Ozmedic Corporation - Budgeted Income Statements - Example

CASE ANALYSIS REPORT [Student’s Name] [Institution Name] [Course Title] 29th October, 2014 Executive summary This report aims at providing detailed study of issues raised by the management and to provide guidance to management in their decision making on several issues of concern to the management. These issues include the decision on whether to increase sales agent’s commission to 20% of sales or for the company to hire its own sales people. To help in deciding on this matter two budgeted income statement for the two options have been made. Based on the forecasted income statement the management can easily make a decision using the results obtained. Since the aim of the company is to maximize on its profit, the option hiring own sales people is recommended because it has a higher net operating profit. Management is also concerned on the effective date of launching the BPM-201. The report has used both the price and non-price information to show that the best time to launch the BPM-201 is in December. The report has aid in decision making in Penlights Division on whether the Division should accept the offer by the local government and has shown that the offer should be rejected. Table of Contents Executive summary 2 Introduction 4 Budgeted income statements 4 If the company pays a commission of 20% to sales agents 4 If the company hires its own sales people 5 Breakeven point 5 Level of Indifference 7 Recommendation 8 Launching of BPM-201 8 Introduction of BPM-201 8 Non-financial factors to consider 9 Instrulite LED Penlight 10 Offer by local government for Instrulite 10 Maximum price 10 Non-price factors to be considered 11 Conclusion 12 Bibliography 14 Introduction Ozmedic Corporation deals with manufacturing of instruments for medical use such as stethoscopes, blood-pressure monitors, penlights, thermometers among others. The company sells its disposable thermometers through an independent sales agents’ network located in Australia. These sales agents are paid commission but currently they are demanding a commission rise to up from 18%. This has raised an issue of concern to the management which will be addressed in this report. The BPM has come up with a new machine called BPM-201 which is expected to replace the BPM-100. The launching date is particularly important to the company since they have a stock pile of the BPM-100. This report will show the date at which the company should launce the new equipment. The Penlights Division of the company manufactures and sells Instrulite LED Penlight. Adriana is faced with a situation on whether to accept an offer from the local government and also whether to outsource the equipment from an external supplier. This report will provide enough information to help Adriana in her decision making. The report will be divided into several sections clearly showing the requirements by the management. Budgeted income statements If the company pays a commission of 20% to sales agents OZMEDIC CORPORATION Budgeted Income Statement $ $ Sales 30,000,000 Cost of goods sold: Variable 17,400,000 Fixed 2,800,000 20,200,000 Gross Profit 9,800,000 Selling & administrative expenses; Commissions 6,000,000 Fixed advertising expenses 800,000 Fixed administrative expenses 3,200,000 10,000,000 Net operating income (loss) (200,000) If OZMEDIC Corporation agrees to sales agent demand to increase their commission to 20%, the company will incur a loss of $200,000. If the company hires its own sales people OZMEDIC CORPORATION Budgeted Income Statement $ $ Sales 30,000,000 Cost of goods sold: Variable 17,400,000 Fixed 2,800,000 20,200,000 Gross Profit 9,800,000 Selling & administrative expenses: Payroll (including fringe benefits) 700,000 Commissions 3,000,000 Travel & Entertainment expenses 400,000 Salaries & fringe benefits (Sales manager & support staff) 200,000 Fixed advertising expenses (800,000 + 500,000) 1,300,000 Fixed administrative expenses 3,200,000 8,800,000 Net operating income (loss) 1,000,000 If the management of Ozmedic Corporation hires its own sales people, the company will get a net operating income of $1,000,000. Breakeven point Breakeven point refers to the sales volume at which the company neither experiences a profit nor incurs a loss (Bazerman and Moore, 2009). That is, it is a point of zero profit and zero loss. This is calculated by rearranging the income statement items in order to determine the contribution margin which is sales less the variable costs. Therefore, in this case the costs of the company are divided into either fixed costs or variable costs. The breakeven point in terms of sales is then arrived at by dividing fixed costs (FC) by CMR contribution margin ratio (Brigham, 2009). Contribution margin ratio (CMR) is determined by using the formula below The table below shows the income statement of the company If OZMEDIC Corporation agrees to sales agent demand to increase their commission to 20% and when presented using contribution margin format. OZMEDIC CORPORATION Budgeted Income Statement $ $ Sales 30,000,000 Variable costs: Variable cost of goods sold 17,400,000 Commissions 6,000,000 23,400,000 Contribution margin 6,600,000 Fixed costs: Fixed cost of goods sold 2,800,000 Fixed advertising expenses 800,000 Fixed administrative expenses 3,200,000 6,800,000 Net operating income (loss) (200,000) Breakeven point (B.E.P.) in sales Therefore, if OZMEDIC Corporation agrees to sales agents’ demand to increase their commission to 20%, the company will breakeven at a point where sales equals $30,909,091. The table below shows the income statement of the company if OZMEDIC Corporation hires its own sales people and when presented using contribution margin format. OZMEDIC CORPORATION Budgeted Income Statement $ $ Sales 30,000,000 Variable costs: Variable cost of goods sold 17,400,000 Commissions 3,000,000 20,400,000 Contribution margin 9,600,000 Fixed costs: Fixed cost of goods sold 2,800,000 Payroll (including fringe benefits) 700,000 Travel & Entertainment expenses 400,000 Salaries & fringe benefits (Sales manager & support staff) 200,000 Fixed advertising expenses (800,000 + 500,000) 1,300,000 Fixed administrative expenses 3,200,000 8,600,000 Net operating income (loss) 1,000,000 Breakeven point (B.E.P.) in sales Therefore, if the management OZMEDIC Corporation hires its own sales people, the company will breakeven at a point where sales equals $26,875,000. Level of Indifference Indifference is a situation whereby the analyst is undecided on which option to choose. The level of indifference in these two option will arise at a sales point where the two options have the same operating income or operating loss (Fess, 2004). This level is attained at a sales point of $18,000,000. At this sales level the two options will have the same net operating loss of $9,800,000. Any sales level below this amount will be preferable for agreeing to sales agents’ demand to increase their commission to 20% since the option will have a lower net operating loss. However, any sales level above this amount will be preferable for hiring its own sales people since the option will have a lower net operating loss. Recommendation It is recommended that the management of Ozmedic Corporation hires its own sales people. This is because at the same level of sales beyond $18,000,000 with the option to agree to sales agents’ demand to increase their commission to 20%, the option of hiring their own sales people will have better results than the option to increase sales agents’ commission to 20%. Moreover, the option to hire own sales people has a lower breakeven point in sales than the option to increase sales agents’ commission to 20%. The breakeven point in the case of agreeing to sales agents’ demand of increasing the sales commission to 20% is $30,909,091 whereas if the management decide to hire its own sales people the breakeven point in sales is $26,875,000 which is evidently lower than the former. Notice that any sales above the breakeven point brings profit to the company hence the hiring own sales people option will start earning a profit earlier than the increasing sales agents commission option (Spiceland, 2001). Launching of BPM-201 Introduction of BPM-201 Based solely on financial factors BPM-201 ought to be launched in December. This is because BPM-100 has a higher per unit of operating income than BPM – 201. Therefore, introducing BPM-201 in September will cause the company to forfeit a higher operating income it would have got by selling the BPM 100. However, this decision will also depend on the demand of BPM-201 relative to the demand of BPM-100. It may be that the operating income for every BPM-201sold is lower than the profit obtained for each BPM-100 unit sold by significant amount which would impact on the decision made earlier. Non-financial factors to consider There are many factors that need to be considered by the management before the launching of BPM-201 apart from financial factors. These factors are discussed hereunder The level of competition – the management should consider the possibility of a competitor who offers a similar product or even the remote possibility of new entrants dealing in a similar product. When competition is high the company may be forced to lower its selling price than anticipated which may eventually force the company to operate at a loss (Buttle, 2004). Quality of BPM-201 – quality of a product is very key to its user (the customers). Therefore, the company should ensure that BPM-201 has even more quality service than the BPM-100. The possibility of a competitor selling similar product in the market which is more efficient than what the company is promising may be disastrous to the company. This may cause the company to lose customers to its competitor. The accuracy of projections – any delay in introducing the BPM-201 will mean lost sales for the business. Therefore, the management should consider the accuracy of projections especially in the time taken to sell off all the stock pile of BPM-100. This is because if they set the launch date in December and the remaining stock of BPM-100 is cleared before December then it means that the company will be idle before the launching of the BPM-201. This may not go well with the reputation and goodwill of the company because of stock out costs (Gronroos, 1984). Therefore, it may be advisable for the management to introduce the BPM-201 even before the stock of BPM-100 is exhausted. This will eliminate the remote possibility of the company running out of stock of either brand. Instrulite LED Penlight Offer by local government for Instrulite Ozmedic Corporation is supposed to decline local government’s offer for Instrulite. Alternative B which has considered the acceptance of the offer will incur a loss of $2,000 as opposed to alternative A which has not included local government offer which will result to a profit of $2,000 per month. This is shown by the calculations below Alternative A Regular Customers Sales (20,000 units @ $6.00 per unit) 120,000 Costs @ $5.90 per unit 118,000 Profit 2,000 This alternative has a profit of $2,000 per month. Alternative B Alternative B Regular Customers Local Government Total Sales 90,000 18,500 108,500 Costs @ $5.90 per unit 88,500 22,000 110,500 Profit (Loss) (2,000) This alternative has a loss of $2,000 per month. Maximum price The table below shows the cost schedule to determine the maximum price they can pay without affecting the operating income for the Instrulite. Manufacturing cost Direct materials 1.00 Direct manufacturing labour 1.20 Variable manufacturing overhead cost 0.80 Fixed manufacturing overhead cost 0.25 Marketing cost Variable 1.50 Fixed 0.72 Total Cost 5.47 Therefore, the maximum price to be paid that would not affect the operating income for the Instrulite is $5.47. Non-price factors to be considered There are many other factors besides price that the Penlights Division needs to consider before making a final decision on whether to outsource the Instrulite or not. These factors are discussed in this section as below. The availability of inputs – if Penlights Division is to continue manufacturing and selling Instrulite LED penlight it has to consider the availability of inputs like raw materials, direct labour among others required for the continued manufacturing of the Instrulite LED penlight. Each locality is endowed with productive resources which may be different from those in other locations (Barney, 1991). If Penlights Division is comparatively disadvantaged in endowment of inputs for the manufacture of Instrulite LED penlight compared with the outsourcing firm then it would be better for the Penlights Division to outsource the Instrulite LED penlight. Quality – the quality of a product manufactured is very key to making outsourcing decisions. Therefore, Penlights Division should compare the quality of the Instrulite LED penlight it manufactures with the quality of Instrulite LED penlight purchased from an outside supplier. If it finds that the quality of its product is better than that purchased from an outside supplier, it should manufacture the Instrulite LED penlight instead of outsourcing. However, if the quality of purchased Instrulite LED penlight is better than the Instrulite LED penlight it manufactures, it would be wise to outsource. Effect on employees – employees are very key to the success of the business. Adriana should put into consideration the impact of a decision to purchase Instrulite LED penlight from an outside supplier on the employees of Penlights Division and the trade union reactions to the decision made instead of manufacturing the component. Purchasing the component from an outside supplier will mean that the employees who have been tasked with manufacturing of the component will be retrenched since they are no longer required in the manufacturing process of the Instrulite LED penlight. This decision will hurt the employees of the Penlights Division an act that will de-motivate the staffs of the Division. The accuracy of the estimates of costs and selling prices – for Adriana to arrive at a good decision he must have the correct estimate of costs. For both alternatives A and B Ariana has used estimated figures. These estimates should be as accurately as possible and not a weird guess if the analysis and decision made is to be valid. Wrong estimated figures usually lead to wrong results hence the accuracy of the cost figures and other related data should be considered before making a decision on whether to outsource or not. Conclusion In conclusion, the management of Ozmedic Corporation should hire its own sales people since the net operating profit obtained from this option is higher than the option of increasing sales agents’ commission to 20%. The BPM-201 should be launched in December to give room for the company to sale the remaining stock of BPM-100. However, the company should keep monitoring the market to ensure that a competitor does not launch a similar product before their launching in December. The offer by local government for Instrulite should be rejected in totality since it does not add to the value of the company (Hilton, 2004). The report has concluded by setting the maximum price that the company should pay for the outsourced Instrulite from an outside supplier at $5.47. Any price beyond this is unacceptable and the company should continue manufacturing the component. Bibliography Barney, Jons. 1991. “Firm resources and sustained competitive advantage”. Journal of Management 17(19): 99-120. Bazerman, Milton and David Moore. 2009. Judgment in managerial decision making. Hoboken: Wiley. Brigham, Herhardt. 2009. Financial Management: Theory and Practice. Ohio: Thompson South Western. Buttle, Fredrick. 2004. Customer Relationship Management: concepts and tools. Oxford: Elsevier Butterworth-Heinemann. Fess, Warren. 2004. Accounting principles. Canada: Southwestern Company. Gronroos, Cuel. 1984. “A service quality model and its marketing implications”. European Journal of Marketing 18 (84): 36-44. Hilton, Ryle. 2004. Managerial Accounting: Creating Value in a Dynamic Business Environment. New Delhi: McGraw-Hill Publisher. Spiceland, Sepe. 2001. Intermediate Accounting. New Delhi: McGraw-Hill Publisher. Read More