Management by exception Essay
Management by exception
With the release of the new budget for year 9 from Competition Bikes, there are a couple of areas that are a concern that warrant being addressed. The first being the prediction of amount of bikes to be sold; Competition Bikes is expecting 3,510 units to be sold after a year 8 that sold only 3,400 units which was a 15% drop in sales from the year prior (which sold approximately 4,000 units) with zero drop in price point which may make it harder for customers to justify purchasing a bike in the current economy. Understandably, year 8 was in the middle of a recession and the economy could rebound for a productive year 9. However, with only an extra $984 being spent on advertisement, the expectations could fall short unless advertisement spending is increased to approximately the $2,000 range it was in year 7. Competition Bikes is putting themselves at risk for over ordering raw materials and a surplus of raw materials only takes up more storage space, which leads to extra money being spent for storage.
There is also an issue with General and Administration Expenses. General and Admin expenses is the same amount as it was in year 8 ($170,000). However, in year 7, Competition Bikes spent $12,000 less and sold 600 more units then it did in year 8. Year 7 was proof that Competition Bikes has the ability to produce and sell a successful amount of bikes without having an extremely high operational cost. That extra $12,000 could be spread into other aspects such as: advertising, factory maintenance and even bonuses.
A flexible budget is a budget that adjusts or flexes for changes in the volume of activity” (Averkamp, 2013). A flexible budget is more useful than a static budget because it is based on actual output. The difference between an actual output and a budgeted amount is known as a variance. When the amount of the actual result is higher than budgeted, it is considered favorable, whereas when the budgeted amount turns out higher is unfavorable.
Within the Competition Bikes flexible budget there are a few favorable variances, the first one of note being within Net Sales. The company had a budget of $5,247,250, with the flexible budget being $5,117,385, however the final numbers were $5,096,847, which gives the company an unfavorable variance of -$130,065. Total Variable Cost however was a favorable expense. With a planned budget of $3,967,962 and a flexible budget of $3,869,612 the actual output was $3,805,400 the favorable variance came out to $98,349. Contribution margin was also an unfavorable variance (-$31,716).
Advertising Expenses went over cost for an unfavorable variance of $3,754 from a standard budget of $28,412 and a flexible budget of $27,708. The extra money spent towards advertising may have been to help boost extra sales towards the end of the year. Transportation Out also went over its budget for an unfavorable variance by $5,607. However, there is more to the Transportation Out than what the budget says. The price of shipment is supposed to be $30 per unit and with 87 less units sold; there should be an extra $2,610 in the budget. This requires extra investigation.
In terms of corrective action, the best course is to focus on where the points where there were unfavorable variances. A key point to that would be to also create realistic predictions of sales and budget. By predicting a high sales goal (one that exceeds the amount of units sold the year prior), Competition Bikes is potentially setting itself up for another down year.
To prevent another unfavorable variance in Net Sales, which was affected by the unfavorable Actual Output of Units Sold. Although the projection output was missed by only 87 units, that totaled out to $130,065. It would behoove Competition Bikes to create realistic predictions (as stated above). Another idea would to be to examine the sales process. Compare and contrast what strategies were compared between the successful year 7 and the down year 8 to determine if any changes took place in the sales process and development. Competition Bikes should not have been as aggressive as they were following a down year. An improved variance here could also directly affect the Contribution Margin and Operating Income, which both were unfavorable.
Advertising Expenses should be increased to the level of year 7. Competition Bikes lowered their budget for advertising but yet ended up spending more anyway. With the economy still in a rut, the chances of hitting a high prediction is slim, especially with low advertising. Since fewer sponsors are using the products from Competition Bikes, it would be wise to advertise to a different market of users (i.e. college students, those who live in traffic congested cities (New York), bike cops, etc).
Meanwhile, the transportation unfavorable variance could be fixed by determining what the additional costs were. Since the transportation cost per units is $30, with sales prediction 87 less than projected, that is $2,610 that could have put transportation costs into favorable. The additional costs could be because of rising fuel prices, toll roads, raises for drivers, etc. Many avenues have to be explored in the future to save money on transportation (renegotiate contracts, new source of transportation, new transportation company, etc.)
“Management by exception is the practice of examining the financial and operational results of a business, and only bringing issues to the attention of management if results represent substantial differences from the budgeted or expected amount” (Steven Bragg, 2014). This practice can be effective as it leaves upper management with more serious issues. By utilizing accurate and up-to-date information, management can keep the budget on track and consistent with what was forecasted. One main target for Management By Exception is net sales. Breaking down the yearly goals into weekly or monthly targets will allow the company to better breakdown the trends and identify areas of need and growth. By monitoring the trend of sales, management can initiate discussions on how to improve sales and how to keep up with demand if sales are higher than expected.
Competition Bikes would be wise to make start/restart contract negotiations to maintain consistent material and labor costs. Spending variance on materials was favorable but labor was unfavorable. If the price of the materials or labor increase substantially overtime, the budget could become more expensive, costing the company more money.
Averkamp, Harold. “What is a flexible budget?.” Learn Accounting Online for Free. N.p., n.d. Web. 27 Feb. 2014. .
Bragg, Steven. “What is management by exception? – Questions & Answers – AccountingTools.” What is management by exception? – Questions & Answers – AccountingTools. N.p., 5 June 2013. Web. 28 Feb. 2014. .