Business Management Decisions

Business Management Decisions

Introduction

A business might have several departments within a single business premise. Furthermore, each department might specialize in handling a specified line of product for the company. Unfortunately, not all products might generate the same amount of revenue after deducting direct and indirect expenses. For instance, there is a situation in which business management has to decide on closing a department after proving that the cost of operating the department is higher than the revenue generated from it. Additionally, the administration of a business might have a challenge of maintaining production level above specific critical volume to avoid making losses. Therefore, the paper in an in-depth analysis of two business cases to determine the relevance of operating all the departments and the critical production level that the business should maintain to curb losses.

Departmental Contribution to Income

Departmental contribution to overhead is the amount of revenue that each department in an organization has after deducting the direct expenses (‘What is Departmental Contribution to Overhead, ‘2019). Direct expenses are the cost that varies in business due to the number of inventory and sales made during a specified period (‘Direct Expenses,’2018). For instance, in table 1, the direct expenses are listed. Still, usually, the expense sums up in the cost of goods sold with only the commission expense, if any left out in a company’s income statement.

Else ways, a company’s income statement is a table that summarizes the profit and loss incurred in a business within a specified period in addition to the revenue and cost within the same period (‘Income statement,’2020). The revenue from each department in an organization is always useful in offsetting business indirect business expenses. Table 1 shows that the guitar department contributes negative 5700 dollars to Sadar overhead cost. More specifically, the guitar department does not add to the business overhead. Instead, it increases the overhead value by 5700 dollars.

Table 1. Guitar and piano department income statements

On the other hand, the piano department contributes 61,300 dollars to the Sadar business overhead. The piano department is profitable and helps in offsetting the indirect cost incurred in the business. Indirect cost in business is expense realized from the whole operation of a company, and the price is not directly related to the number of goods or services sold (‘Indirect Expense,’2018). The assumption made during the calculation of the department contributes to the overhead is that the indirect cost is included in the overhead expenses of the business. Hence during the calculation of the department overhead contribution, there is a deduction of the direct costs only except for the indirect costs.

The decision to eliminate the guitar department is valid after performing cost versus revenue trade-off form the department, as shown in table 2.

Table 2. Revenue versus cost trade-off for the guitar department

Eliminating the guitar department is justifiable since the will reduce the business operation cost by 376,200 dollars as compared to its revenue of 370,500 dollars if left operational.

Preparation and Analysis of Flexible Budget

Table 3. Classification of the items, their price, and cost

The management of Phoenix Company planned to produce and sell 15,000 units at a total sales price of 3,000,000 initially. Therefore, the unit price was given by substituting values in equation (i), and it was 200 dollars, as shown in table 3.

………………. (i)

The direct material is variable items since their cost changes with the amount of material produced. Therefore, the cost of material used to create the units was 975,000 dollars, and the price per unit is given by substituting values in equation (ii), and it was 65 dollars per unit produced.

…………………….. (ii)

Similarly, the cost of labor was a variable item since it changed with the number of goods produced. The cost of labor per unit was given by equation (iii), and it was 15 dollars per unit generated, as shown in table 3.

…………………… (iii)

The cost of machinery repairs was also dependent on the number of goods produced, hence it a variable item. Another cost was the machinery repairs, which were given by equation (iv), and it was 4 dollars per unit produced.

……………. (iv)

The rate of depreciation was a straight-line depreciation. Thereby it was a fixed item similar to 150,000 dollars cost of utilities. Moreover, the variable cost of utilities per unit produced was 3 dollars. The utility cost per unit produced was given by substituting values in equation (v).

……………….. (v)

Plant management salary was a fixed item since it does not change with the number of goods produced (‘Examples of fixed costs,’2018). Else ways, packaging cost, was variable since it was directly related to the amount of item produced. The unit price for each package was given by equation (v), and it was 5 dollars, as shown in table 3.

……………….. (vi)

Similarly, the shipping cost was a variable item since it changed with the amount of the item produced, and it 7 dollars as given by substituting values in equation (vii).

……………….. (vii)

Contrarily, sales salary, advertising expenses, salaries, and entertainment expenses were fixed items since their cost is not affected by the amount of the item produced.

The flexible budget for Phoenix Company for 14000 units had a total sales revenue of 2,800,000, as shown in table 4. Moreover, the total cost of 14000 units of goods was 1,868,000 dollars. The values shown in table 4 were the result of multiplications between the corresponding unit prices in table 3 with 14,000 units. The amount of utility cost was as a result of multiplying the variable unit price, which was 3 dollars with 14000 and adding the result to 150,000.

On the other hand, the fixed values that never changed were during the computation included the plant management salaries, sales salary, and general administrative expenses. The revenue earned from the operation was 58,000 dollars after Phoenix produced 14,000 units, as shown in table 4.

Table 4. Phoenix flexible budget at a sale of 14000 units.

The flexible budget for Phoenix Company for 16000 units had a total sales revenue of 3,200,000, as shown in table 5. Moreover, the total cost of 16000 units of goods was 2,042,000 dollars. The values shown in table 4 were the result of multiplications between the corresponding unit prices in table 3 with 16,000 units. The amount of utility cost was as a result of multiplying the variable unit price, which was 3 dollars with 16000 and adding the result to 150,000.

On the other hand, the fixed values that never changed were during the computation included the plant management salaries, sales salary, and general administrative expenses. The revenue earned from the operation was 260,000 dollars after Phoenix produced 16,000 units, as shown in table 5.

Table 5. Phoenix flexible budget at a sale of 16000 units

The income from operations for 18000 units equals 260,000 dollars, which 101,000 dollars higher compared to the 159,000 dollars (Vesty & Brooks, 2017). The income from operations was 101,000 dollars more compared to the budgeted amount without modification to the Phoenix business capacity.

Table 6. Phoenix flexible budget at a sale of 18000 units

Loss in business operation income of 144,000 will occur if the Phoenix Company produces 12000 units, as shown in table 7.

Table 7. Phoenix flexible budget at a sale of 12000 units

Conclusion

The decision to close one department of a business can be made after analyzing and comparing reduced revenue and cost due to the closure of a department. If the amount of the reduced cost is higher than the revenue, the decision to close a department is valid. Furthermore, the Phoenix business should ensure its production level is maintained above 12,000 units to avoid making losses, which leads to business failure.

Reference

Direct Expenses. (2018). Retrieved from https://www.accountingtools.com/articles/what-is-direct-expense.html

Examples of fixed costs. (2018). Retrieved from https://www.accountingtools.com/articles/what-are-examples-of-fixed-costs.html

Income Statement: Example, Format, Explanations. (2020). Retrieved from http://www.accounting-basics-for-students.com/income-statement-example.html

Indirect Expense. (2018). Retrieved from https://www.accountingtools.com/articles/what-are-indirect-expenses.html

Vesty, G., & Brooks, A. (2017). St George Hospital: Flexible Budgeting, Volume Variance, and Balanced Scorecard Performance Measurement. Issues in Accounting Education, 32(3), 103-116.

What is Departmental Contribution to Overhead. (2019). Retrieved from https://www.myaccountingcourse.com/accounting-dictionary/departmental-contribution-to-overhead.