Managing Finance and Budgets Seminar 6

Seminar Six - Activities  Preparation: read Chapter 11  Describe key concepts: Activity based costing Pricing strategies Cost plus pricing Marginal cost pricing Penetration pricing Price skimming  Exercises 11.4 (page 365) and pages 367-8

Starting Points (1)  Define what is meant by the following:  Fixed Costs  Variable Costs  Direct Costs  Indirect Costs  Give an example of a Fixed Cost which may be a Direct.  Give an Example of a Direct Cost which is Variable.

Starting Points (2)  Define what is meant by the following:  Activity-Based Costing  Cost Pool  Cost Driver  What sorts of cost drivers are generally used to allocate costs from the cost pool to various activities?

Some Economic Theory (1)  Explain how the graph on the next slide describes how the market responds to a price increase.  Explain how the market can respond differently to the same price rise in two different commodities A and B, using the next two slides.  What is meant by the term ‘Elasticity of Demand’?  Which of the commodities, A or B has the higher elasticity of demand?

Graph of quantity demanded against price for commodity A Price per unit (£) Quantity (units) Q2Q1 P2 P1

Graph of quantity demanded against price for commodity B Price per unit (£) Quantity (units) Q2 Q1 P2 P1

Example (A)  Widgets and Wodgets both cost 15p each to make. Market research suggests that for a selling price of £1.00, the market will support sales of 100 of each type of item. What total profit will we make?  Market Research suggests that for widgets, each price reduction of 10p we make from the original selling price, will increase our sales by 100 widgets.  Market Research suggests that for wodgets, each price reduction of 5p we make from the original selling price, we will increase our sales by 100 wodgets.  Which item, widgets or wodgets has the higher elasticity of demand?

Example (A) - Solution  Widgets and Wodgets both cost 15p each to make. Market research suggests that for a selling price of £1.00, the market will support sales of 100 of each type of item. What total profit will we make?  Turnover:100 x £1.00= £100  Cost100 x 15p= £ 15  Profit £ 85

Example (A) – Solution 1 Widgets SalesPrice p p p p p p p p p p Sales Price This shows a relatively inelastic demand pattern

Example (A) – Solution 2 Wodgets SalesPrice p p p p p p p p p p Sales Price This shows a relatively elastic demand pattern

Some Economic Theory (2)  Describe briefly what the graphs on the next two slides show.  Why is the first graph a straight line, increasing?  Why is the second graph a curve, with a downwards dip at the end?

Graph of total cost against quantity (volume) of output of product X Cost (£) Quantity (units)

Sales revenue (£) Quantity (units) Graph of total sales revenue against quantity (volume) sold of product X

Example (B)  Widgets and Wodgets both cost 15p each to make. Market research suggests that for a selling price of £1.00, the market will support sales of 100 of each type of item.  Market Research suggests that for widgets, each price reduction of 10p we make from the original selling price, will increase our sales by 100 widgets.  Market Research suggests that for wodgets, each price reduction of 5p we make from the original selling price, we will increase our sales by 100 wodgets.  Calculate, for each item, the total turnover for the different levels of sales. What is the maximum turnover for each item?

Example (B) – Solution 1 Widgets SalesPriceTurnover p£ p£ p£ p£ p£ p£ p£ p£ p£ p£100 Sales Turn- Over In fact, Maximum turnover of £ occurs at sales of 550 widgets

Example (B) – Solution 2 Wodgets SalesPriceTurnover p£ p£ p£ p£ p£ p£ p£ p£ p£ p£ p£ p£540 Sales Turn- Over In fact, Maximum turnover of £ occurs at sales of 1050 widgets

Some Economic Theory (3)  Explain what the graph on the next slide shows.  Why does the point of maximum profit occur where it does, rather than at the highest point on the curve?  If we applied Break-Even Analysis to this situation, would we have got the same answer? If not, why not?

Cost (£) Quantity (units) Graph of total sales revenue and total cost against quantity (volume) of output of product X Total cost Optimum level of sales Total sales revenue Maximum profit

Example (C)  Widgets and Wodgets both cost 15p each to make. Market research suggests that for a selling price of £1.00, the market will support sales of 100 of each type of item.  Market Research suggests that for widgets, each price reduction of 10p we make from the original selling price, will increase our sales by 100 widgets.  Market Research suggests that for wodgets, each price reduction of 5p we make from the original selling price, we will increase our sales by 100 wodgets.  Calculate, for each item, the total profit for the different levels of sales. What is the maximum profit for each item?

Example (C) – Solution 1 Widgets SalesPriceT/OverProfit p£100 £ p£180£ p£240£ p£280£ p£300£ p£300£ p£280£ p£240£ p£180 £ p£100-£50 Sales Profit Maximum profit £225 occurs at sales of 500 widgets

Example (C) – Solution 2 Wodgets SalesPriceT/OverProfit p£100 £ p£190£ p£270£ p£340£ p£400£ p£450£ p£490£ p£520£ p£540£ p£550£ p£550£ p£540£360 Sales Profit Maximum profit £405 occurs at sales of 900 wodgets

Starting Points (3) Explain what is meant by:  A pricing strategy  Cost plus pricing  Marginal cost pricing  Penetration pricing  Price skimming

Exercises  M & A Exercise 11.4  M & A Exercise 11.8

Total Life-Cycle Costing  Specify the three phases in the ‘Life-Cycle’ of a product.  Describe the costs that might be accrued in each of these phases from the various activities.  There is a tension between traditional Management Accounting and the Life-Cycle cost method. What is this?

The total lifecycle of a product The lifecycle of a product Post-production phase Production phase Pre-production phase Research and development production set-up pre-production marketing costs Manufacturing and marketing costs After-sales service and production facilities decommissioning costs