Business Analyse and Decision Making - Essay Example

Business Analyse and Decision Making Value added is the proportion of the value of goods and services and they are enhanced by each successive production stages. Basically, it can be broadly explained as the difference between the price of finished goods or services and the raw materials bought to make it. An example is a manufacturing company which buys the necessary components and resources to produce goods for sale. A major concern in added value to a company is the substantial value it can add to its product taking into consideration the operating performance; this is done in reference to the economic growth rates. This enables the company to produce a product that makes a difference in the market among their competitors in the same industry. There are two methods used to calculate value added and they are: subtractive and addictive methods. The strategy used to analyse these methods include value added statement, merits and drawbacks. The first method used to calculate added value is the subtractive method. It is a mathematical method and the added value is calculated by subtracting purchased costs (costs incurred in producing the sales products) from the sales revenue. It is derived from gross output or the sales which indicates creation of added value. The second method is addictive and it shows how the wealth created has been distributed. The added value is built from the operating profit, labour costs, depreciations, interest, taxation, payroll costs and dividends. Subtractive: Value added = Sales revenue – Purchased costs Addictive: Value added = Cost of labour + Depreciation + Interest + Dividends. Whichever method is used the added value is still the same and it all depends on how the business wants to perform its statement. However, the addictive method has an advantage over the subtractive method; its considerations are more relevant and they approach the form of accounting convention unlike the subtractive method in which the purchases are not revealed. Another advantage of addictive method is that it can reconstruct a value added system by providing the annual report and accounts especially to those engaged in service or financial operations. This is because it avoids the problem of determining what constituents in an intermediate product must be excluded from the added value (Allan, Nicholson and Renshall 1979). The added value shows the basis of the product shifting in the market and the revenue that flows back to the company. Finished goods usually incur some costs such as labour, resources and taxation by the government. After paying for all the costs, businesses use the capital left to pay for bank loans interests, pay dividends and depreciation on fixed assets. Paying dividends increase the value of the share prices in the market. This part of value added is retained for future development of the business and the maintenance of fixed assets. A research conducted on Ford Company revealed that; 70 percent of its sales revenue is used to pay suppliers of materials, components and services, the 30 percent is their value added which is generated from the operations and it caters for labour and capital within the Ford. 80 percent of the value added caters for labour and the other 20 percent is used to pay for interest and dividends, and reinvestment. The added value is determined by the past, present and future probability of the company’s operations and involves evaluation of tangible and intangible assets, and supply chain capabilities and requirements. The Ford Company has both the supply chain and value chain. Both flow in a different direction; supply chain value flows from the recourse person and value chain flows for the consumer (Eldridge, Stead and Tetley 2007, p.5). Interdependence between business and the market can be well elaborated by value added. The value added is calculated the same way as the national accounts of economy (Haslam 2009). Value added is presented in many forms such as a percentage in sales ratio, labour share, depreciation share and operating share. These forms can be used in comparison with competitors. Thus, the value added generated by a company or a business pertains to the cost reduction and cost recovery because the value added is calculated by subtracting purchases from sales. This means that for the business to feel the effect of value added, it must work on cost reduction and cost recovery. For example, to increase the value added, cost reduction must be significant over the cost recovery in order to recover the investment. However, reducing the cost or increasing cost recovery depends on the financial performance and the status of the business at that period. Cost reduction is crucial and decisions are made based on the marginal cost of optimum product mix, choosing alternative methods of manufacturing and reaching break even points. The following strategies are used to achieve cost reduction; retrenchment, marketing mix, economies of scale and measuring productivity and among other strategies. It is important for the UK manufacturing companies to look at the concept of retrenchment. This is because it is all about reducing the business’ activities in order to reduce cost and improve the efficacy or focus on key activities of the business such as disposal of business units and outsourcing, this is suitable to a manufacturing business. For example, Fujitsu made 10 percent of its workforce (around 12, 000) redundant due to the substantial decline in its sales during the economic recession (Guardian 2009). Fujitsu released a statement to back its decision which said, “Action is necessary to ensure that the company remains competitive in the current difficult global economic climate” (Bhushan 2009). The company may want to reach its break even point where revenue and costs are levelled for the company to realise its profits and losses during its trading period. All businesses aim at recovering their investment and the more they can reduce the costs and utilise their strategies, the more they can be able to recover their costs. In this case, the Return on Capital Investment (ROCE) can be used to measure its profit towards the value added in a percentage. This shows how an asset can be turned into profit. It is vital to measure productivity because it shows the output per worker by measuring products against the workforce. This assists the company to make decisions concerning redundancy or increasing the number of employees if the manufacturing company tends to use labour intensive rather than capital intensive. The businesses should also take into consideration its target market segment. Machinery skills refer to the production process and they contribute to the value added. The value is added after the goods are finished. The price that a customer pays shows exactly the amount of added value. For instance, a business can add value because of its increased reputation for quality and value. Nike trainers sell much more than Hi-Tec; even though their production costs per pair are almost similar, the difference is their products (Riley 2009). Businesses can also put more concern on the product and features, for example, different motor vehicle models are designed to achieve the same effect (Riley 2009). A business that successfully adds value is able to operate profitably. A value added statement is formed from all the measurements and calculations of added value. Value added statement shows sales, amount paid to suppliers, distribution of value added such as its division in taxation, employees and returns on capital. Thus it is distributed to employees, shareholders, government in taxation and other finance users. The statement shows the two methods of calculating value added; subtractive and addictive methods. It also shows how the value added has been achieved and how it is shared out between the stakeholders. Value added has its own merits and drawbacks. The following are advantages of value added. It is a good measurement of the size of a business organization and revenue created by a company. It measures sales revenue which is used to classify a business as a weak or a strong cash generating business. Value added can be used as a basis for taxation that is VAT (Value Added Tax). It can also measure the size of the national economy and it is referred to as GDP; GDP is calculated from the sum of all firms’ value added in an economy. Value added statement can be used to calculate the amount taken (a) by the employees as wages and income, (b) by shareholders as dividends, (c) by lenders in form of interest, (d) by the government in the form of taxation and (e) by the organization as the retained profit. From the point of view of investors, the statement can be very revealing. Calculation as a percentage is a vital tool for comparing one company and another in the same industry. For example, sales ratio is a financial proxy for the degree of vertical integration and it is meant to see whether a business generated its value added within the business (managerial control systems) or outside the boundaries of the business in the supply chain (outsourcing and supply chain costs). Ford makes a comparison between car manufacturers to see whether their outsourcing costs are more or less than its competitors (Haslam 2009). Calculating the labour share of value added is important for the UK industries. According to Bernard Cox (2009, p24), “payroll normally accounts for a large proportion of value added – the average is about 70% in UK manufacturing industries.” The statement has a drawback because it has brought problems in the lack of standardization and equal treatment of items. In summary, the value added shows the overall turnover of the business which is achieved by the business’ own activities. For a company to add more value, the strategies stated earlier on in the essay are crucial. To achieve more, the company can consider reducing production cost while still maintaining the quality of the product. Finding ways to add value is important when starting a business as it makes the difference between survival and failure of the business and its profits or losses. References Cox, B. (1979) Value Added: An Appreciation for the Accounts Concerned with Industry. London: Heinemann. Eldridge, C., Stead, T. & Tetley, J. (2007) Adding value to Ford Motor Co supply chain. Southampton Solent University. Gilchrist, R. (1971) Managing for profit: the added value concept. London: George Allen and Unwin. Gray, S. & Maunders, K. (1980) Value Added Reporting: Uses and Measurement. London: The Association of Certified Accountants. Guardian, (2009) Fujitsu to cut 1,200 UK jobs, Guardian News, 26 August. Haslam, C., Neale, A. & Johal, S. (2009) Competitive business: the macro-economic context, In: Haslam, C., Neale, A. & Johal, S (3rd edn.) Economics in a business context. London: Business Press, pp.67-85. Morley, M. (1978) The Value Added Statement: A Review of its Use in Corporate Reports. London: Gee and Co Publishers Ltd. Renshall, M., Allan, R. & Nicholson, K. (1979) Added value in external financial reporting: a study of its aims and uses in the context of general purpose financial reports. London: The Institute of Chartered Accountants in England and Wales Read More