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How do you manage your budgeting process? Can you look beyond the legacy?



THE INTRODUCTION:

The client in question is a group entity of a global giant leading in power and energy management solutions. It operates in three business categories: power electronics, automation, and infrastructure and has three manufacturing facilities with a strong presence across India.



THE PROBLEM:

The company seeks to make its budgeting framework more realistic and practical. Accordingly, the requirement is to review its budgeting process comprehensively along with other controlling aspects so that the differences between budgeted and actual values can be minimised.

Furthermore, re-configuration of the budgeting framework into the SAP-ERP system (SAP-FI-FM) is also needed to enable its alignment with the SAP system.



THE SOLUTION:

Budgeting is the tactical implementation of a company’s strategic plan to deliver financial and operational goals. An organisation needs to translate its long-range strategic plan into a detailed set of expected revenues and expenses that can be measured to track performance. Therefore, performance analysis becomes easier as goals are to be achieved within a predetermined period which is reflected through budgets as roadmaps.

The management can deliberate on deviations from budgeted targets, and remedial action can be taken promptly in case of significant variations. Thus, budgets ensure that the company’s income is carefully spent and appropriately invested to achieve the desired business outcomes.


The following processes give a bird’s eye view of budgeting activity in the company in question:

- Analysing management objectives: The company follows a top-down approach [1] in budgeting; as a result, the management perspective is of utmost importance. The level at which the management sets goals is based on various factors, including the previous year’s business trends, analysing changing market scenarios like market demand, acceptability, technology innovation, commodity pricing, etc., and availability of skilled manpower.


- Analysing sales: Top-line feasibility is of utmost importance in deciding the sales target. Therefore, these figures are determined after brainstorming relevant factors, such as sales volume, sales trends, product profitability, production capacity, product portfolio, selling and distribution channels, market research, pricing policy, advertisement and sales promotion policy, etc.


- Analysing raw material consumption

The raw material cost is decided based on the trend analysis and commodity pricing anticipations in line with the revenue budget. Further, extensive back calculations can also be performed to derive procurement requirements using the material bill of materials (BOMs). Therefore, accurate material consumption can be predicted based on sales orders and material requirement planning (MRP) functionality.


- Analysing conversion cost

Conversion cost primarily consists of two costs – direct labour and manufacturing overheads. The factory labour cost is computed based on the production labour hours required to achieve the revenue targets. Trend analysis and inflation impact on the wage increase also play an important role in arriving at the exact figure. In addition, the indirect cost (overheads) relating to production is based on previous years’ trends and any additional specific expenses projected for the current year’s estimates.


- Analysing employee headcount

Headcount requirements are analysed at all levels of the organisation based on the existing business and new opportunities/ prospects. The organisation chart – employees - are linked with the responsibility and profit/ cost centres. Based on the estimated headcount, the cost is budgeted.


- Analysing administrative costs and selling and distribution costs

These costs are generally linked to revenue. Therefore, they are computed based on past trend analysis and future forecasts relating to inflationary conditions and new business opportunities (new contracts in the pipeline).


- Analysing the current year’s budget estimates with the previous/ current year’s actuals

Variance analysis of different budgeted items with the actuals is performed regularly and reported to the management. Significant variances are resolved. The revised estimates are then monitored so that further escalations can be avoided.



THE RESULTS:

After in-depth deliberations and continuous collaboration with the client for over a month, our team at Chandra Wadhwa & Co. developed a detailed-oriented budgeting support system to help determine more accurate budgets. Major actions taken in this respect were:

• Identification of areas that are not considered in the budgets

• Inclusion of Inventory obsolescence provision in the budget

• Inclusion of Notional Finance costs in budget comprising 8% of (Average Accounts Receivables + Average Inventory – Average Accounts Payables)

• Defining responsibility team against budgetary estimates

• Finetuning/ Aligning the general ledger (G/L) accounts with the commitment items in the SAP funds management module.

• Finetuning/ Aligning the responsibility centres with the fund centres in the SAP funds management module.

• Defining funds management tolerance limit messages of warning at 90% budget usage and error at 100% budget usage



Budgeted P/L and Ratio Analysis Extract with Responsibility Status


Description

Responsibility for providing budgetary estimates

A

Production Value

Production Team

1

2

3








4

5


Material Cost

Subcontract FEE - SB

Conversion Cost

- Direct Labor


- Manufacturing Overhead





Scrap

Provision

Production Team

Production Team

Production Team

Production Team

HR Team (Headcount Nos and Rate)

Production Team

Inward Logistic Team

Procurement Team

Quality Team

For IDL - HR Team (Headcount Nos and Rate)

Production Team

Production Team

A= 1 to 5

Total Manufacturing Cost

B

Manufacturing Profit

Operating Revenue

Sales Team

1

2


3


4

Sales Return & Allowance

Total COGS


- Other Cost (excl Warranty)


- Warranty Cost

Sales Team

MFG - Production Team

Trading - Material Procurement team

MFG - Production Team

Trading - Material Procurement team

MFG - Production Team

Trading - Material Procurement team

B=1 - (2 to 4)

Gross Profit

5

6


7


8


9

R&D

Selling Exp


Management


SDE-Corp


GSA Non-Region

Exp R&D Department HR Team (Headcount Nos and Rate)

Sales Team Outward Logistic Team HR Team (Headcount Nos and Rate)

Administration, Facility, Corp Management Team HR Team (Headcount Nos and Rate)

Finance, IT, Legal, HR, Support and Shared function team HR Team (Headcount Nos and Rate)

Globe Team for all related shared burdens to the IND company

(5 to 9)

Operating Expense

10

11

Non-OP Income

FINANCIAL COST

Finance team

Calculated field - By System itself

B-(5 to 9) + 10-11

Net OP Profit

Ratio Analysis

Return on Net Asset %

SCRAP OF WIP

Q Cost; % of Net Sales

Overdue AR; Aging Days

AR; Turnover Days

AP; Turnover Days

Stock & Turnover Days

Cash-to-Cash Conversion

Fixed Assets

DL Cost; Headcount

IDL Cost; Headcount Production

IDL's Cost; Headcount Admin, Management etc.

IDL's Cost; Headcount - Sale

IDL's Cost; Headcount - R&D

Total Headcount; DL/IDL Rate

Calculated field - By System itself

Production team

Quality Team

AR Team

AR Team

AP Team

Sales and Production Team

Calculated field - By System itself

Finance Team

HR

HR


HR


HR

HR

HR



FOOTNOTES


1. ⌃ Understanding the budgeting approaches:

- Top-Down
This process involves the creation of the budget by the company’s senior management based on the company’s objectives. The departmental managers are assigned the responsibility for its successful implementation. Every department can create its budget based on the company’s broader budget allocation and goals.

This approach’s advantage is that the lower management saves time and has a ready-made budget. They hardly participate in the preparation of the central budget. The senior managers’ experience, coupled with past-performance figures, comes in handy in such budgeting processes.


- Bottom-up
This budgeting process starts at the departmental level and moves to higher levels. First, every department within the company must prepare plans for its proposed activities for the next budget period and estimate the costs it will incur. Then, these individual budgets are combined to create a bigger all-inclusive budget.

The budgeting process with this approach can be lengthy and time-consuming. However, employees and managers are more motivated to achieve the budget goals since they have prepared them. They have complete knowledge of what the budget expects them to do and how to achieve that. Therefore, such budgets tend to be more accurate and closer to the actual situation.

 


CONTACT US

Reach us if you have any concerns regarding cost management accounting issues in your organization.


SANKALP WADHWA

Partner, Chandra Wadhwa & Co. (Cost Accountants) | B.Com, FCMA, ACA, DISA | Certified SAP-CO Consultant | Executive Program on Management and Finance (IIM, Ahmedabad)


Address: 1305 & 1306, Vijaya Building, 17, Barakhamba Road, New Delhi - 110001, India Mail: sankalp.wadhwa@cwcindia.in

Tel: +91-8800018190, +91-7503703599.

Website: www.cwcindia.in



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