The cost which the organization incurs the production and acquisition of products and services which it intends to sell is very important. The pricing strategy of the organization is significantly affected by costs. Therefore, costs designed to tackle the challenges of the economic and the noneconomic factors very efficiently. The objective of the costing models is to categorize the factors of the marketing objectives of the company and the mission of the company (Gitman, 2003).
Accurately determination of cost is important in organization to remain profitable. Costing does not only require including direct and indirect cost associated with business operations but also includes the opportunity cost and the exit costs (Kaplan, and Atkinson, 1998). Opportunity costs accounts the opportunity that business has forgone by adopting certain decision and leaving the other opportunity. While exist cost includes costs associated with leaving the decision once adopted. Other factors that affect the costing include competition in the internal and the external environment of the organization, focusing on the needs of the customers and inscribing the proper controls which are required to be regulated over time to ensure maximum efficiency. Pricing hence requires including costs that has incorporated all these factors (McLaney, 2009).
The pricing strategy of the company is affected largely by the cost of the products. Companies differentiate and gain the competitive advantage with the low production cost in the market with improved the efficiency while adding premium to cost percentage.. Hence, costing plays critical role in price determination of the price of product.
The costing system of an organization helps an organization in analyzing its performance. It helps in determining the success of the company by controlling costs and increasing margins.. The costing system also helps in analyzing the company to reduce the expenses which were associated to the marketing, public relations and sales efforts decisions of the organization.
The organizations competing in the industry always want to differentiate themselves from the competitors in some way or the other. The objective of all the organizations is to reduce the cost of production to increase the profitability. In order to attain the cost leadership the organizations constantly look towards innovation and the technological advancement of the industry.
The costs the company incurs can be divided into four components which are:
PRIME COST: The prime cost is directly induced cost for performing the operations of the company. This cost deals with all the expenses which are associated with the production or the running of the company. Prime cost is the most important form of the cost mainly because it is associated to the performing of the job (Weygandt, Kieso, & Kell, 1996).
WORK COST: All the indirect cost that is incurred by the company is called the work cost. It comprises of all sorts of the indirect expenses incurred to the material, labor and the expenses of the production side of the organization (Weygandt, Kieso, & Kell, 1996).
COST OF PRODUCTION: The cost of production is all the sorts of the cost. It includes the sum of the cost incurred for the production of the products and the overheads of office and the administration of the organization (Weygandt, Kieso, & Kell, 1996).
TOTAL COSTS: The total cost includes all the expenses which impact directly on the production, sales and the distribution related activity.
The combination of these costs help in determining the efficiency of the organization.
Lenovo operates in the market with low cost. Lenovo which have a low cost benefit being a Chinese company succeed in creating a competitive edge. The products of Lenovo have made their existence in the industry by offering low cost products. This also increases the profitability of the company. The pricing system of the company is the process of identifying the cost which is incurred by the company in the making of the product and setting a price in accordance to that product. Lenovo needs to focus on the research and development because apart from the cost advantage the products fail to offer innovation to the customers. As Lenovo is offering the wide range of personal computers and other personal technological gadgets with high level of vertical integration; therefore, it must develop the ABC based costing. As the core components of the most of the products have much familiarity so by adopting the ABC based costing Lenovo would be able to identify the core areas where cost playing critical role in affecting prices. The pricing shall then be developed in percentage linkage with critical pricing components.
IMPROVEMENTS TO THE COSTING AND PRICING SYSTEM USED BY AN ORGANIZATION
The process of determining the costs and the price which is required to be charged by the customer forms the costing and the pricing schedule. To improve the costs structure analysis of direct costs, indirect costs shall be conducted. For example, allocated cost, full cost, administration cost, research & development cost and the capital cost of the companies are identified. Then monitoring of this system efficiently will improve the costing and the pricing of the company.
Lenovo having a high level of vertical integration is available with greater opportunity to exploit cost efficiencies. For example, as suggested above that Lenovo shall adopt the ABC costing system that identifies the cost associated with different activities. Once the activities and associated costs will be identified it will then be able to generate efficiencies across all activities thereby generating an overall cost efficiency.
The trend line for the given data is as follows:
The trend line that has been drawn in the graph above shows a rise and fall in the overall cost, revenue and the profits for the year. The figures which have been plotted are showing a continuous upwards and downwards trend in the figures of the company’s performance at regular intervals. The variation which can be seen in the graph can forecast that the company mentioned above gains and loses its popularity over the years. The figures of the company are not showing a consistent growth rate. Sometime the performance of the company is high and sometimes it is below the market standards. The rise or fall in the company’s profits is showing a consistent pattern.
Average forecasting technique has been applied on the above given date to develop the future trends.
AVERAGE FORECASTING TECHNIQUE
The average forecasting technique is the method of recording the data in such a way that the future results can be forecasted on the basis of average of past certain years. In the above chart we have calculated the average for the year 1993 for the cost, revenue and profit. For forecasting of 1993 the trend has been generated on the basis of calculating the average for the 3 years to note forecast the figures for the next year. Hence, the forecast for the three elements for 1993 has calculated.
The possible sources of funds which may be available to KAFCO Ltd. are
- The company can raise funds through bank loan. The positive of bank loan is that the company will have to give a lower interest cost and funds can be attained easily. However, the negative of raising funds from bank loan is that if the company is not able to pay its loan back, then the company will become bankrupt.
- The company can also generate the funds by offerings ownership in form of share of the company. They can sell or issue shares to the investors. The investors are paid back by offering dividend to them along with capital ownership. The positive of raising funds from equity is that the ownership is divided. On the other hand, the negative of raising funds from equity is that the cost of raising funds from equity is high.
- The other source of raising funds is from personal investment. The risk of investment is very high if the funds are raised from this source.
- The company can also raise funds from retained earnings. This would allow the company to have access to funds quickly.
The KAFCO Ltd can generate the funds by complying with the above methods. These are the basic ways of generating the funds in any company. The aim of the company to take up new projects and to improve the production facilities can be attained by the generating funds by above mentioned factors suiting to the conditions of business.
FORECASTED INCOME STATEMENT
Jim Smith intends to increase sales for the next three years by 10 years on annually. In addition, Jim also intends to take profitability to 8% by end of three years. By the end of six months Jim has incurred net loss of around -2050. The company has though managed to get cash position in profitable zone. Further, for the month of July, if all remains same then company will move towards the better position. Hence, Jim will be available with cash to increase sales. For move into profitability as currently business is in loss Jim shall control the level of inventory that has been accumulated significantly. Reducing closing inventory will improve the profitability of business and so the targets can be achieved. Assuming following conditions Jim will not be required to fund from external sources.
PROGOTI INDUSTRIES LTD.
The operating statement shown here depicts that the forecast which were made by the company differed a lot from that of the actual figures. The difference in the actual and the budgeted statement is about 49% in net profit which is quite high. The difference in the net profit figure was of £29600. Inflow estimates were overvalued. while outflow factors like material and labor cost were undervalued. This all caused major reason for the difference in the projected figures.
The senior management of the business can use the figures to depict exactly the performance of the company to project the future expectations of the company performance in a more efficient manner. The senior managers of the company must try to increase the sales of the product. The sales figures of the company will cover up the cost of the raw material and the labor cost which the company incurred. Senior management is required to look into matters that caused the differences in performances. In case the material and labor was actually undervalued or the production departments has caused wastages. Similar estimations analysis must be done for the sales as the actual figures lacked to meet the targets. Hence, senior management requires evaluating if the flaws were in estimation or the business performance and undertaking actions accordingly.
BUDGETARY MONITORING PROCESS
The budgetary monitoring process is the process in which the companies follow to analyze the amount of investments and the actual performance generation from that investment. In the given scenario the budgeted and the actual figures of the companies were shown that had significant variation and required senior management of the business to look into factors that caused variation. .The budgets are made in the beginning of the month with setting targets and across the period the actual and budgeted targets are constantly compared with the set targets to evaluate the alignment of the company direction with targets. For instance, Kwara State College of Education, Ilorin has developed budget monitoring committee that evaluates the proxy budgets once they are set followed by approval of the budget, After the budget approval, budgetary disbursements and inflows evaluation are assessed by referred committees (Kwara State College of Education, 2012).
METHODS OF MANAGING COST REDUCTION IN THE ORGANIZATION
The methods which can be used to reduce the cost in the operational function of the company are by initiating the ways which reduce the cost and increase the efficiency of the company. Some of the strategies which can improve the efficiency of the company are referred below:
JUST-IN-TIME (JIT) SYSTEM
The Just in time inventory process increases the efficiency of the company by reducing the inventory level of the company. It increases the efficiency by reducing the storage cost holding cost of the raw material beforehand.
ACTIVITY BASED MANAGEMENT
This is a system designed to allocate costs on the basis of the activities. This enables business to identify the activities that are not generating any value. This leads to elimination of the cost incurring process which does not possess any value. This improves the efficiency of the production.
LIFE CYCLE COSTING
This process uses the method of calculating the overall cost across the life of the product. This increases the overall estimation of the product life hence enabling business to make more informed decisions for the future position of the business.
KAIZEN COSTING
This process emphasizes on the reduction of the cost of the production by following continuous improvement on regular basis than radical and extensive changes.. Kaizen, Japanese word refers to continuous development and requires business to generate efficiencies across business on the basis of improvement learning.
RE ENGINEERING THE BUSINESS PROCESS
The structure of the business process is reformed integrating required changes. It aims to develop stronger linkages between the processes and activities to reduce wastages and leakages. This increases the efficiency and the effectiveness of the company process resulting in cost saving.
TOTAL QUALITY MANAGEMENT (TQM)
The improved quality can only be ensured by constant up gradation and improvement of the company. TQM sets strict standards for the acceptable variations in products and results in cost saving with reduced wastage.
BENCH MARKING
The activity based costing method is the process of costing or the budget allocation is done as per the need of that activity. This process increases the functionality of the company. It increases the efficiency as the resources of the company are allocated to the segment of activity in product or service development in accordance to the need (Brealey, Myers, Allen, & Mohanty, 2007). Activity based costing system identifies the overheads associated with each activity as well as cost drivers. This identification enables business to develop system where cost drivers can be controlled to retain the cost level under control. This also allows business to identify the more benefit generating product and business can take measure to push the sales of such product. Further, it also identifies the activities that excessively increasing costs while revenue generation or the value addition from that particular activity is not countable. Therefore, company on the basis of the value of the activity to business can eliminate such unwanted activities adding financial benefit to its business operations. Further, company can combine the certain activities of different product and generate efficiencies from them. In addition business can also make timely decisions of outsourcing or in sourcing certain activities that are not core to business.
The organizations like Lenovo that manufactures the products with high vertical integration highly require this technique. The efficient usage of this process will improve the functions of the business. The aim of this model is to minimize the inefficiency by reducing the activities in production and business process with low sales contribution or which are less profitable. The products which don’t generate the sales are a major reason for the ineffectiveness of the company..
- NET PRESENT VALUE
- ACCOUNTING RATE OF RETURN (ARR) BASED ON THE AVERAGE INVESTMENT COST:
PAYBACK PERIOD
STRATEGIC INVESTMENT DECISION
Based on the above assessment, project X is feasible for adoption. The justification for the referred recommendation is based on the fact that NPV of the project is higher than Project Y. As both projects are incurring similar initial investment with similar cost of capital, however, the return generated from project X is much higher than project Y. The other measures of the average rate of return are almost similar. Similarly the payback period of the two projects only differ minute timing. Hence, the most preferred method of NPV has proved the project X more feasible for adoption.
POST AUDIT APPRAISAL AND APPROPRIATENESS AND SUITABILITY OF THE BUDGETING TECHNIQUES
The strategic investment of the company must be based on the rationale that the company intends to maximize the profits of the company with using the best plan that is available. On the basis of three different techniques project X has been found more feasible. With almost similar payback period and average rate of return, higher NPV supports the decision. Hence, the project appraisal with techniques enables business to identify the project that is capable of generating more benefit to business.
Capital budgeting techniques are widely used in business decision making. each of the three techniques have various merits and demerits to offer and so are not used in mutual exclusivity. For instance, in the project X under consideration have positive higher NPV number with payback period of more than three years while the NPV value of the project Y is lower yet the payback period is lower; than the decision may vary. These numerical factors are assessed under the light of various other factors such as longer duration of project increases the risk over time etc. Hence, all these project significant insight in collaboration with technical and analytical factors assessment.
COMMENT ON THE RELATIVE PERFORMANCE OF THE COMPANY
The company’s overall position has deteriorated as compared to that of the previous year. The net profit of the company is higher than that of the previous year. The gross profit has decreased due to the increasing cost of inventory. The overall operations of the business have reduced the performance as business has been delaying payments as well delay in receipts is also witnessed. In addition the debt servicing capacity of the business has reduced. Among all declining performances, the return performance of the company has improved. The increasing returns on capital employed is very healthy sign.
In-depth assessment of the business reveals that business has significantly reduced the administrative expenses from US $ 315 to US 240. Though this factor has contributed well in the returns of business; however, reduction in these administrative expenses has negatively affected business. Business needs to reconsider constituents of administrative factors reduction in which have negatively affected business.
IMPROVEMENT OF THE RATIOS
- GROSS PROFIT RATIO
The gross profit of the company can be improved by the reducing the amount of inventory. The production process implemented by the Just In Time (JIT) method will increase the profitability of the company.
- NET PROFIT RATIO
The increase in the net profit of the company is comparatively higher than the previous year. The profits of the company can be further increased by improving the sales and other functional performances of the business as reduction in administrative cost has caused decline in the business..
INVENTORIES TURNOVER IN DAYS (BASED ON COST OF SALES)
The inventory turnover shows that either the inventory has been stored in a large quantity or the sales which have been generated are lesser than that of the previous year.
Since higher inventory storage incurs higher cost; therefore, it has already been suggested that business shall integrate JIT system to control inventory level or at-least reduce the inventory levels. TRADE RECEIVABLES TURNOVER IN DAYS (TRADE RECEIVABLES COLLECTION PERIOD)
Increase in receivable TO days result in restricted cash position of the business affecting its ability to pay off debts. Company is required to develop some system that enables it to collect from debtors earlier. Such as discounts on cash purchases etc would improve the conditons
RETURN ON CAPITAL EMPLOYED (ROCE)
The ROCE of the company has already increased. However, the reason of this increase has negatively affected the over all performance of the business operations.
INTEREST COVER RATIO
Decline in interest coverage ratio has been due to increased debt on the balance sheet. This can be improved by reducing the time allotted for the recovery of the trade receivables. Further, overall improvement in business conditions that have been identified to be affected by administrative factors will also improve the cash position of the business and thereby will ultimately reduce its debt requirement and affect in above ratio
- INVEST RECOMMENDATIONS
- It is recommended that Sarah should not invest in the business in the current point in time. Since the performance of the company has decline due to single factor as evident from the income statement and that may be resultant from some improvement measures from the company that didn’t prove beneficial for the company. It is recommended that Sara shall the halt the decision and view the performance changes in the coming year. If the company is able to generate some improvement in business condition then only it can be considered as investment option.
References
Bodie, Z., Kane, A., and Marcus, A. (2004). Essentials of Investments, 5th ed. London, McGraw-Hill Irwin.
Brealey, R., Myers, S., Allen, F., & Mohanty, P. (2007). Principles of corporate finance. New York: McGraw-Hill.
Gitman, L. (2003). Principles of Managerial Finance. Boston: Addison-Wesley Publishing.
Kaplan, R., and Atkinson, A. (1998). Advanced Management Accounting. New Jersey: Prentice-Hall.
Kwara State College of Education. (2012). Standing Committees. Available from http://kwcoeilorin.edu.ng/index.php/administration/comitees [Accessed 31 May 2013]
McLaney, E. (2009). Business Finance: Theory and Practice. Pearson Education: New Jersey.
Weygandt, J. J., Kieso, D. E., & Kell, W. G. (1996). Accounting Principles (4th ed.). New York, John Wiley & Sons.
