production and inventory management. understand cost relationships economic efficiency (profits)...
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Production and Inventory Management
Production and Inventory Management
Understand Cost Relationships
Economic efficiency (profits) Understanding of relationships helps
managers Effective production decisions
Managers are Better Able to Meet Financial Objectives
Management Information Systems
MIS provides1. Accurate and timely production
• Cost information • All phases of business
2. Data in proper form needed3. Accounting information that allow accurate and
quick development of business financial documents
4. Efficiently and effectively monitoring and controlling business production costs
Cost Concepts
Cost: Acquire good or service Opportunity cost: Return (measured by
highest value) Implicit cost: Do not include cash payments
Included in calculation of total cost of product
Cost Concepts
Controllable and Uncontrollable Costs
Incremental, Avoidable, and Sunk Costs
Total Cost = Total Fixed + Total Variable Costs
Costs
Total Fixed Cost (TFC) Total Variable Cost (TVC) Total Cost (TC)
Contribution Concept
Selling Price/Unit = Total Cost/Unit + Profit/Unit
Total Cost/Unit = Variable Cost/Unit + Fixed Cost/Unit
Selling Price/Unit – Variable Cost/Unit = Fixed Cost/Unit + Profit/Unit
Contribution = Selling Price/Unit minus Variable Cost/Unit
The Contribution Concept
Selling Price/Unit = $200 100% Minus: Variable Cost/unit = -$120 - 60%
Contribution to Fixed Costs = $ 80 40%
and Profit/Unit
We can use this information to make pricing decisions
Applying the Contribution Concept
Establish Selling Price of New Product
If contribution/unit is typically 40% of selling price/unit, the proper selling price/unit for a new product would be:
Total Variable Costs Per Unit
= [1- Contribution Margin Percentage]
* [Selling PricePer Unit]
$120 = [1 – 0.40] * Selling price per bag
$200 = Selling price per Bag
Shutdown Point
Short Run vs Long Run Pricing
Short run Firm with idle capacity can take job where price does not
cover all total cost Contribution is positive (P- AVC > 0).
Contribution is negative (P-AVC < 0) firm is better off to shut down.
Long Run All costs covered
Are we better off to harvest the crop or
just leave it in the field?
Shutdown Point In-Class Exercise From Casavant, Infanger, & Bridges, pg 96
A drought has hit the farm and now it is harvest time
We have $18/acre invested in our crop
Going in to harvest what is left will cost an additional $6/acre (the variable cost) for a total cost $24/acre
Crop is expected to yield six bushels per acre and market price is $2/bushel
In the short run do not worry about the sunk costsLook only at incremental revenue and cost
Shutdown Point In-Class Exercise From Casavant, Infanger, & Bridges, pg 96 The Answer
Harvest the crop! Incremental Revenue > Incremental Cost $12/acre > $6/acre We will have $6/acre more to reduce the fixed costs than if we don’t
harvest
Shutdown Point In-Class Exercise From Casavant, Infanger, & Bridges, pg 96
The Answer
If we do not harvest we lose $18/acre (the sunk costs)
If we do harvest we lose $12/acre $18/acre sunk cost + $6/acre harvesting cost = $24/acre total cost Total Revenue: $12/acre (6 bu/acre x $2/bu) Less: Total Cost - $24/acre Loss - $12/acre
Break-Even Analysis
Break-Even Analysis helps managers find combination of costs, output, and selling price that permits firm to break-even, no profits and lossesSelling Price
Output Costs
Calculating The Break-Even Pointin Units
The break-even point is calculated from the profit equation when profit is zero
Profit = 0 = Total Revenue - Total Cost
0 = Total Revenue TVC/Unit TFC- -
= P*Y - VC*Y - TFC
= (P-VC) Y - TFC
TFC = (P-VC) Y
TFC
(P-VC) Y = = Break-Even Point in Units
Calculating The Break-Even Point in Dollars
TFC
CMPBEP$ =
Where: BEP$= Break-even point in dollars TFC = Total fixed costs
CMP = Contribution Margin Percentage
For example,
BEP$ =
$750,000
0.40
BEP$ = $1,875,000 = the Break-Even Point in Dollars
Production Costs
Meeting Profit as Percentage of Sales Objective Using Break-Even Analysis
TFC
(CMP – RPP)
BEP$ =
For example,
BEP$ = (0.40 – 0.10)
$750,000
= $2,500,000
(or 20,000 bags at $125 per bag)
RPP = Required Profit Percentage
Evaluating Changes in Fixed Costs Using Break Even Analysis
Change in Fixed Costs
Contribution Margin Percentage=
Minimum Changein Dollar Sales Neededto Break-Even forChange in Fixed Costs
For example:$1.00
0.40= $2.50 = minimum increase in dollar sales needed to break-even for each new dollar spent on fixed costs
Determining a Selling PriceUsing Break Even Analysis
Selling Price/Unit = Contribution + Variable Cost/Unit
Determining a Selling PriceUsing Break Even Analysis
If Variable Cost/Unit is known, all needed is Contribution
TFC
Y= Contribution
Determining a Selling PriceUsing Break Even Analysis
Determine contribution by rearranging terms
of the break-even equation
TFC
Contribution= Y
____TFC___ = P – VC
Y
____TFC__ + VC = P
Y
Inventory Management
Reasons to hold inventory1. Matching supply with demand2. Prevent stockouts3. Lower purchasing costs
Reasons Not to hold inventory1. High maintenance cost2. High protection cost3. Depreciation and obsolescence4. Taxes
Impact of Inventory on Profits
Inventory Value = $100,000
Inventory Carrying Cost = $25,000 (25 percent)
Each $1,000 reduction
In Inventory = + $250 Profits
Each $1,000 reduction
In Inventory = +$5,000 in Sales Why It Pays to Keep Inventories Low!
Basic Inventory Management Model
Total cost of inventory (TC) Ordering costs sum (OC) Carrying costs (CC)
TC = CC + OC
Managers’ Goal
Managers determines
1. Economic Order Quantity (EOQ): Number of items to order each time Minimizes total cost
2. Reorder Point (ROP): When to reorder more Stockouts minimized
Basic Inventory Model