Incorporated Finance plc is a finance company having one hundred branch offices in major towns and cities throughout the UK. These offer a variety of hire purchase loan facilities to personal customers both directly and through schemes operated on behalf of major retailers. The main function of the branches is to sell loans and to ensure that repayments are collected; the head office is responsible for raising the capital required, which it provides to branches at a current rate of interest.
Each year branch managers are invited to provide estimates of the following items for the forthcoming year, as the start of the budgetary process:
Value of new loans (by category e.g. direct, retail, motor) Margin percentage (i.e. loan rate of interest less cost of capital provided by head office)
Gross margin (i.e. value of new loans × margin percentage) Branch operating expenses
Net margin (i.e. gross margin less operating expenses).
The main branch expenses relate to the cost of sales and administrative staff, and to the cost of renting and maintaining branch premises, but also include the cost of bad debts on
outstanding loans.
These estimates are then passed to headquarters by area and regional managers and are used, together with other information such as that relating to general economic conditions, to set an overall company budget. This is then broken down by headquarters into regional figures; regional managers then set the area budgets and area managers finally set branch budgets. However, a common complaint of branch managers is that the budgets they are set often bear little resemblance to the estimates they originally submitted.
Budget targets are set for the five items specified above, with managers receiving a bonus based on the average percentage achievement of all five targets, weighted equally.
(a) Discuss the advantages and disadvantages of allowing managers to participate in budget-setting, and suggest how Incorporated Finance plc should operate its budgetary system.
(b) The managing director is considering changing the performance evaluation and bonus scheme so that branch managers are set only a net margin target. Prepare a report for him outlining the advantages and disadvantages of making such a change.