Posted: June 24th, 2021
A successful and sustainable business must be able to consistently earn operating profit, which is considered as the litmus test of all successful businesses (2002:109). Its realization depends mainly on the ability of a manager to make sound decisions on financial and operational aspects of the business. Businesses have many operating expenses that do not vary with sales activity but remain constant for a certain period of time (2002:112). These costs remain in place over a range of various sales activity levels, whether the business is earning or losing.
Fixed expenses are incurred because the operation needs space, equipment, personnel and other relevant activities of the business. PRM, a medium-size supply company based in Melbourne, Australia, produces three quality of papers, namely: Supreme, Recycle papers, and Durable. For the past 10 years, the company has been generating a profitable level of revenue. However, the lower value of Australian currency in the past year has made imported raw materials more expensive.
The first report shown above on the Sale performance of PRM Company for the first quarter is not suitable as basis for analysis and decision making mainly because it lacks details on the overall financial activity. Further analysis and scrutiny regarding the substantial and relevant information on sales and cost operating expenses will not be possible. The overview of the report above tells us right away that profit loss on the Durable paper may have been due to low sales volume. However, if we will present an alternate Profit Report, such as the one presented below, a more comprehensive assessment on the losses can be derived.
From the table above, we can see that per unit cost of Supreme paper is $ 40. 5 while Durable is $ 42. The respective unit sale is $ 60 and $ 40, which obviously states that the price for Durable is not cost-effective at all. In fact it generates a $ 2 loss for every unit of Durable paper sold due to its sale price while Supreme paper earns at $ 19. 5 per unit. By subtracting the Selling and Administrative Expenses, it can be concluded that more losses were incurred by the company in selling the Durable paper. Thus, it is suggested that final profit computation should be based on Net Income to take away income tax expense.
Also, it can be observed that the total sales of Recycle and Durable Papers are the same, $ 270,000. But we can see that the expenses for advertising and promotions for Durable only amounted to $ 6,000, while $ 11,000 was spent on Recycle paper and $ 23,000 on Supreme paper. This is another factor that should be considered for profit assessment because heavy advertising can bring volume and market share to a high level (2001: 340). If the general manager, Diana Button has implemented her proposed course of action in addressing the losses, it will not have been the wisest action.
To immediately drop the Durable paper based on the abovementioned factors that pushed the losses will not remedy the problem. An increase in the product unit sale price should first be implemented to cover the production and relevant administrative costs. Button also proposed an increase in quarterly sales promotion by $ 100,000 on the “Supreme” line in order to increase sales volume by 15%. If we will add the 15% to the sales volume, the amount will be $ 552,000. That is only $ 72,000 additional sales but an additional cost $ 77,000. That is still an apparent loss to the company in the amount of $ 5,000 (refer to Table 3 below).
A product cut on the “Recycle Papers” by 50% is likewise suggested by Button. According to her, the traceable advertising and promotion for this line should also be reduced to $20,000 each quarter. This proposal means decreasing volume sales and expenses. But note that it was reported that the company is manufacturing at capacity and all papers produced are sold. To address the manager on this aspect is to review the Variable Manufacturing Overhead. For this Recycle Paper, it is $ 9 per unit – a much higher value than the rest of the product’s costs such as raw material ($5), labor ($6), and fixed manufacturing overhead cost ($3).
PRM should consider various qualitative factors before identifying and deciding to drop production line. It has been reported that the company operates on capacity. Since production uses common equipment and facilities to manufacture the 3 product lines, they must consider the product that will have optimum sales. This can be done by hiking up production volume but making sure that all papers produced are sold. It is impractical to manufacture a product that utilizes same resources and time of another product which has more profitability than the former.
Profitability is directly proportional to increased sales volume and indirectly proportional to expenses and sales (2002:26). Advertising cost should be appropriated well if the returns become disproportionate to the production cost of goods especially in the case of new products (2004:31). Effective decision-making in business need comparative reports of the financial performance of the product lines as reference. It is more practical to look up the former profit reports on RPM during the previews quarters. This will help in creating frameworks and benchmarks on the actual performance of the products.
Ideally, the company should create profit targets and financial goals to look ahead, predict and be proactive on the changes in economic environments (Tracy 2002:253).
List of References Baker, M. J. (2001) Marketing: Critical Perspectives on Business and Management. Taylor and Francis. Dolly, J. (2002) Pricing for Profitability. John Wiley and Sons. Tyagi, C. L. and Kumar, A. (2004) Advertising Management. Atlantic Publishers & Distributors. Reeve, Warren (2007) Accounting. Thomson Asian. Tracy, J. (2002) The Fast Forward MBA in Finance. John Wiley and Sons.
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