Accounting, Behaviour and Organisations

Budgeting and Market Responses

Topic Objectives

• To understand the market responses to management decisions

• Undertake an analysis of profit performance for an entity by:
– Understanding and calculating meaningful variances between
actual and planned profit
– Interpreting and explaining variances
– Distinguishing competitive effectiveness effects in variances
• Be able to calculate and report on manager performance in relation
to:
– Pricing strategies
– Market share
– Market size
– Product mix
• Be able to tell the performance ‘story’

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Let’s recall from MAB

• Variances are calculated by comparing standard revenue and costs

with actual revenues and cost.
– Prepare ‘Flexible budgets’ (actual volumes x budgeted input data)
– Then evaluate variances

• Why should managers analyse these variances ?

– Helps them create more accurate plans
– Learn if planned improvements have been achieved
– Provide information for evaluating employee performance
– Assess market conditions and evaluate where the business
stands as compared to it’s competitors.

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 Market-related data: Competitive effectiveness
• Market-related data and analysis allows organisations to
evaluate performance relative to others (competitors/industry)
• Access to industry-related data is quite important
– In most industries, industry-level data is compiled and made available via
subscription by organisations such as AC Nielson and IBIS
• Analysis and benchmarking performance across a variety of
aspects of operating performance
• This week we consider the use of market-related data to help explain
deviations from planned revenue performance
–Profit/loss from competitive effectiveness (revenue stream)
–i.e. Market share and selling price effects
–reflect ‘strategic’ management span of accountability
 Examples of why market analysis is important

• Subaru demonstrates that a business can enjoy long periods of growth

with strong market research and understanding the customer very well.
• Post GFC, sales of most car makers declined whilst Subaru continued on an
upwards trajectory.
• Key customer attributes:
– Customers have higher incomes/ college degree and wise spenders
– Want an experience rather than just goods
– Eco-friendly bunch who value freedom using “AWD”
• [USA] Subaru of America, Inc. Announces December 2016 As Best Ever
Sales Month; Sets Eighth Consecutive Yearly Sales Record
http://www.subaru-global.com/news/news_20170104_001.html
• At Subaru, Sharing the Love Is a Market Strategy
https://www.bloomberg.com/news/articles/2010-05-20/at-subaru-sharing-the-lov
e-is-a-market-strategy
 Market-related data Example 1: Market Share data & metrics are
also a rich source of performance information in the FMCG
industry

• “Market share” can also serve as both a leading and lagging indicator of
performance depending on how you use the information
• Market share info is particularly useful when creating future financial targets such as
forecasts & Budgets
 Market-related data Example 2: Consumer research can also create many
other potential performance metrics TWE Brand
Competitor
Treasury Wine Estates owns five of the top ten most loved still Four out of the top ten most salient brands are owned by
wine brands in Australia Treasury Wine Estates*

* Based in response to the question “of the brands you are aware of, which are you favourites? Select all that apply. This is a measure of brand equity in he
wine *Treasury wine estates brands account for 75% of spontaneous wine brand responses to the question “when thinking about wine, which
brands come to mind?” a multi response question where consumers can list as many brands as they can think of
Source: Nielsen ScanTrack Liquor data to August 2010
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 Variance Analysis

Actual v’s Plan = Overall Profit Plan Variance

Revenue Variances Cost Variances

Price Volume Efficiency/ Non-Variable

Cost Factors Costs

Product Mix
Market Share Market Size
Also recall from MAB

• The analysis focused on the following budgets:

– Static budget:
(budgeted revenue and costs × budgeted volume)
– Flexible budget:
(budgeted revenue and costs × actual volume)
– Actuals:
(actual revenue and costs × actual volume)

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 Benny’s Illustration

Benny’s is a wholesale gourmet ice cream manufacturer and uses standard cost
system to monitor its operations. Benny’s has a number of different product lines,
Purple Madness (blackberry ice-cream), French Vanilla, Macadamia Twirl are the
most popular products.
The management would like to investigate the overall profit variance for two ice
cream products, French Vanilla & Macadamia twirl. While actual profit was
$284,000 higher than expected ($5,348,000 actual - $5,064,000 budget),
Benny’s management team were expecting greater profits, given the weather
was extremely hot and ice-cream sales volumes had increased.

Why are profits only $284,000 higher than planned when Benny’s did so
well in sales?
• Where has it all gone?
• Have Benny’s sales kept pace with overall market growth or not?
 Benny’s Illustration
Benny’s Ice cream Profit Plan (‘000) Actual (‘000)
Volume Volume Total
$ $
Litres Litres Variance
Sales Data
French Vanilla 2,020 28,076 2,104 29,283 1,207
Macadamia Twirl 336 8,570 350 8,910 340
Total Sales 2,356 36,646 2,454 38,193 1,547

Less Variable cost

Cost ice-cream (French Vanilla)
Dairy ingredients (litres) 1,919 16,106 1,934 16,684 -578
Other ingredients (100gr.) 1,313 6,213 1,335 6,367 -154
Labour (hours) 34.01 988 37.1 1,081 -93
Cost ice cream (Macadamia Twirl)
Dairy ingredients (litres) 320 2,726 318 2,675 51
Other ingredients (100gr.) 241 1,680 244 1,699 -19
Labour (hours) 30 869 28.79 839 30
Total variable cost 28,582 29,345 -763
 Contribution margin  8,064
What makes up this favourable performance?  8,848 784
Fixed costs 3,000 3,500 -500
Profit 5,064 5,348 284
 Benny’s Flexible Budget: A volume adjusted profit plan
Benny’s Ice cream Profit Plan (‘000) Actual (‘000)
Volume Flexible Volume Total
$ Variance Variance $
Litres Budget Litres Variance
Sales Data
French Vanilla 2,020 28,076 1,168 29,244 39 2,104 29,283 1,207
Macadamia Twirl 336 8,570 357 8,927 - 17 350 8,910 340
Total Sales 2,356 36,646 1,525 38,171 22 2,454 38,193 1,547
Sales price variance
Less Variable cost
Cost ice-cream (French Vanilla)
Dairy ingredients (litres) 1,919 16,106 - 670 16,776 92 1,934 16,684 -578
Other ingredients (100gr.) 1,313 6,213 - 258 6,471 104 1,335 6,367 -154
Labour (hours) 34.01 988 - 41 1,029 - 52 37.1 1,081 -93
Cost ice cream (Macadamia Twirl)
Dairy ingredients (litres) 320 2,726 - 114 2,840 165 318 2,675 51
Other ingredients (100gr.) 241 1,680 - 70 1,750 51 244 1,699 -19
Sales
Labour (hours) 30 869 - 36 905 66 28.79 839 30
Totalvolume
variable cost 28,582 - 1,189 29,771 426 29,345 -763
 Contribution margin  8,064 336 8,400 448  8,848 784
FixedVariance
costs 3,000 - 3,000 - 500 3,500 -500
Profit 5,064 336 5,400 52 5,348 284

Overall variance of $284 to be explained

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 Revenue variance

• This variance analysis is sometimes referred to as ‘competitive effectiveness’

due to its analysis of market conditions.
• The revenue variance can be examined from price and volume perspective.

Revenue Variance

Sales Price Sales Volume

Variance Variance
(Actual price – Standard price) x (Actual volume – Budgeted volume) x
Actual volume Standard price

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 Competitive Effectiveness - Sales Price Variance
• Sales Price Variance:
– Measures the effect on profit of sales prices being higher or lower
than planned
– Can calculate directly from Flexible Budget
– difference between actual and flexible budget (see Slide 12)
– Can also use formula below:

Actual total revenue - (Actual sales * Budgeted Prices)

(figures are in ‘000)

French Vanilla: $29,283 – [2,104 litres* ($28,076 ÷ 2,020 litres)] = $39F
Macadamia Twirl: $8,910 – [350 litres *($8,570 ÷ 336 litres)] = $17U
Total Sales Price Variance = $22F

Revenue (and profit) gained from:

• increase in selling price of French Vanilla ($13.90 to $13.92)
• minor offset from price drop in Macadamia Twirl ($25.51 to $25.46)

*Rounded to 2 decimal places

 Sales volume variance
– This reflects the difference between the standard and actual
quantity of units sold at the standard selling price.
– Sales volume variance is favourable when actual sales quantities
exceed standard quantities, and it is unfavourable if the reverse is
true.
– Can calculate directly from Flexible Budget
– difference between flexible and static budget (see Slide 12)
– Use formula below
Sales volume variance = (Actual volume – Budgeted volume) x
Standard price

Sales
volume variance

Market size variance Market share variance Product mix

variance 1
 Calculations Required: Breaking down the Volume Variance

1. Average Budgeted Contribution Margin (for use in formulas below):

i. Average budgeted CM @ budgeted mix (for budgeted mix)
ii. Average budgeted CM @ actual mix (‘flexed’ for actual mix)

2. Market Size

Change in mkt size * Budgeted mkt share * Budgeted avg CM (i)

3. Market Share
Change in mkt share * Actual mkt size * Budgeted avg CM (i)

4. Product Mix
Change in average CM (i-ii) * Actual unit volume
 Calculating Average Budgeted CM
Average Budgeted Contribution Margin:

1. For budgeted mix

Average budgeted CM @ budgeted mix: $8,064 ÷ 2,356 litres = $3.42275
CM = Total Sales Revenue – Total Variable cost
= $36,646 - $28,582 = $8,064

2. ‘Flexed’ for actual mix (for volume effects) - required for Product Mix
calculations
Average budgeted CM @ actual mix: $8,400 ÷ 2,454 litres = $3.42298

Note: The effect is very small, so you will need to go to more decimal places
 Market Size Variance
• Measures the expected profit increase/decrease as a result of change in the
magnitude of the total market for the firm’s products
Market Information:
Budgeted Market Size = 19,633 litres; Budgeted Market Share = 12%
Actual Market Size = 20,811 litres; Actual Market Share = 11.79%

Change in mkt size * Planned mkt share * Planned avg CM

= (20,811 litres – 19,633 litres) * 0.12 * $3.42275

= $484F
Given their planned market share and standard product CMs, Benny’s would have
gained $484 profit due to overall market growth.
Note: Planned Market Share = Budgeted sales / Budgeted Market Size
= 2,356/19,633 = 12%
Actual Market Share = Actual sales / Actual Market Share
= 2,454/ 20,811 = 11.79%
 Market Share Variance

– Given the actual market size, the market share variance measures the
profit increase/decrease due to actual market share being different from
that reflected in the profit plan
Change in mkt share *Actual mkt size * Planned CM

= (0.12 – 0.1179) * 20,811litres * $3.42275

= $148U

– Lost $148 in potential profit due to loss of market share

– Note how a small loss in market share (0.0021) equates to large
dollar amounts (52% of overall profit).
 Product Mix Variance

– This is the suitable calculation when products are substitutes - deemed to

be operating in the same market

= Change in average Budgeted CM * Actual unit volume

= (3.42298-3.42275) x 2,454 = $0.57F

– Minor product mix variance is caused by selling products in a different mix

than planned
– Favourable or Unfavourable?
– Favourable as the total average contribution margin increased

– Remember to use the flexed average CM for actual mix to isolate the
volume effects associated with the mix
 Reconciliation of revenue volume variances

Reconciliation

Planned CM @ Planned quantity (Static budget) $8,064

Explained by:
Market size variance 484 F
Market share variance 148 U
Product mix variance 0.57 U
$ 336 F (rounded)
 
Planned CM @ Actual quantity $8,400
 
 
Strategic Profitability Analysis
Interpreting the Flexible Budget:

1. What is the total impact on contribution margin of volume being different from
that reflected in the profit plan?
– Solution: $336,000 F
– Profit/loss from competitive effectiveness (revenue stream)
– eg. Market share and selling price effects
– reflects ‘strategic’ management accountability and attention

2. What is the total impact on contribution margin of price/cost/efficiency effects?

– Solution: $52,000 U
– Profit/loss from operating efficiencies (cost stream)
– eg. Production efficiency, cost control
– reflect ‘operational’ management accountability and attention

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 Calculate Meaningful Variances: Competitive Effectiveness

• Sales revenues for French Vanilla are higher than budgeted due to
both volume and price effects. Macadamia Twirl, has an
unfavourable price effect against a favourable volume.
• What more should we know about the revenue stream?
– How much relates to volume, how much to prices?
– Did sales volume keep pace with overall market growth?
– Has market share improved?
• Therefore, we can look at both sales price and volume
– including market size, market share and product mix
– Note: Product mix is only relevant if there are substitute products
– Domestic heating systems and commercial heating systems (not substitutes)
– Outdoor tables and outdoor chairs (not substitutes)
– Outdoor bench seat and outdoor chairs (substitutes)
– Regular and specialty ice-cream (substitutes)
– Coffee and Coke (substitutes)
 Operating Efficiencies summarised

• Variable Cost Variances - See Flexible Budget Slide

• Variances on Dairy Ingredients ($257 F = 92 F + 165 F), Other
Ingredients ($155 F = 104 F + 51 F), Labour ($14 F = 52 U + 66 F)
amount to:
– $426 Favourable Variable Cost Variances (rounded up)

• Each of these variances could reflect price/efficiency variances or both

– i.e. Dairy Ingredients French Vanilla $92 F variance could reflect
price of material inputs being lower than expected or less usage
(over what was expected) given actual volume of output produced
(remember volume effect has been neutralised)
– We do not detail the efficiency variances in this lecture – they just
help to tell the overall profit plan story
 Non-Variable (Fixed) Cost Variances

• Total fixed cost variances

= $500 Unfavourable Fixed Cost Variance

• These represent ‘overspending’. Note that the level of these costs

is not treated as responding to the volume change (recall, these
are the fixed costs from prior decisions and do not vary with
changes in sales volume)
• Rather than just assuming overspending/underspending on fixed
costs, we could analyse these much better with individual line item
analysis, activity analysis and/or a re-evaluation of managerial
judgment
Refer back to Flexible Budget to find the variance data
Benny’s Ice cream Profit Plan (‘000) Actual (‘000)
Volume Flexible Volume Total
$ Variance Variance $
Litres Budget Litres Variance
Sales Data
French Vanilla 2,020 28,076 1,168 29,244 39 2,104 29,283 1,207
Macadamia Twirl 336 8,570 357 8,927 - 17 350 8,910 340
Total Sales 2,356 36,646 1,525 38,171 22 2,454 38,193 1,547

Less Variable cost

Cost ice-cream (French Vanilla)
Dairy ingredients (litres) 1,919 16,106 - 670 16,776 92 1,934 16,684 -578
Other ingredients (100gr.) 1,313 6,213 - 258 6,471 104 1,335 6,367 -154
Labour (hours) 34.01 988 - 41 1,029 - 52 37.1 1,081 -93
Cost ice cream (Macadamia Twirl)
Dairy ingredients (litres) 320 2,726 - 114 2,840 165 318 2,675 51
Other ingredients (100gr.) 241 1,680 - 70 1,750 51 244 1,699 -19
Labour (hours) 30 869 - 36 905 66 28.79 839 30
Total variable cost 28,582 - 1,189 29,771 426 29,345 -763
 Contribution margin  8,064 336 8,400 448  8,848 784
Fixed costs 3,000 - 3,000 - 500 3,500 -500
Profit 5,064 336 5,400 52 5,348 284

Overall variance of $284 now explained

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 Overall Explanation of Actual v’s Planned Profit
• View variances as a ‘package’. Together they tell a ‘performance story’.
• What do overall results show?
– Gain in volume, due to overall market growth
– Lost market share but gained higher selling prices for French Vanilla only
– Perhaps higher prices led to loss of market share?
– Operating effects need further analysis, but both variable and fixed costs are
over budget
– Perhaps the increased market size increased demand but purchasing
manager had only poorer quality materials available at the time, at cheaper
prices, to help meet demand? This might have contributed to the loss in
market share?
– Perhaps the unfavourable variance for French Vanilla labour was the result
of having to employ more staff at higher wages to help meet the increased
demand
– Perhaps meeting the increased market size placed more demands on fixed
costs? Maybe fixed Selling costs? Maybe they needed to employ additional
fulltime/permanent salaried staff?
Overall Reconciliation of variances

Net Profit - Profit Plan 5,064

Volume Effects
Additional Sales Volume Contributed 336
Explained by:
Market Growth 484
Loss of Market Share - 148
Product Mix Effect 0.57

Price Effecs
Selling Prices 22
Variable Costs 426
Fixed Costs -500 -74

Total Variances 284

Net Profit - Actual 5,348

Note: there will be some rounding errors if not using excel

Negative numbers are ‘Unfavourable’ and positive numbers are ‘favourable’
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 Interpreting Profit Analysis

• What sort of questions are raised that Benny’s managers have to deal with?
– Review selling prices and their connection with market share
– Review cost control
– Review sales forecasting. Should volume have been more accurately
forecast?
– Corrective action responses to variances will differ
• Profit analysis encourages management to evaluate the factors that are within
management’s control

• Note: while we can use formulae to assist with our analyses, data is not
always readily available to accommodate an easy formula-driven solution
– i.e. for some company’s identifying the market is difficult or too costly
• Managers must take note of the bigger picture
Conclusion: The Value of Profit Analysis

• Encourages Strategic Learning

– Management are able to review assumptions (SWOT analysis) given actual
results
– Can check validity of strategy
– Can check effectiveness of strategy implementation

• Early Warning Signs can be recognised

– Management can check implications for the interlocking profit wheels (week 3)
– Management can avoid crises, take advantage of new opportunities

• Performance Evaluation
– Managers that influence achievement of profit plan are accountable for
outcomes.
– Reduces potential to reward/punish on superficial (uncontrolled) results such as
higher revenue or lower costs
– Variances calculated then track causes and offsetting effects
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