Organisations' behaviour is guided by financial data. In the short term, such data will help determine operational expenditures; in the long term, historical data may help generate forecasts aimed at determining strategic plans. In both instances, data can assist managers in performing what-if analysis (sometimes referred to as 'sensitivity analysis'), whereby discussions can focus on likely behaviour given changing sets of data.
Suppose that the management of a manufacturing company has approached you as a consultant. You have been asked to analyse financial data and develop alternative budget scenarios to help the company make some pricing decisions with which it is struggling.
The details of this are as follows:
The Blake Manufacturing Corporation manufactures and sells folding umbrellas. The corporation's condensed income statement for the year at 31 December 2011 follows:
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Sales (200,000 units)
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$1,000,000
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Cost of goods sold
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600,000
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Gross margin
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400,000
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Selling expenses
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$150,000
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Administrative expenses
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100,000
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Net profit (before income taxes)
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$150,000
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Blake's budget committee has estimated the following changes for 2012:
- 30% increase in number of units sold
- 20% increase in material cost per unit
- 15% increase in direct labor cost per unit
- 10% increase in variable indirect cost per unit
- 5% increase in indirect fixed costs
- 8% increase in selling expenses, arising solely from increased volume
- 6% increase in administrative expenses, reflecting anticipated higher wage and supply price levels
Any changes in administrative expenses caused solely by increased sales volume are considered immaterial.
Because inventory qualities remain fairly constant, the budget committee considered that for budget purposes any change in inventory valuation can be ignored. The composition of the cost of a unit of finished product during 2011 for materials, direct labor and manufacturing support, respectively, was in the ratio or 3:2:1. In 2011, $40,000 of manufacturing support was for fixed costs. No changes in production methods or credit policies were contemplated for 2012.