Master budgets and planning



Table of contents

Introduction3

Master Budget Slingshot Ltd3

Overheads Budget Slingshot Ltd4

Variance Analysis5

Comments on the Analysis6

Conclusion8

Reference:10

Master budgets and planning

Introduction

Slingshot Ltd manufactures hi tech screens for computer arcade games, laptop computers and specialist medical equipment. The senior managers are engineers who have attempted to use financial techniques to run the company efficiently.

The company uses cost plus pricing, averaging out the cost of all units of output and adding 15%

The managers have started to use variance analysis. The following is the master budget and the overheads budget in millions.

 

Master Budget Slingshot Ltd

 

                                                  Budget         Actual

 

Sales                                            230             200

Less

Direct Costs                                110            112

Gross Profit                                120              88

Less

Overheads                                    50              80

Net Profit                                     70                8

 

Overheads Budget Slingshot Ltd

 

                                                  Budget          Actual

 

Administration                                5                   8

Personnel                                       10                   9

Production                                     13                 18

Design                                            15                 18

Marketing                                        7                 27

 

The Board are considering the purchase of new computer aided manufacturing machinery. They need to choose between the following two machines. Both machines have a useful life of five years and a scrap value of zero.                              Machine A                  Machine D

 

Initial Cost                                                                     £40,000                        £50,000

 

Net Cash flow (income less running cost)

 

Year 1                                                                              £18,000                       £20,000

Year 2                                                                              £22,000                       £20,000

Year 3                                                                              £15,000                       £18,000

Year 4                                                                              £14,000                       £19,000

Year 5                                                                              £12,000                       £19,000

Variance Analysis

Variance is the amount by which the actual result differs from the budgeted figure. It is usually measured each month, by comparing the actual outcome with the budgeted one. It is important to note that variances are referred to as adverse or favourable - not positive or negative. A favourable variance is one which leads to higher than expected profit (revenue up or costs down). An adverse variance is one which reduces profit, such as costs being higher than the budgeted level.

The following table shows the variance analysis of Slingshots Master Budget:

Variable

Budget (million)

Actual (million)

Variance (million)

Sales (less)

230

200

30 Adverse

Direct Costs

110

112

  2 Adverse

Gross Profit (less)

120

  88

32 Adverse

Overheads

  50

  80

30 Adverse

Net Profit

  70

   8

62 Adverse

 

The following table shows the variance analysis of Slingshots Overheads Budget:

 

Variable

Budget (million)

Actual (million)

Variance (million)

Administration

   5

   8

  3 Adverse

Personnel

 10

   9

  1 Favourable

Production

 13

 18

  5 Adverse

Design

 15

 18 3 Adverse

Marketing

   7

 27

20 Adverse

 

Comments on the Analysis

Sales turnover had an adverse variance, a decrease of £30 million. This could have been as a result of a decline in total sales volume due to an increase in selling price per unit as a result of an increase in direct costs, thus, reducing total sales volume and in return reducing sales turnover.

There could also have been a reduction in consumer demand or a change in consumer tastes. The company may have also had a change in marketing strategy or faced increased competition. Seasonal variation could also have had an effect on total sales volume. As sales slipped below budget, management should have cut back on production plans.

Direct costs also had an adverse variance, an increase of £2 million. It's possible that there could have been changes in the quantity of direct materials purchased thus reducing the amount of discounts allowed or suppliers could have increased their selling ...