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Debenhams plc is a UK based company, it is the leading department store which was formed in 1778 by Messrs Flint and Clark, and in 1813 William Debenham was made a partner so the name was changed to Clark and Debenhams. It has a strong presence in key product categories across women's wear, men's wear, children's wear, home and health and beauty. The company has a total 167 stores in the UK, the republic of Ireland and Denmark. In addition, it has 61 international franchise stores in 24 countries and an online store.
According to the latest management statement of Debenhams, the performance of their business year-to-date has been pleasing, they have made good progress in terms of both gross margin and market share. Moreover, the Group has continued to invest in the business in terms of new stores, a new department store opened in Bath in September, and in January 2010, it completed the acquisition of Denmark-based department store, Magasin du Nord. This consisted of six well-invested department stores, including a store in central Copenhagen. (Debenhams plc Company Profile - Feb 14, 2011). Furthermore, Debenhams increase their multi-channel access points to improve availability and ranging for indoor customers. At the end of the year, Debenhams invested a new facility to manage working capital efficiently and minimize interest cost of borrowing, which the Group will benefit from the lower fees under the smaller facility in the future.
In order to have a strong and successful business, as managers in Debenhams who have been given responsibility to make decisions, they need to know what and how business decisions they should make for the business. For example, what cost "drives" the activities of their company and how does their company perform during the period? What the Return on the Investment (ROI) of this company is, and how long it takes to recover the initial cash flow? Moreover, what the most profitable products or services are, so that salespeople (or your salespeople) can really push those? If the sales volume drops, then how far the sales volume can it drop before you get deficit? Or if price is lower in order to sell more, what sales volume is required to break even? To answer those questions, some techniques may be used to help managers make better decisions such as Activity-Based Costing (ABC) analysis, Internal Rate of Return (IRR) analysis, payback period and Cost Volume Profit (CVP) analysis. However, the quality of information generated from an analysis technique is under various assumptions which may create limitations for each method. In addition, the next three parts of this easy are going to talk about how each four analysis technique that we mentioned before influence managers making decisions on the investment and how these four techniques help managers to make decisions, but also what are the limitations of using each technique in the end.
Producing products creates demand for activities, while products are based on their activities' consumption in the contrary, and afterwards activities consume costs. Behind this idea, Activity-Based Costing (ABC) is a costing model that measures the cost and performance of activities and cost objects(Peter B. B. Turney, 1996 ) In a business strategy, Activity-based costing can be used in planning, controlling and decision making for instance, which items should make or buy. Assuming that the steps to implementation activity-based costing must be followed by "Identify activities, identify cost drivers, and then create cost centers for each activity, at last trace costs to products." Cost drivers are the actual activities that cause the total cost in an activity cost pool to increase. When using Activity-based costing, the total cost of each activity pool is divided by the total number of units of the activity to determine the cost per unit.
In this way, managers of Debenhams can prepare a business model of the organization to understand what their organization do and what 'drives' its activities. Moreover, Activity-based costing can estimate the cost of individual products and services and eliminate those that are unprofitable.
Except the costing method Activity-Based Costing, mangers may also use other suitable non-costing management accounting techniques for instance, Internal Rate of Return to make decisions on investment. The Internal Rate of Return (IRR) is the interest rate at which the net present value of the project is zero and is referred to as the yield of the project. (Laurus Nobilis, 2010) The internal rate of return is compared to a minimum acceptable rate, which is referred to as a hurdle rate the project can meet the financial criteria and be determined to commence, as long as the internal rate of return for the project is greater than the hurdle rate. For example, if the managers of Debenhams considering a single project, accept it if the internal rate of return is greater than the cost of capital. If choosing from multiple projects, then choose the one with the highest internal rate of return. Another non-costing technique is called "Payback" which calculates the payback period for recovering the initial cash outflow of a project The basic premise of the payback method is that the more quickly the cost of an investment can be recovered, the more desirable is the investment. The payback period is expressed in years. When the net annual cash inflow is the same every year, the following formula can be used to calculate the payback period:
Payback period = Investment required / Net annual cash inflow
Accounts often use Cost Volume Profit (CVP) analysis to plan future levels of operating activity and provide information such as: what is the sales volume needed to achieve a targeted level of profit, what is the amount of revenue required to avoid losses. For example, suppose that a manager of Debenhams want to sort out the expected quantity of goods or services that must be sold to achieve a target level of profit, then there is a formula to calculate the expected quantity:
Q= (Fixed cost + profit)/(Price-Variable cost)= Quantity (units) required to obtain target profit
Many organizations sell a combination of different products or services. The sales mix is the proportion of different products or services that an organization sells. For example, we learned that Debenhams plc is a department store selling combined different products across a large range, if managers want to use cost volume profit for multiple products or services, a constant sales mix is assumed to allow cost volume profit computations to be performed using combined unit or revenue data for an organization as a whole.
Clearly, those four method Activity-Based Costing (ABC) analysis, Internal Rate of Return (IRR) analysis, payback period and Cost Volume Profit (CVP) analysis are all useful for assisting managers to make decisions on their business in some way. Firstly, there are some advantages of using Activity Based Costing method. One significant advantage is that this method utilizes unit cost rather than just total cost, improves understanding of what drives overhead and more accurate appointment of cost, such as costing of products/services, customers, distribution channels. Besides, Activity-Based Costing method recognizes the complexity of modern production process and is better suited to modern business environment. In addition, Activity-Based Costing is a simple way to supports managers estimating the performance of an investment. Nevertheless, implementing an activity based costing system requires numerous resources causes a major problem of using activity based costing , this method can be too complex to cost more time to collect , check and enter data into the system. Activity based costing data can be easily misinterpreted, and the cost drivers may be hard to identify. Managers must identify which costs are really relevant for the decisions before making any significant decision using activity based costing data. In addition, Activity-Based Costing analysis must be used with care when used in making decisions.
Secondly, considering about using Internal Rate of Return, one of the advantages is that all cash flows are equally important. We give equal importance to all the cash flows capital budgeting in which we want to know where the present value of cash inflow is equal to present value of cash outflow. In this method, there is no need t to calculate cost of capital because without calculating cost of capital, we can check the profitability capability of any project. Another advantage is internal rate of return uses one single discount rate to evaluate every investment which makes calculation and comparisons easy. The calculation entails listing out the net cash flows on a periodic (usually monthly or annual) basis, Assume that the discount rate always at which gives this net present value becomes zero. On the other hand, internal rate of return has a major problem on rate mutually exclusive projects, this method is not suit for comparing two project. When a project is an independent project, both the NPV and IRR will always give the same result, either rejecting or accepting a project. However, when analysis mutually exclusive projects, NPV and IRR do not always point in the same direction. For example, when IRR of the investment is high, the NPV may low.
The cash payback technique is simple to use and understand, it is useful especially for non-large size company. For example, a company just set up, it may not want to take risk and want have quick return on their investments, therefore, managers of the company can select those projects which have low payback period. However, payback technique ignores the time value of money and therefore may not evaluate true cash flows of a project. It also not take into account the cash flows beyond the payback period and therefore it may ignore the profitability of the project, and reject a project which may be beneficial for a company especially in a long term business.
At last, Cost Volume Profit analysis often provides useful information on business strategy. Cost Volume Profit analysis can be used to help find the sales volume, selling price, and the most profitable combination of variable costs, fixed costs. Profits can sometimes be improved by changing the unit contribution margin because the greater the unit contribution margin, the greater is the amount that a company will be willing to spend to increase unit sales. That is why companies with high unit contribution margin (such as auto manufacturers) advertise so heavily.
Nevertheless, there are also limitations of cost volume profit technique as following shows: Assume sales mix remaining constant since this depend on the changing demand levels is impractical, the analysis is restricted to the relevant range specified and beyond that the results can be unreliable, the linear property of total cost and total revenue relies on the assumption that unit variable cost and selling price are constant, which is likely to be valid within relevant range only. Excluding volume this factor, other elements like inflation, efficiency, capacity and technology can affect costs.
In conclusion, As Managers of Debenhams plc, they need useful information on planning and making business decisions . They use Activity-Based Costing to measure the cost and performance of activities and cost objects, they use Internal Rate of Return and Payback period to see how the Return on the Investment changes, and they use cost-volume-profit analysis to identify the levels of operating activity needed to avoid losses, achieve targeted profits, and monitor organizational performance. However, according to the above analyzing of each technique's limitations , we can see that to measure performance of a project, and to make a decisions for the business, managers need to use a range of measures instead of a single measure and include both financial and non financial (e.g. quality) measure within the range. However, the performance of the business cannot only be measured by mangers or accountants, but also how do customers view the business, how do shareholders view the business, and can the business continuing creating value. ( Kaplan and Norton- 'Balanced Scorecard')