Managing Internal Cost and Controlling Finances
JET Task #2

Competition Bikes, Inc. Budget Process

Budgets are used for forecasting future business growth and outcomes. Providing a comparison between a forecasted budget with previous year’s actual results allows leadership to strategize and plan for the company’s future on past performance. Producing a master budget roadmap for future operations may be done in two ways--by using fixed budget or flexible budgeting processes. There are advantages and disadvantages of each method of evaluation or projection of growth and it is recommended that the leadership of Competition Bikes, Inc, (CBI) consider all options presented to optimize future corporate growth.
The CEO of Competition Bikes, Inc. requested a review of current budgetary information (“Year 8”) projection for the upcoming business year. Areas of analysis and management intervention have been reviewed based on data provided by CBI. Competition Bikes, Inc.’s “Year 9” budget (pro forma) has been based on financial information provided based on a current trend analysis from three previous years and focusing on “Year 8” financials. A master budget was created to plan and control revenues and costs for future growth and corporate development for “Year 9.” The benefit to CBI leadership in reviewing “Year 9” financial plans allows for decision-making on planning, coordination of operations, and benchmarking for an evaluation of actual performance at the end of “Year 9.”
To review, a static budget does not change after it is developed, however, a flexible budget is one that summarizes revenues and costs from different volumes compared to similar ranges to like companies. Since a flexible budget is more complex and difficult to predict due to variances in costs compared to a fixed budget, it is necessary to answer questions when selling items with variable costs per unit, varying selling prices, and unpredictable volumes. (Horngen, C., Harrison, W., Oliver, S.)
Items for Concern in Budget Planning
Management at Competition Bikes, Inc. anticipates that the market will improve moderately during the upcoming year (“Year 9”) with no change in pricing expected for the upcoming year. Forecast in of the 3510 CarbonLite unit in “Year 9” included the sales of 3,423 units in “Year 9.” However current economic conditions makes this forecast optimistic as most bike racers using CBI’s top racing model are professional riders that had cutbacks on funding levels from their sponsors.
Although the CarbonLite brand is the top-selling model for CBI, technology and competitors are consistently closing the industry sales gap with new manufacturing designs and frame compositions to improve performance and decrease costs. This will represent a concern for CBI Research and Development Team to remain innovative with materials, manufacturing costs, and labor issues related to developing new products for competitive racing enthusiasts.
Monitoring (costs of) goods sold based on inventory is a focus for CBI’s future budgeting. Although it is important to have the most cost-effective bids for materials, having quality raw materials for production is imperative to remain competitive in the industry. Maintaining the balance between cost-effectiveness and quality products is a focus of concern for Competition Bikes, Inc.
An area of concern is also the relationship between manufacturing and accounting. Currently, there is a delay in the final product delivered to monies received of at least a month based the CBI storyline. Costs to CBI include expenses accrued with the bidding process for goods, purchase order process, and used parts inventory which is evaluated monthly. If there is any additional delay (regardless of reason) in the process between manufacturing and AP/AR, the ability to focus on growth in R&D, marketing/sales, or dividends to investors is diminished.
Since bikes are made ‘to-order” based on specific measurements for custom made products, ensuring inventory remaining current and cost-effective is crucial. CBI management must maintain (and improve on lean production processes) with no further excess of unused parts or delays in production without full understanding of the effects on the budget. Excessive inventory or any delay in manufacturing/shipping processes will cause a lag in revenues and the ability to manage accounts payable effectively. Flexible Budget and Variances
A general format for expressing any corporate budget is a flexible budget. Using this format, the accountant expresses the relationship between actual corporate activity and total budgeted overhead cost. This comparison allows for flexibility in market, costs/overhead, and changes in economy that would impact the sales prediction for an upcoming annual budget. This method allows for effective analysis of productivity for accountants, managers, and the administrative team to drive future endeavors or initiatives for corporate growth.
At the beginning of the fiscal “Year 9,” Competition Bikes, Inc. prepared a master budget based on previous sales volumes and costs. Variances were noted in the static budget and denoted as favorable or unfavorable. The following information was noted from the CBI budget proposal for “Year 9.” REVENUE | StandardOutput | ActualOutput | Variance Amount | Favorable/Unfavorable | UNITS | 3,510 | 3,423 | N/A | N/A | Net Sales | 5,247,450 | 5,117385 | (130,065) | U | Variable Costs | Direct Materials | 2,292,028 | 2,235,219 | (56,809) | F | Direct Labor | 1,053,000 | 1,026,900 | (26,100) | F | Manufacturing Overhead--Variable | 331,798 | 323,574 | (8,224) | F | Variable Selling Expenses | 157,424 | 153,522 | (3,902) | U | Advertising Expenses | 28,412 | 31,461 | 3,049 | U | Transportation Out | 105,300 | 108,297 | 2,997 | U | TOTAL VARIABLE COSTS | 3,967,962 | 3,878,973 | (88,989) | F | Contribution Margin | 1,279,488 | 1,238,412 | (41,076) | U | Fixed Manuf. Expenses | Depreciation | 150,000 | 150,000 | 0 | -- | Total Fixed Manuf. Expenses | 150,000 | 150,000 | 0 | -- | Fixed Selling Expenses | Website Creation and Maint. | 6,000 | 6,000 | 0 | -- | Dist. Network Contracted Supp. | 50,083 | 50,460 | (370) | F | Total Selling Expense | 56,830 | 56,830 | 0 | -- | Fixed Gen and Admin Expenses | Administrative Salaries | 170,000 | 171,000 | 1,000 | U | Executive Compensation | 220,000 | 218,000 | (2,000) | F | Employment Taxes | 29,835 | 29,758 | (77) | F | Utilities and Services | 150,000 | 148,223 | (1,777) | F | Research and Development | 85,861 | 82,841 | (3,020) | F | Depreciation Expense | 80,000 | 80,000 | 0 | -- | Other General and Admin Expenses | 170,000 | 172,000 | 2,000 | U | Other Utilities and Services | 54,000 | 53,500 | (500) | F | TOTAL Gen and Admin Expenses | 992,696 | 990,099 | (2597) | F | TOTAL Operating Expenses | 1,199,526 | 1,196,929 | (2597) | F | OPERATING INCOME | 79,962 | 41,484 | (38,478) | U |

Corrective Actions/Areas of Concern
Recommendations for corrective actions for areas of concern are based on the findings of the budget analysis and variances found in the previous table. The unsatisfactory findings include items that reveal a significant decrease in overall operating income (noting a -$38,478 variance in the budget). Variable costs are found with selling expenses and advertising expenses--as well as the contribution margin must be analyzed and addressed to improve overall financial outcomes in the upcoming year’s budget.
Strategies on how to increase overall sales of the product must be analyzed by management to understand the $130,065 variance. The variance in net sales based compared to projections may have various reasons reflecting issues in the competition bike market or the competitor’s pricing, product selection, customer service, and marketing/advertising strategies.
“Other” Administrative salaries and general/administrative costs reveal an area of concern increasing $3,000 (total) in the overall budgetary forecast. A line item review of the “Other General and Administrative Expenses” and “Administrative Salaries” is recommended (in light of the fact that actual Executive Compensation decreased), yet administrative costs have increased. The rationale for the variance may be related to utilization of increased support staff for executives—despite the fact that executive salaries are below budget and are viewed as favorable in the fixed budget analysis.
Corrective actions for leadership include review advertising costs through creative marketing strategies to promote sales. Such initiatives to consider would be providing improving exposure to improve sales through direct sponsorship of a professional racing team to attract top racers to be spokespersons for the product line. .A totally different strategy would be develop a lower-priced unit and focus marketing and advertising dollars to general consumers that are cycling enthusiasts who want to have a top end performance bike, but cannot afford the high end professional models current produced by Competition Bikes, Inc. This can be managed by redirecting funds to the top selling customer demographics (such as competitive racers or general consumers) to increase Net Sales.
“Transportation Out” expenses also need to be reviewed to determine where excessive spending may be curbed or deleted from the budget. Competition Bikes, Inc. internal documentation notes that bikes are delivered to the customer’s ordering location by a common carrier chosen for its reliability and superior handling of the product through a contractual agreement which ensures the safe delivery of the product to the final destination. However, due to energy costs, shipping insurance rates, and labor costs for the shipping company is potentially passed on to CBI in shipping rates. Re-evaluation of the contractual agreement for shipping to set a fixed rate per unit or shipping limit may reduce costs. Due diligence in evaluation of other carriers for delivery services must also be performed to determine if the same level of service can be offered through a different carrier for a lesser cost to decrease variable operating costs.
Cost of sales is an area for leadership to focus on for future budgetary planning. Although “Year 7” had the highest total selling expense, the majority of those costs were related to commissions and transportation. Compensation is an important part of employee satisfaction; however, if the compensation (in the form of commission) is overwhelming the ability for the company to grow, the commission structure may need to be re-evaluated. Commission costs at CBI were approximately 45% of CBI’s total selling expenses. CBI leadership may wish to consider decreasing the overall budget for commission or revise the current commission structure to continue to reward high performers and attempt to re-engage low performers to sell more units to receive optimal compensation. Increased sales is a win-win for both the corporation and the sales force receiving commission-based wages when prioritizing changes to areas of concern.
Accounting Concerns
Accounts Payable an area of concern for review. Each year the “Accounts and Notes Payable” portion of Current Liabilities has increased each year with an all-time high of 87% in “Year 8.” If this trend continues in “Year 9,” there will be less opportunity utilize assets for other expenses and corporate growth. Reviewing the accounting practices of CBI may provide an opportunity for improvement in payment practices in collaboration with the current billing structure. However, as Accounts Payable percentages have increased, Accounts Receivable percentages (of Current Assets) also increased in the data provided by CBI for analysis. “Year 8” Net Accounts Receivable was almost 39% of Current Assets of Competition Bikes, Inc. Continued progress and monitoring of incoming cash flows and monies received will allow for additional assets for growth for CBI.
Contribution Margin
Evaluation of the contribution margin (which is the amount of money contributed per unit divided by the selling price of each unit) allows for flexibility of the company to potentially raise or lower prices and maintain manufacturing overhead and other expenses. (Horngen, C., Harrison, W., Oliver, S.) Competition Bikes, Inc. noted a contribution margin variance of $41,076 which would indicate that an assessment of the unit price may need adjustment to meet budget.
Although Competition Bikes, Inc. had some unfavorable revenue variances, it also some very favorable variances that indicate positive effort in expense management. CBI was exceptionally successful in managing the fixed costs of materials, labor costs, research and development, and the variability of overhead costs. Other modest favorable variances assisted in savings such as executive compensation, utilities and services, and general/administrative expenses. The favorable findings of these noted items saved money for CBI in “Year 9 although an overall loss was experienced by the corporation.
Adjusting the contribution margin by increasing (the amount of money contributed per unit divided by the selling price) will allow more room for error when forecasting fixed and variable costs in future budget planning. It will also validate the rationale for adjusting the cost of the end product so that there is a positive contribution margin in line with industry standards.
Management by Exception (MBE)
“Management by Exception refers to the process where managers focus on the important information that indicates a significant deviation of actual results from the budgeted or planned results. Its objective is to facilitate management's focus on really important tactical and strategic tasks. In MBE, the decision that cannot be made at one level of management is passed on to the next higher level.”
(http://www.businessdictionary.com/definition/management-by-exception-MBE)
Management at Competition Bikes, Inc. must focus on both areas of concern for each category noted as “unfavorable” isolated in the tables below as well as improving the “favorable” variance items. Using MBE allows the leadership team of Competition Bikes, Inc. to focus on the areas of success and concern to provide efficient management of the company based on the findings and potential for future success.
Management by exception for “unfavorable” and “favorable” variances will allow for growth for the “Year 10” budget process which allows CBI to optimize profits that can be returned into growth strategies and returns to investors since it is traded on the Philadelphia Stock Exchange.
The following tables split the revenues into unfavorable as well as favorable for leadership to review and determine strategies for improving each area: REVENUE | StandardOutput | ActualOutput | Variance Amount | Favorable/Unfavorable | Net Sales | 5,247,450 | 5,117385 | (130,065) | U | Variable Selling Expenses | 157,424 | 153,522 | (3,902) | U | Advertising Expenses | 28,412 | 31,461 | 3,049 | U | Transportation Out | 105,300 | 108,297 | 2,997 | U | Contribution Margin | 1,279,488 | 1,238,412 | (41,076) | U | Administrative Salaries | 170,000 | 171,000 | 1,000 | U | Other General and Admin Expenses | 170,000 | 172,000 | 2,000 | U | OPERATING INCOME | 79,962 | 41,484 | (38,478) | U |

All recommendations for “areas of concern” and improvement must be considered by management to make Competition Bikes, Inc. optimally successful in the competitive market of racing bikes. Two of the most important areas for managing by exception must focus on Net Sales and the Contribution Margin to improve unfavorable findings. Adjusting these areas first will allow for the most significant improvement in overall company financial success for future operations. One of the most crucial considerations would include adjusting the price of each unit (bicycle) to allow for increased profit, yet not exclude the customer.
The Chief Executive Officer and CBI leadership must also consider delegating strategies for improvement in areas of concern to top managers over sales, marketing/advertising, accounting, and product distribution. These leaders must be brought into the planning and execution of meaningful changes to reverse unfavorable findings in CBI revenue. Reviewing all of the recommendations and examination of processes must be performed on all unfavorable areas of performance. REVENUE | StandardOutput | ActualOutput | Variance Amount | Favorable/Unfavorable | Direct Materials | 2,292,028 | 2,235,219 | (56,809) | F | Direct Labor | 1,053,000 | 1,026,900 | (26,100) | F | Manufacturing Overhead--Variable | 331,798 | 323,574 | (8,224) | F | Dist. Network Contracted Supp. | 50,083 | 50,460 | (370) | F | Executive Compensation | 220,000 | 218,000 | (2,000) | F | Employment Taxes | 29,835 | 29,758 | (77) | F | Utilities and Services | 150,000 | 148,223 | (1,777) | F | Research and Development | 85,861 | 82,841 | (3,020) | F | Other Utilities and Services | 54,000 | 53,500 | (500) | F | TOTAL Gen and Admin Expenses | 992,696 | 990,099 | (2597) | F | TOTAL Operating Expenses | 1,199,526 | 1,196,929 | (2597) | F | The recommendation for management by exception in areas that were found to be “favorable” must also be an area of focus for CBI leadership to continue growth and departmental performance improvements initiatives. Strategizing control on labor costs, direct material costs, manufacturing overhead, R&D, executive compensation, as well as the modest budgetary profits in utilities and services, must be part of the overall planning for the “Year 10” and future budgets at CBI.
It is imperative for CBI leadership to carry on engaging managers in successful areas (those with “favorable” findings in revenue analysis) to continue to optimize labor and manufacturing costs under a challenging economic environment and an international market which also will attempt to produce high-quality bikes with potentially less labor and material costs as long as there is a viable market for the product.
Competition Bikes, Inc. has been a successful company for the last nine years and must continue to perform self-evaluations of all aspects of production, marketing/sales, distribution, R&D, while maintaining costs of labor, overhead, support services to increase net sales and overall financial success.

References Horngen, C., Harrison, W., Oliver, S., (2009), Accounting 8e, Upper Saddle River, NJ: Prentice Hall. http://www.businessdictionary.com/definition/management-by-exception-MBE