Management accounting for business decisions Trailer Construct plc - Coursework Example

?Management Accounting for Business Decisions Trailer Construct plc Case Study Executive Summary The Trailer Construct PLC is a small family businesswhich is in the process of expansion into a higher level of operations. The enterprise is involved in the construction and repair of trailers custom made according to the specifications of the client. The demand for construction of new trailers has been consistently rising through the five years to 2011, although demand for repair remained consistent throughout the same period. As a result, the company decided to raise its production level, however its policies and practices remained the same. Trailor Construct’s problem is comprised of a mismatch between its increased scale of operations, and its policies regarding inventory management, cash management, cost tracing and determination, price setting, and its human resources management. The firm is comprised of three divisions, namely Administration, Repair and Construction. The aforementioned policies involved practices undertaken in all three, and therefore are resolved using a systemic approach. This report recommends that the economic order quantity be applied to the inventory management practices of the company, instead of the present long lead time, large inventory storage employed by the company which unnecessarily inflates carrying costs. Production should be enhanced to make better use of expanded capacity and increase production efficiency, to reduce the level of fixed costs distributed to each unit of production. Cash management should be managed better by speeding up collection of receivables. This is to avoid the need to borrow from the bank to bridge cash shortfalls, and thereby eliminate unnecessary interest charges. Finally, employee performance should be improved by motivation through employee engagement. Table of Contents Executive Summary 2 Table of Contents 3 Introduction 4 Repair 4 Construction 5 Administration 6 Inventory management 7 Treatment of employees 8 Conclusion 8 References 10 Introduction The case of the Trailer Construct plc concerns the transformation of a small family business into a larger corporation as a result in the escalation in the scale of operations. This is typical of successful enterprises which attract a greater volume of business than its usual procedures are suited for. The administrative procedures, employee management, and inventory policies should evolve when a company shifts towards a higher scale of operation, because the greater business volumes enable the development of economies of scale, and demand a greater efficiency in these policies and activities. Repair The financial performance of the Repair division shows turnover to be almost unchanged from one year to the next; in comparison, turnover in construction is growing steadily. There is therefore no reason for the procedure that the client can bring in their trailer for repair after only a phone call. However, there is concern that maintaining a large stock or spare parts is unnecessary investment in materials when a lower stock level would do. There may be some merit to stocking up on materials in anticipation of higher prices, but this seldom results in the anticipated savings (unless a sudden significant rise in price or severe shortage takes place) because of the increase in storage and carrying costs that may just offset and even exceed the amount saved by chasing the lower price. The recommendation therefore is that the inventory system should employ the economic order quantity (EOQ) system which is described in the discussion on inventory below. Construction Being the larger of the two divisions, the Construction division shows a steadily rising turnover, indicating that the market is expanding. This presents an opportunity that Trailer Construct should take advantage of. The financial show that although turnover rises, profits remain unchanged for Construction. This may or may not mean that the firm is unduly incurring unnecessary expenses. The company decided to increase capacity by investing in a larger production plant. This appears to be justified by the rising turnover, although the immediate effect is a one-time increase in overhead expenses in the form of increased operating and depreciating expenses, due to the higher level of assets (Nikolai, Bazley, & Jones, 2010). As revenues continue to increase, however, the operating leverage effect will be evident, causing outputs to increase at a faster rate than that at which overhead increases (Bhar, 2008). At this point, overhead expenses shall remain relatively steady or increase minimally causing profits to increase (Hansen, Mowen, & Guan, 2010). Overhead costs are not the only problem facing Construction. The industry is experiencing a steady increase of steel prices which raises the cost of sales. At the same, prices are inelastic and could not tolerate an increase because of the stiff competition. The effect of these twin developments is to exert downward pressure on the company’s gross profit margin. If the company is able to find new suppliers which could provide the right quantity and quality of steel in due time at a lower price, then this could afford some relief to the company by lowering materials cost, thereby tending to increase gross and net profit provided other costs remain constant. Administration The three procedures in the Administration department which present a concern during a period of expansion are cost tracing, pricing, and cash management. Cost tracing as practiced in Trailer Construct may be classified as direct tracing (versus driver tracing), because the costs are identified with the specific cost object with which they are physically attributed to (Hansen, et al., 2009). This is seen in the worksheet system wherein the worker records the duration, the order worked on, and the parts used. From the duration, administration can estimate the period costs associated with the particular trailer, and recording the parts provides the direct product costs. This is acceptable because it directly associates the costs incurred to the cost object. Unfortunately, because of some problem in the proper maintaining discipline and work ethic among employees by managers, the employees had not been filling in the worksheets properly. The information contained therein may therefore be erroneous, which would create errors in the setting of prices based on historical data which these worksheets comprise. Managers should more strictly oversee the accomplishment of the worksheet. Concerning price setting, it appears that in an era of rising prices, it is not sufficient to merely rely on historical costs in quoting prices to prospective clients. The cost tracing method, by differentiating the different components of the cost, allows for the calculation of the proportion of each component. By distinguishing, for instance, the proportion of cost allocated to the purchase of steel, then management can look forward to the price of steel at the time the order is to be accomplished – not based on what the price was several months or years ago. Having an idea of the future trend in prices enables the manager to estimate a quoted price closer to the actual price if the manager projects the current costs rather than rely on historical costs. The manager should ensure, however, that quoted prices remain competitive with the industry. With regard to cash management, the company incurs additional costs by resorting to bank loans to meet short-term cash shortfalls, instead of firming up their collection procedures. The key to effective cash management is to collect receivables within as short a period of time as possible, while extending the settlement of payables for as long a credit period as possible without incurring penalties (Hopkins, 2012; Tennent, 2012). The company should rethink its collection policies, follow up with its customers more frequently, and generate the cash from the regular cash cycle instead of borrowing from the bank and having to pay the interest cost. Inventory management The economic order quantity is that inventory level that minimizes the order or administrative costs and the carrying costs (Megginson & Smart, 2008). Another method is the just-in-time inventory (JIT) method which does away almost entirely with carrying costs because orders are made just in time for the delivery of materials to coincide with their use (DuBrin, 2012). In the case of Trailer Construct, however, the sole use of JIT in managing inventory is not advisable because of the uncertain nature of the repair division. The company should first investigate if there are other suppliers whose prices are cheaper but which are capable of providing the same or better quality materials, at the right quantity, and which could be relied upon to deliver on time. Sometimes contracts with tried and tested suppliers allow for discounts and other amenities, aside from the familiarity with the desired quality, ability to deliver the requisite quantity at the right time. Even if price may be slightly higher than other suppliers, this may be offset by savings in delivery efficiency. A careful assessment should first be made about tradeoffs in price and possible hidden costs. Treatment of employees The high turnover of employees prompted managers to give employees too much freedom on the job, resulting in absenteeism, too many breaks, and failure to fill in worksheets correctly, in which case the company incurs additional costs due to poor performance. Failure of employees to meet production levels increases the labor cost attributable to each unit because of the longer time it takes to complete one order. Management should demand more of each employee, but by motivating them through employee engagement. This method strengthens the employees affinity towards the company by a holistic approach including empowerment, close collaboration between management and employees, and open candid communication (Federman, 2009). The work assignment should match the individual’s personal inclinations and interests, so that he or she may feel the desire to invest of him or herself in the job. Management must impress upon employees their importance in achieving company goals, as well as their importance to the company as individuals (Macey, et al., 2011). Conclusion Trailer Construct plc is in the process of expanding its scale of operations in response to strong market demand. As a consequence, it needs to adopt changes to its policies and procedures that will enable it to operate with greater efficiency and take advantage of economies of scale. Inventory levels for the firm should be reduced to a reasonable safety stock that is replenished by the economic order quantity method, instead of providing for unreasonably long lead times and large stockpiles. Production should rise to take advantage of strong demand and newly expanded capacity, while new suppliers who afford lower prices, good quality and sufficient quantity with reliability in delivery should be explored, but the shift made only if the incremental benefit over present suppliers exceeds incremental costs. Costing for the purpose of price setting should be forward-looking in that management should anticipate predictable price increases in supplies, but quoted prices should be kept competitive. Cash requirements should be met by improving collections and shortening the cash cycle to avoid resorting to unnecessary borrowing that incurs interest costs. Lastly, employee performance should be improved by motivation and employee engagement. References Bhar, B K 2008 Cost Accounting: Methods and Problems. Kolkata: Academic Publishers. DuBrin, A J 2012 Essentials of Management, 9th edition. Mason, OH: South-Western Cengage Learning. Federman, B 2009 Employee Engagement: A Roadmap for Creating Profits, Optimizing Performance and Increasing Loyalty. Hoboken, NJ: John Wiley & Sons. Hansen, D R; Mowen, M M ; & Guan, L 2009 Cost Management: Accounting & Control, 6th edition. Mason, OH: South-Western Cengage Learning. Hopkins, R 2012 Practical Cash Management, Budgeting, Forecasting and Analysis for Smaller Business. Bloomington, IN: Booktango. Macey, W H; Schneider, B; Barbara, K M & Young, S A 2011 Employee Engagement: Tools for Analysis, Practice, and Competitive Advantage. Hoboken, NJ: John Wiley & Sons. Megginson, W L & Smart, S B 2008 Introduction to Corporate Finance, 2nd edition. Mason, OH: South-Western Cengage Learning. Nikolai, L A; Bazley, J D; & Jones, J P 2010 Intermediate Accounting, 11th edition. Mason, OH: South-Western Cengage Learning. Tennent, J 2012 Guide to Cash Management: How to Avoid A Business Credit Crunch. Hoboken, NJ: John Wiley & Sons, Inc. Read More