Cost Management

Session 3

Overview

• Theory

• Exercise: 1.39; 1.42; 1.50; 1.51

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Theory

• is measured at one specific time, and represents a quantity existing at that point in time

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A stock variable

Flow variables

can be measured over an interval of time

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-Operational performance analysis-Strategic performance analysis-Characteristics of cost management analysis-Cost benefit analysis and variance analysis-Cost and expense

Operational performance analysis

• Measure whether performance of current operations is consistent with expectations

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Strategic performance analysis

• Measure whether long run performance of operations is consistent with expectations

Cost benefit analysis

• Measure effects of a plan by comparing its expected cost and benefits ( can be quantitative, and qualitative)

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Qualitative : impact on customer’s perception of service quality Quatitative: cost ( in euros, dollars, numbers)

variance analysis

• Difference between actual and expected quantities

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Exercise 1.39 (pag.33)

(a) Based on quantifiable benefits and costs of the decision, would you recommend that Lillis outsource its accounts receivable function?

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Exercise 1.39(1a)

Net Benefit= £ 405,000- £ 200,000= £ 205,000

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Benefits (£) Costs (£)

Personnel cost savings 230,000 Contract costs 150,000

Facilities savings 100,000 Training costs 35,000

Other support service 75,000 Contract administration 15,000

Total 405,000 200,000

Exercise 1.39(2a)

• What qualitative factors should Lillis also consider?

Qualitative factors to consider include:• service quality (timeliness, accuracy), • impacts on existing customers, • contacts with existing customers, • impacts on current and future employees.

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Exercise 1.39(3b)

• (b) Prepare an analysis similar to the one in Exhibit 1.6 (pag. 21)

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Exercise 1.39(4)

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Benefits of outsourcing accounts receivable

Expected amount

Actual amount Variance Qualitative Information

1. Personnel cost savings

230,000

170,000

(60,000)

Large overestimate of savings

2. Facilities cost savings

100,000

120,000

20,000

3. Support cost savings

75,000

100,000

25,000

4. Quality of service

--

--

-- Fewer billing complaints

Total quantifiable benefits

405,000

390,000

(15,000)

Exercise 1.39(5)

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Costs of outsourcing Expected amount

Actual amount Variance Qualitative Information

1. Contracted service

150 ,000

150,000

0

2. Training costs

35,000

40,000

5,000

2. Contract administration.

15,000

17,000

2,000

3. Loss of direct contact with customers

--

--

-- Lower sales growth

4. Adverse effects of personnel reductions

--

--

--

Increased personnel turnover

Total quantifiable costs.

200,000

207,000

7,000

Net quantifiable annual benefits

205,000

183,000

( 22,000)

Net benefits lower than expected

Exercise 1.39(6c)

• On balance do you agree with the outsourcing decision?

• Why or why not?

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Exercise 1.39 (7)

• Although quantitative benefits were lower than expected, they are still positive. Unknown is whether the outsourcing contract is responsible for lower sales growth and increased personnel turnover. This looks like a close call, and deserving of more investigation.

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Exercise 1.42 (pag. 35)

• (a) Given the following information compute MST’s cost-reduction target

Input Data:

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Expected market price $200

Required return on sales 25%

Product life 2 years

Currently feasible cost $ 30,000,000

Expected average annual sales, units 75,000

Exercise 1.42 (1)

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Target costing analysis

Sales price $200 Return on sales x 25% Dollar return on sales $ 50 Target cost per unit ($200 - $50) $ 150

Product lifecycle sales 150,000 Total target cost $22,500,000 Currently feasible cost $30,000,000 Cost reduction $7,500,000

(2 x 75,000)

($150 x 150,000)

Exercise 1.42 (2)

(b) If MST believes it can reduce the cost of the device by no more than 18%, is this a feasible product for MST? Why or why not?

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Exercise 1.42 (3)

• MST expects to reduce costs by 18%• Expected cost reduction= 0.18 x $30,000,000 =

$5,400,000

• Required cost reduction is $7,500,000

• $5,400,000 < $7,500,000 so unless further cost reductions are possible or the price can be raised, this is not a feasible product

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Exercise 1.50 (pag. 39)

(a) and (b)• What costs would be incurred as a result of

taking the contract?

• If the contract will pay £ 250,000 for the six months, should Change Management accept it?

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Exercise 1.50 (1)

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Statement of

income New contract

changes

Monetary impact of new

contract Income with new contract

Sales revenue $ 1,750,000 $ 250,000 250,000 $ 2,000,000 Costs

Labour 650,000 225,000 225,000 875,000 Equipment lease 105,000 12% 12,600 117,600 Rent 130,000 - - 130,000 Supplies 70,000 15% 10,500 80,500 Officers' salaries 420,000 420,000 Other costs 48,000 15% 7,200 55,200

Total costs 1,423,000 255,300 1,678,300

Operating profit (loss) 327,000 (5,300) $ 321,700

Exercise 1.50(2)

• Technically, the new contract reduces profit of the company by £5,300. By itself, this one-year contract appears not to be worth the effort of hiring and training new, part-time consultants.

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Exercise 1.50 (3c)

(c) What considerations, other than costs, are necessary before making the decision?

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Exercise 1.50 (4)

• Other considerations include: (1) whether this will enable the company to get

into a new, profitable line of business; (2) what other opportunities the company has

for expansion; (3) whether the contract will provide for more

revenues in the future; (4) what obligations the company makes to its

employees.

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Exercise 1.51 (pag. 39)Input Data:

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Exercise 1.52 (1)

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Annual Customer profitability

Large Customer

Small customer

Revenues €3,000,000 €210,000

Cost of supplies 2,400,000 157,500

Gross margin 600,000 52,500

Operating costs

Ordering costs 90,000 9,000

Delivery costs 240,000 16,800

Internet access costs 2,500 2,500

Total operating costs

332,500 28,300

Customer profit €267,500 €24,200

(3,000 x $1,000, 300 x $700)

(80%, 75% of revenues)

(3000x$30, 300x$30)

(8% of revenues)

Exercise 1.51 (2)• Is it worth adding 10 small customers to replace 1 large

customer?

• Gains: 10 x €24,200 = €242,000 profit

• Losses: €267,500 profit of large customer

• Gains< Losses Unless Corporate Express feels that these companies will grow to be more profitable than its current average customer, this can be an unwise tradeoff.

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Exercise 1.52 (3)

(c) On average, each small customer would have to increase its profitability from €24,200 to €26,750:

• by increasing the value of its orders,• by paying a premium for services,• by demanding less costly service, • or a combination of these actions.

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Exercise 1.51(4d)

(d) Do you recommend that Corporate Express consider this business alternative further?

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Exercise 1.51 (5)

• Consider pilot program with a few companies

Avoids risk of full-scale implementation

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See you next week!

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