Financial performance management

Financial performance management

Introduction

Financial performance management refers to the corporate performance management system that helps in analysing the current performance of an organization and maximizing the revenue of the business. The current report will focus on the aspects of analysing financial decisions and demonstrating proficiency in control and budgeting process. The report will also focus on the aspects of costing and management accounting. The first task will focus on calculating the cost and provide a summary of the result for performance improvement in the business. It will also make use of standard costing methods as an important part of determining financial position and the discussion of zero based budgeting and incremental budgeting as essential tools of planning control and coordination.

Question 1

a) Calculate the cost (and hence the profit) per unit, absorbing all the overheads on the basis of labour hours.

b) Calculate the cost (and hence profit) per unit, absorbing the overheads using an Activity Based Costing approach.

Working notes:

c) Critically evaluate the results obtained from 1a and 1b above and discuss why you think one technique is better than the other.

The above analysis suggests that the Activity based costing is an effective method of analysing the cost and profitability of a business. It is a highly accurate and precise method of gaining the required result so that the overall business decision can be improved. The activity based costing provides a proper breakdown to the overall indirect cost of the business although its calculation is complex and hard to determine. The traditional costing method that is absorption through labour hour treats overhead cost as a single pool of indirect cost. It is stated that the method of ABC is costly to implement and difficult to understand. The difference in the two methods of costing is the complexity and accuracy of the method of calculation (Tanis and Özyapici, 2012).

The part (a) is calculated by the absorption of overheads that are based on the labour rates of the product. The labour hours is decided as per the hours consumed by each product that is the lip balm, gloss and lipstick. The profit is calculated by subtracting cost from the selling price of each product to identify relevant profits and loss of the business. It has been analysed that the loss in the lipstick business is -2.16 per unit, lip gloss profit is 3.23 per unit and the profit from the sale of lip balm is 1.05 per unit.

The part (b) calculation shows that the apportionment of the overhead cost is based on the relevant cost driver of the product. The total overhead has been divided by the amount of utilisation of the cost driver and the cost is then totalled and reduced from the selling price to ascertain profits. It has been analysed that the lipstick loss accounts to -0.55, loss of lip gloss is -27.13 and the profits of lip balm is 2.38. It is hence concluded that activity based costing is an effective method of identifying the actual position of the business.

d) Discuss how sensitivity analysis helps managers to cope with uncertainties.
Sensitivity analysis is an effective tool used by the business to make effective decisions. It helps in predicting the future outcome of a situation of a business in a case of situation turning against the predicted notions. It helps in identifying the dependency of an output on the input value thus improving the management of the business. Sensitivity analysis is an effective method of determining decisions for the future rather than devising solutions to the existing problems. This financial model supports in how target variables are impacted with a change in the other variables that are the input variables of the business (Borgonovo, 2017).

It is also known as the simulation analysis that helps in predicting the outcome of the decision in a certain range of variables. This method helps the manager to analyse the contribution of the inputs in the uncertainty of the outcomes. This analysis is essential as it helps in predicting the outcome if a decision turns out to be different from that of the competitors. This is an essential tool for the managers as it helps in predicting the reasons for smaller amounts of profit and variables that create an impact on the business profits. The managers in such situation determine the methods of managing risk in such a situation through engaging in the methods of sensitivity analysis.

Question 2

a) Calculate the following variances for the last month:

b) Discuss the problems with the current system of calculating and reporting variances for assessing the performance of the production manager.

Variance analysis is a part of standard costing method of accounting. In the current methods of calculation, the performance manager provides only the statistical information about the material price, usage and efficiency variance. There are no other details of any feedback or commentary on the calculation of the variance. This results in inadequate information that impacts the overall performance of the business. The production manager is not able to gain an insight on the qualitative information of the business.

The performance of production manager is not adequate and can lead to the problem of making decisions about a particular product line. This method of standard costing does not provide the deviation of result from actual to standard cost. The result of this method is limited to the skill and confidence of the person that is calculating the statistical information. The selection of a standard is a complex activity with which the deviation is to be measured. The performance of the production manager is deviated due to lack of proper information by the performance manager (Drury, 2013).

Question 3

Critically discussed why neither ZBB nor the IB provides the perfect toll for planning coordination and control.

Zero-based budgeting and its limitations

Zero based budgeting refers to the process of making budget from the bottom line. This budget does not take into consideration the previous budgetary outcomes; it starts with a zero value and provides justification for every future expense that is being indulged in by the business. The expenses are justified before adding them to the official budget of the business. The main advantage of this method is that all the expenses are justified and it is flexible. The zero based budgeting is a resource intensive method as every expense is deeply reviewed for its future, this takes long time and cost in allocation of right budget to right expense. The expenses are not able to justify the cost and time involved in this process (Pyhrr, 2012).

The managers have a lot of control on this method of budgeting and hence they can manipulate the information to gain more resources to their department. This brings a change in culture and improper management of the business activities. One of the major drawbacks of this method is that it is based on short term thinking as it is based on allocation of resources for the future and has no connection to the past expenses. For instance, low cost is allocated to the activities of research and development that might require higher allocation of expenses.

Incremental budgeting

Incremental budgeting is based on the traditional concept of preparing the budget based on the base as the actual performance or the current budget. The incremental amount is added to the new budget to determine the actual performance. This method provides the advantage of stability of funding, reduces internal rivalry and consistency in terms of operational stability. The drawbacks associated with this method is that there are unnecessary spending already increasing the cost of the business as the managers tend to spend all the money of the previous year budget to get hand over new cash. The budgeted figures are based on the performance and amounts of the previous year thus reducing the scope of innovation at work and financing of new activities (Ouassini, 2018).

This method of budgeting is not considered as a most important and appropriate tool as it lacks in conducting external research and considering these elements in the budget o the business. The budget is not responsive to the external changes and unanticipated factors of the business environment. The inability of the business towards adjusting to the external and internal situation leads to problematic limitation to the organization.

Justification

It has been analysed in the above part that both the methods of ZBB and IB have many advantages of being adopted in the workplace but the limitations makes it complicated to be implemented as a part of planning control and coordination. Budgeting is an essential method of controlling and managing the activities of a business. Budgeting is a complex activity as it requires the determination of quantity of the objectives. The two methods have their own disadvantage that disallows them to ensure transparency and effectiveness in decision making. It is hence stated that both the methods are not accurate as a tool of budgeting and there are certain limitations that needs to be managed in order to gain effective results (Van Schalkwyk, 2012).

Conclusion

The financial performance analysis is an effective tool that supports in improving the overall business performance. The current report provides an analysis of the activity based costing and absorption costing that are beneficial to the process of decision making in the business. These methods of costing have been devised to enhance the operations of a business and ensure smooth business functions. The methods of costing are although time and cost consuming and hence it is essential to make appropriate decisions.

References

Books and Journal

Borgonovo, E., 2017. Sensitivity analysis. An Introduction for the Management Scientist. International Series in Operations Research and Management Science. Cham, Switzerland: Springer.

Drury, C.M., 2013. Management and cost accounting. Springer.

Ouassini, I., 2018. An introduction to the concept of Incremental Budgeting and Beyond Budgeting. Available at SSRN 3140059.

Pyhrr, P.A., 2012. Zero?Based Budgeting. Handbook of Budgeting, pp.677-696.

Tanis, V.N. and Özyapici, H., 2012. The measurement and management of unused capacity in a time driven activity based costing system. Journal of Applied Management Accounting Research, 10(2), p.43.

Van Schalkwyk, A., 2012. Results based budgeting. IMFO: Official Journal of the Institute of Municipal Finance Officers, 12(3), pp.8-10.