1.1 The purpose of this report is to research and analyse how organisations ensure financial stability and performance through planning tools used for budgetary control and how to prevent and solve financial problems making use of management accounting. The report will be structured in two parts. In the first one, a comparison of planning tools used in management accounting is carried out, while the second one consists of a comparison of different ways to apply management accounting to solve and prevent financial problems.
- BUDGETARY CONTROL
2.1 A budget is a document, usually presented in a report form, that represents an amount of money allocated for a determined purpose in a set period. It is considered a tool used by organisations or individuals to plan strategies, forecast financial results and financial position, and to measure the organisation’s performance, and it can include volume of sales, revenue, resources, assets, liabilities, costs, expenses, and cash flows. A master budget consists of a summary of the entire budget document (Bragg, S., 2019).
- COMPARISION OF PLANNING TOOLS
3.1 Types of budgets
3.1.1 Fixed budget: is based on a fixed level of activity and is designed to remain unmodified (Levinson, C., 2018). This type of budget can be inaccurate since it assumes there is no change between periods. However, it provides stability because of its fixed nature and increases the level of savings since any irregular income is not considered for spending.
3.1.2 Flexible budget: is based on a determined production level and is designed to be modified depending on the level of activity (Levinson, C., 2018). This type of budget is more accurate because it includes changes between periods. However, it can be confusing and can be easily broken.
3.1.3 Incremental budget: is based on the previous year’s budget adding an increment and is designed to allocate funds to different activities (Levinson, C., 2018).
3.1.4 Zero-based budget: is based in current activities/projects, excluding old ones, and is designed to plan and monitor activities and costs during the budget period (Levinson, C., 2018).
3.2 Budgeting methods
3.2.1 Production volume budget: is based on the stock levels of finished goods at the beginning and at the end of a period as well as the sales volume. This budget is used to calculate the number of units that must be produced.
3.2.2 Raw material purchasing budget: is based on the stock levels and usage of raw materials. It is used to plan the amount of raw materials necessary to meet budgeted production.
3.2.3 Cost of sales budget: is based on the stock levels and the cost of production. It is used to calculate the gross margin.
3.2.4 Cash receipts budget: is based on the amount of income planned to be received on a period, considering cash payments and credit payments. It is used to control the cash balance.
3.2.5 Cash payments budget: is based on the amount of expenses planned to be paid on a period, considering purchases as well as opening and closing creditors. Like the cash receipts budget, the cash payments budget is used to control the cash balance and predict the company’s cash position in future periods.
3.2.6 Master budget: is based on the opening balance of the period, the planned cash receipts, and cash payments, which equals the closing balance. This budget is used to manage the cash flow position.
3.3 Depending on the purpose of the budget, the accountant, or the person responsible for the budget can use one type of another, depending on its suitability for the purpose. For example, the fixed budget is usually used for short-term controls because it assumes there is no change between periods and it could be wrong if used for long term controls, while the flexible budget can be used for long-term controls since it includes any possible variations.
3.4 Advantages and disadvantages of different types of planning tools
Fixed budget – Provides stability
- Increases the level of savings
- Easier planning
- Prevents from overspending
(Montoya, 2020) – Reduced flexibility
- Is not adjusted to changes
- Does not adapt to the constantly changing business world
Flexible budget – Includes adjustments and changes between periods
- Includes irregular earnings
- Reduces stress levels due to its flexibility
(Wroblewski, 2018) – Can be confusing
- Is easy to break
- Does not follow the same program every period
Incremental budget – Is simple and easy to produce
- Ensures operational and funding stability
- Avoids competition among departments
(Yvanovich, 2019) – Can lead to unnecessary spending
- Reduces innovation
- Does not consider changes and external factors
- Does not provide incentives
- EFFECTIVENESS OF MANAGEMENT ACCOUNTING
Management accounting consists of gather, analyse, and provide financial information to a business to enable the management team to organise and develop the company, and it can be adapted to respond to financial problems through different techniques. The most common ways to do so is through key performance indicators (KPIs) and variance analysis. These techniques will be defined and evaluated below.
4.1 Key Performance Indicators (KPIs):
KPIs are relevant indicators of progression towards a desired result, which consists of a range of markers used by companies to measure performance, which enables organisations to improve operations and strategies and supports the decision-making process (KPI.org, 2020). In terms of financial performance, some examples of KPIs that can be used to solve problems are the following:
4.1.1 Gross profit margin:
Indicates the amount of revenue that is profit after deducting expenses. For an organisation to financially succeed, the gross profit margin must be of a minimum of 10%. Therefore, it can be used as an indicator of financial success. If the gross profit margin is below 10%, indicates that the company must respond by increasing revenue or decreasing expenses (Gerber, 2015).
4.1.2 Net profit
Indicates the amount of cash available after deducting expenses. Net profit must be always positive to avoid losses. If the net profit is too low, the organisation must respond to this financial problem through increasing sales or decreasing expenses (Gerber, 2015).
4.1.3 Net profit margin
Indicates the percentage of profit received from the revenue. It can be used to set objectives and calculate profitability. Net profit margin can be compared with the gross profit margin to analyse the company’s profitability. If the net profit margin is too low, the company must respond to this financial problem through eliminating costs (Gerber, 2015).
4.1.4 Aging accounts receivable
Indicates the customer invoices that have not been paid. It can be used to identify the cause of cash flow problems. If the aging accounts receivable is too high, the company must respond to this financial problem by start charging interests or avoiding slow-paying customers (Gerber, 2015).
4.1.5 Current ratio
Indicates company’s liquidity and is used to identify the availability of cash. If the current ratio is less than 1% it informs of a lack of cash which will lead on unpaid bills. Therefore, the company must avoid having less than 1.5% of current ratio by continuously controlling this KPI to be able to respond in advance (Gerber, 2015).
4.1.6 Quick ratio
Like the current ratio, the quick ratio indicates the company’s liquidity. However, unlike the current ratio, the quick ratio informs about the ability of the company to pay short term liabilities, while the current ratio informs about the ability of a company to pay long term liabilities (Gerber, 2015).
4.1.7 Customer acquisition ratio
Indicates the amount of revenue received for each new customer by analysing the frequency of purchase and deducting the cost of customer acquisition. If the customer acquisition ratio is less than 1%, the company must respond to this financial problem by reducing the cost of acquisition, for example, through marketing campaigns (Gerber, 2015).
4.1.8 Return on investment (ROI)
Indicates the amount of investment that is returned in profit form, which means the profitability of each investment. If the ROI is less than 5%, the organisation must respond to this financial problem by evaluating the relocation of financial resources (Gerber, 2015).
4.2 Variance analysis
4.2.1 Variance analysis consists of analysing the difference between the forecasted numbers and the real results, which is called variance. It enables the organisation to identify its performance during a period. An example could be a comparison between the standard cost of raw materials and the actual costs of it. This technique enables organisations to identify any financial problems and solve them or even improve the company’s performance. There are two types of variances: materials, labour, and variable overhead, which consists of price and quantity variances, and fixed overhead, which includes variances in volume and budget.
5.1 Management accounting is the basis of the decision-making process. The leaders of the organisation focus on the information provided by accountants to analyse and evaluate the company’s performance and situation to be able to make right decisions. Therefore, management accounting is a relevant function of the business and it can lead organisations to sustainable success by analysing and reporting the environmental and social factors that impact on the company’s performance to increment financial and commercial benefits.
5.2 Management accountants can lead their organisation towards sustainable success through the identification of environmental and social trends that influence on the creation of value, the relation between sustainable challenges and the organisation’s strategy and business model, the analysis of the impact of these sustainable challenges to the company, the development of KPIs that support strategic goals, the application of tools and techniques to introduce sustainability issues in the decision-making process, the report of information regarding sustainability impact to make right decisions in terms of budgets, prices, investments and planning, and the development of a strategy that includes financial and non-financial information (CGMA.org, 2014)
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