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It is recommended that Jim Peterson use the following outline for the presentation to the board of directors at Midwest Ice Cream Company.
Outline for Presentation
? Identify the problem
? Analyse Figure 1 and Illustrations 1 – 3
? Commend the areas that did well
? Discuss the corrective actions to consider
? Make recommendations
? Conclude the presentation
The following case study provides Jim Peterson with all the necessary information to make a non-technical presentation to the board of directors.
Budgeting is a vital element of the management planning and control process. Budgeting is the process that translates corporate intentions into specific tasks, and identifies the resources needed by each manager to carry them out. In the process, budgeting enhances communication and co-ordination of different administrative units, facilitates decision-making, and provides a framework for monitoring and for performance evaluation.
All managers are responsible for preparing a budget. Since specific departments play important roles in improving various components of the balance sheet and the income statement, it is critical that they prepare their budgets in a responsible way.
Once budgets are in place it is necessary to analyse the difference between the actual and budgeted costs (variance). A variance analysis involves the decomposition of the variance into the individual factors that caused the variance. Managers need to be able to understand how to break down and analysis the variances; this helps them determine the proper corrective action.
The Midwest Ice Cream Company is doing many things wrong, and the mistakes they are making are being covered up by a poorly planned budget.
The overall variance at Midwest Ice Cream is $71,700F . This is considered a good variance because it means they made more money than their original budgeted figure. However, the breakdown of this variance shows quite a different picture, it seems that Midwest under-budgeted their sales forecast by 248,037 gallons of ice cream or $117,700F. This figure was slightly offset by the $(58,000)U operating variance which brings the total number to $71,700F.
When looking at variances it is possible to break them down into their specific areas. In the analysis of the Midwest Ice Cream Company the variances can be broken into three broad areas Sales, Operations and Sales Price/Operations. The following variance analysis lets managers understand why the variances occurred.
Sales – Refer to Appendix A
The overall sales variance is $117,700 this number on its own can be misleading that is why it is necessary to break it down into the specific areas. The sales variance can be dissected into three areas: industry volume, market share and sales mix.
Industry Volume $167,619F
Market Share $(55,259)U
Sales Mix $5,339F
Now that the specific variances have been identified it is easy to understand what corrective action needs to be taken. For example the market share is $(55,259)U, this means that the overall market share dropped from 50% to 49%.
Operation Expenses – Refer to Appendix D
The operation consists of expenses such as manufacturing, delivery, advertising, selling and administrative. The greatest variance within operations is the unfavourable manufacturing expense of $(99,000)U. This manufacturing variance can be broken into fixed and variable costs.
Variable Cost Variance $(59,100)
Fixed Cost Variance $(39,900)
The $(59,000) can be broken down into $(80,700)U due to price increase and $21,600F due favourable usage variance. The $(80,700)U price increase is most likely due to an unforeseen environmental change which Midwest probably has little control over. The detailed manufacturing variance analysis allows management the opportunity to make the proper corrective actions for 1974’s budget.
Operating – Refer to Appendix C
The operating variance can be found by subtracting the flexible budget income from the actual income. In the case of Midwest the operating variance is $(46,000)U, this unfavourable variance is mainly due to a decrease in sales. The operating variance can be broken down into Gross Margin and Fixed Costs.
Gross Margin $(22,100)
Fixed Costs $(23,900)
This operating variance is added to the income variance to give a final variance of $71,700F. The reason why the operating variance is $(46,000)U and not $(58,000)U is because there was a $12,000F variance in the Sales Price. This $12,000F is because there were more high margin flavours sold in 1973.
Marketing Mix – Refer to Appendix B
The mix concept gives you a breakdown of sales by product and enables you to see the influence each product has on the gross margin. This is a very important area of the business because it allows a manager to determine which products are stars and dogs. A good manager will constantly change the mix to support the products that best help the gross margin. In the case of Midwest the product mix variance shows there has been a large decrease in the sales of vanilla and chocolate and an increase in the sale of strawberry and cherry swirl. The break down of the market mix variances show the managers at Midwest what flavours are popular and what flavours are not selling well. Midwest might want to consider encouraging their salespeople to push the high margin flavours (Pecan Chip and Walnut), this would be an effective way to maximise the profits.
What areas deserve commendation for 1973 performance?
? Within Manufacturing – Flavouring, Additives and Other expenses were all below budget
? The Delivery, Selling and Administrative expenses were under-budget
? Management has established a good four step budgeting process
What corrective actions should Midwest consider?
? The sales forecast needs to be continuously updated to consider environmental factors such as weather, competition and the economy. Midwest is very lucky they did not run out of cash throughout the year, due to the increase in expenses.
? The market share went down 1%, which is equivalent to $55,259 in contribution margin. They should consider taking action to rectify this problem.
? The 1973 variance summary (Figure 1) should be used in the planning of next year’s budget.
? Within Manufacturing – The 1974 budget will need to account for price variances (e.i. sugar and milk)
? Midwest may consider changing their market mix more often to capitalise on high margin flavours, also they should establish a commission policy for salespeople to encourage them to sell high margin products.
? Finally Midwest should develop a formal control system to deal with fluctuations that occur throughout the year.
Budgeting is probably the most crucial part of corporate planning and control; it is the means by which planning efforts are translated into dollars.
It would be recommended that Midwest begin a Zero-base budgeting system. This system is based on the premise that every budget dollar requires justification. Unlike the traditional budget approach – whereby expenditures of the previous years are automatically incorporated into the new budget proposal, and only increments are scrutinised and subjected to debate – zero-base budgeting places all dollars, last years expenditures and new requests, on equal footing.
Also Midwest should maximise their flexible budget capabilities. This can be accomplished by doing weekly variance checks and adjusting the budget to suit the changing environmental conditions that were unforeseeable in the past (weather, economy, competition, technology). Doing this will give Midwest an appropriate profit figure long before the books are completed at month end. More importantly, this will give Midwest time to take corrective action on undesirable situations.
Budgeting is the process that translates corporate intentions into specific tasks, and identifies the resources needed by each manager to carry them out. To do this well requires effective communication, sound co-ordination, and a penetrating search to find new ways of improving efficiency at the operating level. Budgeting also establishes specific financial and operational boundaries (i.e., standards, targets, and ratios) for monitoring purposes. The budgeting process is very complicated and Midwest Ice Cream has done a reasonably good job for their first attempt.
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