Management Accounting and Control
The assignment deals with the two of the most important part of financial management. In the first part of the assignment the concepts and the functions of each part of the responsibility centres are discussed critically. The function of an organisation depends on the performance of each of the responsibility centres that includes: revenue centre, cost centre, profit centre and investment centre. With the critical analysis, the importance of each of the centre has been shown. On the other hand, the second part of the assignment deals with the working capital cycle. With an through discussion it has been shown how the performance each entity of the working capital cycle can be improved.
The organisational goals and objectives can be reached through the performance of each different division of the organisation. In order to evaluate the performance of the managers of an MNC, the concept of responsibility centre has been introduced. According to the view of Kaplan and Norton (2009), responsibility accounting is a concept that views the organisation as a part or sub divisions rather than only a total or single system. The summation of the output of all the responsibility centres can be considered as the output of the organisation. On the other hand, Roslender and Hart (2009) have suggested that responsibility centres are the identifiable segments within an organisation for which individual managers have the authority and accountability. Responsibility centres defines exactly what assets and activities each manager is responsible for.
Managers prepare a report on the performance of the responsibility centres. This report is compared with the budgeted performance and the variances are monitored. The responsibility reports only consist of the controllable costs. Therefore, the managers are not accountable for the activities they have no control. Basically, responsibility centres help the financial directors to identify the performances of each division and take necessary steps if improvements are needed.
- Identification of responsibility centres: Based on the main functioning of the organisation, a responsibility centre can be subdivided in to four parts: cost centre, revenue centre, profit centre and investment centre.
- Delegation of authority or Decentralisation: As stated by Roslender and Hart (2011), to increase the efficiency of an organisation, managers need to assign the specific roles and authority. The managers of each of the responsibility centres work independently along with the members of the centres. Moreover, manager of one responsibility centre has the authority to control the functions of that particular centre only.
- Setting up the performance evaluation criteria: The main purpose of the responsibility centre is to measure the divisional performance. In order to do that, the managers may apply certain parameters like: Standard costing, Budgetary control, Profitability ratios and Valuation measures.
- Electing cost allocation bases: The managers of each of the responsibility centre need to allocate the costs for the joint overheads and corporate overheads. Product wise profitability depends highly on the allocation of the costs.
Revenue centres: Revenue centres have the control over sales only. In order to evaluate the performance of revenue centres, the managers need to look only on the revenues.
Cost centres: Cost centres produce and provide goods and services to the other parts of the company. This centre has no control over the sales prices and can only be evaluated on the total cost of production.
Profit Centres: The managers of the profit centre enjoys control on the revenues and expenses. However, a profit centre is feasible for a larger business (Ucl.ac.uk. ,2014).
Investment centres: According to the view of Cravens and Guilding (2011), an investment centre is the luxury cars of responsibility centres. It enjoys the control on everything: revenues, expenses and the investments made in the centre.
As discussed above, each of the responsibility centres has specific roles and responsibility. Being the financial director of an MNC, it is very much important to decide which of the responsibility centre need to give the most importance. In the following paragraphs, the advantages and disadvantages of measuring the performance of each of the responsibility centre has been pointed out. Based on the discussion the financial director can give suggestions to the board of director which one of the four managements is the most suitable for the company.
Revenue centre management: Revenue centre only deals with the revenue generation of the company and does not possess any control over the other part of the operation. As mentioned by Willmott (2010), the main goals of an organisation are to generate revenue. Moreover, to maintain the sustainability of the organisation, revenue needs to be generated at a constant flow. However, for a large organisation, revenue generation may not be the only criteria. The management of the revenue centre includes the marketing strategies to penetrate more markets and generate more customers. However, the management of revenue centre is certainly not the best approach for the large organisation as the managers need to consider the costs of production to generate the revenues.
Cost centre management: Cost centres only make goods and services and have no access over the sales prices. The evaluation of the performance of the cost centre includes only the total cost of production. The management of the cost centre approaches in the reduction of the unit cost of production. The inputs in producing any materials can be measured in terms of the volume or in monetary terms. On the other hand, outputs are measured in terms of the physical units. However as suggested by Wilner (2009), the main function of the managers of the cost centre is to reduce the unit costs of production. The other responsibilities of the cost centre include quality control of the products, volume of production, training of the employees etc. However, in order to reduce the costs one of the easiest ways is to buy the inferior quality of raw materials. Therefore, the managers need to check the quality of the raw materials very carefully. The sales and revenue directly depends on the quality of the products. Therefore, the management of cost centre is of high importance. On the other hand, as mentioned by Gowthorpe (2009), an organisation cannot sustain by producing only better quality of products, it needs to maintain profitability. As, the cost centre does not have control over the other cost of the organisation, for large organisation, the management of cost centre is definitely not the most important issue.
Profit centre management: As mentioned above, profit centre has the control over both the revenues and expenses. For the large organisation, management of the profit centre is very much important. The profit centre often selects merchandise to buy and sell and it has the authority to set the own prices. The evaluation of the profit centres can be done based on the controllable margin. The difference between the controllable revenues and the controllable costs are determined as the profits. The profit centre excludes all the non controllable costs like over head cost or other indirect fixed costs. The most important aspect of the profit centre is that it determines the profitability of an organisation. The sustainability of an organisation depends on the profitability. The profit centre gives more freedom to the managers to operate in order to increase the profitability. However, the profit centre does not include the assets required to fetch the profitability. This is one of the most important disadvantages of the profit centre. The high profits can be very much lucrative for the managers and also attract the investors to invest more in the organisation However; a financial director needs to check whether the managers have used excess assets in order to boost up the profitability. As the managers of the profit centre are not accountable for the costs of the assets for producing profits, they do not bother to utilise more assets. The management of profit centre is definitely important than the management of the revenue centre and the cost centre, as it is related to the most important aspect of an organisation that is profit. However, the management needs to take care of the assets required to generate the profits. It can be traced from the investment centres.
Management of Investment Centres: Investment centres are the most important centres of large MNCs. The management of investment centres is the vital part of the financial managers. It has the control over all the part of business like: revenues, expenses, and the investment made in the respective centres. Return on investment (ROI) is used to evaluate the performance of the investment centres (Hoque, 2009). In order to improve ROI, the managers may increase the controllable margin or decrease the operating assets. By increasing the controllable margin, profitability of the organisation will improve and by decreasing the average operating assets productivity will increase. Moreover, management of the investment centres will point out the drawbacks of the other centres as the investment centre is the only part of responsibility centre that can access all the parts of the responsibility centre. Concentration on the management of the investment centre will encourage the managers to emphasise on the productivity over profitability (Horngren et al. 2011). This will help the organisation to use the assets in the optimal way.
Therefore from the above discussion it can be concluded that, for an large organisation or the MNC’s the most important job of the financial manger is to manage the investment centre.
This part deals with the concept of working capital in context of XYZ Limited and the way to improve its working capital components. Moreover, the portion also encompasses the working capital cycle and the relation of each component under the cycle to gauge how the operating cycle helps the organisation to turn the operation over the periods.
The word working capital itself defines the concept and its significance in the business operations. In the current context of contemporary business environment, working capital has recognised as one of the important aspects to meet the obligations of the entity in short term. In this context, Deloof (2009) depicted that working capital is the short term amount, needed for daily requirements. Working capital could also be termed as the liquidity of the fund to avail liquid cash to pay off the liability. As stated by Filbeck and Krueger (2010), every organisation needs to possess adequate amount of working capital to improve different stages of the business activities. Moreover, working capital also enhances profitability of the organisation through increasing the probability to earn revenue.
The key parts of the working capital are the cash and bank balance, trade receivable, inventories and trade payables. However, according to Nazir and Afza (2010), current assets and current liabilities are two crucial parts of working capital to obligate the operations of the concerned businesses. From the financial statements, it has been derived that the cash and bank balances, inventory and trade receivable fall under the current assets whereas the trade payables are operated under the current liabilities. Therefore, improvement in each part could affect the overall financial state in the form of working capital level. Thus, being a manufacturing firm, XYZ Limited needs focusing on the production and warehousing to strengthen short term position of the firm (Teruel and Pedro, 2012). Therefore, asset management mechanism is the most potential option to achieve a stable financial position through maintaining adequate short term requirements.
Cash and bank balance:
According to Soenen (2009), the cash and bank balance is important to run the business operations effectively as the daily requirements like, salary, wages, rent, electricity bills and purchase of raw material requires adequate amount of liquid cash at point of time to carry on the business processes. Therefore, cash is one of the major components of the working capital that could affect the profitability of the organisation being present in the organisation in adequate amount. As suggested by Roslender and Fincham (2010), XYZ Limited could minimise the cash conversion period to earn greater volume of money within relatively less period. In this context, Garcia-Teruel and Martinez-Solano (2009) added that effective negotiation with the suppliers as well as the debtors could help the organisation to result good credit norms towards faster shift of inventory towards sales.
Inventory is the second and most important part of earning revenues as it offers desired products and services to the customers as and when required. However, the concept of inventory is generally categorised into raw materials, work-in-progress and finished goods. In this context, Gill et al. (2010) depicted that the best way of measuring the potentiality of inventory is how rapidly the finished goods are moving towards the stores for sale. In that case, XYZ Limited could ascertain the speed of the conversion activity from the raw material to the finished goods that the state of inventory could be measured. This could allows the concerned firm to hold adequate amount of inventory at different time interval based on the demand variable. On the other side, Roslender and Hart (2013) acknowledged that lack of sufficient inventory could lead to incur losses in account of the firm in different ways. For example, inadequate raw material could stop the production whereas demand of the customers regarding the product could not be met due to lack of sufficient finished products. However, concerning to the work-in-progress Deloof (2009) suggested incorporating the innovation in products and services, in order to enhance scope of earning through attracting more customers than usual. Referring to this issue, XYZ Limited needs encompassing the market demand analysis to forecast the amount of finished products to be produced to gain expected return. Thus, XYZ Limited could opt for the Just-In-Time system through lean management system to minimise the wastage of resources for better inventory control. The reason is its dependency on the market demand changing over time.
Trade receivable could also be termed as the debtors who, are basically the customers purchasing products on credit. Thus, according to Roslender and Hart (2013), debtors are the potential sources of fund to collect adequate capital through debt collection process. XYZ Limited could improve the position of debtors by shortening the period of colleting cash for the credit sales. In this context, Soenen (2009) enlightened that the debtors’ collection period could be reduced through offering discounts on cash purchase for early payments. This could lower the operating cycle period resulting more cycle within a year. Moreover, the organisation needs to investigate capability of its debtors to ensure about recovering the amount that firm has allowed to its debtors in terms of credit sales.
Trade payable is the fourth component of the operating cycle that could also be termed as the creditors or suppliers of the organisation. An effective credit management system in organisation could enable the organisation to set better terms in the credit transactions. It could expand the credit payment period that in turn could reduce significant amount of liability through paying off from the received amounts. On the other side, trade payable are also recognised as the resources of finance.
2.3 Implications of working capital improvements on XYZ limited and other relative components:
Referring to the above options, it could be inferred that the above recommendations could lead to improve each part of the working capital of XYZ Limited. However, such initiatives could also enable XYZ Limited attaining surplus benefits in the form of developing allied elements through expansion of efficiency. Implication of such improvement could affect majorly on the debtors and creditors. In this context, Cadez and Guilding (2010) found that efficient working capital enriches liquidity through allowing XYZ Limited increasing asset value that it could be liquefied on requirements. In addition, sound short-term capital could also strengthen the firm through paying off the liabilities.
Therefore, improvement of working capital enables the firm to collect debt before paying off the liabilities. However, Deloof (2009) argued that working capital affects the relationship of other business partners and anticipated supply chain system. On the other side, short debt collection could dissatisfy the customers dealing with the company. Hence, such attempt could lead to loss potential clients. Moreover, expanding the credit payment period could delay further action and thus fails to manage the inventory at the optimum level. This may therefore weaken relationship with suppliers and other supply chain components. Hence to keep balance between the asset and liability, XYZ Limited could utilise statistical mechanism like, liquidity-profitability tangle to measure liquidity to be attained, in order to meet target margin. Furthermore, the limit of letter of credit could also be expanded to widen the source of acquiring sufficient capital.
The above discussion has two major parts: in the first part of the assignment, the concept of responsibility centre has been discussed. It has been shown that the managers of the companies have subdivided the roles and control of the overall organisational jobs into four distinct segments. The segments are treated as responsibility centres. With an critical evaluation, it has been shown that the finance director needs to concentrate the management of the investment centre most as it is the most vital part of an large organisation. In the second part of the assignment, the concept of working capital has been discussed. Working capital consists of the cash, work in progress, inventories etc. The process of improving each factors have been discussed in the second part of the assignment.
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