Budget-Management Accounting and Decision Making Budget

20

Budget-ManagementAccounting and Decision Making

Budget

Needfor Budgetary Planning and the Limitations of Budgets

Uponsetting up of a business and ensuring it is operational, it is vitalto plan and properly manage the financial performance of thebusiness. Having a budgetary plan is an essential way to ensure thatthe business stays on track and course to achieve its mandate (Bland,&amp Rubin, 1997, p.27). This is no different a great need for ElDorado hotel in Menorca. First, budgetary planning allows the companyto have a comprehensive analysis of the manner in it wishes to spendits money in future period. Through budgetary planning the needs ofeach department in a business is catered for. Second, through thebudgetary planning companies like El Dorado are able to limit themuch amount they spend on certain specific operations. Through thebudget, there is expense account that ensures that capital is notused on unnecessary goods or the company does not overspend foreconomic resources that are used in the business (Bland &amp Rubin,1997, p.36). Additionally, budgetary plan ensure that a company setsup a financial roadmap for the operations. The companies are able toreview their past performances and budget variances that occur (Bland&amp Rubin, 1997, p. 49). Budgetary planning is also essential inthe business growth and expansion. The saved capital is used inidentification and funding of new business ideas and opportunities ofthe company.

Budgetingon the other hand has its limitations and the first one is that beingan approximate estimate, budgets are not able to be accuratelymeasured. The other limitation of budgeting is the concept ofover-budgeting. Over-budgeting means that the small expenses areblown out. Thus, the managers find themselves working on these smallitems with no space for delegation to juniors. Additionally,budgeting as a tool is used to hide inefficiencies in a system. Thisis done through boosting some expenditures and intentionallyoverlooking some essential items. Budgets are mainly made forlong-term purposes and achieving of quick results may prove to betricky as budgets are prepared for annual basis in several instances.Budgets are known to have psychological tendencies and thus restrictfreedom of action. People are obliged to achieve as stated and theymight not execute certain actions as they comprehend.

PreliminaryAnalysis over the Convenience of Expanding the Tennis Court Provision

Giventhat the guests who express interest in using tennis court rangebetween 20 to 30% of the room occupancy, this analysis will use 25%,the average. The guests interest for each month will be 30 guests inApril, 33 guests in May, 40 guests in June, 48 guests July, 49 guestsin August, and 47 guests in September. Assuming that each roomrequires usage of tennis per day for just an hour, it is inconvenientto expand from the calculations that arise. For two more tenniscourts, the company will require 400,000 euros yet the amount thatthe company gets from the existing 2 tennis is just 255,500 euros.However, the cost of managing both the existing courts translates to74,000 euros. The company will have to either borrow to meet thedemands of the many customers that it has. Further, this willinconvenience the company in its other operations.

Occupany

April

May

June

July

August

September

Occupancy

60%

65%

80%

96%

98%

95%

Av Percentage of Guest

25%

25%

25%

25%

25%

25%

Total No of Guests

200

200

200

200

200

200

Total Occupancy

30

32.5

40

48

49

47.5

Utilization of Tennis Court

April

May

June

July

August

September

Percentage Use

80%

85%

80%

100%

100%

100%

No of Guests

30

32.5

40

48

49

47.5

Actual No of Users

24

27.625

32

48

49

47.5

Cost (Euros)

40

40

40

40

40

40

Total Cost Per Month

960

1105

1280

1920

1960

1900

Total Paid(Euros)/day

9125

Total paid (euros)-6 months

255500

Total Cost of Maintanance

Cost (Description)

Total

%Fixed

% Variable

Supervision

15000

100%

0%

Administration

10000

100%

0%

Worker`s Wages

30000

20%

80%

Supplies

10000

80%

20%

Repairs

5000

20%

80%

Utilities

2000

50%

50%

Miscellaneous

2000

20%

80%

Total Cost

74000

CashBudget

Thetables below show cash budget prepared in excel file for the existingprovision and for the subsequent year. One assumption that is made isthat costs increase by 3% and revenue on the other hand increase by5%. The costs have been spread evenly over the six months. It isassumed that the opening cash balance is € 5,000.

Existing Provision

April

May

June

July

August

September

Cash Balance

5000

5000

5000

5000

5000

5000

Add Receipts

Collection From Customers

42583.33

42583.33

42583.33

42583.33

42583.33

42583.33

Total Cash Available

47583.33

47583.33

47583.33

47583.33

47583.33

47583.33

Less Disbursments

Supervision

2500

2500

2500

2500

2500

2500

Administration

1666.667

1666.667

1666.667

1666.667

1666.667

1666.667

Worker`s Wages

5000

5000

5000

5000

5000

5000

Supplies

1666.667

1666.667

1666.667

1666.667

1666.667

1666.667

Repairs

833.3333

833.3333

833.3333

833.3333

833.3333

833.3333

Utilities

333.3333

333.3333

333.3333

333.3333

333.3333

333.3333

Miscellaneous

333.3333

333.3333

333.3333

333.3333

333.3333

333.3333

Total Disbursments

12333.33

12333.33

12333.33

12333.33

12333.33

12333.33

Cash Surplus (Deficit)

35250

35250

35250

35250

35250

35250

Financing

Borrowing

0

0

0

0

0

0

Interest

0

0

0

0

0

0

Cash Balance

35250

35250

35250

35250

35250

35250

Next Year

April

May

June

July

August

September

Cash Balance

35250

35250

35250

35250

35250

35250

Add Receipts

Collection From Customers

44712.5

44712.5

44712.5

44712.5

44712.5

44712.5

Total Cash Available

79962.49

79962.49

79962.49

79962.49

79962.49

79962.49

Less Disbursments

Supervision

2500

2500

2500

2500

2500

2500

Administration

1716.667

1716.667

1716.667

1716.667

1716.667

1716.667

Worker`s Wages

5150

5150

5150

5150

5150

5150

Supplies

1716.667

1716.667

1716.667

1716.667

1716.667

1716.667

Repairs

858.3333

858.3333

858.3333

858.3333

858.3333

858.3333

Utilities

343.3333

343.3333

343.3333

343.3333

343.3333

343.3333

Miscellaneous

343.3333

343.3333

343.3333

343.3333

343.3333

343.3333

Total Disbursments

12628.33

12628.33

12628.33

12628.33

12628.33

12628.33

Cash Surplus (Deficit)

67334.16

67334.16

67334.16

67334.16

67334.16

67334.16

Financing

Borrowing

0

0

0

0

0

0

Interest

0

0

0

0

0

0

Cash Balance

67334.16

67334.16

67334.16

67334.16

67334.16

67334.16

d)Usage of Court

Fromthe table derived from excel sheet, the contribution per hour oftennis court usage sold is 9125 euros. In order for El Dorado toincrease their contributions, they need to increase the quantity ofgood they provide, that is, the number of tennis courts so that theymeet the demand. The company should make the good (tennis courts) tobe as elastic as possible. This is possible by ensuring a smallchange in price of tennis court while admitting double number ofguests for their services. The company can ensure that they reducecost of tennis per hour by a small percentage while increase thedemand by a large percentage. This works given that tennis court inthis context is just but a luxurious good. Assuming that El Doradohave equal competitors in the hotel industry offering the tenniscourt service, they have to ensure by all means that they are able tomeet the demand of their clients or else the customers can easilysubstitute them by seeking the services in other hotels.

BreakEven Point

Break-evenpoint refers to the point where the costs or expenses incurred equalsthe revenue generated. At this point there is no net loss or gain atall (Alhabeeb, 2012, p.12). In calculating the break-even point it isof great significance to note the variable costs, fixed costs and theprice of product (Alhabeeb, 2012, p. 13).

FixedCosts/Price – Variable Costs = Breakeven Point in Units

FirstYear

Cost (Description)

Fixed Cost

Variable Costs

Supervision

15000

0

Administration

10000

0

Worker`s Wages

6000

24000

Supplies

8000

2000

Repairs

1000

4000

Utilities

1000

1000

Miscellaneous

400

1600

Total Fixed Cost

41400

32600

Fifth Year

Cost (Description)

Fixed Cost

Variable Costs

Supervision

17389.11111

0

Administration

11592.74074

0

Worker`s Wages

6955.644446

27822.58

Supplies

9274.192594

2318.548

Repairs

1159.274074

4637.096

Utilities

1159.274074

1159.274

Miscellaneous

463.7096297

1854.839

Total Fixed Cost

47993.94668

37792.33

Priceof Tennis Court after 5 years= 51.05 Euros

BreakEven Point= FC/ p-v

WhereFC is Total fixed cost

Pis price per unit

VariableCost per Unit

47993.94668/(51.05-44.99048)

Break-evenpoint =7920.42054

Marginof Safety

Marginof safety is a concept that is used in sales especially in analysisof break-even to show the amount of sales that are way above thebreak-even point (Klarman, 1991, p.5). It is an indicator or apointer of the amount that the sales of the company would reduce tobefore the company starts making losses.

Marginof Safety = (Expected Sales)-(Break-even Sales) / (Expected Sales)

Marginof safety= 9125- 7920.42054/9125

Marginof safety (percentage of sales): 13.20 %

Marginof safety (amount of sales): 1,204.58

Methodsof Appraisal

PaybackMethod

Thismethod is considered as one of the simplest methods of appraising aninvestment. This method entails the measuring of how fast the returnsfrom investments are able to cover the investment costs (Lefley,1996, p.207). Upon calculation of payback period of a project by afirm, the project is decided whether to be adopted or not. If uponcalculation there is more than one project, then the one with theshortest payback period shall be selected and executed (Lefley, 1996,p. 209).

Costof Constructing Tennis Court = 200,000

TotalCost of Maintenance= 74,000

Gainsafter 1 year: 255,500

After2 years = 511,000

Hencethe Payback Period = 511,000/274,000

1.86years

Fromthis method, any investment with a short payback period ensures thatthere is fast cash inflow hence it is useful for budgeting method forthe firms that are considered poor. Additionally, it is easy tocompute (BEUCKELEER, REYNS, ROODHOOFT, 1992).

PaybackDiscounted Period Method

Thisis a capital budgeting procedure that is used to determine the levelof profitability of any project. The discounted payback periodprovides the number of years a project would take to break even fromthe time the first expenditures were made. The cash flows that areexpected in future are usually discounted to the time “zero”.Hence, different from payback method, this method brings thedimension of time value of money (Lefley, 1996, p. 214).

DiscountedCash Inflow =&nbspActual Cash Inflow/ (1 + i) n

CashFlow after two years= 511,000

PresentValue Factor= 0.9009

DiscountedCash Flow= Cash Flow*PV

=511,000*0.9009

=460,359.9

NetPresent Value

Thenet present value refers to the difference between the value of cashinflows and that of cash outflows (Feltham and Ohlson, 1995, p. 17).Usually, it is used when doing capital budgeting to analyze theprofits that accrue from a project or an investment. Having acapital of 7% and a growth of 5%, this is a good investment giventhat the payback period is expected to be 2 years. After two years,there are a lot of gains that shall have been made from the gainsowing to the growth of 5%.

SensitivityAnalysis

Sensitivityanalysis is a method that is used to determine the impact ofdifferent values of independent variable on a specific dependentvariable under certain group of assumptions (Saltelli, Chan, &ampScott, 2000, p.12). The technique is often used within certainprecincts that will rely on one or more input variables. The methodis significant in prediction of an outcome of a decision especiallyin situations that are seen to be different in comparison to the mainpredictions (Saltelli, Chan, &amp Scott, 2000, p.23)

Dropin demand by 10% and an increase in inflation by 2% from 3% to 5%will have negative effects on Net value present. The cash outflowsare likely to reduce thus affecting the difference by making it smallhence the company making little. This combined effect (reduction indemand and increase in inflation) has a negative impact on thepayback discounted period and payback period (Lefley, 1996, p.221).It will take a longer time for the investments or the company tobreak even.

Conclusion

Thepaper covers the essentials of setting up of a business and ensuringit is operational. Budgetary plan is given with a case study of ElDorado. The cash budget of the company is worked out. Variousaccounting methods have been explored to ensure proper decisionmaking in the investment such as net present value, sensitivityanalysis, payback discounted period, break-even point and the paybackperiod.

ReferenceList

Alhabeeb,M. J., 2012. Break‐EvenAnalysis. Mathematical Finance, 247-273.

BEUCKELEER,K. D., REYNS, C., &amp ROODHOOFT, F., 1992. Break even analysisunder price changes. Antwerpen, Centrum voor Bedrijfseconomie enBedrijfseconometrie, Universiteit Antwerpen.

Bland,R. L., &amp Rubin, I. S., 1997. Budgeting. International CityManagement Association (ICMA).

Feltham,G. A., and Ohlson, J. A., 1995. Valuation and clean surplusaccounting for operating and financial activities*. Contemporaryaccounting research, 11(2), 689-731.

Lefley,F., 1996. The payback method of investment appraisal: a review andsynthesis. International Journal of Production Economics, 44(3),207-224.

Klarman,S. A., 1991. Margin of Safety. New York, NY: HarperBusiness.

Saltelli,A., Chan, K., &amp Scott, E. M. (Eds.)., 2000. Sensitivity analysis(Vol. 1). New York: Wiley.