- Impact of incremental budgeting
The use of incremental budgeting is crucial since it operates under the premise of making minor changes in the original budget to arrive at the new budget (Hansen, Mowen, and Guan, 2007). The reliability of the budgeting process is dependent on the consistency of the method used and the ability to stick to the organizational plan. The incremental budgeting allows for slight adjustments of the budget to maintain consistency and reliability. The use of the incremental budgeting approach makes this possible by ensuring the continuity of funding to various departments without significant analysis or delays (Hansen et al., 2007). The incremental budgeting is vital and helps incorporate the notion of change and ensures the continuity of the business operations even when departments or production units exceed their budgeted amounts (Hansen et al., 2007). Additionally, the approach ensures that there are no significant deviations in the original budget since it only allows for gradual changes in budgeting.
- Impact of zero-base budgeting
Zero-based budgeting, as explained by Hansen et al. (2007), is an approach whereby the budget of the current year is prepared from scratch as opposed to incremental budgeting which makes adjustments to the previous budget. The old and new business activities are ranked based on their importance and allocated without taking into account the previous achievements and budget. The approach ensures that the organization has a fresh budget, and the allocation of resources is justified by the current year’s expenses (Hansen et al., 2007). This approach is ideal as it ensures the efficient and ideal allocation of resources as well as eliminating wasteful expenses since allocations are made after taking into account the associated risk and the cost benefit analysis (Hansen et al., 2007). Moreover, this approach encourages innovation, a necessary feature for the growth and future success of an organization. Moreover, the method allows an organization to integrate new goals into the budget and set new targets.
- Recommended budgeting approach
The growing competition demands a management technique that ensures efficiency, innovation and competitiveness of an organization. However, incremental budgeting approach does not offer any of this and relies on previous performance and techniques. The zero-base budgeting is ideal for organization in the current business environment that is characterized by uncertainties. Globalization, technological innovation, and increased competition has created an unstable business environment, and organizations are required to adopt agile management techniques so that they can respond to changing market conditions within the shortest time possible (Masood and Farooq, 2017). Zero-base budgeting allows for the development of a new budget each year depending on the prevailing market conditions, thereby incorporating flexibility and allowing for innovation due to implementation of new methods. As such, the zero-base budgeting technique should be implemented instead of incremental budgeting.
- Break-even Analysis
- Risk and return of manufacturing options
The concept of operational gearing refers to the impact of fixed costs on the correlation between the sales and operating profits (Abid and Mseddi, 2010). The fixed costs have a huge impact on an organization, and it is vital to examine how they affect an organization. The first option for Agnew Agricultural Ltd is in-house manufacturing. The organization will have to incur an additional £600,000 in manufacturing overheads when this option is employed. However, the variable entity will incur lower variable costs for producing its products in-house. This increases the risk of the organization due to the greater risk associated with in-house manufacturing, such as machine breakages, substandard materials, and employee inefficiency. However, the returns can be considerably higher due to the lower variable costs, which increases the profit margin with every increase in sales.
The second option entails the use of outsourcing manufacturing. The second option has higher variable costs and lower fixed costs compared to the first option. This means that the organization is exposed to lesser risks, and the returns are also smaller due to the higher variable costs, meaning an increase in sales will also result in higher expenditure compared to the in-house manufacturing option. The option with the high fixed costs tend to increase operational gearing, and in this case, the in-house manufacturing option (Abid and Mseddi, 2010). Equally important, the option that generates sales with low variable costs and a high gross margin generally high operating leverage. The high degree of operating leverage for in-house manufacturing (since it has low variable costs) underlines a greater danger from forecasting risk (Abid and Mseddi, 2010).
- Recommended manufacturing option
Although the outsourced manufacture option will have lesser risk, I recommend the first option (in-house manufacture due to the expected high returns. Since outsourcing will have greater variable costs, then it will ultimately have higher costs compared in-house manufacturing. Table 1 below indicates the actual return from both options in case sales increase by 20%.
Table 1: Profitability of the two options
| Increased sales by 20% | In-house manufacture (2,659 units) | Outsourced manufacture (2,874 units) |
| Sales (for | 7,977,000 | 8,622,000 |
| Variable | 6,222,060 | 7,587,360 |
| Fixed | 1,212,000 | 612,000 |
| Gross profit | 542,940 | 422,640 |
This indicates that the in-house manufacture is a better option despite the associated risks. Also, the sales for outsourced manufacture needs to be high to break-even or match profits from the in-house manufacture.
- Difference Between Net Cash Flows and Operating Profit
The net income/ operating profit depicts he profit earned by the entity while the net cash flow indicates the amount of money that go in and out of the organization on a daily basis. The net income of the entity is computed by factoring in the expenses (amortization, cost of sales, depreciation, taxes, interest, operational expenses) from the total revenue/ sales of the organization. The cash flow statement indicates the amount of cash or cash equivalents transacted each day. Notably, the net income is the first item on the cash flow statement. Notably, there are certain items that are incorporated differently on the income statement than on the cash flow statement.
The income statement and the cash flow statement shows that some items, including non-cash expenses such as share-based compensation, amortization, and depreciation are included in the operating profit. However, these transactions/ items do not reduce the amount of cash generated by an organization for the specified duration. As such, the expenses from these items are included back into the cash flow statement. This results in a difference in the cash flow system as a result of the different accounting/ recording methods for the non-cash expenses. Furthermore, the operating profit statement and cash flow statement differ as a result of the time gap between actual sales and documentation of sales. The inventory turnover rate significantly affects the documentation of the actual payments. In case the consumers pay the invoiced amount before the next period, the situation is under control. However, there tends to be a significant difference between the operating profit and the cash flow statements when the payments are postponed further. If the situation persists, the annual financial statements will be characterized by low net income and cash flow.
- Original and Proposed Costing Methods
- Reason for apportionment bases (250)
The allocation and apportionment of expenses to cost centers requires the identification of production overhead expenses that have diverse service/ production cost centers. This is done through apportionment and allocation of overheads among the different departments. The choice of the bases of apportionment is complex since the the expense that is apportioned should be measurable using the basis used and there should be a correlation between the basis of apportionment and the expenses. This means that different allocations can be utilized, as is the case in Document 4. The different use of allocation basis in the manufacturing process have resulted in the difference in the overhead absorption rate.
During the original costing method, the cost of labor, machine value, and floor area are used as the basis for the allocation. These factors, particularly machine and floor area are fixed costs and do not vary with production capacity. However, the proposed costing method utilizes a different approach, including the number of workers. This approach is used where the expenditure is more dependent on the number of workers as opposed to the wage bill in terms of labor hours. This tends to lower the amount allocated compared to the use of fixed parameters such as the floor area.
- Appraisal of sales director’s view
The director’s view is accurate and justified since the absorption rate should be based on the production levels. Since the Large Machinery profit center has struggled to improve sales, then the production has been low as a result of the low demand. As such, the utilization of machine, direct/ indirect labor, human resources, and space is lower than the other profit centers. Equally important, costs such as machine depreciation, machine insurance, and indirect labor should be decreased due to the lower performance/ productivity of the profit center.
The costing method adopted should ensure the accurate allocation and apportionment of costs based on resource utilization. This is to help track the actual expenses incurred by each production line and determine the appropriate price of the products and expected profits. The proposed strategy appears to reflect the actual use of resources and factors of production for the large machinery. The reduction in the overheads means that the organization can lower the cost of the large machinery, thereby increasing sales and generating more revenue.
- Capital Investment Appraisal
- Advantages and disadvantages of capital investment appraisal approach
The Weldmaster option
The major benefit of the Weldmaster option is that it will increase efficiency through cost reduction. Furthermore, this option will require lower capital investment as opposed to the second option. The remaining capital can be directed to other organizational operations to boost production and efficiency.
The Weldmaster option is a risky approach since it offers a short-term impact. The firm will generate significant profits during the first year of implementing the new technology. However, the net profits will decline throughout the next five years, thus indicating the loss of efficiency and cost-saving ability.
The Solderking method
This approach will have a high rate of return for the organization at 14.6% compared to the cost of capital. The approach will help improve the production innovation, thereby affecting quality, sales, and profitability. Likewise, the greater efficiency will stimulate profitability across the five years. Furthermore, the future cash flow for this option will be considerably higher than that of the Weldmaster option.
Despite this advantage, the Solderking option will not be fully effective until the introduction of a number of new product lines in the next few years. The lifetime of both options is five years, and thus the additional investment in expanding new product lines is not viable considering the time limitation. Furthermore, Agnew Agricultural Ltd is unlikely to recoup its investment in case the Solderking is not implemented immediately considering the time limitation of the investment.
- Risk and return from the Weldmaster and Solderking Options
The greatest risk offered by the Weldmaster option is the longevity of the expected cost saving considering the gradual decline in profitability over the five years. Theoretically, the accounting rate of return is greater than the cost of capital. However, this may not be the case in case the option loses its ability to lower the cost of production and enhance efficiency after the first year. Notably, this approach will have an instant return since it will lower costs immediately after introduction. On the other hand, the second option offers a greater accounting rate of return as well as a steady increase in profits over the period under investigation. Also, the net present value will be considerably higher, thus indicating the viability of the option. However, the second option is risky since it will not have an immediate impact on the organization. Since both strategies are short-term decisions, they should have an immediate impact on the entity.
The Solderking option is the better option due to the higher profitability as well as higher net present value.
References
Abid, F.,and Mseddi, S. (2010). The impact of operating and financial leverages and intrinsic business risk on firm value. International Research Journal of Finance and Economics, 44, 129-142.
Hansen, H., Mowen, M., and Guan, L. (2007). Cost Management: Accounting and Control. Boston: Cengage Learning.
Masood, Z., and Farooq, S. (2017). The Benefits and Key Challenges of Agile Project Management under Recent Research Opportunities. International Research Journal of Management Sciences, 5, 20-28.