Week 7 Ch8 Identifying Relevant Information Must be both 1 must occur in the future 2 must differ between the alternatives Avoidable costs RELEVANT costs that are incurred under one alternative but not under the other alternative Unavoidable costs costs incurred under all alternatives Sunk costs costs that have already been incurred in the past Special Order Pricing Purchases of large quantity but wanting to pay less than the regular sales price The company must decide whether to accept or reject the proposal EX Normal price of meal is 20 the Seminole club wants to buy 100 meals at 14 per meal Sales 20 per meal Cost of Goods Sold Direct Materials Direct Labor 3 Variable Over Fixed Over 1 3 4 Gross Margin Selling Admin Fixed 9 2 Variable 2 Operating Income 5 Costs Total 15 Direct Materials Direct Labor Variable Overhead Variable S A are all RELEVANT Fixed Overhead Fixed S A are both IRRELEVANT Add Relevant costs to find whether they add up to MORE or LESS than the proposed sales price If more reject If less accept In this case the relevant costs are 3 3 4 2 12 So we ACCEPT the offer as we will get 2 profit per meal sold at the proposed 14 a meal Increasing our GP by 200 If operating at Full Capacity If at full capacity we would NOT accept the offer b c we would be giving up 100 meals at 20 per meal giving up 6 per meal losing 600 the opportunity cost Outsourcing aka make or buy Outsourcing transfers the production of goods to a provider outside the company EX A company can supply for 0 35 a gallon Our Costs Direct Materials 0 15 RELEVANT Direct Labor 0 05 Variable Overhead 0 10 RELEVANT RELEVANT Fixed Overhead 0 20 Irrelevant Total Manufacturing 0 50 Pumped 300 000 gallons MAKE 300 000 15 300 000 05 300 000 10 90 000 45 000 15 000 30 000 90 000 BUY 300 000 35 105 000 In this case it would be 15 000 better to MAKE EX Continued Suppose the space that would open up as a result of stopping the production and starting buying the product would result in space to generate an additional 20 000 profit in total Should the company continue to produce the product still MAKE 45 000 15 000 30 000 20 000 110 000 BUY 300 000 35 105 000 In this case we would want to BUY the product as it would save us 5 000 For any OUTSOURCING example one must consider QUALITATIVE factors as well such as 1 Quality of the product provided 2 Reliability of the supplier 3 Stability of the price offered 4 Theft of intellectual property Allocating Constrained Resources How can we work around constraints while still earning max income A constrained resource is anything that limits a company s ability to produce products Ex Cash Machine Hours Facilities Labor Hours Bottleneck the most constrained resource that a company has to deal with Deciding which service to undergo at full capacity is dictated by the service that generates the largest CONTRIBUTION MARGIN EX If only 1 200 hours are available how many of each service should be provided Contribution Margin Sales Price Variable Expense Cost Required Hours constraint Fishing CM 70 Hours 8 Demand 95 8 75 CM perhour 2 Priority Rank Scuba CM 30 Hours 6 Demand 55 5 00 CM perhour 3 Island CM 40 Hours 4 Demand 65 10 00 CM perhour 1 Prioritize by greatest CM per hour the main constraint Island 65 demand 4 hours 260 total hours Fishing 95 demand 8 hours 760 total hours Scuba 1 200 1 020 180 180 6 hours 30 new demand Notice the Scuba service only gets to serve 30 people with the leftover 180 hours divided by 6 hour per service Week 8 Notes Ch 8 Managerial Decisions Keeping or Eliminating Operations Segment Margin Contribution Margin of a particular segment less minus and direct fixed costs Direct Fixed Costs Fixed Cost that can be directly attributed to one specific segment If that segment is eliminated these fixed costs will too be eliminated AVOIDABLE Common Fixed Costs Fixed Cost that are shared by all segments If that segments is eliminated UNAVOIDABLE A company begins to consider whether or not to continue running a segment based on whether the segment is still profitable or as profitable as wanted If the segment is not profitable then it will be considered for elimination If a segment has a positive segment margin then keep it EX Segment A Revenue 255 000 Variable Exp 195 000 Contr Margin 60 000 Fixed Exp 40 000 Segment Margin 20 000 If the company stops running Segment A they will be worse off by 20 000 If there is Common Fixed Exp it is allocated to all segments based on percent of total sales For instance EX 200 000 Common Fixed Exp four operating segments For an operating segment that had 340 000 Sales out of total 1 700 000 Sales 20 of sales 40 000 Common Fixed Exp would be allocated to this segment 20 of total Sales so 20 of common fixed exp Suppose that if Segment A is eliminated we would expect a 15 increase in sales for Segment B Segment B has Sales of 340 000 and Variable Costs of 95 000 EX 340 000 15 51 000 gain 95 000 15 14 250 loss We would be 20 000 worse off based solely on eliminating Segment A There would be a 36 750 increase in sales revenue with the 15 increase in sales This would NOW make eliminating Segment A a better course of action So eliminating Segment A and causing a 15 increase in sales for Segment B would make the company better off by 16 750 overall Sell or Process Further Some products may be sold as is or processed further into a product that can be sold for a higher amount Additional costs will be incurred to process further so the company must decide if the costs are worth the gain EX A cruise intends to start selling a dinner cruise instead of the traditional sunset cruise Sunset Cruise Dinner Cruise Sales Price 50 75 Direct Materials 15 28 Direct Labor Variable Overhead 8 6 15 8 Fixed Overhead 4 4 Unit Cost 33 55 To calculate whether to sell as is or process further you take into consideration a few things Additional Sales Rev Additional Relevant Costs Additional Sales Revenue 75 50 25 Additional Costs 55 33 22 Additional Profit per sale 3 CH 5 Planning and Forecasting Types of planning Strategic planning identifying the overall focus of the organization Tactical planning developing concrete actions that help to achieve the strategic plan Tactical planning includes the budgeting process Budget an operating plan that is expressed primarily in financial terms Benefits of Budgeting 1 Implements a plan for the future 2 Facilitates communication between divisions of the company 3 Serves as a benchmark to evaluate performance Top Down vs
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