SECTION A- STRATEGIC PLANNING AND CONTROL
QUESTION 01- FRENDZEE
Frendzee is a food manufacturer based in Savoy land, whose objective is to maximise shareholder wealth. Frendzee has two divisions: Dairy division and Luxury division. Frendzee began manufacturing dairy foods 20 years ago and Dairy division, representing 60% of total revenue, is still the larger of Frendzee’s two divisions.
This division manufactures cheeses and milk-based desserts. The market in Savoy land for these products is saturated, with little opportunity for growth. Dairy division has, however, agreed profitable fixed price agreements to supply all the major supermarket chains in Savoy land for the next three years. The division has also agreed long-term fixed volume and price contracts with suppliers of milk, which is by far the most significant raw material used by the division.
In contrast to Luxury division, Dairy division does not operate its own fleet of delivery vehicles, but instead subcontracts this to a third-party distribution company. The terms of the contract provide that the distribution company can pass on some increases in fuel costs to Frendzee. These increases are capped at 0.5% annually and are agreed prior to the finalisation of each year’s budget.
Production volumes have shown less than 0.5% growth over the last five years. Dairy division managers have invested in modern production plant and its production is known to be the most efficient and consistent in the industry.
This division was set up two years ago to provide an opportunity for growth which is absent from the dairy foods sector. Luxury division produces high quality foods using unusual, rare and expensive ingredients, many of which are imported from neighbouring Vee land. The product range changes frequently according to consumer tastes and the availability and price of ingredients. All Luxury division’s products are distributed using its own fleet of delivery vehicles.
Since the company began, Frendzee has used a traditional incremental budgeting process. Annual budgets for each division are set by the company’s head office after some consultation with divisional managers, who currently have little experience of setting their own budgets. Performance of each division, and of divisional managers, is appraised against these budgets. For many years, Frendzee managed to achieve the budgets set, but last year managers at Luxury division complained that they were unable to achieve their budget due to factors beyond their control. A wet growing season in Vee land had reduced the harvest of key ingredients in Luxury’s products, significantly increasing their cost. As a result, revenue and gross margins fell sharply and the division failed to achieve its operating profit target for the year.
Frendzee has just appointed a new CEO at the end of Q1 of the current year. He has called you as a performance management expert for your advice.
‘In my last job in the retail fashion industry, we used rolling budgets, where the annual budget was updated to reflect the results of every quarter’s trading. That gives a more realistic target, providing a better basis on which to appraise divisional performance. Do you think we should use a similar system for all divisions at Frendzee?’, he asked.
You have obtained the current year budget for Luxury division and the division’s Q1 actual trading results (Appendix 1) and notes outlining expectations of divisional key costs and revenues for the rest of the year (Appendix 2).
Luxury division current year budget
|Cost of sales
Expected key costs and revenues for remainder of the current year
- Sales volumes are expected to be 2% higher each quarter than forecast in the current budget.
- Average selling price per unit is expected to increase by 1.5% from the beginning of Q3.
- The exchange rate between the Savoy land Dollar (C$) and the Vee land Dollar (V$) is predicted to change at the beginning of Q2 to C$1.00 buys V$1.50. For several years up to the end of Q1, C$1.00 has been equivalent to V$1.40 and this exchange rate has been used when producing the current year budget. Food produced in the Luxury division is despatched immediately upon production and Frendzee holds minimal inventory. The cost of ingredients imported from Vee land represents 50% of the division’s cost of sales and suppliers invoice goods in V$.
- The rate of tax levied by the Savoy land government on the cost of fuel which Luxury uses to power its fleet of delivery vehicles is due to increase from 60%, which it has been for many years, to 63% at the beginning of quarter 3. 70% of the division’s distribution costs are represented by the cost of fuel for delivery vehicles.
- The CEO has initiated a programme of overhead cost reductions and savings of 2.5% from the budgeted administration costs are expected from the beginning of Q2. Q3 administration costs are expected to be a further 2.5% lower than in Q2, with a further 2.5% saving in Q4 over the Q3 costs.
a. Using the data in the appendices, recalculate the current year budget to the end of the current year and briefly comment on the overall impact of this on the expected operating profit for the year.