Cost Management Consulting

Abstract

In this paper we will try to come up with the solution for the given problem, we will work on finding out the break-even cost. And we will find discuss the purpose of assigning cost categories of fixed and variable costs. We will discuss the relationship of variable costs to contribution margin. After that we will discuss the limitations of the data and finally we will speculate what data is missing from the case.

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost Management Consulting

Here are the important data point we are going to work with

Currently, the chain of operations has $22,500,000 of revenue from 5,000 events that they have serviced.

The cost data I have:

  • Floral costs, $200 per event,
  • Table arrangements, $100 per event,
  • Soft drinks and children snacks, $500 per event,
  • Annual allocated costs of tents and other structures, $500,000,
  • Annual allocated costs of trucks and vehicles, $2,000,000,
  • Annual costs related to maintaining permanent staff, $3,500,000,
  • Wage for temporary staff (paid per event), $1,800 per event.

Now let us find out the variable costs –

We know amount for temporary staff per unit, floral cost per unit, soft drinks and snacks cost per unit and table arrangement cost. So the total variable cost per unit is ($200 + $100 +$500 $1800) = $2600

Fixed cost includes –

Annual allocated costs of tents and other structures, $500,000,

Annual allocated costs of trucks and vehicles, $2,000,000,

Annual costs related to maintaining permanent staff, $3,500,000,

  • So total fixed cost – $6,000,000
  Total Per Unit
Sales (5000*$4500) $22,500,000 $4,500
Variable Costs (5000 *$2600) $13,000,000 $2,600
Contribution Margin $9,500,000 $1,900
Fixed Costs $6,000,000  $1200
Net Income $3,500,000  $700

 

Solution to the question how far she can lower her prices without losing money?

Breakeven results if – Sales = Total Variable Costs + Total Fixed costs

Step 1. (Number of events * $4500) = (Number of events * $2600) + $6,000,000

Step 2. (Number of event * $4500) – (Number of events* $2600) = $6,000,000

Step 3. Number of Events * $1900 = $6,000,000

Step 4. Number of events = $6000000 / $1900 = 3150.78 ~ 3151

My client can come down to 3151 events every year if she wants to keep charging $4500 per event.

But her specific query was, she wanted to reduce her price keeping the number of events constant

So let us find out the breakeven cost:

Per unit cost = $4500 and Per unit net income = $700

Now, if she wants to reduce cost without losing money she should be able to go down as low as ($4500 – $700) = $3500 per event

Here is another way to find out the breakeven cost – let us quickly find out how much she has to spend on each even, considering her revenue s $22,500,000 from 5000 events

So cost breakdown for each event would be –

Floral costs – $200

Table arrangements – $100

Soft drinks and snacks – $500

Other structures – ($500000 / 5000) = $100

Trucks and vehicles – ($2000000/5000) =$400

Permanent staff cost = $3500000 /5000) = $700

Temp staff= $1800

So total cost for each event $3800

Currently she is charging $22,500,000 /5000 = $4500 per event

This is one way to find out the breakeven point which is $3800, so she should be able to give a discount of ($4500-$3800) = $700 on each event without losing any money

 

 

 

 

 

Purpose of assigning cost categories of fixed and variable costs

What is a ‘Variable Cost’

A variable cost is a corporate expense that changes in proportion with production output. Variable costs increase or decrease depending on a company’s production volume; they rise as production increases and fall as production decreases. ( Investopedia,2018)    

We know following costs per unit, and we understand the total cost ( for following items) may go down or come up based on number of units going down from 5000 or going up from 5000. –

  • Floral costs, $200 per event,
  • Table arrangements, $100 per event,
  • Soft drinks and children snacks, $500 per event,
  • Wage for temporary staff (paid per event), $1,800 per event.

Following costs are fixed in a year, regardless how many events my client serves to, be it 1 or 10000 she has allocated following –

  • Annual allocated costs of tents and other structures, $500,000,
  • Annual allocated costs of trucks and vehicles, $2,000,000,
  • Annual costs related to maintaining permanent staff, $3,500,000,

Since the above line item costs are fixed and do not depend on number of events , these are considered as fixed cost items.

 

 

Relationship of variable costs to contribution margin

  Total Per Unit
Sales (5000*$4500) $22,500,000 $4,500
Variable Costs (5000 *$2600) $13,000,000 $2,600
Contribution Margin $9,500,000 $1,900
Fixed Costs $6,000,000  $1200
Net Income $3,500,000  $700

 

What is ‘Contribution Margin’

Contribution margin is a cost accounting concept that allows a company to determine the profitability of individual products. (Investopedia, 2018)

Per the table above, Per unit cost = Variable costs + Fixed Cost + Net Income

            And Contribution Margin = Per unit cost – Variable Costs

So one way to look at it is Variable costs = Per unit Cost – Contribution Margin

Or, Variable costs = Per unit cost – (Fixed cost + Net Income)

Limitations of the data and what data is missing from the case

Floral costs – We do not know if it can change based on event or not, can a client order some special flower that would cost more than $200 or can someone request for no flower? So we do not exactly know if $200 figure can change based on event

Table arrangements, $100 per event – We do not know if this can go higher or lower based on number of tables ordered

Soft drinks and children snacks, $500 per event – we do not know if this amount would go up or down based on number of children present in the event

Annual allocated costs of tents and other structures, $500,000 – We do not know if the cost could be less than total allocated amount or if it could go beyond allocated amount.

Annual allocated costs of trucks and vehicles, $2,000,000 – We do not know if the cost could be less than total allocated amount or if it could go beyond allocated amount based on certain circumstances

Annual costs related to maintaining permanent staff, $3,500,000 – We do not know if the cost could be less than total allocated amount or if it could go beyond allocated amount. If someone leaves the job, does the cost go down? Do the employees get raise resulting in more expenses?

Wage for temporary staff (paid per event), $1,800 per event – We do not know if the cost could be less than total allocated amount or if it could go beyond allocated amount. Do we need same amount of temporary stuffs in every even or can it vary based on event size and how would that impact cost?

So these are the areas we do not need enough information on.

 

 

 

 

 

 

References

Retrieved on 2/19/2018. Retrieved from https://www.investopedia.com/terms/c/contributionmargin.asp

 

Retrieved on 2/19/2018.  Retrieved from https://www.investopedia.com/terms/v/variablecost

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