Budget Concerns

Budget Concerns

Competition Bikes Inc. (CBI) year 9 budget has several areas of concerns that should be addressed to reduce costs and free working capital. While some are endemic of larger, company-wide problems, others are simply poor budgeting.

Proper, accurate sales forecasting is an essential part of budget planning. CBI projected 3510 units to be sold in year 9 and used this number as the cornerstone for its budget. In year 8, CBI saw a significant 15% decrease in net sales. A drop that size would indicate a more conservative sales forecast should be used. While year 7 did see a large sales increase, with only the data available to use, it's possible it was an unusual year. Furthermore, considering the known economic slump, CBI was overly optimistic in future sales which lead to all variable costs being incorrectly budgeted. More concerning still is CBIs budget is not broken into quarters. Breaking the budget down would have allowed CBI to adjust as sales expectations did not meet reality.

CBI specifically states that bikes are made to order and under its production budget does not specify any target ending inventory. At the same time, the raw materials budget show a target ending inventory of 140 units. Considering all bikes are made on-demand, CBI should consider lowering its target ending inventory. The current inventory is approximately 50% of the expected number of units produced each month and is likely due to a poor purchasing system that doesn't allow a PO for projected monthly supplies to be sent until the first day of that month. This requires CBI to keep significant inventory on hand while new inventory for the month is in transit and further highlights the necessity of correcting the purchasing system.

Distribution network support is budgeted at $50,830 in year 9 which is exactly the same as actual year 8 costs, while units sold is expected to increase in year 9. While distribution network support is a fixed cost, it has varied year to year trending with sales and there is a reasonable expectation that it will continue to follow that trend and be higher in year 9 than year 8.

CBI budgets $150,000 for utilities in year 9, which is the same as in year 8. However, every year utilities had risen to some degree or another. While year 8 did show an uncharacteristically large increase compared to other years, it is still likely that CBIs utilities costs will increase some in year 9.

Another area of concern is CBIs operating income. In year 8, CBI has $97,533 in operating income on 3400 units of sales while the year 9 budget shows operating income at $80,585. Since variable budget items all scales with sales, the difference is in the fixed items. It appears that CBI is budgeting for utilities twice, once for $150,000 and once for $54,000. On previous year's income statements, there has only been one line item for these expenses.

Flexible Budget Variance Analysis

The contribution margin income statement gives us a much better view into CBIs budgeting and forecasting accuracy. All numbers are from year 9 unless otherwise specified.

Perhaps the most significant area of concern is in sales. Net sales were budgeted at 3510 units for total net sales of $5,247,450 but only came in at 3423 units for $5,117,385. CBI was too aggressive in predicting its recovery from the previous year's drop in sales. This was possibly based on the apparent sales boost at the end of year 8 that was reflected in CBIs account receivable. Since CBI has market itself as a premium product and commands an equally premium price, CBI should pay close attention to economic conditions and be more conservative when forecasting growth.

With the exception of advertising expenses and transportation out, all other variable production and distribution costs favorably decreased with net sales as expected. Advertising expenses and transportation out were both approximately $3,000 higher than budgeted. Transportation out costs most likely increased as fuel costs increased. CBI claims to have a contract rate with their transportation supplier, so budgeting should be relatively simple. CBI must negotiate their annual transportation contract before budgeting transportation costs for the year. Additionally, CBI should pay attention to fuel costs when budgeting for any logistical operation.

Advertising expenses appear to have been increased in an effort to foster lagging sales. However, as income sheets reveal, advertising is not a major component of CBIs sales and appears to have little effect either way. CBIs sales primarily come from word of mouth due to the boutique nature of their product and their target professional or prosumer audience. Until they offer a more budget friendly, consumer oriented line; CBI should not spend additional funds on advertising.

Distribution network support came in under budget, which is technically favorable, however since sales were also lower is it worth noting that distribution network support would have likely been over budget if sales forecasts were correct. Also, distribution network support is a fixed cost and should not have had any variance. CBI needs to reevaluate its fixed costs to determine what