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In this study, Open University Malaysia has been chosen to investigate and analyze the relative strengths and weaknesses by absorption costing, cost volume profit analysis and others.
Open University Malaysia was set up with the objective of offering open and distance learning. These colleges established on 10 August 2000 and it was seventh private university in Malaysia. It was incorporated as a private university under Private Higher Educational institutional Act 1996. Open University Malaysia (OUM) is consistent with its philosophy of democratizing education. Philosophy is based on the belief that education should be made available and accessible to all people regardless of age, location and socio-economic background. Open and Distance Learning (ODL) mode is specifically targeted at adults who need to take care of their families and manage their careers while pursuing higher studies.
University employs a blended learning approach which involves use of print modules, face to face interview and online learning platform. The modules are meticulously developed to support self-placed learning. The development process involves subject matter experts who are academics at OUM or other higher education universities. Therefore to supplement the modules various learning tools are produced in house. These incorporate the most current best practices among open and distance leaning university. The vision of OUM is to be the leading provider of Flexible Learning. Mission of OUM is to widen access to quality education and provide lifelong learning opportunity by leveraging of technology, adopting flexible mode of learning and providing a conductive and engaging learning environment at competitive and affordable cost. Universities are keep on growing and improvement their learning information let students have motivation, energetic, self perception and others to upgraded their knowledge.
Define financial modeling and Cost Volume Profit (CVP)
Cost volume profit is determined how changes in cost and volume affect a company's operating income and net income. Therefore, as accountant of OUM should have plan future levels of operating activities and provide information about:
which products or services to emphasize
volume of sales needed to achieve a targeted level of profit
amount of revenue required to avoid losses
whether to increase or reduce fixed cost or constant to affect company profit
how much to budget for discretionary expenditures
whether fixed cost expose the organization to unacceptable level of risk
Hence OUM top management need to estimated future revenues, costs and profits to help company plan and monitor operations. OUM use Cost Volume Profit (CVP) analysis to identify the levels of operating activity needed to avoided losses, plan future operations, monitor organizational performance and others. Therefore, managers analyses operational risk as they choose an appropriate cost structure.
Explanation computation of Cost Profit Volume (CVP) to improve OUM finance
These studies were done by much calculation based on the computed information which was attached in appendix. In this stage, as a director of OUM should understanding what the relationship among revenue, cost , profit and volume can be expressed graphically by preparing a CVP graph. How company should apply this technique to their business improve company performance.
According to graph is been highlighted that CVP relationship over wide range of activity and can gives company perspective which can be obtained in no other way. It also illustrates that how organization's profit are expected to change under different volumes of activity. In the graph presented that when no students are studies in OUM, fixed cost are RM 43,303,000 and it will be resulting in a loss of RM 43,303,000. When students fees (sales volume) increases, the loss will be decreased by contribution margin for each student fees. The cost and revenue line intersect at the break even point of 2166 students which mean the ranges of profit will be on RM 13,381,000 to RM 26,382,000. Therefore, in CVP graph are shows that the assumption of students fees (sales) of OUM are increase beyond the breakeven point, profit will be increase. When OUM are expected to achieve profit target level they should make decision which based on the chart of profit and loss to make decision. The range of achieve target profit level ranges on 3000 to 3500 students and sales revenue ranges will be on RM 95,000,00 to RM 110,000,000 to meet the profit target with the range of RM 39,223,000 to RM 52,144,000.
Margin of safety is the excess of an organization's expected future sales above breakeven point. OUM top management use this technique to evaluate future risk when planning and estimated sales to increase company performance. In contribution margin chart represents that amount of sales in RM available to cover fixed costs. Graph show that OUM Company has sufficient cash flow to operate their business. Thus it is the amount available to cover fixed expenses and then to provide profits for the period. OUM contribution margin have sufficient to cover the fixed expenses. OUM will have to accepted students in ranges in 2166 student in a period, since each student unit contribution be RM 20,000 per student fees.
The process by which total overheads are absorbed into production is known as absorption. The objective of the overhead absorption process is to include in the total cost a product an appropriate share of the company's total overheads. Once all the overheads have been apportioned to the production cost centre it is necessary to charge the overhead into cost units that has pass through the production cost centre in Open University Malaysia.
According result show that Overhead after re-apportion showing different cost for the 4 method as below:
X = 3,633
Y = 7,222.60
Based on the result showed that the higher for this test overhead after re-apportion for production X and Z is elimination method and production Y is ignore intensive. Therefore the highest overhead after re-apportion will be flexible and chargeable to the cost service center. This is to assign of specific overhead that can directly identified to a specific cost service center.
Ignore intensive method is the computation of service cost centre do not break down any balance figure from any service department. It show that the cost center do not need to transfer any cost forward direct compute finish with the percentage which available in the test. This service is call as one way flow.
Elimination method called as two ways flow services. Where the service departments service each other. In this case, company are using this method to test if accumulated cost centre until significant how much their will gain on that period and what will be affected to company performance.
In Repeated Distribution situation Open University Malaysia have two service cost that also support each other and the first application of the calculation will not transfer to all the service costs over to the production cost centre therefore it will required to use repeated distribution to compute cost centre for the period. Therefore, in this case is from service cost library to service cost advertisement. The transfer is added up once and using percentage to calculate from the total and amount transferred to the left. This process is repeated until the amount become insignificant. The computation which are show at appendix for further details.
Simultaneous Equation. According table as above this method is no mathematical limit to the number of step allocations that can be made. In the alternative, calculus could be used to achieve numerous simultaneous allocations. These situations provide intellectually stimulating challenges but company may not be worth the cost of implementation. As a result, companies are usually content to rely on direct or very simplified step allocations of service department costs.
advantages and disadvantages of CVP graph
Cost Volume Profit can be used to help company find the most profitable combination of variable cost, fixed cost, selling prices and sales volumes. Sometimes profit can not assume it because sometimes profit can be improved by reducing the contribution margin if fixed costs can be reduced by a greater amount. Basically, company seen that the way to improve profits is to increase the total contribution margin figure. Sometimes this can be done by reducing fixed cost (such as advertisement, salaries and other OUM fixed cost). In the sometimes, company can try to increase volume sales (student fees) and trading off variable and fixed cost with appropriate change in volume.
It is the simple presentation of cost, volume and profit structure of the company. In the same times each of the significance can be seen at a glance. It is also a tool for cost control as it shows the relative importance of the fixed cost and variable cost. Profitability of various products can be studied and a most profitable product mix can be adopted. Additional, profits at different levels of activity can be ascertained. Therefore, there is the benefit be affect company profits potentially can be judged from the position of break even point and the angle of incidence.
The disadvantage of CVP analysis for OUM relies on short run in marginal analysis. The unit variable costs and unit revenue are constant which is appropriate for small deviation from current production and sales.
Strength and weakness of financial modeling
There is some strength and weakness from financial modeling which can affect company performance. Open University will provide master budget to predict their financial performance for future. Therefore, there are some benefits which OUM should consider:
As a large universities like Open University Malaysia engage in financial budgeting and modeling. It is the only ways to maintain control over businesses with hundreds of employees or department and millions of sales. The universities will spends so much money to maintain their strategic financial plans therefore it must start-ups a finance growth to maintain it.
OUM case, financial modeling is the only way deal with multiple events that may affect company performance. Sales forecast, product cost, operating expenses, availability of financing (equity and debt and other will competitive pressure consider in decision making process.
A top management has to consider many facts and problem which will affect company performance in future. The strength and weakness of financial modeling can show company how to improve their strength to get better profit and how to reduce their weakness. Therefore, understanding break-even analysis, absorption approach is important therefore top management can make better decision which based on the fixed and variable cost and able to reduce their cost to increase their profit. This approach can predict company during economic downturn.
Recommendation on how Financial modeling and CVP analysis can improve OUM finance
OUM can use absorption costing approach to make decision during the period of time when they are facing pricing or other problems. In this stage, it can appear what company can ignore demand and arrive at a price that will safely yield profit whatever profit companies are targeted.
Additional, top management can consider pricing can involve a complicated decision making process on the part of consumers and how to increase their profits on pricing strategy an psychology of pricing before making decision on the product and services. The chart shows the profit by the amount of unit contribution margin can cover back fixed cost as well as increase profits.
OUM can use CVP techniques may used to derive a target cost estimated by subtracting a desired margin or target profit from a competitive market price. The cost may be less than the planned initial products cost but will be a cost that is expected to be achieved by the time product reaches the mature production stages. If OUM desired to improve their profit they should increase their sales volume or sales values which are required to achieve a range of profit targets.
Breakeven point will provide a thought process which can insight how profit change as sales increase or decrease. Forecasting an accurate amount of sales or profits is nearly impossible due to a company's many products with varying degrees of profitability and services with customer's demands, interaction between price, promotion and number of unit sold. The break-even technique can be adapted to determine the sales needed to attain a specified amount of profits. . Break-even point in units for OUM is the number of students it needs to pay their fees in order to cover companies fixed and variables expenses during the years.
As conclude, how far sales could drop before the companies begin to lose money is the fact of Cost Profit Volume. Therefore, company should keep looking on graph and assumption to achieve company performance and profit.