Q 32Q 32
River Beverages Case: Budget Preparation
River Beverages is a food and soft drink company with worldwide operations. The company is organized into five regional divisions with each vice president reporting directly to the CEO, Cindy Wilkins. Each vice president has a Strategic Research team, controller, and three divisions: Carbonated Drinks, Noncarbonated Drinks, and Food Products (see Exhibit 12.3). Management believes that the structure works well for River because different regions have different tastes and the division's products complement each other.
The U.S. beverage industry has become mature, its growth matching population growth. Consumers drank about 50 billion gallons of fluids in 1995. Most of the industry growth has come from the nonalcoholic beverage market, which is growing by about 1.1 percent annually. In the nonalcoholic arena, soft drinks are the largest segment, accounting for 53.4 percent of the beverages consumed. Americans consume about 26 billion gallons of soft drinks, ringing up retail sales of $50 billion every year. Water (bottled and tap) is the next largest segment, representing 23.7 percent of the market. Juices represent about 12 percent of the beverages consumed. The smallest segment is ready-to-drink teas, which is growing rapidly in volume but accounts for less than 5 percent of the beverages consumed.
Susan Johnson, plant manager at River Beverages's Noncarbonated Drinks plant in St. Louis (see Exhibit 12.4), recently completed the annual budgeting process. According to Johnson, division managers have decision-making authority in their business units except for capital financing activities. Budgets keep the division managers focused on corporate goals.
At the beginning of December, division managers submit a report to the vice president for the region summarizing capital, sales, and income forecasts for the upcoming fiscal year beginning July 1. Although the initial report is not prepared with much detail, it is prepared with care because it is used in the strategic planning process.
Next the strategic research team begins a formal assessment of each market segment in its region. The team develops sales forecasts for each division and compiles them into a company forecast. The team considers economic conditions and current market share in each region. Management believes the strategic research team is effective because it is able to integrate division products and more accurately forecast demand for complementary products. In addition, the team ensures continuity of assumptions and achievable sales goals.
When the corporate forecast has been completed, the district sales managers estimate sales for the upcoming budget year. The district sales managers are ultimately responsible for the forecasts they prepare. The district sales forecasts are then compiled and returned to the division manager. The division manager reviews the forecast but cannot make any revisions without discussing the changes with the district sales managers. Next, the district sales forecasts are reviewed by the strategic research team and the division controller. Finally, top management reviews each division's competitive position, including plans to increase market share, capital spending, and quality improvement plans.
After top management approves the sales budget, it is separated into a sales budget for each plant. Plant location is determined by product type and where the product needs to be distributed. The budget is broken down further by price, volume, and product type. Plant managers budget contribution margins, fixed costs, and pretax income using information from the plant sales budget.
Budgeted profit is determined by subtracting budgeted variable costs and budgeted fixed costs from the sales forecast. If actual sales fall below forecasts, the plant manager is still responsible for achieving the budgeted profit. One of the most important aspects of the plant budgeting process is that plant managers break down the budget into various departments.
Operations and maintenance managers work together to develop cost standards and cost reduction targets for all departments. Budgeted cost reductions from productivity improvements, unfavorable variances, and fixed costs are developed for each department, operation, and cost center in the plant.
Before plant managers submit their budgets, a member of the strategy team and the regional controller visit the plant to keep corporate-level managers in touch with what is happening at the plant level and to help them understand how plant managers determine their budgets. The visits also allow corporate managers to provide budget preparation guidance if necessary. The visits are especially important because they force plant managers to communicate with corporate-level managers.
The final budgets are submitted and consolidated by April 1. The vice presidents review them to ensure that they are in line with corporate objectives. After the vice presidents and the chief executive officer (CEO) have made all changes, the budgets are submitted to the board of directors for approval. The board votes on the final budget in early June.
Variance reports are generated monthly at the corporate office. River has a sophisticated information system that automatically generates reports based on input that is downloaded daily from each plant. The reports also can be generated manually by managers in the organization. Most managers generate variance reports several times during the month to solve any problems before they get out of control.
Corporate managers review the variance reports, looking closely at overbudget variance problems. Plant managers are questioned only about overbudget items. Management believes that this ensures that the plant managers stay on top of problem areas and that this keeps the plant operating as efficiently as possible. One week after the variance reports are generated, plant managers are required to submit a response outlining the causes of any variances and how they plan to prevent the problem(s) in the future. Corporate can send a specialist to the plant to work with a plant manager who has repeated problems to solve them.
Sales and Manufacturing Relations
"We are expected to meet our approved budget," remarked Kevin Greely, a division controller at River. Greely continued, "A couple of years ago one of our major restaurant customers switched to another brand. Even though the restaurant sold over 1 million cases of our product annually, we weren't allowed to make revisions to our budget."
Budgets are rarely adjusted after approval. However, if sales decline early in the year, plant managers may file an appeal to revise the budgeted profit for the year. If sales decline late in the year, management usually does not revise the budgeted amounts. Instead, plant managers are asked to cut costs wherever possible and delay any unnecessary expenditures until the following year. It is important to remember that River sets budgets so it is able to see where to make cuts or where operating inefficiencies exist. Plant managers are not forced to meet their goals, but they are encouraged to cut costs below budget.
The sales department is primarily responsible for product price, sales volume, and delivery timing; plant managers are responsible for plant operations. As you might imagine, problems between plant and regional sales managers occur from time to time. For example, rush orders can cause production costs to be higher than normal for some production runs. Another problem can occur when a sales manager runs a promotional campaign that causes margins to shrink. Both problems negatively affect a plant manager's profit budget but positively effect a sales manager's forecasted sales budget. Such situations are often passed up to the division level for resolution; however, it is important to remember that the customer is always the primary concern.
River Beverages's management has devised what it thinks is an effective system to motivate plant managers. First, plant managers are promoted only when they have displayed outstanding performance in their current position. River also has monetary incentives in place to reward plant managers for reaching profit goals. Finally, charts that display budgeted items versus actual results are produced each month. Although not required to do so, most plant managers publicize the charts and use them as a motivational tool. The charts allow department supervisors and staff to compare activities in their department to similar activities in other plants around the world.
Cindy Wilkins, CEO of River Beverages, looks to the future and comments, "Planning is an important aspect of budget preparation for every level of our organization. I would like to decrease the time spent on preparing the budget, but I believe that the budgeting process keeps people thinking about the future. The negative aspect of budgeting is that sometimes it overcontrols our managers. We need to stay nimble enough to react to customer demands while staying structured enough to achieve corporate objectives. For the most part, our budget process keeps our managers aware of sales goals and alerts them when sales or expenses are off track."
a. Discuss each step in the budgeting process at River Beverages. Begin with the division manager's initial reports and end with the board of directors' approval. Discuss why each step is necessary.
b. Should plant managers be held responsible for costs or profits?
c. Write a report to River Beverages management stating the advantages and disadvantages of the company's budgeting process. Start your report by stating your assumption(s) about what River Beverages management wants the budgeting process to accomplish.
(Copyright © Michael W. Maher, 2006)