Accounting for Managers: Interpreting accounting information for decision-making

120 ACCOUNTING FOR MANAGERS

year-end inventory holding is 194 days (£17.5 million/£90,000), equivalent to 81%
of working days (194/240).
Global’s services will increase the production costs because of its premium
pricing, and expects the price differential to be £250,000 per annum. However,
Global’s services will generate savings for SuperTech. First, the service will reduce
the lead time in manufacture by 10 days. The company’s interest cost of £787,000 is
5.4% of its borrowings of £14.5 million. This is a very rough estimate as borrowings
increased during the year and the company most likely had different interest rates
in operation. However, it is useful as a guide. If Global’s services can reduce
SuperTech’s lead time by 10 days, that will reduce the level of inventory by
£900,000 (£90,000 per day×10), which can be used to reduce debt, resulting in an
interest saving of £48,600 (£900,000 @ 5.4%).
Second, Global also believes that its services will increase the yield from existing
production because of the higher quality achieved. Global estimates that this yield
improvement will lower the cost of sales from 60% to 59%. This 1% saving on sales
of £35 million is equivalent to £350,000 per annum.
Global’s business proposal (which of course needs to demonstrate how these
gains can be achieved from a technical perspective) can contain the following
financial justification:

per annum

Savings:

Interest savings on reduced lead time £48,600

Yield improvements £350,000

Total savings £398,600

Additional cost of Global’s services £250,000

Net saving per annum £148,600

This is equivalent to an increase of 0.4% in the net profit (after interest)
to SuperTech.

Conclusion

This chapter has introduced various cost concepts, including cost behaviour,
cost – volume – profit analysis, alternative approaches to pricing and understanding
segmental profitability. While marketing is critical to business success, so is
the fulfilment of the promises made by marketing, which is the subject of the
next chapter.

References............................................

Doyle, P. (1998).Marketing Management and Strategy. (2nd edn). London: Prentice Hall
Europe.
Porter, M. E. (1980).Competitive Strategy: Techniques for Analyzing Industries and Competitors.
New York, NY: Free Press.
Porter, M. E. (1985).Competitive Advantage: Creating and Sustaining Superior Performance.
New York, NY: Free Press.