Online Class

EMB 834

Question 1. Case Study

Budgeting, Budgetary Control and Performance Evaluation: A Case Study of Techville Solution

Preface

Tarry Williams, the founder and CEO of Techville Solutions called Martins Joel, CFO of Techville Solutions, after perusing the second quarter profit and loss statement (see Exhibit 1). Our last quarters Profit and loss result looks good. Surprisingly, we exceeded our billed hours and revenue targets. But why, with higher revenues, is our bottom line less than half of what we had budgeted. Can we have a meeting tomorrow morning at 9AM so you can explain this discrepancy to me? Martins had been preparing to go home but now anticipated a long evening ahead to prepare for the next mornings meeting.

History

Tarry Williams had founded Techville Solutions twelve years ago to perform system integration projects for clients. While initially set up to operate in client-server environments, Techville had been quick enough to make the transition to web applications, and his company had continued to grow and prosper during the rapid technological evolution of the 1990s.

The annual revenues been in excess of N12 million over the years, and profit margins were usually between 15% and 20%. Currently, Techville Solutions offered two types of services to clients. The Solutions business helped clients rapidly develop targeted information management strategies, and then mobilized business and technology resources to deliver software solutions. Typical services included; IT strategy and management, IT architecture and design, information management, and data warehousing. The Contract business offered clients experienced software engineers, programmers, and consultants, on a short-term project basis, to help the clients implement their own IT tools and solutions. This service enabled clients to implement major IT projects without having to hire expensive, experienced software personnel.

Preparing the Budget

Each quarter Tarry and Martins prepared a detailed budget for the next three months, based on the annual plan, and recent operating experience and information from the market. Tarry knew that in his fast-paced business, he could not manage with just an annual budget. He wanted to continually scan the environment and industry trends before locking into a hiring plan, an operating plan, and a budget for a period. For the quarterly budget, Martins estimated consulting revenues by multiplying together the expected number of full-time-equivalent (FTE) consultants at the firm, the number of hours available (450 per quarter) per FTE consultant, the expected billing percentage (the ratio of hours billed to total hours available), and the average hourly billing rate. He calculated consultant expenses by multiplying the average compensation (including fringe benefits) per consultant by the number of FTE consultants. He then estimated operating expenses; such as advertising, administrative support, education and training, information systems, occupancy, office expense, postage and telecommunications. Exhibit 2 contains the budget and the actual financial results for the second quarter of 2021. EMB 834 Case study 2

Expense Analysis

Martins knew that the budgeted operating expenses were neither entirely variable nor entirely fixed during the quarter. Some expenses varied during the quarter based on the number of consultants hired and working, while other were fixed, independent of the number of consultants on board. Obviously, consultant expense varied with the number of consultants hired. Occupancy expenses, however, were fixed through the quarter unless he authorized the acquisition or rental of additional space. Expenses, such as computing and telecommunications, had both fixed and variable components. Because of the profit shortfall in Q2 2021, Martins knew that he had better be prepared to explain to Tarry why expenses had exceeded the budgeted amounts. During the evening, he spent several hours studying the operating expense categories, eventually preparing Exhibit 3, which showed budgeted operating expenses by category and his judgment about their degree of variability. He also listed the actual operating expenses for the period on the exhibit.

Billing Percentage

Martins wondered why if the actual number of consultants was nearly 8% higher than budgeted (see Exhibit 2), revenues had increased only 3%. Were consultants becoming less productive? He knew that a key operating statistic for consulting organizations was the percentage of time billed.

Additional Analysis

Martins was finally driving home at about two in the morning, he felt well equipped for the meeting the later in the morning but wondered about other forms of analysis he might have done if he had more time. For example, Tarry had been quite pleased with the growth in revenues and billed hours. But was that due to good work by the firm, or had the overall consulting industry grown faster than expected during the quarter. In other words, was Techville Solutions increasing or decreasing its share of software consulting business? Also, Martins had assumed that operating expenses varied only with the number of consultants. He pondered whether the consultants from the Solutions business required more support than did the consultants in the Contract business. Also, did support expenses vary with the number of consultants, of either type, or with the number of hours they worked or billed? Within each business line, he had used an average billing and cost rate per consultant. Would he get additional insights by looking at the mix of consultants used within each business or even on each job to understand better the economics of the business? He resolved to think more about these issues in the upcoming quarter, but his most urgent task was to get some sleep before presenting his analysis to Tarry Williams in a few hours.

Exhibit 1 Techville Solutions Income Statement, Quarter 2, 2021

	ACTUAL (Naira)	BUDGET(Naira)
Revenue	3,514,980	3,420,000
Expenses	3,163,482	2,769,550
PROFIT	351,498	650,450
Profit Margin %	10.0%	19.0%

Techville Solutions

Exhibit 2 Budget and Actual Income Statement: Quarter 2 2021

Techville Solutions Exhibit 2 Budget and Actual Income Statement: Quarter 2 2021

ITEM	ACTUAL(Naira)	BUDGET (Naira)
Revenue	3,514,980	3,420,000
Less:
Consultants' salaries and fringes	2,151,168	1,855,599
Operating expenses	1,012,314	913,952
	3,163,482	2,769,550
Operating Profit	351,498	650,450
Profit %	10.0%	19.0%
Operating Statistics
Number of consultants (FTE)	113	105
Hours supplied	50,850	47,250
Hours billed	42,000	38,000
Average billing rate	83.69	90.00

Techville Solutions Exhibit 3 Expense Items: Budget Q2 2021

ITEMS	ACTUAL(Naira)	BUDGET (Naira)	VARIABLE (%)
Advertisement and promotion	23,837	15,732	0
Administrative and Support	242,681	199,240	80
Information systems	136,117	125,013	80
Depreciation	25,239	23,648	0
Dues and subscriptions	12,727	13,647	80
Education and training	39,045	40,525	80
Equipment leases	25,347	23,378	25
Insurance	36,240	33,545	0
Professional services	42,604	36,150	0
Office expense	45,408	38,077	100
Office supplies	92,974	93,343	80
Postage	29,445	25,732	80
Rent -real estate	126,475	122,159	0
Telephone	43,143	40,108	100
Travel and entertainment	62,342	58,652	100
Utilities	28,690	25,003	25
	1,012,314	913,952

QUESTION

1. Prepare a variance analysis report based on the information in Exhibit 1. Would this be sufficient to explain the profit shortfall to the CEO at the meeting at 9am?

2. Why could the CEO of Techville Solutions not manage with just an annual budget? what advantage(s), if any, do you see in the company's practice of the quarterly preparation and review of the budget?

3. Prepare a variance analysis report based on the information in Exhibit 2. What strategy would you recommend for Techville Solutions to enhance its profit margin given the result of your variance analysis?

4. Prepare a spending and volume variance analysis of operating expenses based on the additional information supplied in Exhibit 3.

5. Prepare an analysis of the revenue change, separating the volume effect (increase in number of consultants) from the productivity effect (billing percentage).