Discussing the Statements Concerning Critical Accounting - Assignment Example

Critical Accounting Assignment "To Maximize profit, you need to sell output at the highest price." This is a great idea in theory. However, with an economy that is gradually moving towards a recession, profit margins will increase with competitive pricing. It is a good idea to introduce products at higher prices to gain sales of individuals with more money to spend. However, it is also good business to reduce those prices after the introduction period has ended to capitalize on profits from consumers on a budget. This way, the product is not closed to one portion of the market. Certainly, a company should sell the product in question at bare market standards or higher. In addition, companies are wise to consider what their competitors are selling the same product for. If a product is worth $50 and the competitor is selling the product for $49, then matching that $49 is essential unless there is a marketing strategy that promotes the product as being better than what the competitor is offering. Raising prices to a ridiculously high amount is not going to increase profits when many customers are going to ba able to find the same product somewhere else for less money. High prices must be justifiable for a market for the expensive product to develop. One must also consider that consumers seeking a bargain will wait for price cutting to occur. Thrifty consumers are willing to wait until newer models are released so that the prices of the old model are slashed significantly. These are all factors that must be anticipated by the company when establishing what type of profit needs to be expected from the product and in what type of time frame. So, in a linear sense, as time progresses, it is wise for a company to sell output at the highest possible rate that can be justified by the current market. This is noticeable in the cell phone industry. With most cell phone companies, when one signs a contract, a free or reduced price cell phone is given to the customer at time of contract. In many cases though, money can be made on the contract signing with the sale of an upgraded phone. Most individuals with any extra money to spare are going to be lured in by the newest and most muti functional phone. This When these higher tech phones are released onto the market, they are typically very expensive. It is later when they are replaced in the commercials by a newer model that they are sold at more reasonable and reduced prices from their original release price. Customers will often find reduced price, used phones on e-bay. "Elasticity of demand deals with the extent to which costs increase as demand increases." Certainly the video game industry is proof of this statement. When new gaming systems are released onto the market, advertisements explode all over television. Everyone marks the new system on their wish lists and the holiday seasons make it almost impossible to find and purchase whatever is the newest in gaming technology. The video game system companies are clever about advertisement and product testing. They make sure that anyone who has ever enjoyed playing video games in their life, feels the need for the latest system. As this demand increases, shortages follow. This sense of wanting something that you can't have right away causes an even stronger desire for the product and the several hundred dollars charged per system is justifiable. The prices of gaming systems are quite hefty when they are first released. The gaming companies make a huge margin of profit initially and once the prices of the systems are lowered such that almost anyone can afford one, the company has already made more than anticipated profits. "Provided that price is large enough to cover marginal cost of production, sales should be made." The bottom line in any business is to turn a profit. It is important though at difficult economic times to break even. This means that selling a product for the price that it costs to produce. If a product costs a company $10 to produce, and the product is not creating a demand, the company will gradually lower the selling price from a retail value to the eventual cost of production. The expected retail value may be $50 when the production cost was only $10. If the company is not moving the product, the company may choose to sell the product for $10 to simply break even. This is necessary in times of economic depression and with products that do not create a heavy demand. In other words, it is not bad business to ultimately sell a product for the cost of production when no other options are present. This will prevent dollar loss in production of a product that is simply not selling. "According to economic theory, profit is maximized where total cost equals total revenue." This is true but depends entirely on the product. Many times, a product can be produced for an extremely low price but sold with a 1000% mark up. This is the case in fashion jewelry for example. It is very cheap to make, under $1.00. From there, they are marked up to as much as $10 or so. The product may only be plastic or acrylic and therefore quite cheap to make. Considering the cost of production as low and factoring in the cost of labor, overhead for this type of product is incredibly low. This allows for a large amount of profit. It is crucial to establish a reasonable overhead budget that allows for quality as well as low production cost. Many companies are forced to settle for products that are not of high quality in order to maintain a low cost and therefore a higher margin of profit. Again, products like plastic jewelry or trinkets are always going to have a low production cost but in addition, customers may be returning the products to the stores more frequently. Also, a company will end up "eating" the production and revenue costs due to damaged products that are never sellable. "Price skimming is charging low prices for output until you have a good share of the market and then putting up your prices." This is essentially creating a need for the product. If a company has the resources to create, market and sell a product while settling for a lower profit margin, a "following" can be created. This can be said of certain name brands that started out as virtually unknown. Once a fashion trend was born and the product became in high demand, the prices could then follow suit. Also, many products in the food industry have started out as inexpensive but as the demand for the product increased, the selling price followed. Starbucks coffee is one of the most successful chains of coffee houses in the world, it is also about as much for a cup of coffee at Starbucks as it would be for an entire meal at certain fast food restaurants. This is an extremely successful business as there is a need for the product. One can get a cup of coffee at a corner store for under $1. But, this is not going to be a Starbucks cup of coffee and everyone knows that. Starbucks has successfully cornered the coffee market such that many people would walk several city blocks farther for a $6 cup of Starbucks coffee as apposed to a $1 cup of corner store coffee. Starbucks does not reduce their prices, they increases them with inflation or as they see fit. They are turning a huge profit off of coffee. They have not invented anything new, coffee is coffee. They have however, created a huge client base and monopolized the market. One could use fast food restaurants as a model for this theory as well. It is common to think that fast food is cheap as well as quick. If one is on a low food budget and in a hurry, fast food is often an easy choice. Due to the contents of fast food, individuals fond its appeal almost addicting. Fast food is rarely healthy but instead full of fat, sugar and sodium. This regard for taste alone makes its appeal world wide. Due to this, fast food restaurants can essentially charge what they wish (within reason) and still attract a huge number of customers. Another example that could be used is power chains such as Wal-Mart. Wal-Mart is the largest retailer in the world. In most rural areas that have seen a Wal-Mart move in, small family owned businesses have seen a decline in business. Wal-Mart is known for its ability to sell most household items at low prices. However, most individuals find that a trip to Wal-Mart is rarely cheap. This retail super store has really cornered the market on one stop shopping and has begun to raise prices. Small, family owned businesses are choked out by Wal-Mart and even with Wal-Mart's increased prices, the little guys are still not able to charge the prices that Wal-Mart charges. What Wal-Mart has done is basically monopolized the market, making it nearly impossible to function as a small, family run store or chain. Unfortunately, this gives Wal-Mart full reign over what prices are appropriate. Pharmaceutical companies are also captain at creating a need for their product followed by the raising of prices of that product. Certainly moving a drug through the approval process is difficult and lengthy but once a drug hits the market, doctors' offices are flooded with samples which can be given out to patients for free. This creates a need for the product. When a patient realizes how the drug is helping them, they require a prescription. At this time, their insurance company pays top dollar for them to have the medication or they may find that they have to pay for the drug themselves. Either way, the pharmaceutical company makes a great deal of profit. Even though perhaps at first the company took a bit of a loss by allowing for free samples to be given out. "A budget is a forecast of what is expected to happen in a business during the next year." Budgets are important in any business regardless of what type of business. Without a budget, there is no measure of checks and balances. There is no way of knowing what is to be expected in expenditures as well as no way of knowing what is affordable. Businesses are not able to properly function or prosper unless governed by a sensible and comprehensible budget. It is important to note that a budget is a general idea of what can be expected as far as incoming and outgoing dollars. There should always be contingency plans for worst case scenarios and also best case scenarios. A budget is not a concrete guarantee that the figures projected will definitely come about. By establishing a budget, a company can reduce the risk of over spending on production, payroll and so forth. Many retail chains have to work cautiously with payroll budgets as loss in sales coupled with heavy payroll expenditures can result in the need to close down a location or two. This happens often in small, economically depressed areas, the sales decrease with the economy and stores are not watching their outgoing payroll. The end result is often the need to close down the location where sales loss and over spending has occurred. In projecting the budget for the year, a business can also gage where profits and losses should be at the end of each month. A business can foresee to some extent, what type of outgoing cash flow can be expected based on inflation and figures from previous years. Budgets also allow businesses to look ahead when hiring. Knowing what the budget will allow in payroll is extremely important. Over staffing can drain profits quickly from a business if payroll is not budgeted for on a yearly basis. Budgets are not an option for a company wanting to see long term staying power. The larger the company, the larger the necessity for a detailed system of budgeting. Especially for companies with heavy overhead. There has to be a line drawn in expenditures such as advertising, personnel, training, product cost and so on. No large business succeeds without a budget. "Monthly budgets must be prepared with a column for each month so that you can see the whole year, at a glance, month by month." Certainly a yearly budget is crucial but a yearly budget broken down month by month is entirely practical. It does not make sense to have a yearly budget which is simply open to interpretation. If a company can spend a certain amount of dollars in a year in wages, it would make even more sense for that company to know how much they could spend per month. This would make it then more realistic to break the dollar amount into hours if employees are paid hourly. This holds true for advertisement expenses, repairs and so on. Monthly break downs are simply a part of maintaining a comprehensive budget overall. Columns for each month can be created based on sales history for that particular month In years passed. A spreadsheet can be developed in order for one to view the overall budget for the entire year but with each month in separate columns. This is extremely simple and easy to create employee schedules from. This can provide a manager with easy access to total number of monthly payroll hours available as well as maintenance budgeting and so on. This is much simpler that a single budget for a single year. "Budgets are OK but they stifle all initiative. No manager worth employing would work for a business that seeks to control through budget." This is simply not a reasonable statement. It is crucial and fundamental to have a budget. It is financial suicide to not provide managers with financial guidelines. This does not mean that a company cannot provide a bit of financial leeway for creativity, but not making managers aware of financial guidelines would severely cripple most businesses. It is frivolous to say that 'no manager worth employing would work for a business who seeks to control through budget' as companies would go bankrupt all the time if everyone possessed that mindset. Many managers worth employing, in fact would not work for a company that did not operate under a budget. Most individuals trained in a managerial capacity are aware of the necessity of budget. These guidelines, though sometimes inconvenient, insure that employees receive regular paychecks. Also, the system of checks and balances following a budget will prevent a company from having to claim bankruptcy. No matter how tedious or bothersome, budgets are a necessary evil. "Activity - based budgeting is an approach that takes account of the planned volume of activity in order to deduce the figures to go into the budget." It is convenient to assess the different levels of business activities possible in any given year in conjunction to the possible output of dollars that would need to accompany it. These different projections allow businesses to see fluctuations in possible profit gains and losses as compared to the expenses that will accompany those gains or losses appropriately. For example, if a company has budgeted for 1 million dollars in annual payroll, but the products are exceeding selling expectations, the company will need to hire a larger staff as a result. An increase in payroll allotment will need to follow product demand and production accordingly. In addition, if a company has created a market for a specific type of product, there may need to be consideration to the fact that development of further like products would be a further increase to profit. This would require a corresponding increase in production and development budgeting. On the inverse, if a company has budgeted for 1 million dollars in payroll but the profit is much less than expected, it may be necessary to cut hours back in payroll accordingly. Many retail chains operate in this manner. A budget for hourly employees on a yearly basis is drafted based on the profit and sales of the previous year. If the sales for the current year fall under the sales of the previous year, the company will gradually decrease employee hours to save the company money. "Any sensible person would start with the sales budgets and build up the other budgets from there." This is a blanket statement. In theory, it makes sense. You cannot put out what you do not have coming in, but at some points in any business, you must be willing to take some risks. A new business for example may see a large overhead at first in order to get their products advertised and sold. The sales may not meet the outgoing budget amounts at first. Sensible business ventures are often not profitable business ventures. It is wise to establish what your company can afford to spend at one time with the lowest possible profit margins. If and when a market has been established, one can then increase and base all budgets on the outgoing sales and profits. It can sometimes be a matter of what type of initial loss one is willing to take or what is affordable rather. If one has a business that has been firmly established, it is then wise to base expenditure budgeting on sales histories and profit margins. If a sudden rise or fall occurs, one should be prepared to adjust outgoing budgets accordingly. Read More