The report has focused on evaluating the financial performance of the A2 Milk Company Limited for 2018 along with anticipating future performance depending on a number of assumptions made by the organisation. It is an ASX listed organisation producing milk and other dairy products operating in Australia and New Zealand (The a2 Milk Company 2019). In addition, a detailed discussion of the top-down and bottom-up approaches to the budget process is made in this paper. Furthermore, the income statement for 2019 has been estimated, which could help in determining the future income of the firm. Adequate analysis of the components of master budget is conducted for determining the impact on the overall financial performance of the organisation. The analysis of the components of master budget assists the management to identify income and expenses, which is anticipated to carry out the business operations in future. By assessing the projected income statement, it would help in adopting suitable measures for the organisation for generating the desired level of income. Finally, the report covers comparison of the actual income statement of 2018 with the budgeted income statement of 2019 for the A2 Milk Company Limited.
With the help of the above figure, the different components of the master budget are represented, which a firm uses to prepare budgets for the respective periods. These components primarily assist the management to acquire the required level of income from operations and this has reduced the probability of occurrence of variance from the budgeted sales figure to actual sales figure (Bandy 2014). Moreover, the components of budget direct help the organisation in setting up relevant expenses and income, which would be derived from business operations over the period. As pointed out by Banker and Byzalov (2014), master budget would assist the organisation to derive high level of income from business operations, which could enhance the overall efficiency of the management. The master budget would help in obtaining the needed level of funds for supporting the master budget and due to this; there would be significant improvements in the entire business operations. The master budget consists of a number of components, which are described as follows:
Sales budget:
This is the initial element of the master budget, which allows the organisation to detect the level of selling units to be incurred from operations. The selling price per unit and number of units sold are estimated for the upcoming quarters or periods in sales budget. Moreover, the values included in the sales budget are identified from the previous growth in selling figures, which are derived by the firm. The sales budget exercises direct impact on the components of the master budget, as rise in selling units would have effect on the expenses and production needs of the firm (Barr and McClellan 2018).
The main reason behind the use of production budget by the organisation is that they could detect the estimated level of production, which is needed to be conducted by the management so that they could support the overall product demand (Bhalla 2014). In addition, the production budget provides enhanced value to the organisation to determine the requirement of raw materials along with other purchases, which are needed for ensuring smooth flow of business operations. The production budget ascertains the companies in determining the activity levels, which would be needed for supporting sales demand from the customers (Chenhall and Moers 2015).
Cash budget:
The cash budget is mainly prepared with the intent of determining the income and expense levels expected to be derived from operations. The cash budget assists in representing the cash position which the firm would derive in the accounting year. The cash budget is prepared after the sales and production budget are prepared, which would assist the management to determine the overall cash flows expected to occur from a particular timeframe.
Direct labour budget:
The direct labour budget would be affected directly by the sales budget expected to be derived from the firm. The rising level of output, which is needed by the sales budget, would exercise direct influence on the direct labour requirements in the production system (Cokins 2014). Hence, direct labour budget assists the firms in determining the staff levels needed in the production function for helping the production results along with compliance to the sales budget. The direct labour budget is made after the preparation of production units and this determines the level of labour input needed for the upcoming period (Finkler, Smith and Calabrese 2019).
Direct materials budget:
After production budget and sales budget are prepared, an organisation prepares its direct materials budget, which help in determining the level of materials needed in order to support sales demand from the customers. In addition to this, the direct materials budget would aid in determining the expense level adequately needed by the organisation in order to enhance its production needs. Furthermore, the direct materials budget would help in providing an overview of the material needs after the analysis of inventory currently held for production (Karadag 2015).
By using this budget, the firm could obtain an insight of the factory expenses, which it has to spend besides costs related to direct labour and direct materials. The information included in the cost of budget has direct relationship with the cost of sales of the firm. This would help in determining the level of expenses, which is necessary for the form to incur in order to provide adequate support to the future selling units. The factory overhead budget is considered to be beneficial in nature, as it takes into account a huge portion of expenses, which the company has to incur so that it could accommodate the estimated sales (Kotas 2014).
For evaluating the estimated operating expenses, the managers of any organisation use this budget along with other manufacturing expenses incurred in the accounting year. In addition, this evaluation helps the organisation to determine the selling and administrative expenses needed to be understood by the organisation for providing its adequate support to its future operations. By computing these expenses, the level of spending could be determined and it is needed to be understood by the organisation so that its operations could be supported in the accounting year through analysis of the outcomes (Lavia López and Hiebl 2014).
Budgeted financial statements:
The budgeted financial statements are to be prepared by the firm after the aforementioned components of the master budget are prepared effectively. The reason is that they assist in preparing the balance sheet and income statement for the accounting year (Melitski and Manoharan 2014). In addition, with the help of budgeted financial statements, the company could determine the projected incomes expected to be earned over the upcoming accounting periods. Due to this, the income and expense levels could be determined in the accounting period.
It is critical to engage various business units when there is preparation of a comprehensive budget. This mandates the requirement of all unit representatives to participate in the budget development process appropriately. Normally, a budget committee is present to look after the process, which comprises of some top level executives of the organisation (Menifield 2017). These personnel offer valuable judgements about the aspects having association with sales, financing, production and other operating stages. Along with these, the position of these individuals needs to be proper so that they could provide better information to their concerned units along with advice on resource needs and opportunities.
There are a number of differences that could be noticed between top-down budget approach and bottom-up budget approach that the firms could utilise for the preparation of budgets. In addition, the comparison would help in detecting the suitable budgeting process, which the organisations could utilise for preparing budget so that its business operations could be supported adequately. The two above-stated approaches are mainly used in different business areas that aid the management in the process of decision making regarding its future operational activities. By using the top-down approach to the budget process, both specific and general perspectives could be used for evaluating a particular scenario. On the other hand, the bottom-up approach to the budget process focuses on specific conditions after which it is shifted to basic features. In addition to this, a particular variation is evident between top-down budget approach and bottom-up approach of the process of budget, which signifies the alternative measures undertaken on the part of each process (Miller 2018).
The management of an organisation mainly uses the top-down approach to the budget process for preventing the budget holders in obtaining an opportunity to involve in the budget process. Along with this, the top level management provides direct assistance in preparing the budget. In this case, there has been adequate allocation of resources, which is conducted by complying with the approval of the top officials. The firm is not engaged to utilise department heads in this process for determining the budgeted values. With the help of top-down budget approach, the managers could formulate the budget falling with the limits of the desired budgeted values. This type of approach is highly advantageous that assists in reducing the lead time in order to ensure completion of the manufacturing process. This is because the top level management of an organisation bears the obligation of developing the required budgets. As a result, it would lead to saving additional time, which could reduce the efforts of the individuals accountable to conduct day-to-day business operations (Miller-Nobles, Mattison and Matsumura 2016).
However, this budget approach suffers from a number of drawbacks. One of such drawbacks includes the non-involvement of the persons detecting the specific expenses, which could take place while carrying out daily business operations. Due to this, the budget would be unable to cover up the expectations, as the top individuals would not take into consideration the expenses to be incurred across the various departments (Noreen, Brewer and Garrison 2014).
The bottom-up approach to the budget process could be defined as a method where there is chance for the budget holders to be involved in their own budgets. This procedure seems to have direct involvement with the managers of the departments in order to prepare the budget in tandem with the requirements and expenses. This approach is considered to be highly valuable, as the estimated expenses could be accommodated appropriately within the budget. On the other hand, the bottom-up approach to the budget process suffers from various limitations, since the expenditures would be handled because of the increased spending target of the departments. Therefore, the bottom-up approach to the budget process would help in raising the level of expenses, which is needed for all the departments. The reason is that the budget would take into account the expenditure requirements of all relevant managers associated with the departments (Parker and Fleischman 2017).
For both the budgeting approaches, there have been different advantages and drawbacks, which are observed to have adverse impact on the prepared budgets of the business entities. By considering all these aspects, the A2 Milk Company Limited would become beneficial by implementing the top-down approach to the budget process, as the budgets could be developed by the organisation in order to support its future operations. Along with this, this approach would assist the concerned firm in preparing the needed income and expense levels to be earned and spent in a specific accounting period.
The above table mainly assists in depicting the estimated income statement of the A2 Milk Company Limited for 2019 by using the financial data of 2018. This has aided in detecting the income and expense levels, which would be spent in the later financial period. For preparing the budgeted income statement of the organisation, certain assumptions are made that are undernoted:
After analysing the above table, it is clear that there has been improvement in the financial performance as evident from gross margin, operating profit and net profit in 2019. The estimations are carried out by based on the incremental sales and expenses, which would be spent in the specific year (Rogulenko et al. 2016). Hence, by using this budget procedure, the A2 Milk Company Limited could obtain control of the whole income and expenditure scenario estimated to be generated in the upcoming period.
In addition to this, the above table clearly signifies the fact that the relevant increase in total sales of the firm is estimated at 10% owing to which increase in total sales could be observed in 2019. Due to such increase, improvement could be observed in the gross margin of the A2 Milk Company Limited as well. On the other hand, there would be rise in cost of sales as well by 8%; however, the rise in revenue would offset such increase in cost of goods sold in 2019. Moreover, the operating expenses are forecasted to increase by 2% and despite such rise, the operating profit is found to be higher compared to 2018 owing to increased gross margin in 2019. The evaluation of financial performance could be conducted by using the above table coupled with the determination of income level to be derived from operations. In this regard, Sandalgaard and Nikolaj Bukh (2014) stated that budgets are prepared by considering a number of assumptions, as it allows the organisation to detect the upcoming operating needs needed to be met by the management.
By enforcing adequate marketing techniques, the A2 Milk Limited Company Limited has the ability of meeting the budgeted income target by increasing its product demand in the market. The increase in overall sales of the firm is critical, since the management could generate the adequate cash flows to meet its expenses and outflows (Van Dooren, Bouckaert and Halligan 2015). The projected income statement of the A2 Milk Limited Company Limited is found to be suitable for the organisation in comparison to the financial performance in 2018. As commented by Segun and Olamide (2015), if the A2 Milk Limited Company Limited fails to conduct proper research before the preparation of the master budget, the procedure could exercise negative impact on its business functions and activities.
From the above table, it could be observed that the projected income statement of the A2 Milk Company Limited is prepared by taking into consideration a number of estimations by using the actual data of 2018. By carefully analysing the same, it has been observed that there is considerable increase in overall income in the budget of 2019 because sales revenue would increase by 10%. In addition, this increase in sales has raised the overall revenue to $1,014,589 in 2019 from $922,354 in 2018. The main reason that the sales revenue has increased for the organisation is due to the estimation that there would be overall rise in sales by 10% in 2019. On the other hand, there has been rise in cost of sales from $458,005 in 2018 to $494,645 in 2019. However, this rise is offset by total increase in sales revenue due to which increase in gross margin could be observed from $464,349 in 2018 to $519,944 in 2019.
As per the annual report of the A2 Milk Company Limited in 2018, it contains certain line items of expenses and the budgeted income statement of the organisation contains the same items as well. These expenses are listed down as follows:
This denotes that the changes in the budgeted values are overinflated due to which considerable rise in net profit of the organisation could be observed in 2019. This is because even though there would be increase in cost of sales and other related expenses of the A2 Milk Company Limited, it would be offset by sufficient increase in sales revenue. This clearly denotes that the generated budgeted figures are not in tandem with the income statement prepared by the organisation in 2018. Therefore, it is crucial to develop the budgeted income statement depending on relevant growth observed in the past accounting year (Wang 2014).
Conclusion:
From the above discussion, it is clear that the different components of the master budget are represented, which a firm uses to prepare budgets for the respective periods. These components primarily assist the management to acquire the required level of income from operations and this has reduced the probability of occurrence of variance from the budgeted sales figure to actual sales figure. The A2 Milk Company Limited would become beneficial by implementing the top-down approach to the budget process, as the budgets could be developed by the organisation in order to support its future operations. Along with this, this approach would assist the concerned firm in preparing the needed income and expense levels to be earned and spent in a specific accounting period.
By enforcing adequate marketing techniques, the A2 Milk Limited Company Limited has the ability of meeting the budgeted income target by increasing its product demand in the market. The increase in overall sales of the firm is critical, since the management could generate the adequate cash flows to meet its expenses and outflows. The projected income statement of the A2 Milk Limited Company Limited is found to be suitable for the organisation in comparison to the financial performance in 2018. However, it is to be noted that the generated budgeted figures are not in tandem with the income statement prepared by the organisation in 2018. Therefore, it is crucial to develop the budgeted income statement depending on relevant growth observed in the past accounting year.
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