1. Managing Finance and Budgets Seminar 6

2. 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 11.8 - pages 367-8

3. 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.

4. 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?

5. 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?

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

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

8. 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?

9. 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

10. Example (A) – Solution 1 Widgets SalesPrice 100100p 200 90p 300 80p 400 70p 500 60p 600 50p 700 40p 800 30p 900 20p 1000 10p Sales Price This shows a relatively inelastic demand pattern

11. Example (A) – Solution 2 Wodgets SalesPrice 100100p 200 95p 300 90p 400 85p 500 80p 600 75p 700 70p 800 65p 900 60p 1000 55p Sales Price This shows a relatively elastic demand pattern

12. 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?

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

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

15. 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?

16. Example (B) – Solution 1 Widgets SalesPriceTurnover 100100p£100 200 90p£180 300 80p£240 400 70p£280 500 60p£300 600 50p£300 700 40p£280 800 30p£240 900 20p£180 1000 10p£100 Sales Turn- Over In fact, Maximum turnover of £302.50 occurs at sales of 550 widgets

17. Example (B) – Solution 2 Wodgets SalesPriceTurnover 100100p£100 200 95p£190 300 90p£270 400 85p£340 500 80p£400 600 75p£450 700 70p£490 800 65p£520 900 60p£540 1000 55p£550 1100 50p£550 1200 45p£540 Sales Turn- Over In fact, Maximum turnover of £551.25 occurs at sales of 1050 widgets

18. 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?

19. 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

20. 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?

21. Example (C) – Solution 1 Widgets SalesPriceT/OverProfit 100100p£100 £85 200 90p£180£150 300 80p£240£195 400 70p£280£220 500 60p£300£225 600 50p£300£210 700 40p£280£175 800 30p£240£120 900 20p£180 £55 1000 10p£100-£50 Sales Profit Maximum profit £225 occurs at sales of 500 widgets

22. Example (C) – Solution 2 Wodgets SalesPriceT/OverProfit 100100p£100 £85 200 95p£190£160 300 90p£270£225 400 85p£340£270 500 80p£400£325 600 75p£450£360 700 70p£490£385 800 65p£520£400 900 60p£540£405 1000 55p£550£400 1100 50p£550£385 1200 45p£540£360 Sales Profit Maximum profit £405 occurs at sales of 900 wodgets

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

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

25. 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?

26. 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