Question

Assignment: Operating Budgeting

Scenario

Don Flowers, CEO of Burbage Manufacturing looked around the conference room as his management team chatted and settled in for the monthly meeting.

“Let’s get started,” Don said, “we have a lot to cover today, and frankly it’s not all good news.” The room fell quiet. Don continued, “As you know we recently experienced a cash shortage despite last quarter’s record sales. We can’t keep going back to the bank to borrow money to support operations. I am counting on each of you to figure out a way to keep this from happening in the future.”

Brian Mitchell, the newest member of the team raised his hand somewhat sheepishly. “Sir, perhaps if we looked at the Master Budget for last month we could begin to identify areas for improvement.”

Don looked to Alex, his CFO. “Well, Alex that’s your area of expertise and Brian’s suggestion makes sense. Let’s have a look at that Master Budget.”

Alex looked down at the desk and began shuffling through his paperwork. “Well Don, we don’t exactly have a Master Budget per se. I mean we have budgets for different areas within the company, but I really rely on the managers to know what they need to do in their areas.”

Terri, the production manager spoke up, “Hey, wait a minute Alex. You’re the CFO. I’m doing everything I can just to keep up with demand down there on the floor. I don’t have time to worry about that kind of thing. We had a press go down last week and I had an entire shift of down time. Besides, that’s your job, Alex.”

“You know she has a point there Alex. You are the CFO. I need Terri to put all of her time towards keeping the production line running smoothly,” Don said.

“Look, Don, Alex replied, “In January I asked everyone to send me their budgets for the year and the only thing I got was a sales budget from Peter with a note attached that asked for a pay increase for his account managers.”

Brian raised his hand to speak. “Well, I know I’m new here, but at my last company we had budgets for sales, finished goods, cash – pretty much everything was budgeted. It seemed to work pretty well, and everyone had a good grasp of where we were financially.”

Alex, the CFO gave Brian an icy stare.

Don turned to Alex. “Alex, I think this young man has a point. Is there some reason why we aren’t budgeting like he described?”

“Well”, Alex began, “It’s really complicated, Don. Marjorie in materials is short two people and she’s paying overtime to her remaining people just to meet supply requisitions from the shop floor. And then there’s the problem with the corporate office. Every time I turn around I am getting an invoice from them for some piece of office equipment or another. Last week I got a bill from some company that Jessica hired to water the plants. How am I supposed to keep track of all of this? And then ….”

Don raised his hand to cut Alex off. “Look, I know we are a complex organization – but the fact of the matter is that I can’t keep going to the bank every month, borrowing money to pay the suppliers. For heaven’s sake – we are a multi-million-dollar company.” By this time Don was red in the face and everyone around the table was showing an intense interest in the conference table. He continued, “What am I going to tell the shareholders at the annual meeting when we don’t have enough cash to pay a dividend – that Jessica spent their money on potted plants?”

“This is going to end, today. Brian, you seem like a smart young man. You are going to work with Alex and anyone else in this company to get us on board with establishing and using budgets to correct this situation,” Don explained. “Further, as for the rest of you -when Brian comes and asks you for information treat him as if it was me making the request. Understood?”

Everyone nodded their heads in agreement.

“Meeting adjourned,” Don declared.

Questions

1. Identify the problems that appear to exist in Burbage’s budgetary control system and explain how these problems are contributing to the company’s poor cash position.

2. Identify the budgets that Brian and Alex will need to create to resolve these issues, including the information that is needed to construct each budget.

3. Once you have identified the problems and necessary budgets, prepare a report for Don and the rest of the management team outlining your plan for establishing a budgetary control system, making certain to include how each component of the system will benefit the overall financial health of the company.

Answer 1

1.

Problems that appear in the Burbage's budgetary system are as follows-

• There is no defined standard work among the team because the CFO and production managers were fighting to understand the work distribution.
• The data flow in the organization is poor as the CFO does not know the consolidated data for the organization.
• The response rate in the organization seems very problematic and no one responded to the CFO with there data when it was asked.

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2.

Following are the budgets that Brian & Alex will need to prepare the Master budget for the organization-

• Fixed costs- The first thing is to identify the fixed costs in the organization (Ex: Construction costs, Machinery costs. etc)
• Variable costs- Once the identification of all the fixed costs is over, then they need to identify all the variable costs in the organization (Ex: Employee wages, Raw material costs)
• Total costs- Sum of fixed costs & variable costs gives the total costs for the organization to be run.
• Identify the sales & selling prices to generate a revenue report for the period.

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3.

To establish the budgetary control systems the following steps needs to be followed and the benefits of each step are maintained-

• Budgetary Objective- Defining the objective is an important step in the control system as it will help in understanding why and when we require budgetary control systems.
• Organization for budgetary control- identifying the people and standardizing the work for controlling the budget is the second step. It will prevent the duplication of works.
• The Budget center- This is the place where the budget is prepared. it may be a department or a combination of departments.
• Standard operating procedure- Having a standard operational procedure help ease the preparation of the budget.
• Review management- Once the budget is prepared, we should present them to a committee of a higher authority to review the entire thing to control the budget which will help in the future planning for controllers.
• Defined time period- Defining the time period for the budget preparation and the review mechanism will help in the systematic approach to the budget.
• Database- Having a database for historical budget and all the related aspects helps the team in proper control over the repeated mistakes in the costs.