Management Meeting Held in FreeAir Skate Pty Ltd - Case Study Example

Executive summary This report has been written with an aim of addressing the issues raised during the management meeting held in FreeAir Skate Pty Ltd. The report first introduces the issues that it addresses. The report then has explained the purpose of cash budgeting and prepared the company’s cash budget for the months of February to April. The report then composes the units to be produced so that a target profit of $280,000 can be achieved during the period of February to April. The report then addresses the issue of the special order recommending for its rejection before recommending discontinuation of the snow skate production line. It is hoped that the report will be a big input into the management making quality decisions on the issues addressed. Table of Contents Table of Contents 2 References: 11 Appendix 12 Introduction FreeAir Skate Pty Ltd will derive a lot of benefits from adopting the preparation of cash budgets as a management tool. This is because it will help the company in organizing its cash resources vis-avis the payments it expects to make. As such if there is a deficit, it will be easier to organize for financing. On the other hand, any surplus cash will be prudently managed so those at no time will the company face financial constraints. The company will also do good by adopting product planning this is because by targeting a certain level of profit for a specific time period, the company will be able to harness its resources towards achieving this goal (Charles, 2013). The decision of whether to accept or decline the special order will have to be based on both qualitative factors such as availability of idle capacity as well as financial factors such as the effects this will have on the company’s profitability. It has also been observed that the company ought to drop the snow skate line and increase production of surf skates since this is the option that would be more profitable. The purpose of this report therefore is to address the issues that have been raised above. The Cash budget By adopting cash budgeting, the company will be able to better monitor its cash inflows and cash outflows at any given time and for given financial periods. Thus the company will be better able to establish its ability to have enough cash to meet its financial obligations at any given time while continuing with its day to day operations. Through cash budgeting also, it will be easier for the company to establish whether it will have cash deficit at a certain time and hence be able to better plan its payments as well as project implementation. This is not important in ensuring that the company has idle cash nor is it in financial difficulties that it is unable to come out of at any given time (Anthony, 2011). This will also inform the company’s credit policy which should be planned in such a way that the company always have enough cash for its needs. Should the company through cash budgeting anticipate any cash deficit in a future time, it will be better able to arrange for financing in advance to avoid getting into financial problems. Through cash budgeting, we will be able to better plan our expenses including tax planning. Planning expenses would also entail cost reduction since the budget will give us a picture of all the necessary costs and those that can be cut. I present the company’s cash budget for the period between February and April below. FreeAir Skate Pty Ltd Cash budget For February-April Quarter $ Cash balance b/f 51,234.00 Budgeted receipts 953,070.00 Total cash available 1,004,304 Less payments: Purchases 493,645 Salaries 474,000 Store deposit 120,000 Council rates 27,650 Total payments 1,115,295 Surplus/deficit 110,991 Financing Bank overdraft 161,000 Budgeted ending balance 50,009 The target quantity Assumptions: i) The projected profit per product depends on its level of sales. As such, Snow skate = 5/100*280,000 = $14,000 hence we expect the product to contribute $14,000 to the total profitability of $280,000 Surf skate = 60%*280,000 = $168,000 hence we expect the product to contribute $168,000 to the total profitability of $280,000 Dirt skate = 35%*280,000 = $98,000 hence we expect the product to contribute $98,000 to the total profitability of $280,000 ii) Fixed costs occur evenly throughout the year and are allocated depending on the percentage sales per product line hence (Ray, 2011) Annual fixed cost = 420,000 Hence for the three months, fixed cost = 420,000*3/12 =105,000 Snow skate = 5/100*105,000 = $5,250. Hence the product line is allocated $5250 of the fixed costs. Surfskate = 60/100*105,000 =$63,000. Hence the product line is allocated $63,000 of the fixed costs. Dirt skate = 35/100*105,000 =$ 36,750. Hence the product line is allocated $36,750 of the fixed costs. iii) It is assumed that $280,000 is the target profit after tax. Hence the number of units at this level of profitability is given by; (F+ (I+) 1-t))/p-v Where F= Fixed cost I= Income after tax P= Selling price V = Variable cost per unit T = Taxes at 30% Hence the number of units at the level of profitability is computed as follows; Snow skate = ($5250+ (14000)/0.7))/ (265-251) = (5,250+20000)/14 = 25,250/14 = 1,803.57 = 1,804 Units Surf Skate = ($63,000+ (168,000/0.7))/ (235-184) = 63,000+ 240,000/51 = 303,000/51 =5,941.18 = 5,942 units Dirt Skate = 36,750+ (98,000/0.7))/ (195-135) =36,750 +140,000/60 = 176,750/60 = 2,945.83 = 2,946 Units As such, in a bid for the company to achieve the desired level of profit of $280,000, its level of production and hence sales units ought to be 1,804 units of snow skate, 5,942 units of Surfskate and 2,946 units of Dirt skate if it is to achieve the target profit of $280,000 during the three months under consideration. The special order The company should consider a number of factors before accepting the special order which are considered as being either qualitative or quantitative factors. The decision rule for quantitative factors ought to be that the company increases its profitability (Jared, 2013). Thus, I deciding whether to accept the special order or not, we first compute the resultant profit as follows; Original plan for February to April Sales = 5,942 unita@235 per unit = $1,396,370 Variable costs = 5,942@184per unit = $1,093,328 Contribution margin = $303,042 Fixed costs =$63,000 Tax = $72,012.6 Profit = $168,029.4 Alternative 2 with special order Sales = 6,942 units @as follows Sales of 5,942units @ 235 per unit =$1,396,370.00 Sales of 1000 units @ 195 per unit = $195,000.00 Total sales = $1,591,370.00 Variable cost@184 per unit = $1,279,168.00 Fixed cost = $63,000.00 Taxes = $74,760.60 Profit = $174,441.40 Comparison of profits between the two alternatives Alternative 2 profit $174,441.40 Alternative 1 profit $168,029.40 Increase in profit $6,412.00 By accepting the special offer, the company’s profitability increases to $174,441.40 from the original $168,029.40 before the special order. This means that based on financial actors alone, the company should accept the offer. However, before the order is accepted, non-financial factors should also be considered Non-financial factors for special order Before accepting the special order, the company should consider if it has enough idle capacity to be able to manufacture the 1,000 extra units without hurting the current sales. At the moment the company only has 10% of its production capacity being idle (Jared, 2013). This means it can only be able to manufacture around 600 units above its current production of 5942 units. As such, were the company to accept the order, it would be necessary for it to gauge whether it can be able to organize for the extra 400 units to be manufactured elsewhere without consuming all the profits it expects to realize from accepting the special order. Alternatively, the company ought to consult the customer whether he/she can accept the 600 units for the first 3 months with the rest being delivered later. Otherwise, if the company was to insist on manufacturing the special order without first having such arrangements, it would have to hurt its current customers and hence profitability. Continue or discontinue Snow skate and increase production of Surfskate. The company can either continue producing snow skate and hence continue making losses in the product line or discontinue it and increase Surfskate production which would increase sales and hence profitability though some costs would have to be incurred. If we consider last year’s performance, the following would be the result of each of the two alternatives. .a) Continue Surf skate Dirt Skate Snow Skate Total Sales $2,100,000 $1,225,000 $175,000 $3,500,000 Variable costs $1,540,000 $857,500 $157,500 $2,555,000 Fixed costs $234,000 $155,000 $64,000 $453,000 Total cost $1,774,000 $1,012,500 $221,500 $3,008,000 Operating income/(loss) $326,000 $212,500 ($46,500) $492,000 Discontinuing would lead to Surfskate sales increase by 15% though its fixed costs would also have to increase since it is assumed it will be the only department benefiting from the discontinuation. Hence, we allocate snow skate’s fixed costs to it. Its performance will thus be as follows; Sales = $2,100,000 * 1.15 =$2,415,000 Variable costs = $1,540,000 * 1.15 = $1,771,000 Fixed costs= $234,000 + $64,000 = $298,000 Discontinuing Surfskate Dirt skate Total Sales $2,415,000 $1,255,000 $3,670,000 Variable costs $1,771,000 $857,500 $2,628,500 Fixed costs $298,000 $155,000 $453,000 Total costs $2,069,000 $1,012,500 $3,081,500 Operating income $346,000 $212,500 $588,500 If we compare the two alternatives, we obtain the following differences as a result of dropping the line. Sales increase $170,000 Variable costs increase $73,500 Contribution margin gained $96,500 Differential fixed cost - Gain from dropping product line $96,500 This implies that the compay’s profit will increase by $96,500 if snow skate production is stopped and Surfskate production is increased. However, it should be noted that dropping the product line will imply; a) Remodeling the manufacture space and show room at a cost of $65,000. This is a one-time cost and is not a relevant cost for this decision (Khan, 2006). b) The current machine with one year useful life is worth $125,000 and will have to be resold at $45,000 though this is not a relevant cost for this decision. c) The new machine to be bought will cost $324,000 and will have a useful life of $324,000 implying that it will have to be depreciated at $108,000 every year which is a lower depreciation than the one of $125,000 which implies cost reduction and hence increase in profit. d) The remaining $48,000 worth of snow skate do not affect the decision whether to continue or discontinue with the product line. Conclusion As a result of the analysis above, I would advise the company to stop production of snow skate and hence increase production of Surfskate since it is the more profitable option. References: Charles, H2013, Introduction to management accounting, London, Rutledge Anthony, R2011, Accounts Demystified: The astonishingly simple guide to accounting, London, Amazon Ray, G2011, Managerial accounting, McGraw-Hill, Irwin. Larry, M2014, Introduction to managerial accounting, London, Rutledge. Khan, J2006, Management accounting, McGraw-Hill, Irwin Jared, B2013, Accounting for management, New York, John Wiley & Sons. Appendix Cash receipts schedule February Cash sales = 40/100* 268,000 = $107,200 14% November receivables 14%*60%*335,500= $28,014 20% December receivables 20%*60%*536,500 = $64,380 65% January receivables 65%*60%*330,000 = $128,700 Total February collection = $328,924 March Cash sales 40/100*252,000 = $100,800 14% December receivables 14%*60%*536,500 =45,066 20% January receivables 20%*60%*330,000 = $39,600 65% February receivables 65%*60%*268,000 = 104,520 Total March collection =$289,986 April Cash receivables 40/100*440,000 = 176, 000 14% January Receivables 14%*60%*330,000=27,720 20% February receivables 20%*60%*268,000 =32,160 65% March receivables 65%*60%*252,000 =$98,280 Total march collection = $334,160 Projected collection for the three months =$953,070 Payment schedule February 70% January Purchases 70/100*170,100 =$119,070 30% December purchases 30/100*270,150 = $81,045 Salaries = $158,000 Store deposit = $120,000 Council rates = $27,650 Total payments in February = $505,765 March 70% February purchases 70/100*155,000 = $108,500 30% January purchases 30/100*170,100 = $51,030 Salaries = $158,000 Total march payments =$317,530 April 70% March purchases 70/10*125,000 =$87,500 30% February purchases 30/100*155,000 =$46,500 Salaries =$ 158,000 Total April payments =$292,000 Total payments for the three months = $1,115,295 Total purchases payments = = $493,645 Read More