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TO: SHAREHOLDERS OF ESTATE LTD.

FROM: RICHARD LEON

DATE: APRIL 3RD, 2015

SUBJECT: BUDGETS FOR 2013

I have attached the budgets and the budgeted Income Statement for 2013 to this memorandum. The purpose of this memorandum is to outline the importance of the budgets for a company, the figures shown in the Cash Budget and how we can improve those numbers. According to Harvard Business School Press (2013), a budget is financial blueprint or action plan for a department or organization. It explains strategic plans into measureable expenditures and anticipated revenues over a certain period of time. The budget is used to plan and control the organization, but it also involves communication, co-ordination, authority and motivation between employees and employers. Also it is used to evaluate the performance of the business. According to Riahi-Belkaoui (2001), at the moment in the market there are several types of budgetary processes, some of them are an updated version of more traditional budgets. The traditional incremental budget, where a budget was given for the following period with a percentage based increase from the following year budget, has been updated to Zero Based Budget (ZBB). ZBB is used mostly in the service industry, where current activities don’t always continue from a period to next one. The advantages of ZBB are that this budgetary process is focusing on the future outcome, not on the past results, it eliminate any perpetuated mistakes overlook by the incremental budget, it allocates more efficient the resources and encourages cost reductions. Disadvantages of this method are that it is very costly and time consuming, it puts a lot of stress on the management, may lead to interruption continuity of activities, is used short term planning, rather than long term and is only effective in a service industry. Another traditional budgetary process is the periodic budget. This is a process which is usually done every year and after that period is just roll to the next year. It is also called a static budget, because it will be revised only at the end of its period. (Vohwinkle, 2015) The updated version of this traditional method is the Continuous Budget. This budget is also prepared for one year, but it will be revised every quarter or semester and it will the budget will be modified according to the actual results. Therefore it will be added another quarter or semester to the budget and it will keep going like that. Doing this process the budget will be more accurate and the performance of managers can be easier appraised, as it makes the management to take the budget more seriously. The disadvantages of this process are that it will be more costly and it will take more time to be complete, but it will also lead to a dilution in the control of actual results. Another way to create the budget is by involving all the levels in the process. This budgetary process is called participatory. Advantages of this process include motivation of employees from all levels, leads to a better communication, the senior managers can concentrate more on the strategy as the information will be more accurate. The disadvantages of this process are that it will lead to a loss of control, some junior managers may be inexperienced and can include information which are not in line with the organization objectives and it will also take more time. If the budget needs to be done quickly and to be sure that the senior management objectives will not be diluted by others, the budgetary process can be non-participatory. This will also lead to smaller chance of information leaking out of the company, but it may lead to a loss of motivation from employees, as the budget is imposed on them.

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In selecting a budgetary process we need to consider a few factors based on the type of the organization, the type of industry, how many products we produce and the culture of the company. Based on the information give the organization should follow a Continuous Budget process, as it is the best fit for a manufacturing organization and it will give a better look at the actual results. The master budget is combined of different budgets such as: Sales Budget, Production Budget, Variable Costs Budget, Fixed Costs Budget, Cash Budget, Budgeted Income Statement and Budgeted Balance Sheet. Based on the accuracy of the calculation in this budget, the profit at the end of the year will be £464,802. I want to clarify the figures in the Cash Budget for 2013. According to Riahi-Belkaoui (2001), the cash budget is made to ensure that an organization will have enough cash resources, in order to be able to cover the costs of the operations shown in the various budgets outlined in the Appendix 3. As it can be seen in the Appendix 4, the Total Net Cash Flow is calculated by how much cash inflow and outflow the company has. Based on the accuracy of the forecast of our cash inflow, the net cash flow for the year will be £355,760. It can be seen that we will have a short-term deficit for March (£12,020), but afterward we will have a long-term surplus for the period April-December. The deficit in the March is due to our sales incurring in February, but being actually paid 2 months after in April. Therefore for that period the organization will not have any cash inflow. It can be seen that in April, even though there will be inflow and outflow of cash, as well as a negative opening cash for the month, the net cash flow at the end of the month will be £9,550. It can also be seen that the biggest net cash flow for a month will incur in November (£60,890) and we will already have a surplus of £237,300 from the previous month in the same time. The only month where the organization cannot sustain its production will be March, where the available will be only £840, the expenditures will be £12,860 and there is no inflow of cash, so the deficit on March will consist of £12,020. Based on the surplus of £355,760 the company will have enough cash to pay dividends at the end of the year.

The organization need to find a way to obtain finance through its short-term deficit period. To do this we need to look at various options to finance the operations. One option would be to obtain an overdraft for the March, but this is a costly option and it will be a good idea to negotiate it before, in order to get a good interest rate on it. Another option would be to increase the payable period, but this might lead to a dispute with the suppliers. A short-term loan is not viable, because we will be in deficit just for a month, and a short-term loan is usually given for a 6 months or one year period. We might want to reduce the budgeted expenditure, but then all the calculation will not be accurate anymore and another budget will need to be prepared. The best way to avoid the deficit will be to make some cash sales in the February-March period, in order to generate enough cash inflow to sustain the operations, or we could decrease the receivable period from 2 months to 1 month, and then we will have a positive net cash flow at the end of each month. A company, in order to sustain its activity, should make whatever it can to have the receivable period smaller than the payable period. By doing this a company will always generate enough cash to meet its expenditures and it will not go in insolvency.

If you have any questions, please contact me and I will respond back within 24 hours.

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APPENDICES

APPENDIX 1

Standard Cost Card

Direct Materials £40

Direct Labour £21

Variable Overhead Production £15

Fixed Overhead Production £4.23

Variable Distribution Cost £2.50

Total £82.73

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APPENDIX 2

Production and Sales for the year 2013 Production(units) Sales(units) Jan 120 0 Feb 140 120 Mar 160 140 Apr 180 160 May 200 180 Jun 220 200 Jul 240 220 Aug 260 240 Sep 240 260 Oct 240 240 Nov 160 240

Dec 180 160 Total 2,340 2,160

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APPENDIX 3

Estate Ltd. Operational Budget for 2013

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Total for the year ending 31st of December 2013

Sales Budget

Sales volume (units) 0 120 140 160 180 200 220 240 260 240 240 160 2,160

Selling Price per unit (£) 300 300 300 300 300 300 300 300 300 300 300 300

Sales (£) 0 36,000 42,000 48,000 54,000 60,000 66,000 72,000 78,000 72,000 72,000 48,000 648,000

Production & Fin. Goods Inventory Budget (units)

Opening Inventory (units) 0 120 140 160 180 200 220 240 260 240 240 160 0

Production (units) 120 140 160 180 200 220 240 260 240 240 160 180 2,340

Sales (units) 0 120 140 160 180 200 220 240 260 240 240 160 2,160

Closing Inventory (units) 120 140 160 180 200 220 240 260 240 240 160 180 180

Direct Material Usage/Purchase Budget

Units 120 140 160 180 200 220 240 260 240 240 160 180 2,340

Price per unit (£) 40 40 40 40 40 40 40 40 40 40 40 40

Material Purchases (£) 4,800 5,600 6,400 7,200 8,000 8,800 9,600 10,400 9,600 9,600 6,400 7,200 93,600

Direct Labour Budget

Units 120 140 160 180 200 220 240 260 240 240 160 180 2,340

Rate per unit (£) 21 21 21 21 21 21 21 21 21 21 21 21

Direct Labour (£) 2,520 2,940 3,360 3,780 4,200 4,620 5,040 5,460 5,040 5,040 3,360 3,780 49,140

Variable Production Overheads Budget

Units 120 140 160 180 200 220 240 260 240 240 160 180 2,340

Rate per unit (£) 15 15 15 15 15 15 15 15 15 15 15 15

Variable Production Overheads 1,800 2,100 2,400 2,700 3,000 3,300 3,600 3,900 3,600 3,600 2,400 2,700 35,100

Variable Distribution Budget

Units 0 120 140 160 180 200 220 240 260 240 240 160 2,340

Rate per unit (£) 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5

Variable Distribution 0 300 350 400 450 500 550 600 650 600 600 400 5,400

Fixed Production Overheads Budget (£)

825 825 825 825 825 825 825 825 825 825 825 825 9,900

Fixed Administration Overheads Budget (£)

325 325 325 325 325 325 325 325 325 325 325 325 3,900

Other Budgets

Capital Expenditure Budget 2,400 0 0 0 0 0 0 0 0 0 0 0 2,400

Share Issue 20,000 0 0 0 0 0 0 0 0 0 0 0 20,000

Depreciation 600

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APPENDIX 4

Estate Ltd. Cash Budget for the year ending 31st of December 2013

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

Total for the year ending 31st of Dec 2013

Cash Inflows

Proceeds of share issues

20,000 - - - - - - - - - - - 20,000

Cash Sales - - - - - - - - - - - -

Receipts from debtors

- - - 36,000 42,000 48,000 54,000 60,000 66,000 72,000 78,000 72,000 528,000

Total Inflows 20,000 - - 36,000 42,000 48,000 54,000 60,000 66,000 72,000 78,000 72,000 548,000

Cash Outflows

To creditors for materials

- 4,800 5,600 6,400 7,200 8,000 8,800 9,600 10,400 9,600 9,600 6,400 86,400

Direct Labour

2,520 2,940 3,360 3,780 4,200 4,620 5,040 5,460 5,040 5,040 3,360 3,780 49,140

Variable Production Overheads

1,800 2,100 2,400 2,700 3,000 3,300 3,600 3,900 3,600 3,600 2,400 2,700 35,100

Fixed Production Overheads

825 825 825 825 825 825 825 825 825 825 825 825 9,900

Fixed Administration Overheads

325 325 325 325 325 325 325 325 325 325 325 325 3,900

Capital Expenditure

2,400 2,400

Variable Distribution Cost

0 300 350 400 450 500 550 600 650 600 600 400 5,400

Total Outflows

5,470 13,690 12,860 14,430 16,000 17,570 19,140 20,710 20,840 19,990 17,110 14,430 192,240

Net Cash Flow

14,530 (13,690) (12,860) 21,570 26,000 30,430 34,860 39,290 45,160 52,010 60,890 57,570 355,760

Opening Cash

- 14,530 840 (12,020) 9,550 35,550 65,980 100,840 140,130 185,290 237,300 298,190 -

Closing Cash 14,530 840 (12,020) 9,550 35,550 65,980 100,840 140,130 185,290 237,300 298,190 355,760 355,760

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APPENDIX 5

Working for Budgeted Income Statement

Production Costs for 2,340 units Total for 2,340 units (£) Direct Materials 93,600

Direct Labour 49,140

Prime Cost 142,740

Variable Production Overheads 35,100

Fixed Production Overheads 9,900

Total Production Cost of 2,340 units 187,740

£ 80.23/unit

Production Costs of goods sold = 2,160units x £80.23

173,298

Production Costs of closing inventory = 180units x £80.23

14,442

Total Production Cost 187,740

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APPENDIX 6

Depreciation of Fixed Assets

Fixed Assets Cost on 1st January 2013 2,400

Depreciation-25%/year 600

Distribution & Admin Expenses

Distribution Cost 5,400

Admin Cost 3,900

Admin Depreciation 600

Total 9,900

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APPENDIX 7

Budgeted Income Statement for the year ending 31st December 2013 (£)

Sales 648,000

Less Cost of sales (173,298)

Gross Profit 474,702

Less Distribution Cost & Administrative Expenses (9,900)

Profit from Operations 464,802

Less Finance Costs 0

Profit before Tax 464,802

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REFERENCES

Folger, J. (2015, 03 27). The complete guide to planning a yearky budget. Retrieved from investopedia.com: http://www.investopedia.com/university/guide-to-planning-a-yearly-budget/creating-a-yearly-budget.asp

Hirsch, M. L. (2006). Advanced Management Accounting-Second Edition. Singapore: Thomson Learning .

Larry M Walther, C. J. (2009). Manarial and Cost Accounting. Ventus Publishing ApS.

Press, H. B. (2013). Preparing a Budget: Expert Solutions to Everyday Challenges. Boston: Harvard Business Press.

Riahi-Belkaoui, A. (2001). Advanced Management Accounting. Greenwood Publishing Group.

Vohwinkle, J. (2015, 03 27). Budgeting 101. Retrieved from financialplan.about.com: http://financialplan.about.com/od/budgetingyourmoney/tp/budgeting-101.htm