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BIRMINGHAM CITY BUSINESS SCHOOL
UNDERGRADUATE/POSTGRADUATE DEGREES
 
COURSEWORK FRONT SHEET
 
MODULE TITLE:           MBA Managing Financial Performance
MODULE CODE: ACC7004
LECTURER:       Dr Philip Talbot
ISSUE DATE:  4.02.2013
HAND IN/PRESENTATION DATE: 15.04.2013
HAND BACK DATE: 20.05.2013
 
 
 

Learning outcomes and pass attainment level:
·         Enable students to develop a critical understanding of the main financial objective of the firm and the constraints which impact on that objective.
·        Introduce students to the need for accounting information for management attention and to some basic concepts and ideas such as problem-solving, planning, control and decision-making
·        Introduce students to the main theories and concepts upon which a firm’s investment and financing decisions are founded, and their applications in practice.
·        To introduce students to the financial reports of various types of business entities, the use of accounting ratios, their interpretation and limitations

The assessment for this unit is this one coursework assignment. The required mark has been set at 50%.
This is an individual assessment requirement. There is no objection discussing the content and approaches to be adopted in the final submission you must make 100% your own work. Plagiarism and copying will not be tolerated and may lead to subsequent penalties being imposed.
 
There are three separate questions. All three questions must should be attempted and submitted together on numbered pages. Your answers should be prepared and submitted in Word format. Excel spreadsheets may be used but must be pasted into the Word document and not submitted separately. This should be carefully checked before submission for the use of appropriate and acceptable grammar. The correct use English spelling is to be employed throughout and no other. All submissions must be page numbered and contain your student ID number.
When determining the amount of effort and words for each section of the assignment it will be advisable to examine the weighting of the marks allocated to each question. If any part of the assignment is ignored then this reduces the maximum marks that could be potentially be earned.
The word limit to any potential narrative question in the third section will be a maximum of 1,500 words excluding the bibliography.
The assignment will require a considerable personal investment of time and effort. This is an individual assignment and all calculations, analysis and narrative submitted must be your own work.
The following matrix has been included to help guide you.

 
Section A
Section B
Section C

 
1a. Financial Analysis (39%)
2a. Marginal Cost Statement-Original Contract (14%)
3a. Research (20%)

Fail
Lack of breadth and depth of financial analysis techniques
Accompanied by incorrect formulae, calculation without explanation and poor layout
Failure to produce of a clear and comprehensive Marginal Income Cost Statement without identifying and separating out variable costs, fixed costs and contributions within the limiting factor and across the product portfolio
Intermediate calculations not or inaccurately provided.
Failure to engage with the topic and lacking credible academic argument. No evidence of research other than internet sites of dubious quality. Poorly structured with inadequate grammar

Bare Pass
Evidence of some financial analysis techniques but with errors of formulae and calculation with insufficient  explanation and adequate presentation
Partial production of a comprehensive Marginal Income Cost Statement partially identifying and separating out variable costs, fixed costs and contributions within the limiting factor and across the product portfolio
Intermediate calculations partially and/or inaccurately provided.
Partial engagement with the topic with some limited evidence of research. Grammar, structure and layout adequate.

Above Average Pass
Wide range of financial analysis techniques evident supported by full disclosure of formulae and accurate calculation in clear format.
Production of a clear and comprehensive Marginal Income Cost Statement clearly identifying and separating variable costs, fixed costs and contributions within the limiting factor across the product portfolio.
Intermediate calculations accurately provided.
Identifying the arguments surrounding the topic with reference to credible academic citations that are fully referenced in a bibliography
A  structured, coherent narrative employing above average grammar and evidencing student research

 
1b. Narrative Analysis (11%)
2b. Marginal Cost Statement-New Contract (9%)
 

Fail
Not presented in business report format with no supporting appendices. Descriptive rather than analytical. Poor narrative structure and inadequate grammar lacking an overall knowledgeable synthesis
Inaccurate revised production schedule to maximise returns without clear supporting calculations. Failure to produce an analysed Marginal Cost Income Statement across the portfolio and not identifying variable costs, fixed costs, contributions and the revised overall profit
 

Bare Pass
Attempt at a business report format with some supportive appendices. Mainly descriptive with some attempt at synthesis. Grammar and structure being adequate.
Partial identifying revised production schedule to maximise returns with some supporting calculations. Partially producing an analysed Marginal Cost Income Statement across the portfolio identifying variable costs, fixed costs, contributions and overall revised profit
 

Above Average Pass
In business report format and coherently structured and supported by referenced appendices. Effectively synthesises the  calculative narrative into an informed narrative
Identifying revised production schedule to maximise returns with clear supporting calculations. Producing an analysed Marginal Cost Income Statement across the portfolio identifying variable costs, fixed costs, contributions and overall revised profit
 

 
 
2c. Decision Making (7%)
 

Fail
 
Mainly descriptive without reasoned conclusions on the overall contract decision without consideration of financial and non-financial implications
 

Bare Pass
 
Partially based reasoned conclusion on the contract decision with some financial and non-financial implications
 

Above Average Pass
 
Rationally based conclusion on contract decision with comprehensive evaluation of the financial and non-financial implications.
 

 
Q1
Presented below are the annual financial statements of Clinton Cards Plc for the financial years 2009 to 2011.
Required:

Prepare a business report for the board of directors which analyses the performance of Clinton Cards Plc over the financial period 2009-2011 by using all of the financial information provided and, recommend what the directors should do to address the company’s position.
 (50% Marks)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Appendix 1

Clinton Cards Plc

Statement of Comprehensive Income as at 1st August

2011
2010
2009

£000’s
£000’s
£000’s

Revenue

364,218
394,007
345,200

 

Opening Inventory

37,653
36,217
49105

Purchases

363138
366,810
306447

Closing Inventory

43,202
37,653
36,217

Cost of Sales

357,589
365,374
319,335

Gross Profit

6,629
28,633
25,865

 

Other operating income
94
148
68

Administrative expenses
-13,850
-11,609
-10,276

Loss on plant disposal
-985
-1469
-1824

Profit on acquisition

 
13460

Impairment plant and property

 

Operating Profit/loss
-8,112
15,703
27,293

 

Finance income

96
253
386

Finance costs

-2,992
-3,149
3,089

Loss on financial instruments

-824
430

Profit on financial instruments
356
 

Write down of property
-10
-7
68

provision discount

 

 

Profit /Loss before taxation
-10,662
11,976
24,092

 

Income Taxes

-1,428
3,646
113

 

Profit/Loss from continuing
-12,090
8,330
23,979

operations

 

 

Loss  from discontinued operations
-2943
-952
-57,619

 

Profit/loss for the period
-15,033
7,378
-33,640

attributable to owners of the company

 

 

Other comprehensive income

 

Loss Currency translation differences
-233
-92
-4

 

Total comprehensive income/expenses
-15,266
7,286
-33,644

 

 
Clinton Cards Plc

Statement of Comprehensive Position as at 1st August

2011

2010

2009

£000’s

£000’s

£000’s

Non Current Assets

Goodwill

17,326

17,326

17,326

Intangibles

1,750

1,750

1,750

Property, plant and equipment
48,729

58,162

65,204

Deferred tax asset

172

411

Total non-current assets

67,805

77,410

84,691

Current Assets

Inventories

43,202

37,653

36,217

Trade and other receivables

18,917

17,882

19,418

Derivatives

250

Current tax asset

886

Cash and cash equivalents

19,673

7,225

9,056

Total current assets

82,678

62,760

64,941

Total Assets

150,483

140,170

149,632

Equity and Liabilities

Called up share capital

20,693

20,693

20,693

Share premium account

5,873

5,873

5,873

Capital redemption reserve

50

50

50

Currency translation reserve

233

325

Other reserves

308

308

308

(Accumulated losses)/retained earnings
-3,951

11,082

3,704

Total equity

22,973

38,239

30,953

Non Current Liabilities

Deferred tax liabilities

1,289

Provisions

2,772

1,909

1,298

Deferred income

9,025

9,417

7,868

Total non-current liabilities

13,086

11326

9166

Current liabilities

Borrowings

53,527

41,566

56,581

Trade and other payables

55,458

47,370

51,265

Derivative financial instruments
218

574

Tax liabilities

456

1,301

Provisions

5,221

639

366

Total current liabilities

114,424

90,605

109,513

Total liabilities

127,510

101,931

118,679

Total equity and liabilities

150,483

140,170

149,632

Financial Information
Company share price and FTSE 100 Index as at 1st August

Year
2009
2010
2011
2012
2013

Share Price
In pence
27.09
35.00
12.50
6.75
6.75

FTSE 100
4682.50
5397.10
5774.40
5712.80
6682.00

 
 
 
 
 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Q2
Belling Company Ltd manufactures three types of ceramic coffee percolator, the Basic, Deluxe and the Premium models. The maximum market demand and resource requirements of each of these products are shown below. The percolators are made from an advanced heat-resistant material that gives the firm a competitive advantage. An e-mail from the purchasing manager has informed you that, because of a problem with the supplier, it should be assumed that the half year’s supply of this special material is limited to 28,000kg.
 
Belling Company Ltd operates on a just-in-time production (JIT) method so that opening and closing inventory levels are zero.
 
The sales director has already accepted an order for 1,000 Deluxe percolators that, if not fulfilled, would incur a financial penalty of £2,000. This order is included in the Deluxe’s maximum market demand figure.
 
Belling’s directors need to know whether they should go ahead and satisfy the contract and then prioritise production in the normal way or whether it should consider breaching the contract and incurring the penalty.
 
 
Budgeting Data for first half year 2013
 

 
Basic
Deluxe
Premium

Maximum demand (units per year)
4,500
2,000
4,000

Special ceramic material used per kettle (kg)
2.00
5.00
8.00

 
 
The financial out turns for the previous two half years is as follows;
 

First  Financial Half Year 2012

Basic

Deluxe

Premium

TOTAL

Sales in units
4100

1800

3600

£

£

£

£

Sales
114800

93600

302400

510800

Costs

Raw materials
41000

45000

144000

230000

D Labour
8200

7200

28800

44200

Overheads
60800

42400

56800

160000

Total Costs
110000

94600

229600

434200

Profit/Loss
4800

-1000

72800

76600

 
 
Second Financial Half Year 2012

Basic

Deluxe

Premium

TOTAL

Sales in units
4600

2200

4325

£

£

£

£

Sales
128800

114400

363300

606500

Costs

Raw materials
46000

55000

173000

274000

D Labour
9200

8800

34600

52600

Overheads
64800

45600

62600

173000

Total Costs
120000

109400

270200

499600

Profit
8800

5000

93100

106900

 
 
Required
 

Prepare a product analysed and total marginal cost income statement for the first half year of 2013 assuming that the Deluxe contract is honoured.

 

Prepare a product analysed and total marginal cost income statement for the first half year of 2013 assuming that the Deluxe contract is not honoured.

 

Advise the company what action they should undertake based on your analysis above

 
 
 
(30% Marks)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Q3
 
A firm has a role to play in the economic system if transactions can be organised within the firm at less cost than if the transactions were carried out through the market. The limit to the size of the firm is reached when the cost of organising additional transactions within the firm exceed the cost of carrying out the same transaction through the market.
 
Coase, R, H., (1937), The Nature of the Firm, Econimica
 
Critically discuss  how  the current trend amongst Western European based international companies in order to co-ordinate and standardise their finance and accounting functions across their companies’ is to outsource their routine finance activities to a third party supplier in relation to Coase’s arguments and that of Oliver Williamson (1981).
As an alternative Western European companies could establish a centralised Shared Service Centre (SSC) instead of continuing with multiple geographical accounting offices. The initial formation however, would be expensive and time consuming however, this option it is argued could ensure greater control over operations.
Required
Discuss the relative merits and drawbacks of Western European Companies outsourcing their finance function to a third party provider compared to establishing and centralising the finance function in a dedicated SSC with reference to Coase and Williamson.
(20% marks)
 
                 Total 100% MARKS
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Model Answers
 
AQ1
 
 
Report
 
From:  Financial Analyst
 
To: Board of Directors Clinton Cards Plc
 
Subject: Financial Performance Analysis 2009-2011
 
Date: 29th May 2012
 
Introduction
 
In compliance with your instructions I have undertaken a financial analysis of the company’s performance for the three financial periods 2009-2011. This comprises both a financial ratio analysis and a trend analysis of the audited published financial statements. The analysis has been mainly undertaken on the pre-exceptional figures to identify the underlying core performance trends of above average performance.
 
 
Profitability
 
The most recent financial statements give rise to concern of the profitability of the company. The latest period analysis reveals a substantial decline in overall profitability with a negative ROCE being realised after two previous periods of high returns when compared to the CIMA performance benchmarks indicating a high risk. This decline has occurred despite the trend of increased revenue streams being matched in 2010 by a parallel rise in the cost of sales indicating that these costs had been passed on to the customers. The trend of sales revenues has declined in the last financial period but cost of sales have fallen by a lesser  proportion  resulting in faltering gross profit margins unable to cover operating expenses leading to reported loss in 2011. This is alarming as in the previous financial periods of 2009 and 2010 above average ROCE returns were recorded as were operating profit margins. This recent dramatic decline is also mirrored in the return on assets which has become negative because of the recorded loss although profits were falling previously but this has become substantial during in the last financial period. The asset turnover has been maintained only due to the rationalisation of the asset base demonstrated in the vertical and horizontal trend analyses which have fallen by 20% over the three years.
 
Liquidity
The trend analysis has shown a growth in current assets principally in the proportion of inventory held and cash arsing from the sales of non-current assets and which have become greater in the last period than the non-current assets. The large cash growth has arisen from the disposals of non-current assets. However the trend in current liabilities had increased due mainly to a combination in the proportionate growth of short-term borrowing and trade payables that has compromised the short term solvency of the company.
The short term solvency of the business as measured by the working capital ratio has been high risk by standard benchmarking over the three periods indicating insolvency although it may be the norm for the business sector if it was supported by growing revenue streams. However, the quick ratio has declined substantially and is below 0.2 to 1 that benchmarks indicate higher levels of inventory are been held as sales demand is growing insufficiently. The inventory turn has increased to 44 days from the previous improvement to 37 days leading to the higher inventory accumulation caused by  management inefficiencies coupled to the falling the falling demand.
Efficiency
The level of trade receivables is more or less stable and the company’s credit control has improved whereas the payables have witnessed an upward trend to 56 days approaching 2009 levels. This indicates a positive cash flow although any further deterioration may damage supplier relations and invoke retaliation once the company’s poor financial performance becomes known
The cash operating cycle measures the time between paying out cash for the purchases of inventory, and receiving cash for the subsequent sale. The company’s cash cycle has remained steady in the last two periods with a slight decline and currently remains favourable in the short-term because payments are being delayed.

 
2011
2010
2009

Finished Inventory period
44.10
37.61
41.40

Receivables collection
18.96
16.57
20.53

Payables payment period
(56.61)
(47.32)
(58.60)

 
 
 
 

Operating Cash Cycle in days
6.45
6.86
3.33

 
Gearing
The balance sheet gearing position remains at high risk as it is above average benchmarks and it has increased with the company reliant on short-term borrowing.  The business had reduced its long-term debt which it may have found difficult to secure given its financial performance.
However, the ability to service the debt from operating profit streams had dropped significantly interest cover has dropped alarmingly and it now cannot service its debt from its operating profit, i.e.

 Year
2011
2010
2009

Interest cover
Operating profit /loss finance costs
(2.71)times
(£8112)m / £2992m
4.9 times
£15703m / £3149m
8.8 times
£27293m / £3089m

The 2011 financial statements reveal that the company fortunately had high cash balances from its non-current asset disposals that could meet interest payments albeit within the short -term.
Given the current lack of profitability, and the fear that profitability might deteriorate in future, this will impact on the company’s share price and market capitalisation.
Financial – Share Price
The share price originally recovered in 2010 arising from the reported increased profits and indeed the company outperformed the FTSE 100 Index.  This proved only a temporary trend and the poor results and the extent of the losses reported in 2011 led to the collapse the share price as market confidence in the ability of the company’s management to redress the situation disappeared.
Later movements of the share fell even further so that the company’s market capitalisation has fallen 80.71% since its peak in 2010 and has fallen well below the overall market movement as reflected in the FTSE100
Company Share Price Trend Movement and FTSE100 Trend

Year
2009
2010
2011
2012
2013

Share Price
100%
129.20%
4.48%
2.49%
2.49%

FTSE 100
100%
115.26%
123.31%
122.00%
142.70%

 
Conclusion
The main areas of concern regarding Clinton Cards Plc current position are:

Low profitability
High levels of cash, making Clinton Cards  Plc an attractive takeover target,
Poor management of working capital, and the risk that supplier relationship might be strained.

Clinton Cards requires urgently needed addressing these issues if it is to escape the downward spiral towards corporate failure. Ominously the dramatic downfall of the share indicates that the market regards the company as unsalvageable and is most likely to be no longer a going-concern and the share represents its asset break-up value.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Appendix 1

 
  Clinton Cards Plc

 
  Financial Ratio Analysis

 
Ratio
Formulae
metric
2011
2010
2009
CIMA Average

 

 

 Benchmark

Profitability
Overall ROCE
PBIT x100
%
-10.60%
19.68%
31.18%
8%-11%

 

Cap Employed

 

 

 

 

 

 
Return on Assets
PBIT x100
%
-5.39%
11.20%
18.24%
 

 

Total Assets

 

 

 

 

 

 
Asset Turnover
Revenue
x
2.42
2.81
2.31
 

 

Total Assets

 

 

 

 

 

 
Net profit
NP before int and tax 
%
-2.23%
3.99%
7.91%
3%-10%

 
margin
Revenues

 

 

 

 

 

 
Gross Profit
Gross profit x 100
%
1.82%
7.27%
7.49%
 

 
margin
Revenues

 

 

 

 

 

Liquidity
Working
current assets /
x:1
0.72
0.69
0.59
1-1.5

 
capital ratio
current liabilities

 

 

 

 

 

 
Acid test
ca’s – inventories
x:1
0.34
0.28
0.26
0.75-1.25

 
ratio
current liabilities

 

 

 

 

 

Efficiency
Receivables
Trade receivables x365
days
18.96
16.57
20.53
55-85 days

 
collection days
sales

 

 

 

 

 

 
Payables
Trade payables x 365
days
56.61
47.32
58.60
45-60  days

 
payment days
cost of sales

 

 

 

 

 

 
Inventory
Cl.Inv. x 365
days
44.10
37.61
41.40
 

 
turnover
cost of sales

 

 

 

 

 

Growth
Gearing
Fixed int cap x 100
%
69.97%
52.08%
64.64%
33%-47%

 

capital employed

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Appendix 2
 

Clinton Cards Plc

Statement of Comprehensive Position

as at 1st August

Vertical Trend Analysis

2011

2010

2009

Non Current Assets

Goodwill

11.51%

12.36%

11.58%

Intangibles

1.16%

1.25%

1.17%

Property, plant and equipment
32.38%

41.49%

43.58%

Deferred tax asset

0.12%

0.27%

Total non-current assets

45.06%

55.23%

56.60%

Current Assets

Inventories

28.71%

26.86%

24.20%

Trade and other receivables

12.57%

12.57%

12.98%

Derivatives

0.17%

Current tax asset

0.59%

Cash and cash equivalents

13.07%

5.15%

6.05%

Total current assets

54.94%

44.77%

43.40%

Total Assets

100.00%

100.00%

100.00%

Equity and Liabilities

Called up share capital

13.75%

14.76%

13.83%

Share premium account

3.90%

4.19%

3.92%

Capital redemption reserve

0.03%

0.04%

0.03%

Currency translation reserve

0.17%

0.22%

Other reserves

0.20%

0.22%

0.21%

(Accumulated losses)/retained earnings
-2.63%

7.91%

2.48%

Total equity

15.27%

27.28%

20.69%

Non -current liabilities

Deferred tax liabilities

0.86%

0.00%

Provisions

1.84%

1.36%

0.87%

Deferred income

6.00%

6.72%

5.26%

Total non-current liabilities

8.70%

8.08%

6.13 %

Current liabilities

Borrowings

35.57%

29.65%

37.81%

Trade and other payables

36.85%

33.79%

34.26%

Derivative financial instruments
0.14%

0.41%

0.00%

Tax liabilities

0.33%

0.87%

Provisions

3.47%

0.46%

0.24%

Total current liabilities

76.04%

64.64%

73.19%

Total liabilities

84.73%

72.72%

79.31%

Total equity and liabilities

100.00%

100.00%

100.00%

 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Appendix 3
 

Clinton Cards Plc

 

 

Statement of Comprehensive Position

 

Horizontal Trend Analysis

2011

2010

2009

Non Current Assets

Goodwill

100.00%

100.00%

Intangibles

100.00%

100.00%

Property, plant and equipment

74.73%

89.20%

Deferred tax asset

41.85%

Total non-current assets

80.06%

91.40%

100.00%

Current Assets

Inventories

119.29%

103.96%

Trade and other receivables

97.42%

92.09%

Derivatives

Current tax asset

Cash and cash equivalents

217.24%

79.78%

Total current assets

127.31%

96.64%

100.00%

Total Assets

100.57%

93.68%

100.00%

Equity and Liabilities

Called up share capital

100.00%

Share premium account

100.00%

Capital redemption reserve

100.00%

Currency translation reserve

Other reserves

100.00%

(Accumulated losses)/retained earnings

-106.67%

299.19%

Total equity

74.22%

123.54%

100.00%

Non -current liabilities

Deferred tax liabilities

Provisions

147.07%

Deferred income

114.71%

119.69%

Total non-current liabilities

142.77%

123.57%

100.00%

Current liabilities

Borrowings

94.60%

73.46%

Trade and other payables

108.18%

92.40%

Derivative financial instruments

37.98%

Tax liabilities

35.05%

Provisions

1426.50%

174.59%

Total current liabilities

104.48%

82.73%

100.00%

Total liabilities

107.44%

85.89%

100.00%

Total equity and liabilities

100.57%

93.68%

100.00%

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Appendix 4
 

 

Clinton Cards Plc

Statement of Comprehensive Income

1st August

Vertical Trend Analysis

2011
2010
2009

Revenue

100.00%
100.00%
100.00%

Cost of Sales

98.18%
92.73%
92.51%

Gross Profit

1.82%
7.27%
7.49%

Operating Profit/loss
-2.23%
3.99%
7.91%

Profit /Loss before taxation
-2.93%
3.04%
6.98%

Profit/Loss from continuing
-3.32%
2.11%
6.95%

operations

Total comprehensive income
-4.19%
1.85%
-9.75%

/(expense) for the period

attributable to owners of the

company

 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Appendix 5
 
 

Clinton Cards Plc

Statement of Comprehensive Income

1st August Horizontal Analysis

2011
2010
2009

Revenue

105.51%
114.14%
100.00%

Cost of Sales

111.98%
114.42%
100.00%

Gross Profit

25.62%
110.70%
100.00%

Operating Profit/loss
-29.72%
57.53%
100.00%

Profit /Loss before taxation
-44.26%
49.71%
100.00%

Profit/Loss from continuing
-50.42%
34.74%
100.00%

operations

Total comprehensive income
-45.38%
121.66%
-100.00%

/(expense) for the period

attributable to owners of the

company

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
AQ2
 
Separating out the overheads cost structure – High/ Low method
 

Overhead Cost Structure

Basic

Deluxe

Premium

Units

High
4600

2200

4325

Low
4100

1800

3600

Difference
500

400

725

£’s

High
64800

45600

62600

Low
60800

42400

56800

Difference
4000

3200

5800

VC £’s/Units
8

8

8

Fixed cost

total ohd
64800

45600

62600

less VC
36800

17600

34600

FIXED COST
28000

28000

28000

 
 
 
 

Belling
Contribution per unit

Basic

Deluxe

Premium

Mat’s in Kgs

2

5

8

£
£
£
£
£
£

Sales

28

52

84

Var Costs

D Mat’ls

10

25

40

D Labour

2

4

8

Var Ohds

8
20
8
37
8
56

CPU

8

15

28

Contribution per limiting factor (kgs)
4

3

3.5

Priority Ranking

1

3

2

 
 

 

Assuming Deluxe contract is honoured
 

Demand in Units
4500

2000

4000

per half year

Production Schedule

Units
Kgs

Total Kgs
Cumulative

Kgs

Deluxe

1000
5

5000
5000

Basic

4500
2

9000
14000

Premium
bal fig
1750
8

14000
28000
max

 

 
 

Belling

Marginal Cost Income Statement
First Half 2013

Assuming Deluxe Contract Honoured

Basic

Deluxe

Premium

TOTAL

Unit Sales

4500

1000

1750

£
£
£
£
£
£
£
£

Sales

126000

52000

147000

325000

Var Costs

D Mat’ls

45000

25000

70000

140000

D Labour

9000

4000

14000

27000

Var Ohds

36000

8000

14000

58000

90000

37000

98000

225000

Contribution

36000

15000

49000

100000

Fixed Overhead

84000

Profit

16000

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

Assuming contract dishonoured

Demand in Units

4500

2000

4000

per half year

Production Schedule

Kgs

Units
Kgs

Total Kgs
Cumulative

Basic

4500
2

9000
9000

Premium

2375
8

19000
28000
max

Deluxe

0
5

28000

 
 
 
 
 

Belling

Marginal Cost Income Statement
First Half 2013

Assuming Deluxe Contract Dishonoured

Basic

Deluxe

Premium

TOTAL

Unit Sales

4500

0

2375

£
£
£
£
£
£
£
£

Sales

126000

0

199500

325500

Var Costs

D Mat’ls

45000

0

95000

140000

D Labour

9000

0

19000

28000

Var Ohds

36000

0

19000

55000

90000

0

133000

223000

Contribution

36000

0

66500

102500

Fixed Overhead

84000

Profit

18500

 
 
 
 
Decision
 
The revised production plan ignores the Deluxe contract increases contribution by £2,500, which exceeds the £2,000 financial penalty for breaking the contract. In simple financial terms, there is a net gain of £500 for failing to honour the contract and redirecting scarce resources. Indeed, as long as the penalty is less than £2,500, it would be financially worthwhile for Belling Company Ltd to breach the contract.
 
However, this fails to reflect a range of non-financial factors that have financial implications needs to be considered if a good decision is to be made. Key issues to consider in this case include:
 

The customer retention, whose contract Belling have reneged on, which may become permanently lost business

 

Leakage of the news of Belling’s failure to fulfil a contract if it became common knowledge in the trade, may damage the company’s reputation and the consequent loss of goodwill could amount to in the long term to far more, in terms of lost sales and contribution, than the immediate net gain of £500.

 

The decision to manufacture only two types of percolator instead of three products may have a harmful effect on customer loyalty and sales demand.

 

The long-term effects of vacating the market for Deluxe kettles invites Belling’s rivals to fill the gap created and thus gain market share.

 
 
Belling will need to get to discover the reasons for the material shortages.  So, working from the revised plan, if the company is able to find extra material from elsewhere, then clearly it should do so, as long as the premium for each kilogram (the cost over and above that already being paid) is less than £3.50. Since the contribution per kilogram of material used in producing the premium percolator is £3.50, this would make it worthwhile to obtain material from an additional supplier(s) if quality can be ensured.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
AQ3
 
After the Great War (1914-1918) the role of the company within society was critically debated.  These debates posed awkward questions, about why did companies exist and who were they run for and what the position of the workforce in a company is (Micklethwaite and Wooldridge, 2003:111).  The most prominent economist engaged in this debate was Ronald Coase, (1937), whereby he attempted to explain why the economy had moved beyond individuals selling goods and services to one another. He located the answer within the imperfections of the market and he adjudged it as being particularly related to transaction costs. These were the costs that sole traders might incur in obtaining the most preferential deal and co-ordinating processes such as manufacturing and marketing and arguably now accounting and finance with the advances in IT and communication infrastructures.
 
Coase stated that transaction costs would arise for a company from acquiring information, product pricing, and the payment of commissions or even reaching a point where a contract could be constructed. The consequence of long runs and repetitive transactions would he asserted become significant and so some other form of transaction other than a free market mechanism was desirable. Coase’s arguments required of the company to do things more efficiently than the open market (Micklethwaite and Wooldridge, 2003:127).
 
Coase’s work has been refined further through the work of Oliver Williamson, (1979 and 1981). Williamson suggests that organisations have to choose between two alternative mechanisms to control its resources and operations. These are;
 

Hierarchy Solutions whereby management choose to own the assets and/or employ the staff directly and use the policies and procedures of the firm to control their use and performance. Vertically integrated companies are those which have a high reliance on the managerial hierarchy for control or,

 

Market Solutions whereby management choose to buy in the use of assets or staff externally under a formally negotiated contract

 
Transaction costs arise at the interface between economic agents, particularly between stages in a production or supply process, i.e. third parties supplying the accounting and finance function.  In addition to the normal cost on external suppliers, a market solution for an input or service in addition to the price for the bought in transaction it will incur the following transactions,
 

Negotiating and drafting the contract
Monitoring the suppliers’ compliance with the contract with regard to quality, reliability, invoicing etc…
Pursuing legal actions for redress due to non-performance
Penalty Payments and cancellation payments if the firm seeks to revise the contract

 
 
These costs and risks assumed by both parties to the contract will be increased by two further factors labelled “Transaction Cost Risks”
 

Bounded Rationality – When the contract is negotiated both parties are unable to predict how the contract will unfold or predict the future, e.g. the levels and volumes of accounting and finance work expanding or contracting in the future. This leads to detailed contract negotiations and interpretation issues that increase transaction costs. Legal enforcements would further increase the transaction cost from two specific types of risk

 

Opportunistic Behaviour – When each agent is seeing to pursue their own economic self-interest and thus contract weaknesses could be exploited for individual benefits (e.g. a minor change in accounting and finance work specification could permit a supplier to exact higher prices because the buyer is bound by the contract to purchase the services). This will lead to expensive variations in contract terms or damage claims for breach of contract

 
 
If these transactions costs become too high then the firm may reduce these by bringing the function in-house under direct managerial control, i.e. a Shared Service Centre (SSC) a hierarchy solution. The final decision will be base on management’s requirement to minimise costs. Therefore Coases’s premise is that companies make sense when the transaction costs associated with buying things on the market exceed the hierarchical costs of maintaining a bureaucracy, then modern technology is generally shifting the balance of advantage away from companies and towards markets and individuals (Micklethwaite and Wooldridge, 2003:175-6). Coase and Williamson’s ideas were empirically tested by Joskow (1987: 168) and he concluded that buyers and sellers make longer commitments to the terms of future trade at the contract execution stage and, rely less on repeated bargaining, when the relationship –specific investments are more important.
The merits of the outsourcing option a market solution therefore would include the fact that Western European companies could draw on the expertise of a company already established in the field of transaction processing and financial reporting. It would be standardised, streamlined and make use of the latest technology. The phenomenon of outsourcing to a third party provider has been described as a transformational phenomenon and largely successful but not without risk (Nolan and McFarlan, 1995:160-162).
If Western European companies decided to outsource offshore to an emerging country, significant savings prima facie might be made in terms of wage costs and cost of premises. A large, experienced supplier might be able to offer a higher quality service than is possible in house because of the ability to make use of expertise or technologies not readily available to Western European companies. It could arguably allow Western European companies’ senior finance people to focus on the creation of value.
The drawbacks of outsourcing are largely to do with the problems of ensuring control and the associated issue of retaining confidentiality of sensitive financial data that could lead to opportunistic behaviour by the agent.
There would also be a potentially large problem if things do not work out with the supplier and Western European companies, having dismantled its existing in house finance provision, has to seek a replacement supplier so that hierarchical solutions no longer are readily available.
By comparison, the merits of setting up a hierarchical dedicated SSC are that Western European companies would enjoy complete control of its Finance and Accounting processes and be in a better position to ensure that confidential items remain confidential. These European companies would avoid the risk involved in contracting out the processing of key financial data.
A dedicated SSC also shares some of the advantages discussed above in respect of outsourcing. By centralising its Finance and Accounting operations, the European companies can reduce head count. It can save on cost of premises because most finance staff will now be accommodated in a single location. Related to this, it can choose the location where labour and other costs are lowest or alternatively where highly qualified staff and the most favourable location for a centre are available. One reason for choosing a particular location for instance could be a favourable tax regime.
There is also the advantage that, in working with other functions such as sales, marketing, Research and Development or production, finance staff within the SSC is relating to members of their own organisation and is more likely to share a common organisational culture. There is likely to be a common understanding which would help problem resolution.
Finally an SSC can benefit from economies of scale. These could derive from learning curve effects, specialisation and from being able to afford to invest in a network system with a common database that provides interactive opportunities and the benefits of sharing data.
A major drawback in comparison with outsourcing however, is the initial setting up of an SSC. This will most likely require the engagement of an outside IT contractor to provide an Enterprise Resource Planning (ERP) system tailored to the needs of the European company and also a certain degree of upheaval as well as the considerable capital expenditure.
 
References
Coase. R, (1937), The Nature of the Firm, Econimica 4 (16), pp. 386-405.
Joskow. P (1987), Contract Duration and Specific Investments: Empirical Evidence from Coal Markets, The American Economic Review, Vol. 77, No.1, pp168-185.
Nolan. R and McFarlan F, (1995), Outsourcing, Harvard Business Review, Vol.73 (4), pp. 160-162
Micklethwaite. A, and Wooldridge.  A, (2003), The Company: A Short History of a Revolutionary Idea, London, Weidenfeld and Nicholson.
Williamson, O, (1979), Transaction-Cost Economics: The Governance of Contractual Relations, Journal of Law and Economics Vol.22 No.1, pp.233-261.
Williamson, O, (1981), The Economics of Organisation:  The Transaction Cost Approach, American Journal of Sociology, Vol. 87, No.3, pp.548-577.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

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