Retaining Unprofitable Products
As per the provided information, it could be observed that Sparks Limited manufactures three products A, B and C. However, as Product A is suffering loss of $7,000, the managing director of the organisation makes arguments in favour of discontinuing the product. However, sometimes it is necessary to retain the unprofitable product due to the following reasons:
Remaining raw materials:
There might be some raw materials on hand, which are associated only with the Product A and thus, management would like to draw down such quantities through additional product sales (Armitage, Webb and Glynn 2016).
Hole in product line:
It might be significant to depict complete product line-up to the customers for refraining them from using the competitors’ products; in case, hole in the product line is inherent.
Market blocking:
If Sparks Limited decides to retain Product A at a low price point, the rivals would be kept from making market entry with their own products.
Dependent products:
There might be a chance that the dependent products providing outsized profits could cover up the losses incurred by one product (Ax and Greve 2017). If the situation is similar for Sparks Limited, the other two products B and C could cover up the losses generated by Product A.
Make or buy decision is the act of selecting between producing a product internally or buying the same from an external supplier (Bromwich and Scapens 2016). In this decision, the factors that need special consideration include related production costs and whether the organisation has the ability of manufacturing at needed levels. The following calculations are made to arrive at make or buy decision in the context of Thunder Company:
From the above table, it is inherent that Thunder Company would have to incur $39 per unit to manufacture the product and the overall cost would stand $585,000. On the other hand, if the organisation decides to purchase the product from the supplier, it needs to incur $34 per unit including fixed cost amounting to 75% of the fixed manufacturing overhead. The total cost needed to make the buy decision is obtained as $622,500. However, the buy decision would help in making another product, which would provide a contribution margin of $15,000. It has been analysed that Thunder Company could save $37,500 by undertaking make decision and when contribution margin by choosing buy decision is subtracted from savings, the final savings stand at $22,500. Hence, Thunder Company is recommended to manufacture the product internally.
From the above table, it is inherent that the current ratio of the organisation has been 1.75, which is more than the industrial average of 1.50. With the help of current ratio, it is possible to determine the liquidity position of an organisation by gauging its ability to repay short-term obligations (Cooper, Ezzamel and Qu 2017). A higher ratio is always favourable and in case of J.P. Robard Manufacturing Company, the ratio is above the industry norm. Hence, in terms of liquidity, it is maintaining competitive position in the industry by converting working capital into cash within shorter timeframe.
Make or Buy Decisions
Inventory turnover for the organisation is computed as 3.30 times, which is higher than the industrial norm of 3 times. This ratio helps in gauging the efficiency of an organisation in controlling its merchandise and thus, a higher figure is desirable for the organisation (Fullerton, Kennedy and Widener 2014). The ratio is desirable for J.P. Hobard Manufacturing Company due to increased market demand, which has helped in releasing its merchandise at a faster rate than its competitors. Asset turnover ratio, on the other hand, gauges the efficacy of an organisation in utilising its assets for generation of sales revenue (Kokubu and Kitada 2015). A higher turnover is desirable and in case of J.P. Hobard Manufacturing Company, the ratio is the same as the industrial yardstick, as it has employed its assets effectively to cope up with the industrial trend.
Operating profit margin of the organisation is obtained as 21.25% in contrast to the industry norm of 18% and this margin is a key indicator for creditors and investors to analyse the way an organisation is supporting its operations (Langfield-Smith et al. 2017). In this case, it is more than the industrial average, as it has lower operating costs in contrast to its competitors. The similar is the case with return on investment, which denotes that investments are made after suitable evaluation of projects to maximise the overall returns.
Debt ratio is a measure of solvency that gauges the total liabilities of an organisation as a percentage of total assets (Lavia López and Hiebl 2014). In case of J.P. Hobard Manufacturing Company, the ratio is computed as 50%, while the industrial norm is provided as 60%. A lower ratio is always favourable, since it implies better business stability having the potential of longevity, as an organisation with lower ratio has lower total debt. In this case, the organisation has focused on raising funds partly through debt and partly through equity, which has helped in maintaining optimality in its capital structure. Average collection period denotes the time taken in order to recover the amounts to be obtained from the credit sales made to the customers by an organisation. For J.P. Hobard Manufacturing Company, the amounts are recovered within 91 days in opposition to the industrial norm of 100 days. A lower period is desirable, as recovering money within shorter time helps in increasing the availability of working capital and the case is similar for the concerned entity as well.
In terms of fixed asset turnover ratio, it is 1.78 for the organisation, while the industry norm is given as 1.50. A higher turnover is favourable, as it implies that more revenue is generated through effective utilisation of fixed assets. For J.P. Hobard Manufacturing Company, the situation is similar, since it might have leased a portion of its unutilised fixed assets for generating additional revenues in contrast to its rivals. Finally, in terms of return of equity, J.P. Hobard Manufacturing Company has a better ratio of 20% in comparison to the industry norm of 15%, as more equity shares are issued and accordingly, adequate returns have been provided to the investors and shareholders. Therefore, by taking into consideration all the aspects, J.P. Hobard Manufacturing Company is placed in a favourable position in comparison to all other competitors in the industry.
Financial Ratios for J.P. Hobard Manufacturing Company
Based on the above financial evaluation, it is evident that the capital structure of the organisation is perfectly balanced, as equal weights are assigned to both debt and equity. Since debt ratio is obtained as 50%, it is obvious that the equity ratio would be 50% as well. Moreover, J.P. Hobard Manufacturing Company is making adequate profits in contrast to its competitors in the industry, which implies that the profit earned could be used for investing in business operations. The liquidity position of the organisation is deemed to be favourable, as the owed amounts from the debtors have been collected within shorter period. Moreover, the market demand for the products of the organisation is expected to increase in future, which would help in generation of additional income (Malmi 2016). Hence, Gulf Bank Plc could sanction bank loan to J.P. Hobard Manufacturing Company, as it has the ability of repaying its loan amount by increasing its existing asset base, cash availability and income generated.
In this section, the ratio that could be taken into consideration is the return on total capital. This ratio gauges the profit earned from the end of an organisation by utilising both debt capital and equity capital (Nielsen, Mitchell and Nørreklit 2015). For J.P. Hobard Manufacturing Company, the ratio is computed as follows:
It has been provided that the competitors provide 12% return. In case of J.P. Hobard Manufacturing Company, the ratio is obtained as 21.25%, which is much higher than the return provided by the competitors. The reasons identified behind such higher return are the increased revenue and optimality in capital structure due to which the investors would be provided with sufficient return on their investment. Hence, it is recommended to the investors to invest in the organisation, as it would help in maximising their overall return on investment.
Budgeting provides a range of benefits, which are discussed briefly as follows:
- With the help of budgets, the managers are compelled to think and estimate the challenges to be encountered in future along with developing strategies for meeting the desired goals of the organisation.
- Incentives are dependent on the accomplishments in contrast to the budgeted figures. Therefore, if budgets are formulated realistically, they would help to motivate the managers and employees in a positive manner (Otley 2016).
- In the stages of budgeting, there have been elimination of those activities that do not add value; instead, new or improved processes are developed for enhancing productivity.
- Budgeting is the effective tool for coordinating with all the managerial levels in order to make future plan, promoting teamwork, goal congruency and process enhancement between the staffs and the organisation.
- By setting up budgets, there are proper segregations of delegation of duties, responsibilities and authority limit. The top management of the organisation might feel that they are in complete control of the different business activities with the help of budgeting.
However, budgeting has a number of limitations, which are enumerated briefly as follows:
- The staffs might not be motivated, as they might feel that the budget figures are way too high to be accomplished.
- There is high chance of budgetary slack, as the managers might blow up the budget figures due to the fact that the higher-level management would reprimand them.
- The budgets tend to emphasise on outcomes, rather it ignores the actual reasons.
- Unrealistic budgets could result in certain managerial decisions that might be detrimental to the organisation. For instance, over ambitious sales would result in drastic impact such as providing steep discount for raising volume (Quattrone 2016).
- Regardless of procedures followed in preparing budgets, budgeting does not possess the ability of reflecting the actual scenario or complexities faced by the organisation.
In the words of Senftlechner and Hiebl (2015), variance analysis could be defined as the quantitative examination of the variation between planned behaviour and actual behaviour. This analysis is utilised for maintaining complete business control. In addition, it includes the examination of the differences so that the result is a statement of the variation from expectations and explanation of the occurrence of such variation. With the help of variance analysis, efficient budgeting activity could be ensured for enabling the managers to undertake detailed and forward looking budgetary decisions. Moreover, it helps in assigning responsibility along with engaging control mechanism on departments, as needed. For instance, if labour efficiency variance or material cost variance is favourable, it is possible to increase the control on these departments for enhancing efficiency. However, variance analysis is subject to certain drawbacks, which are elucidated briefly as follows:
- As the accounting staffs compiles variances at month end, it is not possible for the management of an organisation to obtain feedback in less than a month. Therefore, it needs to rely on other measurements for undertaking decisions (Van Der Stede 2015).
- Variance analysis is necessarily the contrast of actual outcomes to an arbitrary yardstick, which might have been derived from political bargaining. Therefore, the resulting variance might not provide valuable information.
Conclusion:
Based on the above discussion, it could be found that it would be feasible to continue with a product, even if it is incurring loss, for using the raw materials in other product lines. Moreover, Thunder Company is needed to manufacture the product internally, as the savings would be more rather than purchasing from the external supplier. From the ratios computed, it has been analysed that J.P. Robard Manufacturing Company has been enjoying leading position in the market due to superior financial performance and position. It has been evaluated that budgeting helps in removing those activities not adding value to the organisation in order to improve the overall productivity. Finally, variance analysis is an important tool to identify the variations from budget in order to undertake corrective actions.
References:
Armitage, H.M., Webb, A. and Glynn, J., 2016. The use of management accounting techniques by small and medium?sized enterprises: a field study of Canadian and Australian practice. Accounting Perspectives, 15(1), pp.31-69.
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