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Options for Company in Financial Difficulty

Introduction

There are a few options for S.B. Ltd to consider getting through difficult times. The five main options are firstly, to discontinue the Nottingham division and Leicester and Loughborough divisions could use their spare capacity to produce 60% of Nottingham’s 2010 output in addition to their own 2010 output, close the Nottingham division and outsource Nottingham’s 2010 output, to launch a major campaign for all 3 products to increase their sales, to introduce a transfer pricing system between the division and the head office to increase motivation among the staff in each division and rightsizing the organisation.

Discontinuation

As seen Nottingham is not making growth, in response to market forces, the first option is to discontinue Nottingham division by selling its assets and settling its liabilities and shifting production from Nottingham to Leicester and Loughborough. The discontinuation decision is a decision when the division profitability highlights the potential of unprofitable (Drury, 2010, pp.91-92). In this option, assuming that Leicester and Loughborough have some spare capacity to produce 60% of Nottingham’s 2010 output on top of their own 2010 output. According to Drury (2010, p.92), discontinuing the Nottingham division could aid the company in eliminating cost of goods sold, and other variable costs in the division.

Leicester Loughborough Derby
Sales – Strawberry jam 280.00
Sales – Orange Marmalade 240.00
Sales – Raspberry jam (60%) 96.00
Total Sales 616.00
Cost of goods produced and sold 173.00 153.00 326.00
Gross Profit 290.00
Advertising costs 30.00
Distribution costs 50.00
Local administration expenses 30.00 30.00 60.00
Head Office Costs 150.00
Net Profit

Other cost such as advertising costs, distribution costs and Head Office costs remain unchanged and is not affected by the discontinuation of the Nottingham division. O’Hare (2010, Management Accounting Lecture 3) suggested other factors which will affect an organisation to discontinue a division, the division is making a loss, to identify avoidable costs or to discover other saving.

Outsourcing

Outsourcing option is also known as sub-contracting option has become increasingly common in organisations, which enables organisations to concentrate on their core performance while outsource other specialist their secondary activities (Collier et al, 2007, pp.220-221). In S.B. Ltd case, according to Oxford University Press (2009), outsourcing could help to get through this hard time by going on a process of business process downsizing. Outsourcing allows operations that have seasonal demands to bring in additional resources in time of needs. Other advantages of outsourcing are, outsource activities will allow S.B. Ltd to focus on important functions without sacrificing quality or service, outsource specialist could help improve the quality and standard of the jam. It may also be able to purchase the jam more cheaply or perhaps more quickly.
Assuming the outsource price for raspberry jam is 20% more then the cost of goods produced and sold for raspberry jam. Hence, the sales of raspberry jam remains the same and Leicester division and Loughborough division have spare capacity which gives them room for expansion of 30% more sales each. All other expenses remain the same for both Leicester and Loughborough divisions. This gives the Head Office a net profit of £76,000

Leicester Loughborough Derby
Sales – Strawberry jam 364.00
Sales – Orange Marmalade 312.00
Sales – Raspberry jam (Outsource) 160.00
Total Sales 836.00
Cost of goods produced and sold 182.00 156.00 338.00
Outsource price 132.00
Gross Profit 366.00
Advertising costs 30.00
Distribution costs 50.00
Local administration expenses 30.00 30.00 60.00
Head Office Costs 150.00
Net Loss 76.00

On contrary to the advantages, outsourcing the jam to some specialist could lead to risk of unsatisfactory quality and standard of the jam. Other disadvantages could be leak of procedures and techniques of making the jam, outsourcing usually focuses on short-term cost-saving, and ignores the unchanged overhead burden.

Major Campaign

Another option is to launch a major advertising campaign for all three products to increase their sales and keep all three divisions. Advertising could boost awareness and generate demand of the sales of jams of S.B. Ltd. and hence acquiring more orders.
In the advertising campaign, assuming the advertising cost increase by 20% and it bring the sales of each product to an increase of 20% each. It simply boost up the profit of the company to £96,000.

Leicester Nottingham Loughborough Derby
Sales – Strawberry jam 336.00
Sales – Raspberry jam 192.00
Sales – Orange Marmalade 288.00
Total Sales 816.00
Cost of goods produced and sold 140.00 110.00 120.00 370.00
Gross Profit 446.00
Advertising costs 90.00
Distribution costs 50.00
Local administration expenses 30.00 30.00 30.00 90.00
Head Office Costs 150.00
Net Profit 66.00

Transfer Pricing

The other option is when an organisation chooses to decentralise its divisions, transfer pricing helps decide what price to charge for in-company transactions (Collier et al, 2007, p.38-39) and as a form of promoting divisional autonomy (O’Hare, 2010, Management Accounting Lecture 8). It is useful when goods are transferred between divisions; hence, the performance measurement of each division is not prejudiced by the corporate objectives. The profitability of each business units will be affected and according to Solomon (1965 cited in Collier et al, 2007, pp.38-39), companies might take advantage of the transfer pricing which are suitable for evaluating divisional performance for the corporate interest, instead of the business units. Transfer pricing strategies and can produce substantial tax savings in addition to enhancing operational performance and improving cash flow. In many organisations, in order to avoid de-motivating effects on different business units, negotiated prices are adopted.
Say, each product is transferred to Derby division and it pays each division 70% of the sales it made from selling all the jams and yet still bare the cost of advertising, distribution and the head office costs. The local administrative expenses shall be bare by the respective divisions.

Leicester Nottingham Loughborough Derby
Sales – Strawberry jam 280.00
Sales – Raspberry jam 160.00
Sales – Orange Marmalade 240.00
Total Sales 680.00
Transfer price revenues 196.00 112.00 168.00
Cost of goods produced and sold 140.00 110.00 120.00
Gross Profit 56.00 2.00 48.00 680.00
Total cost of transfer 476.00
Advertising costs 30.00
Distribution costs 50.00
Local administration expenses 30.00 30.00 30.00
Head Office Costs 150.00
Net Profit 26.00 (28.00) 18.00 (26.00)

There are downsides of transfer pricing. The political process in an organisation might affect the transfer pricing between divisions. Incorrect prices adopted can distort reported performance, by making some divisions more profitable at others expense. Opportunities exist to avoid taxes using artificial transfer prices to transfer profits from a high tax division to a low tax division.

Rightsizing

Rightsizing, or corporate restructuring, with the aim of reducing costs and improving efficiency and effectiveness is also one option in difficult times. Rightsizing is downsizing in the belief that an organisation really should operate with fewer personnel. The primary reason to engage in rightsizing is to make the daily operations of a business more productive. For example, a company may be able to replace assembly line employees with machines which will be quicker and less prone to error. In addition, rightsizing increases profits by reducing the overall overheads of a business.
S.B. Ltd operates a full cost (TAC) standard costing system. The standard costs set fot the year 31 March 2010 and information about future costs and selling prices are in Appendix 2.
Part 2 (700)
Assuming the company decided to go for the option of keeping all divisions open and launching an advertising campaign, you are required to produce a standard cost card for each product and a budget for the company showing clearly the costs attributable to each division for the year to 31 March 2011. State clearly all assumptions made.

Appendix 2 – Standard cost data
Standard cost cards for the year ended 31 March 2010 (per batch of 40 jars each of 500 grams)
Strawberry Jam Raspberry Jam Marmalade
£ £ £
Selling price 28 32 40
Fruit 16kg 4.8 16kg 5.6 24kg 4.8
Sugar 8kg 1.6 8kg 1.6 12kg 2.4
Labour 1 hour 6 1 hour 6 2 hours 12
Other variable costs 1 2 2
Fixed overheads 1 hour 2 1 hour 2 2 hours 4
15.4 17.2 25.2
Profit 12.6 14.8 14.8
Other information
Demand With the right promotion the company believe that they could sell 20%
more of each product at the 2010 standard selling price
Material wastage It is considered that improvements can be made but input weight will
always be at least 10% more than output weight for jam and 50% for
marmalade
Labour Currently operates at 80% efficiency levels
Prices Strawberries are sourced from the UK and prices are expected to rise by
2-5%
Raspberries are sourced from the UK and prices could rise by up to 15%
due to poor weather
Oranges are imported and paid for in euros euro prices are expected to
be as 2010
Discounts on all fruit can be negotiated if quantities increase
Labour rates per hour have been the same for the last 2 years
Variable costs may rise by up to 5 %
Fixed overheads may rise by between 5 and 10%

Standard Cost Card

A standard cost card can be defined as ‘a detailed listing of the standard amounts of materials, labour and overheads that should go into a unit of product, multiplied by the standard price or rate that has been set for each elements’ (Anon 2, 2010). A standard cost card, for example must include the price, specifications, quantity and quality of material required, as well as such factors as the period of credit allowed from suppliers, cash and quantity discounts, spoilage due to wastage and deterioration. A standard cost card demands an investigation of all contributing factors that can constitute a cost before the cost is adopted. According to Drury (2010, p.278), standard costs are ‘predetermined costs’ and they are the target costs that should be incurred under efficient operating conditions. The standard cost card will be subjected to updating caused by revision of standards such as changes in prices, discounts, etc.
Standard costing is a control system which sets standards that are ideal, expected and achievable (O’Hare, 2010, Management Accounting Lecture). Collier (2007, p.36) put forward that standard costing is a control technique which compares standard cost and all of production revenues with actual results. It is to obtain variances of each division and product (O’Hare, 2010, Management Accounting Lecture 8), which are used to stimulate improved performance and to increase motivation of staff in each division. It is a detective control used to prevent problems from reoccurring as it measures variances as it occur, thus allowing management to take necessary corrective action.
The standard cost card for the year ended 31 March 2011 (per batch of 40 jars each 500 grams) for Strawberry Jam, Raspberry Jam and Orange Marmalade are as below:

Strawberry Jam
£ £
Selling price 28.00
Fruit 16/kg 0.31 4.90
Sugar 8/kg 0.20 1.60
Labour 1 hour 6.00 6.00
Other Variable Cost 1.50
Fixed Overheads 1 hour 2.10 2.10
15.65
Profit 12.35
Raspberry Jam
£ £
Selling price 32.00
Fruit 16/kg 0.40 6.44
Sugar 8/kg 0.20 1.60
Labour 1 hour 6.00 6.00
Other Variable Cost 2.10
Fixed Overheads 1 hour 2.10 2.10
18.24
Profit 13.76
Orange Marmalade
£ £
Selling price 40.00
Fruit 24/kg 0.20 4.80
Sugar 12/kg 0.20 2.40
Labour 2 hours 6.00 12.00
Other Variable Cost 2.10
Fixed Overheads 1hour 2.10 2.10
23.40
Profit 16.60

Budget

The principal tool in planning is called ‘a budget’. A budget is a collection of predictions. It is an estimation of the revenue and expenses over a specified future period of time. There are three purposes of budgets as identified by Emmanuel et al (1990 cited in Collier, 2007, pp.39-40), ‘as forecasts of future events’, ‘as motivational targets’ and ‘as standards for performance evaluation’. Budget is a financial plan or qualitative statement for implementing the various decisions to be pursued during a specific accounting period, that management has made in the previous period.
Collier (2007, pp.39-42) suggest that budgets provide a control mechanism through both the feed forward and feedback loops. The control mechanism in the budget is to provide a performance monitoring function to the appropriate managers who are responsible for implementing the various decisions by producing and presenting the performance reports. According to Drury (2010, pp.8-9), the performance report provide feedback information by comparing planned and actual results.
Generally, a functional budget is drawn up for each division of S.B. Ltd. These budgets are, then, merged together into a single combined statement, which is known as the master budget, of S.B. Ltd’s expectations for the future periods. The master budget consists of budgeted profit, which it is expected to convey to everyone in the organisation the part that they are expected to achieve in implementing management’s decisions. The master budget, usually, consists of a budgeted profit and loss, a budgeted balance sheet and a budgeted cash-flow statement. In order to finalised a budgeted profit and loss, other budgets for the individual divisions and produced, such as the sales budget, direct materials usage budget, direct materials purchase budget, direct labour budget, and selling and administration budget.

Master Budget
Budgeted Profit and Loss Account for the year ending 31 March 2011
£ £
Forecast sales (Schedule 1) 816,000
Purchases (Schedule 3)
Materials – Fruit 130,272 Share this: Facebook  Twitter  Reddit  LinkedIn  WhatsApp   

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