Customer Profitability and Transfer Pricing Analysis
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This article analyzes customer profitability and transfer pricing for a business dealing in interior design consulting and window treatment fabrication. It includes recommendations for cost optimization and maximizing profitability.
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Table of Contents Scenario 1: Customer Profitability..............................................................................................................2 Question 1...............................................................................................................................................2 Question 2...............................................................................................................................................3 Introduction.............................................................................................................................................3 Analysis:...................................................................................................................................................4 Recommendation....................................................................................................................................4 Conclusion...............................................................................................................................................5 Scenario 2: Transfer Pricing........................................................................................................................5 References...................................................................................................................................................8
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Scenario 1: Customer Profitability Question 1 The customer profitability reports for all the 5 customers of Louise Fairbern is shown below. The reports include activity-based customer-cost report, distribution channel cost report and a customer-profitability analysis for the five customers. Customer Profitability Analysis ParticularsAdamsBetzChathamDedhamElm Sales234,000188,800357,380147,84073,200 Less: Discount(23,400)---(3,660) Less: Direct Cost(147,000)(117,200)(218,400)(115,720)(57,040) Contribution63,60071,600138,98032,12012,500 Less: Specific Fixed Cost (Note 1)(47,350)(37,751)(76,018)(40,276)(19,866) Profit16,25033,84962,962(8,156)(7,366) Note 1 Total Specific fixed costs attributable85,100136,160221,260 Allocation on basis of direct costs To Adam out of 8510055.64% To Betz out of 8510044.36% To Chatham out of 13616055.83% To Dedham out of 13616029.58% To Elm out of 13616014.59% Amount to of specific overhead to be allocated to Adam47,349 Amount to of specific overhead to be allocated to Betz37,751 Amount to of specific overhead to be allocated to Chatham76,018 Amount to of specific overhead to be allocated to Dedham40,276 Amount to of specific overhead to be allocated to Elm19,866
Distribution Channel Cost report Particulars Architectur al Business Window Treatment Buisness Direct Costs264,200391,160 Specific Overhead85,100136,160 Non Specific Overhead59,57059,570 Discount23,4003,660 Total Cost432,270590,550 Activity Based Customer Cost report ParticularsAdamsBetzChathamDedhamElm Direct Costs147,000117,200218,400115,72057,040 Discount23,400---3,660 Total Activity Based Costs170,400117,200218,400115,72060,700 Question 2 Report on customer costs, Customer Profitability, Distribution Channel profitability and Total Profitability: Introduction In the given case, Louise Fairborn business is having the business of interior design consulting and window treatment fabrication business(Dichev, 2017). The business is primarily comprising of 2 divisions namelyconsulting division and the commercial window treatment business. The company has 5 major customers to deal and handle into, two of which are from the architectural division and the remaining three are from the window treatment business. The 2 big clients in terms of revenue are Adam and Chatham(Belton, 2017). 10% discount is being given to Adam to attract the customer as against the competitor and to lure the customer. Similarly, 5% discount is being given to Elm as the customer makes advance payment and that certainly helps the business in improving the liquidity. 65% of the total overheads being incurred by the company are attributable to the 2 divisions, rest 35% being general in nature.
Analysis: Consulting Business Division: Here, the contribution margin for Betz is higher at 37.92% as against Adam at 27.35%, inspite of the fact that Adam contributes more to revenue than Betz. There can be various reasons for the same like offering of the special 10% discount on price to Adam or there might be use of high grade material or manpower or more than usual direct costs in order to retain the client as against the competitor which might have resulted in lower profits (Heminway, 2017). Commercial Window Treatment: In this particular division, the contribution margins for the 3 clients namely Chatham, Dedham and Elm has been 38.89%, 21.72% and 17.07% respectively. We can see that the margin for Dedham and Elm is very low as compared to Chatham and the main reason for the same is the allocation of the direct costs to each of these clients(Choy, 2018). The direct costproportion for Dedham and Elm is 78.27% and 82.02% respectively whereas for Chatham, the same is as low as 61.11%. Also, since the specific overhead is being allocated to the customers on the basis of the direct costs, the share of Dedham and Elm is abnormally high. In case the specific overheads to contribution percentage is being determined, we can see that the ratio is 54.7%, 125.4% and 159% for Chatham, Dedham and Elm respectively. This makes the rest of the two clients to be loss making for the company(Jefferson, 2017). Recommendation Consulting business Division: On an overall basis, the division has been doing well from the company standpoint of view but the company needs to optimize and lower both the specific as well as general overhead costs, only then the profitability can increase as the price cannot be increased much in the competitive market(Clarke, 2013).It is because of these higher costs that the company is not profitable inspite of higher contribution percentages. Some of the steps that the company can take to increase profitability is outsourcing of the functions, relook at the personnel staff salaries, reducing the administrative costs and fixed costs and greater emphasis on performance based incentive rather than fixed incentive. This will also raise the performance levels of the staff. Commercial Window Treatment business: In case of this division, a greater emphasis and effort is required to lower the costs in case of Dedham and Elm as only then these customers can be
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made profitable for the business. Both the direct material as well as direct labour component needs to be optimized(Visinescu, et al., 2017). For material, better negotiation with the vendors can result in lower costs and forlabour, their performance should be monitored and workers working at less than potential abilities should be replaced. Further, there can be a scope of saving in terms of the overhead costs and the discount given to Elm can be lowered to say, 2.5%-3% to increase profitability on that ground as well. Conclusion Cost monitoring, management and optimization is the only way through which the costs can be lowered and profitability can be increased. Therefore, the overheads and other direct costs needs to be lowered to increase profit per piece. Furthermore, the company should also think of expanding the customer base and increasing the inputs(Sithole, et al., 2017). Scenario 2: Transfer Pricing 1)Calculation showing the contribution margin per hour of selling the Super-Chips and Okay- Chips: ParticularsSuper-ChipsOkay-Chips Selling price per unit ($)8026 Less: Variable Cost per unit ($)6522 Contribution per unit154 Hours required per unit31 Contribution per hour5 (15/3) 4 (4/1) In case no interdivisional transfer of super chips is made to the process control division, and also considering that the semiconductor division is having a maximum capacity of 45000 hours, then it should be producing the product which gives maximum contribution per hour. Further, if any remaining hours are left, then the 2ndproduct can be manufactured. Therefore, in given case, Super chip should be first produced to its maximum capacity and then the Okay chips can be produced(Farmer, 2018).
Hours Available:45,000 Hours Required:45,000 (15000 units X 3 hours per unit) Balance hours if anyNIL Therefore, the division should be producing 15,000 units of super chip and since, there is no remainder hours left, therefore it won’t be able to produce Okay chips. 2)Minimum Transfer price of Super-Chip at which it can be transferred to the process division: (Total Variable Cost of Super Chip + Variable cost of foregoing external sales of 5000 super- chips)/ Number of units transferred (65 X 5000 units + 5 X 15,000 hours) / 5000 = $ 80 per unit Additional procurement cost for Process division = $ 80 - $ 70 = $ 10 which is less than the additional selling price on the improved product which is $ 145 - $ 132 = $ 13. Hence there is still a gain of $3 per piece post covering of the additional procurement costs if at all the units are being procured from the semi-conductor division at $ 80 per unit (Goldmann, 2016). Therefore, the super-chips should be transferred to the Process control division to replace circuit boards. 3)The minimum transfer price for Semiconductor division would be its variable cost i.e., $ 65 per unit for the Super chips. The maximum rate at which the transfer can be done to the Process division is $ 83 beyond which it would not be able to make additional contribution or profitand therefore transfer price beyond that is not a viable option at all(Grenier, 2017). Therefore, it can be said that any transfer price within the range of $ 65-83 would help in achieving the goal congruence for the given entity. The detailed calculation has been shown below: ParticularsSuper-Chips Minimum Transfer price of Super-Chip to process division (As per Part 2) 80 Add: Additional gain for process division on by the use of super13
chip (145-132) Less: Additional procurement cost for process division (80-70)10 Maximum price at which process division can procure goods from its sister concern without a loss to themselves 83 4)Now the Total Capacity is being revised to 60,000 hours Number of hours that will be required for meeting the external sales requirement for Super- Chip = 15000 X 3 = 45,000 hours Number of hours that will be required for manufacturing 5,000 units for Process Division = 5000 X 3 = 15000 hours Unused capacity, if any: NIL. Therefore, in case semi-conductor division will be having capacity of 60,000 hours instead of existing 45000 hours, then it would be able to meet both the demands of both the external sales as well as 5000 unit for the process division without any conflict and question on the minimum transfer price(Linden & Freeman, 2017). Contribution of Process control units without using super-chip ParticularsAmount in $ Selling price per unit132 Variable Cost: Circuit board70 Direct Labor45 Contribution per unit17 Contribution of Process control units using the Super-Chip ParticularsAmount in $ Selling price per unit145 Variable Cost:80
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Super Chip Transfer pricing cost Direct Labor45 Contribution per unit20 Incremental Contribution per unit = $ 3. The company would earn a total incremental contribution of 5,000 X 3 = $ 15,000. References Belton, P., 2017.Competitive Strategy: Creating and Sustaining Superior Performance.London: Macat International ltd. Choy, Y. K., 2018. Cost-benefit Analysis, Values, Wellbeing and Ethics: An Indigenous Worldview Analysis. Ecological Economics,p. 145. Clarke, J., 2013.Australian Contract Law.[Online] [Accessed 8th August 2016]. Dichev, I., 2017. On the conceptual foundations of financial reporting.Accounting and Business Research,47(6), pp. 617-632. Farmer, Y., 2018. Ethical Decision Making and Reputation Management in Public Relations.Journal of Media Ethics,pp. 1-12. Goldmann, K., 2016. Financial Liquidity and Profitability Management in Practice of Polish Business. Financial Environment and Business Development,Volume 4, pp. 103-112. Grenier, J., 2017. Encouraging Professional Skepticism in the Industry Specialization Era.Journal of Business Ethics,142(2), pp. 241-256. Heminway, J., 2017. Shareholder Wealth Maximization as a Function of Statutes, Decisional Law, and Organic Documents.SSRN,pp. 1-35. Jefferson, M., 2017. Energy, Complexity and Wealth Maximization, R. Ayres. Springer, Switzerland. Technological Forecasting and Social Change,pp. 353-354. Linden, B. & Freeman, R., 2017. Profit and Other Values: Thick Evaluation in Decision Making.Business Ethics Quarterly,27(3), pp. 353-379. Sithole, S., Chandler, P., Abeysekera, I. & Paas, F., 2017. Benefits of guided self-management of attention on learning accounting.Journal of Educational Psychology,109(2), p. 220.
Visinescu, L., Jones, M. & Sidorova, A., 2017. Improving Decision Quality: The Role of Business Intelligence.Journal of Computer Information Systems,57(1), pp. 58-66.