The Cost Elements for Bilston, which should be considered as Fixed, or Variable for short-term decision-making are as follows:
Variable Cost Elements of Bilstion:
1) Labor Cost:
Labor cost for Bilston is £ 4.20/hour. Labor cost directly depends upon the amount of production to be done. Therefore, if the production is more, than more labor would be required and vice versa. So due to this reason Labor cost should be considered as Variable cost.
2) Raw Materials Cost:
Raw materials are also dependent on production so it has the same effect as of labor cost, so it is also considered as a variable cost.
3) Power Cost:
Power rates are fixed but it is dependent on the activities. So it is also directly associated with the volume of production so if production volume increases the power consumption also increases and if the production volume is low than power consumption is less so it should be considered as a variable cost.
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4) Repairs Cost:
In the case of repairs the upper and the lower limit of expenses is fixed but it also depends upon the operation so it is obvious to consider the Repairs as the variable cost.
Fixed Cost Elements of Bilston:
1) General Administrative and Selling expenses:
Generally, the administrative and selling expenses does not depend upon the volume of production and it almost tends to remain fixed whether the company is making a profit or loss.
Company is paying £5 per square foot per year and lease has a 12 years run so it is fixed. Company has to pay the rent in any case.
3) Other Factory Cost:
As mentioned in the Exhibit 3 this cost element includes building services, property insurance, Property taxes, light, heat and factory management.
Depreciation should be considers fixed. There is a fixed amount, which is going to be depreciated per year.
Interest is should be considered as a fixed cost as it does not depend upon the volume of sales and production. The company has to pay the interest on loans, which is 6 % annually.
So according to me the above cost elements listed should be considered as fixed or variable.
Contribution means the difference between the sales revenue and variable cost
i.e., Contribution (C) = Sales revenue (S) - Variable cost (V)
So I will extract sales revenue and variable cost from Exhibit -2 and will get the
Contribution is not considered as profit as fixed is not deducted from contribution.
This tables are been prepared by using the Exhibit 2 Analysis of Profit and Loss by product - Year Ended December 31, 2007
The below table is obtained from the table of Profit and Loss Account for 2007 in contribution format which I have prepared in question 2.
Now one can see from the above table that there is a loss of £ 2,19,000 for the sales of nuts and bolts. Now in this case the variable cost is £ 15, 23,000 so if company drops the production of nuts and bolts than this cost will reduce. But the fixed cost of nuts and bolts is 13,64,000 is still going to affect the company's other two operations, which will lead to more loss to the company. Therefore, the company will do less loss if it continues the production of nuts and bolts. So according to me the company should not drop the Nuts & Bolts in 2008.
Among three products of metal fasteners, a wood screw is vital among all three of them. According to the table shown above, if the company does not cut the price of wood screw, it sells 750,000 units, which gives better contribution, but at the same time the fixed cost to company is going to remain same, and the company can bear a loss of â‚¤1, 365,000.
If the company reduce the price of wood screw, it sells 1,000,000 units with the price of â‚¤2.25. But if the company reduce the price, then the contribution margin per 100 piece of unit goes down, but as it sells 250,000 more units its overall loss would be less, as compared to not cutting the price, and the loss to the company would be â‚¤39,000.
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By comparing both the cases of not cutting the price, and cutting the price, my analysis suggests that the company should cut the price of wood screw.
For constructing, the profit forecast for second half of 2008. I have taken the value of the sales unit of self tappers as 7,12,102 and nuts and bolts as 5,01,276 respectively. As there is no information about self tappers and nuts and bolts changes in revenue or expense for the last six months, so I have taken the value of first half of 2008. Sales unit value for the wood screw is taken as 1,000,000 as company sells 1,000,000 units, if they reduce the price to â‚¤2.25.
The Break even can be calculated by
Break even = Fixed Cost
Contribution per unit
Values of last half of 2008 are considered
Break even of wood screws: 1,029,000 = 1,039,393 units
Break even of Self-Tappers: 916,000 = 796,522 units
Break even of Nuts and Bolts: 693,000 = 602,609 units
The fixed cost of the Bilston is one of the problems and so it can be reduced. The total fixed cost of Bilston is £ 4886 out of which £ 1839 is selling expenses which is almost 40 % of the total fixed cost. Therefore, the selling expenses are too much for the company and needs to be reduced. Management can reduce these expenses as they have the authority to change it. So the management should concentrate more on reducing the selling expenses of the fixed cost. By reducing the fixed cost, the breakeven volume could be achieved early and the company can get profit by covering more market-share.
Now it is mentioned in the case study that the wood screw is the company's main product. its market share is 12% and company is concentrating more on that but according to me the company should focus equally on all the three products so that the market share of self tapers which 8% and for nuts & bolts can be increased. This might add to the profitability of the products.
The company is only selling the products in England so company should also focus on creating an international market, which can increase the sales of the products.
The price for woodscrew should be reduced to 2.25£ because there are eight companies which deals with same business and the Nettlefolds is dominant company so if Bilston will not follow its price policy than it will lose its market-share du to the intense competition.
If the company drops, the production of the nuts and bolts than also the company has to bear the fixed cost so according to me if they will stop the production than it will face more loss than continuing it.
The depreciation is of 20 years and the half of equipments have been purchased in last ten years and other before ten years so that half amount already depreciated so in long term prospective the company will gain.
Over all the management should focus on the reduction of the variable and fixed cost by introducing cost effective production techniques, reducing the inventory of the raw materials, which can hold the capital, etc
So by following the above suggestions company might do profit in the long term. In addition, should continue to manufacture all the three products.