|Planning, Development and Evaluation Stages of New Business|
Table of Contents
Costing the Product
Capital investment appraisal
Budgetary control system
Internet sources used:
Professional books used:
My prepared report is an action plan for the Ergo Ltd Company. This is a medium sized office furniture company which is based in the Central Scotland.
The report will be covering Planning, Developing and Evaluating Stages.
Development stage takes the major part in project structure. Firstly, during this stage the main financial analysis was prepared to cost the specially designed chair. The budgets for producing the product was made along with Income Statement and Statement of Financial Positions. Furthermore, the capital investment appraisal was calculated for the new CNC laser, as well as, budgetary control report. All this numerical data assists to make the right decision for viability and profitability of the new project. As it follows further investigation was consider for possible factors which would be related with developing new ergonomic chair, such as, taxation, inflation, and interest rates.
The provided case study was used to complete the calculations, as for the research, internet search was done, along with professional books. Firstly, was considered to find capital allowance and corporation tax rates at the current year which is 19% for the year starting the 1 of April 2017,2018 and 2019, and 18% for the year starting 1 April 2020 (please see Appendix 1).
This information was gathered to prepare the capital investment appraisal. The writing down capital allowance for the years 2017/18 to 2018/19 is 18% (please see Appendix 2).
Spotting the situation and reflect all aspects was decided to buy new equipment new CNC laser would be depreciated during the 10 years, it was considered to research the latest loan rate (please see Appendix 3).
The market research was done to consider consumers needs of new chairs, as there are a lot people who is working in the offices or at home and they possibly has back problems the market would have high demand.
Costing the Product
Absorption costing is currently used by the company which is identified as traditional costing system.
Capacity of the cost driver is the base for allocating manufacturing overheads for this type of costing. Overhead costs are allocated on pre-determined basis i.e. machine/labour hours. Due to its simplicity, absorption costing method is widely used. This method works well if costs units remains the same, however it is less suitable if the quantity of the cost units is differing. Therefore, using traditional costing system may lead to bad management decisions because some of the manufacturing costs are not included. In this case, the cost of one specially designed chair comes to £165.91 while using absorption costing. (please see appendix 4)
There is an alternative costing method identified as Activity Based Costing. This method is used to make sure that the cost drivers are identified, and overhead costs are allocated to specific cost objects. Indirect costs are allocated to cost pools based on activities instead of departments. Therefore, ABC system recognizes that a lot of indirect costs differ along with any changes that are not related to production volume itself. Identifying cost driver that results in a change of cost and allocating costs to cost pools based on the usage of cost driver, it can then be traced more accurately. (please see Appendix 5)
When comparing both of these methods, it can be seen that there is a difference between the costs. When using traditional costing the chair costs £165.91, where if the Activity Based Costing is used then the cost of chair comes to £172.63. This proves that while using traditional system, chair has been under costed by £6.72. The ABC has given more accurate cost, this would be helpful to prevent misleading decisions while costing the chair. As misleading information would affect the viability and profitability of the company. Please see table below.
Prepared functional budgets for the first year can be found in this report, as well as the Master budget of specially designed chair. Revenue, along with an estimate of all costs and resources over specific period (in this case 6 moths) is identified as a budget. Budget reflects an understanding of upcoming financial situation along with goals and objectives. In the process of preparation of these budgets it was found that the revenue demand is value budget factor that bounds most of the activities of Concept Ergo Ltd.
- Functional budgets:
First, the sales budget had to be prepared, it is showing that the company’s plan is to sell 1,800 units of specially designed chairs over 12 months, it is planned that the sale would result in a revenue of £175,500 (please see Appendix 6)
Next, outstanding budgets had to be linked to the sales budget. Production budget figures are shown in units and it includes finished goods inventory plus sales demand. (please see Appendix 7)
After that, Raw materials budget was done to consider all the materials that are required to create new product e.g. Memory foam, Fabric etc., these numbers are based on the sales demand. (please see Appendix 8)
Then Labour budget was prepared to find how much direct labour will costs to meet production target. This budget is the same as materials and the overhead budgets is based on batches. The total for six months the labour will cost £14,280.00 considering that cost per hour is £8.50 and 280 total hours per month worked, per 8 bathes. (please see Appendix 9)
The next functional budgets are the overheads budget. This budget is created from two parts: fixed and variable overheads and based on all manufacturing costs other than direct material and direct labour. (please see Appendix 10)
Production cost budget will include the total of material costs, total variable costs, fixed production overheads and labour costs. (please see Appendix 11)
- Master budgets:
When functional budgets are finished, master budget can be condensed.
The next two budgets are trade receivables and trade payables. It was assumed that Trade Receivables will have to pay 5% as cash and 95% as credit, and there is 1 month’s credit period.
The trade payable will be re-payed after 2 months of purchasing materials. This is the right decision as it follows that company will have more time and money to pay it back to creditors. (please see Appendix 12)
Cash budget was combined using Trade Receivables and Payables.
Variable overheads, fixed overhead costs, direct labour costs and the interest of borrowing along with the loan repayments will be paid monthly, following the month they will be incurred. (please see appendix 13)
After the cash budget was prepared, Income statement was done. The Income Statement gives an idea of possible profit the company would make if they produce the Multi – Level chairs. In this case, the net profit calculated is £16303.46. The information from income statement could be used by bank to analyse is company will be able to pay the interest in time, and by management to make the right decisions and awareness for possible profit or loss, also by possible investors or suppliers about company’s financial viability. (please see appendix 14)
At last, the statement of financial position had to be done which illustrates the total assets, and it balances with the total of equity and liabilities related to production. In this case, it was six months forecast which has included the new equipment purchase and the depreciation. Also, it contains the finished goods inventory and the all direct material inventory. It count’s the trade receivables with bank and cash equivalent. All this added up gave total assets which is at £181,433.46. After this the capital and reserves, non-current liabilities and current liabilities is written in and added. The amount of total equity and liabilities turns out same as total assets, so the totals should balance, as in this case did balanced. (please see Appendix 15)
Capital investment appraisal
The Capital Investment Appraisal is a planning process which is based by the company’s short or long-term investments. The factors for it is selected by priority of stakeholders and decision makers. Positive NPV of £804,206 is expected to be returned by this project by using a discount of 10% on cost of capital in a period of 10 years, this confirms that this is a long-term investment. The £145,000 initially invested will be fully recovered by the end of year XX. That is why this is a viable option. (please see Appendix 16)
It might be recommended to use an additional approach to reach better profits. Sub-contracting to another company may be considered to save on employing additional production staff. This would also mean that the company wold not incur any additional variable overhead costs to replace fixed costs and direct materials.
Alternatively, you could also lease out the equipment used for production. Which would result in decreased costs of equipment, and as a result, there would be no need to raise additional funds for the investment capital. This would lower the monthly payments and release cash. It is also possible that the leasing company will cover all the maintenance costs.
Budgetary control system
The process of comparison of budgeted figures and the actual results and calculation of the difference between the two is identified as variances, this is the main principle of budgetary control system. First stem in this process is the preparation of the budget. Decisions can only be made by managers after accurately looking into the variances, then managers can take any necessary action to correct adverse variances.
(Please note, the table below displays an example of actual figures, to show the differences.)
After creation of budgets, budgeted goals along with the actual performance should then be reviewed by the budget committees. If there are any arisen issues, they can be solved, this can be done by refining any operations that are under-performing. After all the issues are revised and solve, budget committee can support the approving of final budget, also budgeted goals for next year can then be made.
Usually, 4 centres are responsible for the budgetary control:
– Expense centres: they are dealing with all monetary inputs that can be measured, but the outputs are not taken into consideration.
– Revenue centre: it is dealing with monetary measured outputs, however it does not take into consideration any input costs.
– Investment centre: is dealing with comparison of the outputs against actual assets that are involved in production.
Profit centres: these measure the overall performance by consideration of the difference between inputs and outputs.
Budgetary control system is used quite often by companies because it is a very good in providing the foundation for appraisal of performance, it is also improving the allocation of scarce resources, and makes sure that managers are looking into the future goals.
By considering everything and taking into account all the results which was gathered from the financial analysis such as: project costing, completed budgets, budgetary control, and capital investment appraisal, it could be assumed that the whole project is profitable and viable. However, it is necessary to have an adequate budgetary control system in order to have better performance of the company. As it has a good opportunity to grow, the marketing department will have to give most influence into market research as the ergonomic chairs has high demand
As this project is financial viable and profitable, I would recommend going forward and invest in to new ergonomic chairs. Will also recommend setting up an effective budgetary control system, which will have to be appointed along with the budget officer. This also will require to arrange the meeting in order to discuss prepared budgets.
Internet sources used:
Professional books used:
- Drury, C. (2000). Managment Accounting for Business Decisions. International Thomson Business Press.
- Wood, F. (2015). Frank Wood’s Business Accounting Volume 1 13th edn. Pearson Education Limited.
- Wood’s, F. (2016). Business Accounting 2 (13th ed.). Perarson.
- Drury, C. (2015). Cost and Managment Accounting (8th ed.). Andrew Ashwin.
Appendix 1 – Corporation Tax Rates
Appendix 2 – WDA
Appendix 3 – Long term business loan
Appendix 4 – – Absorption Costing
Appendix 5 – Activity based costing
Appendix 6 – Sales Budget
Appendix 7 – Production Budget
Appendix 8 – Material Budgets
Appendix 9 – Labour Cost Budget
Appendix 10 – Overhead Budget
Appendix 11 – Production Budget
Appendix 12 – Trade Receivables and Trade Payables Budgets
Appendix 13 – Cash Budget
Appendix 14 – Income Statement
Appendix 15 – Statement of Financial Position
Appendix 16 – Capital Investment