Sales Function and Budgeting Process - Essay Example

___________ ____________ ____November 2006 Eggsactly LTD The captioned company, under reference, is a small scale company which all along had a bankable project in hand. When it began its operations the project proposal had received ready approval of the financing banker and the requisite finance had been forthcoming smoothly. This project had an innovation at its heart which had a successful test run ,a commercial test production followed by a full scale product launch. The innovation is comprised in a machine that is able to produce perfectly boiled eggs. The company has a simple structure and small size. It has two departments viz. the sales department and the production department. Present scenario included the fact that the market had continued with the original enthusiasm exhibited in this machine and continued to demand more and more of such machines. However despite such a robust demand the company was not as profitable as expected due to certain cost considerations. There are two complimentary approaches to improve the profitability of the concern. One is to increase the funds position of the concern by inviting new capital into the company. This would automatically result in expansion of the production base of the company and hopefully, result in the spreading of most fixed costs on a higher production base thus improving the profits. Second approach is to follow careful budgeting process in the concern covering all of its operations. In fact budgeting process has been missing entirely at the concern with reported mismatches in sales forecast and resultant carrying over of the finished goods' inventories. Ideally the concern would benefit the most if the two approaches are taken in tandem as following second approach would not only help control the fixed costs but also the variable costs would be streamlined. In addition, the budgeting system proposed is likely to be responsibility linked budgeting system in which each executive would be assigned the key budgeted figures and be accountable and responsible for variations if significant. Sales Function Merely an over enthusiastic top executive is no guarantee to a successful sales function. This enthusiasm is, in part, attributable to the fact that the product to be sold is a successful product idea in its present form and features and is well accepted by the market and there is not much need to take up conscious advertising and media campaign. Due to this fact, while it is conceded that normal marketing strategy can be reduced to selling function in case of Eggsactly Ltd; even the vanilla sales function needs to be planned carefully and tied up with the production department. This can come through an integrated budgeting system where in the sales budget is linked and integrated with the production budget. The Sales manager would be accountable for key budgeted figures in the sales budget. The Sales Manager can, in turn, pass down, the accountability down the line to his sales executives, who may be assigned this accountability according to distribution of sales targets to them. As part of individual initiatives the Sales Manager must look into the aspect of high turnover in his department. Some staff retention incentives can be introduced which are linked with sales targets and accountability which would help reduce the high turnover of the staff in Sales department. After this entire budgeting process must be reckoned in all its possibilities for Eggsactly Ltd and end in he choice of the best alternative which suits contextual realities of the concern. Budgeting Process Budgets are drawn to assist in clarifying and attaining business objectives. These objectives can be varied but can be commonly listed as minimizing costs/controlling expenditures, increasing revenues, gaining a higher market share, improving spread/margins (through increased sales), etc. Therefore, a statement of identified objectives becomes important at the commencement of budgeting. Once these objectives have been set then the rest of the budget can fan out after a series of logical coordination. Subsequent to the statement of identified business objectives and determination of the budget period (say 1 week, 1 fortnight, 1 month, 1 year, etc), additional information need to be gathered in order to compile the budget. This information generally includes past and current performance data procured from profit and loss accounts, balance sheets and previous cash flow forecasts of the organization. In case of a new business peer studies can be important guide posts. To help new concerns, good amount of classified data is published by various industry associations. Irrespective of the context this information can then be used to identify probable sales in number of units and associated costs in the future. One approach to budgeting is to compile from scratch ignoring all previous historical data and current performance: this is termed as zero-based budgeting which can be risk prone and should be taken up by those who have very realistic estimates of strengths of their concern vis a' vis market demands. It is commonly observed that during the preparation of budgets certain figures are easier to state with confidence than others. For instance, costs fall in former category while predicting sales falls in the latter category. The obvious reason for this is the fact that sales are affected by several probable factors (e.g. increase or decrease in demand, level of competition, changes in consumption pattern,technology,fashions,fads etc);while costs are technically stated and determined by suppliers/government policies and remain relatively stable.However,these are to be stated preferably on some historical and comparable base. This paper would exhibit subsequently important functional budgets that follow from statement of sales and cost objectives; however two important points need emphasis in respect to the process of budgeting-one, ideally the budgeting should be grass root budgeting that is, not only should all the staff, including lowest rung, be involved in actual budgeting process by actively contributing to target setting but, two, the budgeting should also be accountable budgeting in the sense that maximum number of staff should be tied up in accountable positions vis a vis the targets they helped in setting up. While most budgeting is done on an annual time horizon and runs parallel to the financial year; it must be ensured that budgeting for the next financial year commences at least a quarter in advance of the commencement of the year. When budget are formed on an annual scale, it is better for the budget to be split into monthly statements to make the process more manageable and feasible to follow. Many concerns go as far as to budget on a 1-4 week cycle, but to be truly forward looking some time-cushion is necessary for requisite plan setting. Preferably budgeting should be done by specialists. It may be remembered that as concerns grow, the span of control of business owners/stakeholders reduces significantly. Budgeting perks up this span of control by setting up targets to increase profits and performance. In fact any concern is targeting its Return on Investment (ROI) through budgeting. Budgeting for your small business gives you control over your finances (Campbell, 2005).Consequently, budgeting enables thinking ahead in order to control the management of the concern. A model budgeting process is shown at Annexure A. Sales Budget Sales budget is normally the first of all budgets to be compiled. The reason for this is fairly straight forward viz.All other budgets would be based on this and limited by this budget. As an instance, Eggsactly Ltd is expecting (budgeting) the following sales revenue in the next three months. () November December January 07 Egg Boiling Machine 600000 600000 700000 The above figures are those of sales revenue which will need to be calculated by multiplying the expected number of unit sales by the selling price of the product. An important distinction can be brought about here you can either reckon sales revenue on current prices or factor in a degree of inflation; the latter budgeting would take care of inflation. Another important pricing issue would relate to an active interface with the production budget and Production Manager. Production Manager would have to certify and convince that all variable costs targets that he has built in his cost of productions have been streamlined from accountability point of view ,on the one hand, and from the point of view of production efficiency on the other. This factor is an important determinant in the Sales Manager deciding the price of the product for his budget. Order book of the business can be relied upon to ascertain future orders from existing customers to which a comfortable number of new customers with average orders can be added to get the sales in units. If trade terms afford credit to customers, it is important that all credit sales should be placed in the month of realization and not the month of sale. This example of goods sales can be extended easily to sale of a service. Production Budget For an organization offering services production budget is called an Operating Budget. The production budget is compiled with the objective that the business will meet the expected sales on an ongoing basis. This budget uses stock flow approach and is, therefore, compiled using unit numbers instead of financial figures. Depending upon the number of products/services offered by the concern the production budget is set up for each products/services. Illustration carried below assumes just one product i.e. Egg Boiling Machine: (No. of Units) November December January Opening Stock 2000 0 500 + Units Produced 2000 4000 4000 Less Units Sold* 4000 3500 3000 Closing Stock 0 500 1500 *It may be observed that units sold would correspond to the sales of Egg Boiling machines @ prices utilized in the Sales budget. Thus production budget is used to state the number of units to be manufactured (or procured from suppliers) so that demand can be met (as identified in the relative sales budget). This takes care of undulating stocks and demands as well-building in seasonality and other factors. Idea is not to tie up working capital finance in building up inventory that cannot be sold for long. As such finance is expensive. In case high demand, exceeding manufacturing capacity, is expected during certain month(s) then inventory needs to be built up from those months when utilization of plant is below par. For those concerns that have high demands through out it may be a signal to buy/hire more machinery/staff in that particular month to allow an increased capacity for production. It is evident that basing a production budget on sales budget and vice versa would make budgeting a consultative exercise with earmarked responsibilities both for the Sales and Production Managers. No longer can excess sales forecast or carried inventories be blamed on a person other than the one who was accountable in the budget. Materials Purchase Budget The Production Manager would have to prepare a Materials Purchase Budget and it would indicate the units of raw materials to be purchased, to support production, multiplied by their respective prices. Objective is to reduce the amounts indicated in these budgets by looking for cheap suppliers and bulk suppliers. This is needed in the present instance as cost of production appears to be high. Staff Budget The administrative function at Eggsactly Ltd would have to prepare a Staff budget to cover staffing needs for the budgeted period. This budget would state the number of staff required to carry on with the manufacturing, selling and administrative activities and places in monetary terms their salary bills, perks, bonuses, insurance, health, pension payments etc in staff cost budget. This budget also needs to weave into incentive schemes aimed at reducing high staff turnovers in the Sales and Production functions. Overheads Budget In manufacturing concerns overheads form a proportion of total expenditures. Overhead budgeting can be done either by allocating a fixed proportion to each line/product (preferably based on its overall contribution to business) or in one budget covering all overhead costs -item wise. Production appears to be a heavy overhead function for Eggsactly Ltd.Production manager should rationalize all overheads to the minimum and prepare this budget. Capital Expenditure Budget With the introduction of new capital in Eggsactly Ltd this budget would receive the prime attention. This budget would contribute directly to a revised sales budget as and when expected additional production capacities were expected to go online. Alternatively above additional production capacity may be required depending upon the sales budget with sales being enhanced in the months of additional production capacity becoming available. This additional capacity can be purchased or hired. Capital expenditure budget states the expenditures to be incurred on such capacity enhancement and maintenance. An illustrative master budget for Eggsactly Ltd May look like he example given below: _ _______________________________________________________________________ Table 3 -- A & A Pool Supply Company Final Budget, Year 4 Amount () Percent of sales Sales 523,063 100% Cost of goods 366,144 70% Gross profit margin 156,919 30% Operating expenses: Advertising 3,605 0.7% Depreciation 4,000 0.8% Insurance 2,900 0.6% Legal and accounting expenses 4,142 0.8% Office expenses 2,995 0.6% Rent 24,000 4.6% Repair & maintenance 437 0.1% Salaries 34,650 6.6% Telephone and utilities 6,683 1.3% Miscellaneous 8,507 1.6% Total operating expenses 91,919 17.6% Net profit 65,000 12.4% Source: Pinney Constance & Woelful Charles J.(1991). U.S. Budgeting For The Small Business.Small Business Administration. Financial Management Series. Uses of Budgets for Managers After an operational budgeted period has run through, it is very probable that budgeted figures will vary from those obtained actually at end of period. This may be caused due to calculation errors, changes in plan, or entirely due to external factors out of concern's control such as change in government policy, fashion &style changes etc. These differences are called variances. These variances are the most effective tool in following up on the budgets and throw up material for numerous business decisions.Therefore,upon first sighting variances should not be ignored but acted upon immediately, even if they are positive. These variances are calculated simply by: if the actual figure is more favorable than the budgeted figure, it is often reported with letters fav (favourable). Similarly, if the actual figure is worse than the budgeted figure, it is reported with letters adv (adverse). When we look at variances, we are trying to establish the difference between what has actually happened (what we did achieve) and what we thought should have happened, namely the original budget (what we should have achieved).(Newman,2002)Small variances (impacting cash flows in minor fashion) can be set aside. Such variances can occur invariably. For significant variances, affecting cash flows negatively, investigations should be carried out at once, else it may be too late and causes will snowball into sickness. When you are calculating your variances, take materiality into consideration. (Spafford, 2003) This would bring about causes, uncover responsibilities, and prevent recurrence through appropriate policy. . For instance, it may be found that overheads are shooting up in an unreported faulty machine which is also affecting output quality and sales. This may necessitate immediate managerial decisions on production lines and in markets (withdraw low quality output etc). If the variance is significantly favourable, investigation may lead to policy to profits in terms of making such factors regular. Thus variance analysis itself is an area rife with material for very effective managerial decisions. Recommendations Foremost recommendation is for the introduction of a responsibility linked integrated budgeting at the Eggsactly Ltd with responsibility running down to the last level of executives tied to their responsibilities and targets. Second recommendations pertains to sharp rationalization of production costs and overheads .These need to be studied and budgeted at their most rationalized and economical levels. Third recommendations pertains to formation of realistic sales budget which is based on past data and trends and not on optimism founded on unrealistic optimism. Fourth recommendation is for careful planning of capital expenditure budget ,built on rationalized overheads and production costs, for utilizing the new capital introduced in the business. Fifth recommendation is for a closely monitored variance analysis which leads to responsibility implications in respect of negative variances. Works Cited Campbell, Melody. (2005).Does my small business need a budget Retrieved on November 19, 2006 from http://articles.simplysearch4it.com/article/10246.html Pinney Constance & Woelful Charles J.(1991). U.S. Budgeting For The Small Business.Small Business Administration. Financial Management Series. Newman, Angela. (2002). Variance analysis. Retrieved on November 19, 2006 from http://www.accaglobal.com/publications/studentaccountant/256576 Spafford, George. (2003). The Power of Variance Analysis. Retrieved on November 19, 2006 from http://www.gantthead.com/article.cfmID=177431 Annexure A 1. Review last year's budget and prepare a list of changes needed in operations or the budgeting process based on differences between actual and projected amounts. 2. Calculate return on investment (ROI) for the last year. Determine a realistic ROI goal for the next year. 3. Estimate changes in expenses for the next year. 4. Calculate the revenues needed to meet the ROI goals and anticipated expenses. 5. Evaluate how attainable the revenue goals are. 6. Readjust expense and ROI projections so that revenue goals are achievable. 7. Monitor budget income and expense categories monthly, comparing actual to budgeted figures so that significant variances can be cared for immediately. Read More