[Author Name(s), First M. Last, Omit Titles and Degrees]
[Institutional Affiliation(s)]
On the first scenario, a special order of 400 units is to be added, at a sell price of DEM 50.00. As with the previous analysis, the insufficient sales amount causes that the fixed cost ratio remain higher than the one we should see on a profitable margin. This also shows that the average price per unit is still under the line of profit, giving as a result that the special order only increases the original profit by DEM 1,600.00 (Table 1)
- Compute the number of units the company must sell to make the targeted net income it desires.
The company needs to reach a target net income of at least DEM 30,000.00. To do so, the management has to decide whether to raise the final prices or to increase total production as well as the total sales (Grønhaug†, & O. Ims†, 1988, p. 1-2). The example shown on table 2, displays an increase of total sales to reach this goal. Dividing the total estimated sales by the final price will result on the needed units to be produced. (Table 2)
- Explain what would happen in this situation if the variable costs increased or decreased.
As variant of the already explained calculation, we may find one more possible scenario: a change in the variable costs which are inversely proportional to net income and directly proportional to the production amount. This means that the higher a variable cost it is, the lower the net income it will be, and since variable costs are expressly related to the quantity of units produced, the more the industry produces, the more costs it will have and vice-versa (“Variable Costs and Fixed Costs”, n.d.)
- Explain what would happen in this situation if the fixed costs increased or decreased.
With a change on fixed costs, and as their name state, they remain the same regardless of the amount of units produced. They represent the regular cost of opening the factory every day, such as utilities, salaries and depreciations. As well as with variable costs, fixed costs have direct influence over net income, nevertheless, these costs can be covered with a rise in the production, meaning that with more units produced, the ratio of fixed costs on the total cost of each unit will cut down inevitably.
- What would happen in this situation if the sell price increased by 10% and all other costs stayed the same?
As per new calculations starting from point number 1, with an increase of the 10% of the sell price and assuming fixed and variable costs remained the same, an increase of the net income by 48% was observed, as shown on table 3.
Regarding the data presented in table 3, the big increase on net income is only the result of the costs elements remaining unaltered. Normally, the management would decide to increase the price according to the market and the related costs, since higher costs usually stand for higher investment, and as for any investment, the direction would wish to obtain not less than the same proportion in return.
- Limitations
The limitations about the above-mentioned study-cases start by taking into account that these belong to an academic project, what would be leaving several factors excluded, such as additional indirect costs, post production costs, the type of sales the company might have (retail, wholesale, per sales orders, per sales season) and the cost distribution system the company follows (per processes, per department). On the other hand, the policies the company follows regarding sales predictions and price determination are also unknown (Wokeh & Teerah, 2014).
- Assumption that capacity and sales can be doubled to 4,800 with previous costs remaining the same, besides the addition of new facilities for DEM 500,000.00 at 5-year-life on straightforward calculation.
In this situation, annual capacity and sales are increased by a 100%, resulting in a sales income 109% higher than the expected in question number 4, and a net income 373% higher than the previously mentioned scenario. With the growth of the production, fixed costs lose strength over the overall capacity. Unlike fixed costs which ratio decreases with production growth, variable costs will always keep their ratio of the profit due to their direct relationship with the amount produced (Table 4).
Adding facilities for an amount of DEM 500,000 with a life cycle of five years on straightforward depreciation will sum up annual fixed costs for DEM 100,000. Consequently this reduces the net income by the same amount (Table 5), as explained before, fixed costs remain unaltered regardless of production, and their impact is the same on net total revenues. This phenomenon doesn’t occur with variable costs, since they grow as per production quantity.
References List
Wokeh, P. I & Teerah, L.E. (2014). Relevance of cost accounting systems on manufacturing operations. West African Journal Of Business And Management Sciences, volume 3. Retrieved from http://www.imsubiznessjournals.org/index.php/journals?id=156
Grønhaug†, K. & O. Ims†, K. (1988). Setting the sales budget: an exploratory study. Journal of Behavioral Decision Making, volume 1,1-2. http://www.readcube.com/articles/10.1002/bdm.3960010306
Variable Costs and Fixed Costs (n.d.). Economic Fundamental Finance website. Retrieved from
http://economics.fundamentalfinance.com/micro_costs.php
