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Write A Report On A Firm Maintaining Long Term Profitability

Question

BILSTON FASTENERS CASE STUDY (see below)

You are to compile a report for Joe Major, President of the Bilston Fasteners Company, explaining your solutions to the question set in the case, and considering all the options available for the future of the company.   In reaching your recommendations, you should also consider factors of a non financial nature. You should also note what additional information you could have needed and what assumptions you had to make.

COMPANY RESEARCH

Choose an organization of which you have some knowledge, or in which you are interested. Explain how management accounting can supply information to assist the management of the organization. The organization you choose should be a real one. You should not investigate and report on the organization’s actual management accounting system as these would not normally be made public.

Your report should aim to give a well structured background to the organization showing good reading of appropriate sources. You should use this to describe and explain the organization’s business model, i.e. how does it organize itself to maintain long term profitability. This discussion will involve customers, segmentation, pricing, competition, suppliers, costs and prices, and its future proofing dynamics. An understanding of the business model will lead to the identification of the critical management decisions to be made and what data would be needed to help management make these decisions. In other words, how can management accounting assist the management in their decision making task.

Your proposals should relate to the business model or models previously identified. You should explain carefully how each technique will assist management decisions. For example, it will not be sufficient to propose that the company should use Activity Based Costing to optimize pricing decisions, without explaining what sort of distortions traditional costing could be causing. At least three management accounting techniques should be proposed.

THE BILSTON FASTENERS COMPANY

In February 2010, Barry Cook was appointed general manager by Joe Major, president of The Bilston Fasteners Company. Cook, aged 56, had wide executive experience in manufacturing products similar to those of Bilston. The appointment of Cook resulted from management problems arising from the death of John Major, founder and until his death in early 2009, president of the company. Joe Major had only four years experience with the company and in early 2010 he was 34 years old. His father had hoped to train Joe over a 10-year period, but the father's untimely death had cut this seasoning period short. The younger Major became president after his father's death, and he had exercised full control until he hired Cook.

Joe Major knew that he had made several poor decisions during 2009 and that the morale of the organization had suffered, apparently through lack of confidence in him. When he received the income statement for 2009 (Exhibit 1), the loss of over £70,000 during a good year for sales, despite the recession, convinced him that he needed help. He attracted Cook from a competitor by offering a stock option incentive in addition to salary. The arrangement was that Cook, as general manager, would have full authority to execute any changes he desired. In addition, Cook would explain the reasons for his decisions to Major and thereby train him for successful leadership upon Cook's retirement.

Bilston Fasteners Company made only three lines of metal fasteners – woodscrews, self-tappers, and nuts&bolts. All three products were available in a range of different sizes and materials. These were sold by the company sales force for use by heavy industrial manufacturers and the construction sector. All of the sales force, on a salary basis, sold all three lines, but in varying proportions. Bilston sold throughout the UK and was one of eight companies with similar products. Several of its competitors were larger and manufactured a larger variety of products. The dominant company was Nettlefolds, which operated a large plant in the Midlands. Joe Major had heard many people describe threaded fasteners as a "commodity" business. But he had also heard a speaker say that the term is only used by losers in a business sector.

Price cutting was rare; the only variance from quoted selling prices took the form of cash discounts. Customarily, Nettlefolds announced prices annually and the other producers followed suit. In the past, attempts at price-cutting had followed a consistent pattern: All competitors met the price reduction, and the industry as a whole sold about the same quantity but at the lower prices. Demand was very "inelastic", at least in the short run, for what is a "derived demand" product like metal fasteners. Eventually Nettlefolds, with its strong financial position, again stabilized the situation following a general recognition of the failure of price-cutting. Furthermore, because sales were to industrial buyers and because the products of different manufacturers were very similar, Bilston was convinced it could not individually raise prices without suffering substantial volume declines.

During 2009, Bilston’s share of industry sales was 12% for the woodscrews, 8% for the self-tappers and 10% for the nuts&bolts. Prices charged by Bilston averaged out at £2.45, £2.58 and £2.75 per box of 100 pieces, respectively.

Upon taking office in February 2010, Cook decided against immediate major changes; he chose instead to analyze 2009 operations and to wait for the results of the first half of 2010. He instructed the accounting department to provide detailed expenses and an earnings statement by product line for 2009 (see Exhibit 2). In addition, he requested an explanation of the nature of the costs including their expected future behavior (see Exhibit 3).

To familiarize Joe Major with his approach to financial analysis, Cook sent copies of these exhibits to Major. When they discussed them, Major stated that he thought the nuts&bolts should be dropped immediately, as it would be impossible to lower expenses on nuts&bolts as much as 23 pence per 100 pieces. In addition, he stressed the need for economies on the self-tappers.

Cook relied on the authority arrangement Major had agreed to earlier and continued production of the three lines. For control purposes, he had the accounting department prepare monthly statements using as standard costs the costs per 100 pieces from the analytical profit and loss statement for 2009 (Exhibit 2). These monthly statements were his basis for making minor marketing and production changes during the spring of 2010. Late in July, 2010, Cook received the six months' statement of cumulative standard costs from the accounting department; along with variances of actual costs from standard (see Exhibit 4). They showed the first half of 2010 was a modestly successful period.

In July 2010, Nettlefolds announced a price reduction on the woodscrews from £2.45 to £2.25 per 100 pieces. This created an immediate pricing problem for its competitors. Cook forecast that if Bilston held to the £2.45 price during the last six months of 2010, unit sales would be 750,000 100-piece lots. He felt that if the price were dropped to £2.25 per 100 pieces, the six months' volume would be 1,000,000. Cook knew that competing managements anticipated a further decline in activity. He thought a general decline in prices was quite probable.

Cook and Major discussed the pricing problem. A sales price of £2.25 would be below cost. Major wanted £2.45 to be continued, since he felt the company could not be profitable while selling a key product line below cost.

Exhibit 1   Profit & Loss Account Summary - Year ended December 31, 2009

 

£(000’s)

£(000’s)

Net Sales

 

10434

Cost of goods sold

 

6511

Gross margin

 

3923

Less:

  • selling expense
  • general administration
  • depreciation

 

1839

653

1359

 

 

 

3851

Operating income

 

72

Less: interest expense

 

 

145

Loss before taxes

 

(73)

 

 

 

Exhibit 2 Analysis of Profit and Loss by Product - Year Ended December 31, 2009

 

Woodscrews

Self-Tappers

Nuts&Bolts

Total

 

£(000’s)

Per 100

£(000’s)

Per 100

£(000’s)

Per 100

£(000’s)

Labour

1293

0.61

610

0.59

688

0.70

2591

Raw Materials

1340

0.63

774

0.75

795

0.81

2909

Power

23

0.01`

25

0.02

30

0.03

78

Repairs

18

0.01

15

0.01

10

0.01

43

Rent

186

0.09

157

0.15

187

0.19

530

Other Factory Costs

 

140

 

0.07

 

110

 

0.11

 

110

 

0.11

 

360

Selling Expense

911

0.43

458

0.44

470

0.48

1839

General Admin.

345

0.16

130

0.13

178

0.18

653

Depreciation

565

0.26

428

0.42

366

0.37

1359

Interest

52

0.02

40

0.04

53

0.05

145

Total Cost

4873

229

2747

266

2887

293

10507

Sales (Net)

5168

2.42

2598

2.52

2668

2.70

10434

Profit (Loss)

295

0.14

(149)

(0.14)

(219)

(0.23)

(73)

 

 

 

 

 

 

 

 

Unit Sales (100 pcs)

2132010

1029654

986974

 

Quoted Selling price

£2.45

£2.58

£2.75

 

Note: Per unit amounts are rounded here and in Exhibit 4 to simplify the presentation.

Exhibit 3 Accounting Department's Commentary on Costs

Labour: Union shop at going community rates of £8.40 per hour. (including social security/health insurance/fringe benefits). Labor cost includes maintenance, set-up, and inspection as well as direct and indirect production workers.

Raw Materials:                        Exhibit 2 figures are accurate. Includes allowances for

                                                normal waste.

Power:                                     Rates are fixed. Use varies with activity. Averages per

                                               Exhibit 2 are accurate.

Repairs:                                   Varies as volume changes within normal operation range.

Lower and upper limits are fixed.

General Administrative           These items are almost non-variable. They can be

and Selling Expenses:            changed of course, by management decision.

Rent:   Lease has 12 years to run. The lease rate, £5 per square foot per year, is competitive for the area even though the plant is rented from a trust set up for the heirs of John Major.

Other Factory Costs:   This includes building service, property insurance, property taxes, light, heat and factory management.

Depreciation:   The machinery is depreciated over a 20 year life using straight line rates. About half the equipment in use is over ten years old and about half represents equipment purchased in the past ten years. The average age of the equipment is about ten years.

Interest:           Interest expense reflects the annual charge on equipment

loans at rates averaging 6%

  • Exhibit 4 Profit and Loss by Product (at Standard with Variance) from January 1 to June 30, 2010

 

Woodscrews

Self-Tappers

Nuts&Bolts

Total

Variance

 

 

Standard

£

 

Total

£000

 

Stand

ard

£

 

Total

£000

 

Stand

ard

£

 

Total

£000

 

Stand

ard

£

 

  • £000

     

    Favour-able/

    Unfavble

                       

     

    Per 100

     

    Per 100

     

    Per 100

     

    Per 100

     

     

    Labour

    0.61

    604

    0.59

    422

    0.70

    349

    1375

    1382

    (7)

    Raw Materials

    0.63

    627

    0.75

    535

    0.81

    404

    1566

    1543

    23

    Power

    0.01

    10

    0.02

    17

    0.03

    15

    42

    42

    0

    Repairs

    0.01

    8

    0.01

    10

    0.01

    5

    23

    25

    (2)

    Rent

    0.09

    88

    0.15

    109

    0.19

    95

    292

    261

    31

    Other Factory Costs

    0.07

    65

    0.11

    76

    0.11

    56

    197

    180

    17

    Selling Expense

    0.43

    426

    0.44

    317

    0.48

    239

    982

    983

    (1)

    General Admin.

    0.16

    161

    0.13

    90

    0.18

    90

    341

    328

    13

    Depreciation

    0.26

    264

    0.42

    296

    0.37

    186

    746

    681

    65

    Interest

    0.02

    25

    0.04

    28

    0.05

    27

    80

    73

    7

    Total Cost

    2.29

    2278

    2.67

    1900

    2.92

    1466

    5644

    5496

    146

    Sales (Net)

    2.42

    2416

    2.52

    1797

    2.70

    1355

    5568

    5568

    0

    Profit (Loss)

    0.13

    138

    (0.15)

    (103)

    (0.22)

    (111)

    (76)

    70

    146

    Unit Sales (100 pcs)

     

    996859

     

    712102

     

    501276

     

     

    Quoted Selling price

     

    £2.45

     

    £2.58

     

    £2.75

     

     

    Required:

    1. Discuss which cost elements for Bilston should be considered fixed and which variable for short-term decision making.          

    2. Compute the standard contribution margin per unit for each product line and display the profit and loss account for 2009 in contribution format.        

    3. Discuss whether the company should have dropped the nuts & bolts in January 2010 (based on 2009 figures).

    4. Discuss whether the company should reduce prices of the wood screws to £2.25 in the second half of 2010. You should show the alternative profit effects, taking into account the variances.          

    5. Construct a total company profit forecast for second half 2010 assuming the price of woodscrews is dropped to £2.25, again taking account of the variances.           

    6. What are the long term prospects for Bilston? What alternative options could be considered? In your discussion of these questions, you should take into account medium term estimates of product profitability, whether fixed cost allocations are significant to your views of the future, asset utilization, you researched market prospects the Metal Fasteners industry and any other factors you consider relevant.      

    7. Presentation of the report and the excel schedules                                    

     

    Summary

    The question belongs to Finance and it discusses about writing a report about a company’s long term profitability, pricing, competition, suppliers, costs and prices and future proofing dynamics.

    Total Word Count 2729

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