Question

The executives at Stark Inc., a plumbing supply manufacturer, recently reviewed production capacity for the upcoming year and set production budgets. Based on the number of units that they expected to produce, they budgeted sales and set sales targets for each of their retail locations. They did not ask for the input of the individual store managers as they believed that they had sufficient information and they wanted to ensure that the store targets were not easily attainable. When the actual sales numbers started to come in, they were much lower than the budget. In investigating the variance, the company found that one location had a new competitor that had just opened down the street, and another had significant road construction that impeded the traffic flow and cut down on customers. There were also some new products on the market that were cutting into the company’s market share. Because of the missed sales budget, the company had overproduced, resulting in excess inventory.

Required:

1. Explain the role of a sales budget in the development of the annual profit plan.
2. Identify four factors that should be considered when preparing a sales forecast.
3. Which two factors did management fail to consider in this scenario and what was the impact?
4. Discuss authoritative and participative budgets and identify which type is described in the scenario.
5. Identify and describe two best practice guidelines for the budget process.
6. Identify and describe four characteristics that define a successful budgeting process.
7. Discuss the financial impact of excess inventory.

Answer 1

A. The role of sales budget is:-

1. To know the requirements of different resources.

2. Planning the acquisition of different resources from different sources.

3. To set a standard for the performance to which the actual performance can be compared.

4. To find out the reasons for the variations between the actual performance and standards.

B. Factors that should be consider while formulating the sales budget are :-

1The amount of resources a company possess.

2. The type of product and demand for the product in the market.

3. Availability of substitutes available on the market.

4. Research and development cost.

C. First factor which they didn't considered was of The competiton prevailing in the market as it was necessary before actually formulising the sales budget. The consequence of which is that the sales were not that up to the mark which the company thought it would be.

Second factor was that they didn't ask the managers of the stores about their selling capability or what are the factors influencing their sales of the products in the market. The consequence of that Is the products left unsold in the warehouses which leads to the wastage of resources.

D.

Authoritative budget refers to the budget which is prepared by the top management without the consultation with the different departmental heads.

Participative budget refers to that kind of budget in which the approval and suggestion of the lower level managers are taken into consideration . As they are more familiar with the ground reality.

Under this scenario authoritative budget has been prepared as no suggestions have been taken from the department managers.

E. Two best practices for budget can be:-

A. Taking suggestions from the different levels of managers before setting up the standards.

B. Research about the market and competitors.

F. Four characteristics that will define a successful budgeting process:-

A. Conducting a research of the possible change in the market scenario and knowing about the change in consumer behavior.

B. The availability of resources from different sources.

C. Knowing the strategy adopted by the competitors.

D. Liquidity position of the company.

G. Financial impact of excess inventory will lead to blockage of funds which will hamper the liquidity position of the company. Also if in the next year the taste and preference of the customer got changed it will make the goods incapable. The wear and tear of goods also impact the financial position of the company.