working capital cycle must be completed or the company will regret making the sale if the customer went away without paying. So, XYZ should take into consideration terms of payments, invoices and well manage the cash.

Some ways to improve the cash will be speeding up cash collection, ameliorate the reduction of payment terms and collection processes, besides, a strong credit control and a rigorous collection procedures will help to positively improve profitability. While collecting past due cash, XYZ should secure favorable payment terms, obtain payments, approve new customers and maintain a good relationship with clients that pay on time while keep an eye and be careful from both doubtful and risky clients. Accounts payable: negotiating the best agreements possible. While dealing with suppliers, XYZ should rethink payment terms and avoid early payments.

Paying its suppliers before the due date is strongly unacceptable and better be avoided, and accomplished within or after the due date. Raising terms and procedures of payments, and optimizing discount is highly recommended. Seeking an increase in cash flow operation and the company? s profitability will be achieved by asking for longer credit terms from suppliers, and if possible take inventories on consignment. Other ways to improve working capital can be to consider leasing when thinking of purchasing equipments this will improve the amount of cash in short term only but can lead to additional costs in long term.

Also, consider outsourcing and benefit from price differences. And always negotiate and try to get discounts, besides there is the possibility of converting debtors? cash into factoring or utilizing a bank loan or overdraft. For a XYZ Limited to have working capital the current assets must exceed the current liabilities, it is managing the use of both current assets and current liabilities to improve the company? s short-term liquidity. There is a direct connection between working capital cycle and business performance.

Hence, the most important thing that? s needed to improve and have an efficient working capital cycle is not actually focusing on components of balance sheet that are: inventory, accounts receivable, and accounts payable but is the business cycle TIME that is measured from the time we identify the customer? s need, till we receive the payment of the finished product. Then, by reducing any necessary cash or inventory we will succeed to reduce our working capital cycle. Almost any business performance improvement effort influences the working capital (W.

C) cycle productivity of the business here talking about XYZ and will also affect other businesses that deals either directly or indirectly with it. For example if XYZ did not succeed in collecting cash from its clients it cannot be able to pay its suppliers and debtors and that will be bad since the relationship between them and XYZ will be sensitive so, that would build a miss trust and XYZ will find difficulties to be supplied or get credits this later will cause trouble because it will not have any raw materials and the business will then stop operating. Taking XYZ limited as a manufacturing business, any of the ways to improve its W.

C that was mentioned above will help cut down costs and boost overall working capital productivity by shrinking inventories and driving down accounts receivable. Also, the results behind paying suppliers before the due date would lead to reduction in working capital productivity. XYZ and should closely track its competitors? improvements to ensure that it is performing better. Furthermore, it can be useful to benchmark itself with regard to other industries for perceptions and opportunities to improve working capital productivity and cash flow. Benchmarking the performance of XYZ? system as a whole more accurately with regard to benchmark with other companies in the same sector would be of benefits. References: -APC309 Module Workbook, 2008. „Strategic Management Accounting Version 1. 0?. University of Sunderland. -Davies T. and Boczko T. , 2005. „Business Accounting And Finance. Second Edition.? Mc Graw Hill Education, p. 408. -Drury C. , (2001) „Management Accounting for Business Decisions. Second Edition.? Thomson Learning. -Gowthope C. , (2005) „Management Accounting for non specialists, 2nd Edition?. Thomson Learning, p. 148. -Hofstede G. H. , (1968) „The Game of Budget Control?.

Koninklijke Van Gorcum & Comp. N. V. , Assen, p. 20. -Hope J. and Fraser R. , (1997) „Beyond budgeting: breaking through the barrier to „The third wave??. Management Accounting, London. -Horngren Charles T. , Foster G. , Datar M. (2000) „Cost Accounting: A Managerial Emphasis, 10th edition?. Upper Saddle River (NJ). Prentice Hall, p. 178. -Lucey T. (1996) „Management Accounting, 4th Edition?. London: Letts, p. 108. -Maitland I. (2000) „Budgeting for Non-Financial Managers: how to Master and Maintain Effective Budgets?. London. Pearson Education, p. 1. -Satish B. M. (2002) „Working Capital Management and Control: Principles & Practice?.

New Age International (P) Limited, Publishers. Web sites: ? Behavioral Aspect of Budgeting: http://highered. mcgraw-hill. com/sites/dl/free/0074711717/57451/Budgeting_Ch09. pdf [Accessed the 25th February 2011] ? Better Budgeting: A report on the Better Budgeting forum from CIMA and ICAEW. (2004), Chartered Institute Of Management Accountants. P. 2-3 http://www. cimaglobal. com/Documents/ImportedDocuments/betterbudgeting_techrpt_2004. pdf [Accessed the 28th February 2011] ? The Beyond Budgeting Round Table (BBRT) www. bbrt. org [Accessed the 5th March 2011] ? Beyond budgeting http://www. juergendaum. com/bb. tm [Accessed 5th March 2011] ? Working capital cycle http://tutor2u. net/business/finance/workingcapital_cycle. htm [Accessed 20th March 2011] http://blog. maia-intelligence. com/2009/06/15/working-capital-management-and-bi-part-ii/ [Accessed 20th March 2011] Appendix: Source: Lucey, 1996, p. 108. Figure. 1: Outline of the budgetary process. Figure. 2: From traditional budgeting model to the emerging management model „beyond budgeting? Source: http://blog. maia-intelligence. com Figure. 3: Working capital cycle. Source: tutor2u. net [accessed 20th March 2011] Figure. 4: working capital cycle for a manufacturing firm

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