Management Accounting: Techniques And Tools For Business Management – Case Study

Management Accounting vs Financial Accounting

Management accounting, as the name suggests, is the study of accounting related to financing. It is the process of preparation of management books and accounts and reports that provide the information related to the entity, be in financial terms or statistical terms so as to enable the top management to take short term decisions. Such management reports usually comprises of information’s such as revenue generated, cash-in-hand, abnormal gains /losses, creditors /debtors information, the outstanding liabilities, advances received and made, any abnormal income or loss, or any other material information that is likely to be disclosed (Peterson & Fabozzi, 2012). The role of management accounting is as follows:

• Designing of Reports: The management accountant prepares accounts and reports on finance and cost accounts and does such preparations for decisions required to be made frequently in the short run.
• Forecasting Future Prospects: Such accounting plays an important role in formulation of such plans and actions after considering the future forecasts for the entity. It includes formulating strategic or corporate planning.
• Monitors the Capital Structure: It is the duty of management accountant to monitor the capital structure and maintain a favorable mix of debt and equity securities. He is expected to consider the various cost theories such as leverage, trading on equity, cost of capital, etc and then make reports on raising fund and their reasons.
• Control: The management accountant prepares reports related to costing such as budgets, variances analysis, standard costs, cash flow statement, fund flow statement, performance analysis, investments and responsibility accounting, etc for control.
• Decision – Making: The management accountant holds an important position in the entity and holds a better position than many other accountants & employees. He instructs executives and employees the need for establishing control and the different ways to do so. He extracts the relevant information from irrelevant data and represents the same in his books in clear words.

Management accounting is often confused with financial accounting (Adelaja, 2015). However, the two are different and can be differentiated as discussed below:

• Financial reports are based on the entire business results. Management accounting reports are detailed in nature and are more like weekly reports.
• Financial reports are prepared to ascertain the profitability aspects of a business while management reports are prepared to define the causes of troubles and proposed solutions.
• Financial reports have to contain the information that are true and fair while management accountant focuses on all kinds of information be it estimates rather than proved and completely correct information. In simple words, management reports if contains incorrect information, it won’t create troubles for the management but incorrect information in the financial reports will create legal troubles or ethical troubles depending on the nature of incorrectness.
• Financial reports are prepared carefully as it is distributed to both internal and external stakeholders while the management reports are for the internal stakeholders only.
• Financial reports have to be prepared and presented in compliance with various accounting and auditing standards while management reports doesn’t have to be prepared according to some rules or regulations as it is used for internal purposes only.

There are different techniques of cost models used. However, let us discuss the most common cost models used by operational managers (Rivenbark, Vogt, & Marlowe, 2009):

• ABC Costing: Activity based costing is the model where different activities of the business are identified and then the cost of such are associated to the products & services as per the consumption made by each of them.
• Cost Breakeven Analysis: This analysis helps a business to identify its breakeven point where it will acquire a position of no profits, no gains. It lets a business to know the number of units it has to produce to bear all its fixed & variable costs and thereby, earn an income over that.

Investment appraisal or capital budgeting is the process of  determining whether the firms planning of investment in long term assets such as machinery, equipments, research projects, new products, etc are worth enough to invest money into. The main purpose of adopting such practices is to maximize the value to the shareholders of the firms and earn income in the long run and so as to fulfill the wealth maximizing objectives of the business (Bierman & Smidt, 2010) .

Different Capital appraisal techniques are used as per the stakeholders and investors expectations. Such different techniques for capital investment appraisal are discussed below:

• Net Present Value (NPV): This technique is used to determine the actual cash flow into the firm be it negative or positive after netting of all the committed fixed costs. All firms strive to get a positive NPV. It involves calculation of a cash flow at a particular time (say, present year) discounted at  a rate to bring it back to the present year and calculate the NPV by netting total cash outflows from cash inflows.
• Accounting Rate Of Return: In this technique, the profit that can be earned from the chosen project is estimated and compared with the initial investment to be made for such a project. It is obvious that projects that will yield higher rate of return will be preferred over the projects with lower rate of return. However, such a technique is usually not adopted for decisions as it doesn’t consider the time value of money.
• Internal Rate of Return: IRR is a discounting rate that targets to make NPV zero by computing cash outflows and inflows on the present date. It is one of the most used techniques and is generally considered to calculate the efficiency of the investment made. IRR is calculated by making NPV zero and equating so as to derive the discounting rate. It is probable that if the cost of capital exceeds IRR rate, the project will be rejected and if the cost of capital is lower than the IRR rate, the project is more likely to be accepted. IRR make use of time value of money to derive a discounting rate.
• Modified Internal Rate Of Return (MIRR): The IRR concept fails to answer that why the intermediate cash flows aren’t reinvested and gradually, a low discounting rate will be calculated always. Thus, a better analyzing technique is developed called modified internal rate of return when it is assumed that the reinvestment rate equals with the rate of cost of capital.
• Profitability Index: Profitability Index calculates the value per unit of investment. This method is basically a ratio of the profits through investment to the pay off of the project.
• Payback Period: Payback Period is the calculation of time that would be involved for getting the initial investment back. It is considered to be one of the easiest methods and usually projects with longer time periods are not preferred over projects with shorter time periods for investment decisions.
• Discounted Payback Period : This is almost similar to the previous discussed technique, that is, payback period with the only difference that it considers the time value of money and therefore, calculates the discounted value of cash flow and that is how, payback period is then calculated.

The company wants to expand its business and for expansion there are various proposals available. However, the company has four proposals available. It has to accept the best proposal. So, in order to take up the best proposal the company needs to find the Net present value of all the four proposals and the one with highest NPV should be selected (Dayananda, Irons, Harrison, Herbohn, & Rowland, 2008). 

Discount rates at 10%

Since, proposal 4 has a positive and the highest NPV the company should accept proposal 4 (Menifield, 2014).

The business plan in the operational management is prepared to determine the procedures to be undertaken to carry out the operations of a business. This plan usually considers factors such as labor efficiencies, time duration taken, equipment usage, targets of the company etc (Seitz & Ellison, 2009). A business plan includes the role of all the departments that has to meet up with the required targets so as to achieve the overall target of the business. As per the case study given, Cucumber Ltd has six departments where each of the departments  have different targets and all this has to be adopted to fulfill the mission statement of the company (Peterson & Fabozzi, 2012). The role of business plan in the case organization is:

• It sets the future destination for a business and allows it to work towards a determined goal and therefore, binds the management to work accordingly.
• A smart and detailed business plan if shows enough potential can convince the attractive investors to invest their money into it.
• It defines the different activities of business operations and the different level of managers and employee. Therefore, defines the organizational structure of the firm.

Cost Models for Operational Managers

In a management process, one of the most important tools used and prepared is Budget. Budget is an estimation of costs and revenue from the operations of the business. A business needs it to establish a control over its costs and sets a profit target for the organization. The role of budget in the case organization is (Schroeder, 2014):

• It points out the operational and financial objectives of the business.
• It helps in showing the management of cash, that is, how the cash is being allocated for different activities and how such cash expenses can be controlled.
• It shows a sale forecasts as well so as to determine the budgeted profits and specifies the standards for measuring the performance of the company.   
• It helps in the preparation of the variances report that is the difference between the expected and actual costs (Fridson & Alvarez, 2012).

As per the case study given, Cucumber Ltd has its mission statement of being recognized for providing qualitative mobile phones at affordable prices by both customers and employees. The company has a financial target of earning £5m as profit before tax and having return on capital employed at least 18% (Rosenfield, 2009).  

The following Calculations will show us the levels of sales units required to be achieved by Cucumber ltd in order to attain the level of  profit of Pound 5 million. 

The following illustrative report shows the areas of improvements and targets set up by each of the departments as well as the measures to be taken (McLaney & Adril, 2016).

• The company is planning to spend more on the production facilities so as to bring significant improvements in the product.
• Brown is intending to improve the performances of the staffs and other workers. For this, he has devised a policy of minimum qualifications of the staffs where direct manufacturing staffs should be qualified to NVQ level 4 and the supervisors must have Bask (Honors) level.
• Brown has also set target for defects in finished goods to be 5% that will be rectified and has set up a new measurement system for improving the quality.
• Another department called Customer Support Department, has set up a target of answering all calls within four rings (Girard, 2014).
• The HR department is looking forward to improve the employee turnover. It aims at retaining the employees as a rapid movement of skilled employees has been observed. It is aiming to reduce the employee turnover from 25% to 15%.
• The company has planned to conduct a survey within 4 weeks among its customers after completed sales. The target of the company is to achieve the “Excellent” rating by at least 80% of its customers.
• The company doesn’t own a detailed budgetary plan due to which the sales target cannot be set. It is recommended for the company to use the cost breakeven analysis cost model to determine the level of breakeven sales. It can set the sales target to achieve its target of earnings before tax $5m (Zack, 2009).
• The cost centre of Screen Product shows negative variances which are one of the major concerns for the company and needs improvements. The control should be established over the production as where the budget defines a production of 3000 units, the actual production is 4000 units. This automatically increases the costs provided per unit cost as set by the budget is less than per unit cost in reality. For example, the material cost per unit as per the budget is £33 but in reality it is £9.75. The same has been observed in case of other costs too. This means because of the over production, the company is suffering from negative variances (Rayman, 2009). 

Balanced Scorecard is an approach used in the strategic management to evaluate the performance of various activities and functions of the entity and proposing the improvements and analyzing the outcomes (Paul, 2014). It is a measure to provide the information to the business enterprises regarding both qualitative and quantitative information which are used by the top level management of the enterprise to make decisions in a better way for the entity (Piper, 2015). The balanced scorecard focuses on the four areas which can be summarized as below:

1. Profitability from financial perspective. This perspective shows how the strategy is being implemented and executed and whether such strategies are improving the operations of the company (Pratt, 2009).
2. Customer Satisfaction from customer perspective. This perception is all about providing the best to the customers and maximizes the wealth maximizing objectives. This perception helps a business to survive in the long run (Zyla, 2013).
3. Internal business processes perspective. This perception is focusing towards stability and sound procedures and policies of an organization. This fills in the gap between financial and customer perspectives (Mattessich, 2016).
4. Learning and growth perspective. This involves training and other improvement measures for the labor. It assures that the employees possess such skills and knowledge so as to be able to make up with the targets and be able to sustain the competition.

The balanced scorecard of the case organization is as follow (Taillard, 2013): 

Conclusion

This case study relates to manufacturing firm known as Cucumber Ltd. Though it is a small company but has highly skilled workers in it. There are various departments in the organization to carry out its operations. In this assignment, the company has proposed to take up a new project in order to expand its production. There were four proposals available to the company so based on the NPV of these projects it was found that Proposal 4 shall be accepted as it has positive and the highest NPV. Also, the company had certain problems in budgetary planning for which certain strategies are adopted. However, there has also been an intention of reducing the employee turnover. These changes are made by the company in order to achieve its targets of recognizing customers as well as employees and providing good quality products at reasonable prices. 

References:

Adelaja, T. (2015). Capital Budgeting: Investment Appraisal Techniques Under Certainty. Chicago: CreateSpace Independent Publishing Platform .

Bierman, H., & Smidt, S. (2010). The Capital Budgeting Decision. Boston: Routledge.

Dayananda, D., Irons, R., Harrison, S., Herbohn, J., & Rowland, P. (2008). Capital Budgeting: Financial Appraisal of Investment Projects. Cambridge: Cambridge University Press.

Fridson, M., & Alvarez, F. (2012). Financial Statement Analysis: A Practitioner’s Guide. New York: John Wiley & Sons.

Girard, S. L. (2014). Business finance basics. Pompton Plains, NJ: Career Press.

McLaney, E., & Adril, D. P. (2016). Accounting and Finance: An Introduction. United Kingdom: Pearson.

Mattessich, R. (2016). Reality and accounting. [S.I.]: Routledge.

Menifield, C. E. (2014). The Basics of Public Budgeting and Financial Management: A Handbook for Academics and Practitioners. Lanham, Md.: University Press of America.

Piper, M. (2015). Accounting made simple. United States: CreateSpace Pub.

Pratt, J. (2009). Financial Reporting for Managers: A Value-Creation Perspective. Hoboken: John Wiley & Sons, Inc.

Paul, K. (2014). Managing extreme financial risk. Oxford: Academic Press, Elsevier.

Peterson, P. P., & Fabozzi, F. J. (2012). Capital Budgeting. New York, NY: Wiley.

Rayman, A. (2009). Accounting Standards: True or False? . New York (Estados Unidos): Routledge.

Rosenfield, P. (2009). Contemporary Issues in Financial Reporting: A User-Oriented Approach (Routledge New Works in Accounting History). [S.I.]: Wiley.

Rivenbark, W. C., Vogt, J., & Marlowe, J. (2009). Capital Budgeting and Finance: A Guide for Local Governments. Washington, D.C.: ICMA Press.

Seitz, N., & Ellison, M. (2009). Capital Budgeting and Long-Term Financing Decisions. New York: Thomson Learning.

Schroeder, R. G. (2014). Financial Accounting Theory and Analysis: Text and Cases. Hoboken: John Wiley & Sons.

Taillard, M. (2013). Corporate finance for dummies. Hoboken, N.J.: Wiley.

Zack, G. M. (2009). Fair Value Accounting Fraud: New Global Risks and Detection Techniques. Hoboken: Wiley.

Zyla, M. L. (2013). Fair value measurement. Hoboken: Wiley.

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