February 21, 2013 For effective strategy implementation, ABC Ltd.

has been organized on product decentralization basis and each division is headed by GM (General Manager). GM is responsible for manufacturing, purchasing, finance and marketing activities for his divisional product group. Performance measurement is return on investment (ROI) of division. Annual budgets are given below for the year 2011 and 2012 as prepared by the company; also given are the actual figures for 2011. After going through the data given under all the heads, (a) Review 2011 performance on the basis of computation of various parameters (b)Suggest any revision for 2012 budget, and justify the same.

Account receivable Cash Inventory Fixed Assets Factory costs Marketing costs Freight Administrative expenses Sales

Budget 2011 2012 8.00 7.50 4.00 4.00 18.00 16.50 20.00 2.00 21.00 19.00 7.00 6.00 1.00 0.90 3.00 2.60 40.00 36.00

Actual 2011 8.50 2.00 21.50 20.00 17.00 3.00 0.80 3.20 34.00

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3 4

ABC Ltd. (Analysis of Variance and Preparing Next Budget) February 21, 2013 Method, steps and comments: Detailed steps are given below since this is the first problem; as you solve a few problems of this kind, the sequence of working will be obvious and very simple and quick. Arrange all the data to indicate Balance Sheet, P&L Statement. Relate important data to other existing data, such as: (i) inventory as number of months' factory expenses (please note that taking inventory as number of months' sales would also do; however, since we have factory costs available, which has a higher corelation with inventory, same has been taken) (ii)Accounts receivable as number of months' sales (iii) various costs as a % of sales Work out variance between Budget 2011 and Actual 2011 Work out Budget 2012 after taking into account the analysis of Budget 2011and Actual 2011, and also checking Budget 2012 as given Change the amount or basis of Company's 2012 Budget only when necessary. (i) Sales Budget 2011 was Rs. 40 crores and Actual 2011 was Rs. 34 crores ; this implies Sales Budget was either high or that the Div performed below the potential.Since we are not given the reason, we estimate the Sales Budget for 2012 as somewhere between Rs. 34 crores and Rs. 40 crores. The company has already estimated 2012 sales at Rs. 36 crores, hence the same has been retained. (ii)Likewise, factory costs should be between 50% to 52.50% of the Sales; the company has already estimated 2012 Budget at 52.78%; however, we may retain at 52.50% (level of earlier budget) (iii)Marketing costs were estimated at 18% of Sales, but Actual is only 9%. This means that the company has not fully utilised the Marketing Budgets, which could be a reason why Actual Sales have not achieved the Budget Sales for 2011 The company has provided a Marketing Budget of 17% of Sales as 2012 Budget. Since the company could achieve only 9% in 2011, an estmate at 10% has been taken (this is subjective). (iv) As in (ii) above, the Freight has been retained at 2.50% of Sales. (v) Administrative Expenses Budget for 2011 worked out to 7.5% of Sales and Actual was 9.41%. We have taken this ratio only to estimate the range of amount. Administrative Exp is normally a fixed expense and the Budget 2012 has been therefore estimated at a figure of Rs. 3.00 crores (same as 2011 Budget) rather than a % of Sales. (vi) Budget 2012 for Fixed Assets, as made by the Company (Rs. 2.00 crores), is wrong, since the existing Fixed Assets of Rs. 20 crores will be required for achieving Sales in 2012 of Rs. 36 crores. Hence, the 2012 Budget for Fixed Assets has been changed to Rs. 20 crores. (vii) Inventory as number of months of Factory Costs was estiamed at 10.29 for 2011 and the Actual was higher at 15.18. This implies that the company is engaging nearly 50% higher inventory than the estimated budget (15.18/10.29). Since it is not normally possible to suddenly reduce inventory, although there is need to do so, the 2012 Budget has been taken at 12 times (subjective). (viii)Accounts receivable Budget 2011 and Actual 2011 are 2.40 and 3.00 month's of Sales. The Budget for 2012 is provided at 2.70 month's Sales(subjective). (ix) Level of Cash has been retained at Rs. 4.00 crores in line with the Company's estimate. (x)Thus the 2012 Budget for Balance Sheet and P&L are formed.On this basis, the ROI/ROA works out to 18.82%.

5 Main comments on performance are that:

(i)Profit margin improved from 20.00% to 29.41%, but Asset turnover declined from 0.80 to 0.65. Nevertheless, overall ROA/ROI improved from 16.00% to 19.23%. 6 Main changes in Budget 2012 (as compared to Company 2012 estimates) are as follows: (i)Fixed Assets retained at Rs. 20 crores, instead of Rs. 2.00 crores given by the Company (ii) Inventory in nos of months of factory costs is 12.00 as against 10.42 given by the Company (iii) Accounts Rceivable in nos of months' sales is 2.70 as against 2.50 given by the company (ii)Marketing costs as % of Sales reduced from 16.67% to 10.00% (iii) with these change, ROI / ROA works out to 18.82% as against 25.00% given by the Company.

Adverse Variance : A Favourable Variance : F Division P (figs in Rs. crores) 2011 2012 Variance :Budget 2011& Actual2011 Budget 2012 as given F/ A Budget 2011 Relevant Actual 2011 Relevant Variance between Budget 2012 Relevant Ratios Ratios Actual 2011 and as given Ratios Budget 2011 Balance Sheet 1 Fixed Assets Current Assets: 2 Inventory (inventory as nos of months' factory costs) 3 Account receivable (accounts receivable as nos of months' sales) 4 Cash Current Assets Total Assets P&L Sales Factory costs Marketing costs Freight Administrative expenses Total Costs Divisional Profit ROA/ROI Working Details: Sales Month's sales 20.00 18.00 10.29 8.00 2.40 4.00 30.00 50.00 2.00 32.00 52.00 8.50 3.00 -2.00 2.00 2.00 F A A 4.00 28.00 30.00 20.00 21.50 15.18 0.50 A 7.50 2.50 0.00 3.50 A 2.00 16.50 10.42

Budget 2012 as revised Budget 2012 Relevant as revised Ratios

20.00 18.90 12.00 8.10 2.70 4.00 31.00 51.00

1 2 3 4 5

40.00 21.00 7.00 1.00 3.00 32.00 8.00 16.00% 40.00 3.33

52.50% 17.50% 2.50% 7.50% 80.00% 20.00%

34.00 17.00 3.00 0.80 3.20 24.00 10.00 19.23% 34.00 2.83

50.00% 8.82% 2.35% 9.41% 70.59% 29.41%

-6.00 -4.00 -4.00 -0.20 0.20 -8.00 2.00 3.23%

A F F F A F F F

36.00 19.00 6.00 0.90 2.60 28.50 7.50 25.00% 36.00 3.00

52.78% 16.67% 2.50% 7.22% 79.17% 20.83%

36.00 18.90 3.60 0.90 3.00 26.40 9.60 18.82% 36.00 3.00

52.50% 10.00% 2.50% 8.33% 73.33% 26.67%

Factory costs Month's Factory Costs Profit Margin (Profit/Sales) Asset Turnover (Sales/Total Assets) Return on Assets (Profit / Total Assets)

21.00 1.75 20.00% 0.80 16.00%

17.00 1.42 29.41% 0.65 19.23%

19.00 1.58 20.83% 1.20 25.00%

18.90 1.58 26.67% 0.71 18.82%