Question A – PLEASE ANSWER ALL
- Calculate the budgeted profit after specific fixed costs, for year 1 of the re-cover operation, assuming demand can be met in full. (5 marks)
- Calculate the sales mix that will maximise budgeted profit for year 1 of the re-cover operation based on the limited availability of labour. (10 marks)
- Suggest two actions that the company could take to overcome the shortage of labour. (5 marks)
- Calculate the payback period for the re-cover project. (5 marks)
- Calculate the net present value for the re-cover project. (5 marks)
Question B
The Kalgan Driftwood Company has decided to that it needs to use the budgeting process much more substantially to manage its activities. You are a graduate trainee who has just started work in the accounting department of Kalgan. In your degree studies, you completed a module called Managerial Finance and learned that budgets serve a number of useful purposes including:
- Planning annual operations.
- Coordinating the activities of the various parts of the organisation;
- Communicating plans to the various responsibility centre managers.
- Motivating managers to strive to achieve the organisational goals.
- Controlling activities.
- Evaluating the performance of managers
You are asked to select four of these purposes and explain in a presentation to your Kalgan work colleagues about how budgets achieve these aims. Write an essay that will form the basis of your presentation.
Introduction:
This case revolves around the Kalgan Driftwood Company, which was established in the year 1950. The company has the reputation of building quality furniture at very affordable and reasonable prices from cast-off Jarrah wood. The company has recently started considering providing re-covers service to its customers for replacement cushions after the old ones wear out. The company has researched that its customers keep the furniture for an average period of 18 years. The new service of recovery will be offered in three standard sizes; large, small and medium size.
For the investment appraisal, the service is assumed to be a project for five years and the net cash flow every five years is shown below.
| Year | Net Cash Flows |
| 0 | -£ 140,000.00 |
| 1 | £ 23,240.00 |
| 2 | £ 45,780.00 |
| 3 | £ 54,320.00 |
| 4 | £ 54,320.00 |
| 5 | £ 54,320.00 |
The budgeted data for the units to be sold, its demand, variable and fixed costs have been provided for the first year for all three sizes.
| Large | Medium | Small | |
| Sales (units) | £ 2,300.00 | £ 1,500.00 | £ 2,800.00 |
| Selling Price per Unit | £ 112.00 | £ 84.00 | £ 56.00 |
| Direct Labor Cost per Unit | £ 12.60 | £ 8.40 | £ 6.30 |
| Fabric cost per unit | £ 44.80 | £ 32.20 | £ 21.00 |
| Contribution per unit | £ 54.60 | £ 43.40 | £ 28.70 |
The fixed costs of the operations include.
| Specific Fixed Costs | ||
| Factory Power Costs | £ 84,000.00 | per annum |
| Equipment of re-cover service lease | £ 70,000.00 | per annum |
(Armstrong, 2002)
The labor hours which are needed to produce each of the sizes of fabric for re-covering are shown in the case as.
| Time of Production | |||
| Recover Service | Large | Medium | Small |
| Time of Production | 0.60 | 0.40 | 0.25 |
(Asl, 2015)
The company only has a limited supply of labor hours for the re-cover service which is shown below. Other than this, the cost of capital is also provided.
| Year 1 | ||
| Supply of Skilled Labor | 2500 | hours |
| Cost of Capital | 10% | per annum |
(Azam, Boari, & Bertolotti, 2017)
Question A:
i-For the computation of the total profit for each of the size of re-covers is shown below.
| Large | Medium | Small | |
| Selling Price | £ 112.00 | £ 84.00 | £ 56.00 |
| Labor Price | £ 12.60 | £ 8.40 | £ 6.30 |
| Material Cost | £ 44.80 | £ 32.20 | £ 21.00 |
| Contribution | £ 54.60 | £ 43.40 | £ 28.70 |
| Demand | 2,300.00 | 1,500.00 | 2,800.00 |
| Total Contribution | £ 125,580.00 | £ 65,100.00 | £ 80,360.00 |
| £ 271,040.00 | |||
| Fixed Cost | £ 154,000.00 | ||
| Total Profit | £ 117,040.00 |
(Brigham & Houston, 2015)
ii-For the computation of the sales mix which will be most optimal for the company, firstly the contribution per labor hour is computed. Then accordingly, the three sizes are ranked as per the higher contribution margin (Capon, Farley, & Hulbert, 1994).
| Large | Medium | Small | |
| Selling Price | £ 112.00 | £ 84.00 | £ 56.00 |
| Variable Cost | £ 57.40 | £ 40.60 | £ 27.30 |
| Contribution | £ 54.60 | £ 43.40 | £ 28.70 |
| Labor Hours | 0.60 | 0.40 | 0.25 |
| Contribution per Labor Hours | £ 91.00 | £ 108.50 | £ 114.80 |
| Ranking | 3 | 2 | 1 |
(Chapman, Hopwood, & Shields, 2011)
The rankings have shown that small size is the most profitable among the three, whereas medium size is the second highest profitable and hence is ranked 2nd. As per the demand and labor hours the total labor hours needed is computed (Collis & Hussey, 2007).
| Demand | 2,300.00 | 1,500.00 | 2,800.00 |
| Labor Hours | 0.60 | 0.40 | 0.25 |
| Total Required | 1380 | 600 | 700 |
| 2680 | |||
| Total Labor Hours Available | 2500 |
(Debarshi, 2011)
As per the total hours needed and as per the ranks of the three sizes, the optimal product mix is shown below.
| Product Mix | Large | Medium | Small |
| Labor Hours | 1200 | 600 | 700 |
| Units to be Produced | 2000 | 1500 | 2800 |
| 2500 |
(Ullah, Khondoker, & Fahim, 2014)
As per the optimal product mix, small size is to be produced a maximum of 700 labor hours, medium at 600 labor hours and large size at 1200 labor hours. The units to be produced for each of the sizes is; 2800 as its demand for small size, 1500 as its demand for medium size, and 2000 for the large size that is lower than its demand (Pandey, 2015).
iii-The steps that should be taken to cover the shortage of labor can be;
a-The company can offer lucrative pay and benefits and compensation plans to make the job more desirable. In case it is experiencing any labor shortages then it can seek for the employees with higher skills through providing them with better benefits, and career growth opportunities (Gabcanova, 2011).
b-It can also make use of the outsourcing of the hiring of labor through the use of recruitment agencies.
iv-The payback period of the project is found to be 3.31 years (Griffin, 2016).
| Year | Net Cash Flows | Remaining Cash Flow after payment |
| 0 | -£ 140,000.00 | -£ 140,000.00 |
| 1 | £ 23,240.00 | -£ 116,760.00 |
| 2 | £ 45,780.00 | -£ 70,980.00 |
| 3 | £ 54,320.00 | -£ 16,660.00 |
| 4 | £ 54,320.00 | £ 37,660.00 |
| 5 | £ 54,320.00 | £ 91,980.00 |
(Holt & Hussey, 2012)
| Payback Period = | = 3+ | £ 0.31 |
| Payback Period = | £ 3.31 |
v-The Net Present Value of the project is positive with the value of £27,821.
| Year | Net Cash Flows |
| 0 | -£ 140,000.00 |
| 1 | £ 23,240.00 |
| 2 | £ 45,780.00 |
| 3 | £ 54,320.00 |
| 4 | £ 54,320.00 |
| 5 | £ 54,320.00 |
| NPV | £27,821.04 |
(Keown, 2002)
Question B:
1-Planning:
For any organization, the budget refers to the plan which is in a calculated numeric form setting out the course of action regarding a specific period. Regarding the planning of annual operations, the budget is intended to set out the direction for the company Kalgan Driftwood. The planning phase, including the budgeting, would ensure that the employees and management have definite goals which are aimed for the achievement of targets within a given time frame.
Having a formal plan ensures the promotion of a more coordinated take within the company and the planning process itself motivates and pushes all managers to think regarding the future aspects and plan and revise their actions accordingly. Regarding various variables for business which it can use to control includes human resources, financial resources, products, plant and equipment, production process, etc. It shows that a plan is devised around the variables which can be predicted and controlled (Hill & Jones, 2007).
It also certainly means that there would be some uncontrollable variables as well. These include variables like competitors, consumer spending, interest rates, and governmental regulations. Even though these are uncontrollable, these variables are to be taken into account as well.
Problems and possible barriers are to be predicted and given a solution beforehand by the management through the use of the planning process. Reduction in the rate of hasty decision making would be noticed. Budgeting not only shows the direction it also provides the opportunity to look for the areas which are consuming the most time, effort, and costs and tries to minimize its resource consumption. It directly impacts on the profit-making capability of the company.
2-Coordination:
Coordination is another major and important benefit of budget planning. If done effectively, the budgeting can bring various small plans of each department and manager in line with the overall objective of the company. Even though each department has different functions, the level of interdependence among the departments is essential for successful operations and budgeting aids in this coordination (Harzing & Pinnington, 2014).
One such example of coordination of different functions is the development of the production budget that is developed to plan the level of units to be produced. For its development, sales budget is needed, so it is directly dependent on the sales budget. Sales budget shows how many units are going to be sold, this, in turn, takes into account the expenses and costs which are taken from the manufacturing and administrative departments.
The need for coordination is more important because the plans are required to be revised as per the changes which are needed to be coordinated with the departments in time.
3-Communication:
Another area of importance for any organization is that of communication. Without communication, no plans can be successfully implemented, and no coordination can be done. A budget is needed to make the divisional leaders communicate as per the plans and provide projections to the management for consideration and review. Communication is so vital to the success of an organizational plan that the whole process becomes futile if the plans are not relayed effectively enough to persuade the managers to align with it. The implementation of the budget needs the managers to communicate at all levels. Line managers are, for example, needed to communicate with the staff and finance manager for the execution of the budget by communicating with middle managers. The results of the implemented plans or any deviations in the plan are also to be communicated to the parties concerned. The budget itself is considered a communication medium. It should be precise, clear, and very specific. The budget should not be communicated as numeric targets, but more as the medium to reach organizational goals.
4-Motivating Managers:
It is another important function which is essential for the organization. Budget motivates the managers to try to achieve the goals is important. It can be noted that the budget can be utilized as a tool for the motivation of the managers with more of a fiscal mind, making them think before taking any decision. It can be achieved through the inclusion of managers in the process development, implementation, and monitoring of the budget results.
Decisions are personal in nature to the individual who makes it. It makes the individuals more concerned with the nature of its decisions, and hence the motivation for making decisions aligned with the organizational goals makes it effective for the company and individual as well.
Conclusion:
In the end, it can be concluded that the case has shown the opportunities through which optimal product mix can be used for optimal profits and with the use of labor attracting strategies and management principles of planning, coordinating, and communication and motivating. By using these tactics, the company Kalgan Driftwood can make use of the re-cover service in a more effective manner. The utilization of the management principles will ensure its effective implementation.
References:
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Brigham, E. F., & Houston, J. F. (2015). Fundamentals of Financial Management. Cengage Learning.
Capon, N., Farley, J. U., & Hulbert, J. M. (1994). Strategic Planning and Financial Performance: More Evidence. Journal of Management Studies, 1(1), 105-110.
Chapman, C. S., Hopwood, A. G., & Shields, M. D. (2011). The Handbook of Management Accountin Research. Elsevier.
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Griffin, R. (2016). Fundamentals of Management. Cengage Learning.
Harzing, A.-W., & Pinnington, A. (2014). International Human Resource Management. Sage.
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