Susan, I have just seen the quarterly P&L. It’s great that 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 8 AM so you can explain this discrepancy to me? Richard Norton, CEO of Software Associates
Norton, the founder and CEO of Software Associates called Susan Jenkins, CFO of Software Associates, after skimming the second quarter profit and loss statement (see Exhibit 1). Jenkins had been preparing to go home but now anticipated a long evening ahead to prepare for the next morning’s meeting. Assignment Question 1: Prepare a variance analysis report based on the information in Exhibit 1. Would this be sufficient to explain the profit shortfall to Norton at the 8 AM meeting?
Richard Norton had founded Software Associates ten years ago to perform system integration projects for clients. While initially set up to operate in client-server environments, Norton had been nimble 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. Annual revenues exceeded $12 million, and profit margins were usually between 15% and 20%. Currently, Software Associates 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 Norton and Jenkins prepared a detailed budget for the next three months, based on the annual plan, and recent operating experience and information from the market. Norton 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, Jenkins estimated consulting revenues by multiplying together the expected number of full-time-equivalent (FIE) consultants at the firm, the number of hours available (450 per quarter) per FIE, the expected billing percentage (the ratio of hours billed to total hours available), and the average hourly billing rate. She calculated consultant expenses by multiplying the average compensation (including fringe benefits) per consultant by the number of FIE consultants. She 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 2000. Assignment Question 2: Prepare a variance analysis report based on the information in Exhibit 2.
Jenkins 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 she authorized the acquisition or rental of additional space. Expenses such as computing and telecommunications had both fixed and variable components. Because of the profit...