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Financial Management and Policy Essay

  1. Introduction

      This paper seeks to determine the proper price level that a business should use in pricing its product (suits in the market).  A survey questions are prepared to generate responses from the market and the answers are summarized in processed data for proper analysis.  Questions are explained as to purpose from the survey. Some assumptions are made on the variable cost of the products, the quality each and related price range of each product under each category.

 1.1 Background

        To generate options there is need to ask questions to generate data.  To have data that is required, the purpose of questions must be made clear at this point.      There are five questions asked in the survey and the purpose of each question is explained below:

        First Question: “Have you purchased a suit over the past year? Yes, or No.”    The purpose of the first question is to segment the respondents whether they are new or old customers or buyers of suit.

       Second Question: “How frequently do you purchase a suit? Weekly, bi-weekly, monthly, quarterly or yearly. Yes, or No.   The purpose of the second question is to segment the market on the basis of the frequency of the purchase.  The information gather could provide possible information of quantity demanded over a yearly period that would be enough in forecasting the total quantity of the product or type of product that could be sold.

     Third Question:   “How much on average do you estimate you spend on clothes? Per month or per year: Yes, or No.”  The purpose of the question is to generate the amount of money that could be disposed by the would-be buyers of the product. If the answer to this third question is linked to the answer of the second question, the result would be generating a preliminary demand profile for clothing or total market for clothes that could be served  by product sellers.

       Fourth question: “Would you consider purchasing a suit from?  Burtons, Austin Reed, Bespoke or Luxury Brand? Yes, or No.”   The purpose of this  question is generate whether the respondent have certain  brand preference for each type of suit and if the answers are correlated with the demand profile based on questions no. and 3, the researcher  would have a better picture on what brand of product or its category  should be manufactured to suit the demand of the products.  The three branded products are categorized or assumed to be categorized  into first category that under standards price and standard quality; second category with better quality but higher price range and; third category with best quality but with the highest price among the three..

       Fifth question: What range of price are you willing to pay for the suit?     The purpose of the fifth question is to generate the amount of money disposable by each product or suit category. If the result of this question is combined with the fourth, the effect is to generate the demand of each specific category.

1.2 The results of the questions:

       The amount a person is willing to pay for a suit is within the range of £ 80 to £400 while the amount that people on the average spend on clothing on clothing each year is  £1000 to £ 3000 per year. The approximate price range that could be used in preparing profitability statements are as follows:

 From To
Burton 80 150
Austin Reed 100 250
Bespoke or Luxury Brand 150 400

      The three product categories above are arranged in terms of assumed prices on average of from researchers made on the Internet.  Burton suit is generally priced lower than Austin Reed while Bespoke or Luxury Bond is most expensive among the three categories. Since the result of average disposal income for clothing could cover the amount of money that could be spent for the suit, this paper assumes that the choices made by respondents as to the product within certain price ranges are realistic or have big chance of materializing.

       The results of the survey questions are summarized in the table below. The data generated could be explained in a manner that would generate possible options for pricing strategy[1] of the company that will attain the maximum profit for each option.

Table I.  Results of Survey Questions

 Brand Name  From To respondents
Burton 80 150 45
Austin Reed 100 250 35
Bespoke or Luxury Brand 150 400 20
total 100

          It may be noted from the data above there are 100 respondent chosen at random from 100 British-men  perceived to 30 years of age and above.  The results of the survey questions showed different reactions of would be customers to the prices of the suits and generally what could be observed is that the higher the price of the suit, it appears the that better is perceived quality  of the suit but the smaller of respondents which has chosen the corresponding suit.

         To compute price options there is a need to have a price ranges in relation to the effect product category.  Each product category will be assigned a certain product range from which a choice should be made on what will maximize profitability[2]. In relation to this, there is need to know what are these factors that influence profits. The first factor is the customers. These people may be deemed to always have an alternative source of supply. They must be considered also to be above to substitute one material for another, and they can even choose to make a partial buy or nothing at if the vendor’s prices become too high within their yearly budgets.  For this paper, the customers were asked questions about their possible purchase of different categories or types of suits and results were reflected in Table I above.

        The second factor is the competitors who will usually react usually react and monitor to price changes made by their rivals.  The nature of competition could depend on the market structure where a company operates. It may be a monopoly where is only one seller, a duopoly if there are only two. It could be an oligopoly also if there are only few players controlling the market or it could approximate a perfect competition where not one could dictate or influencing pricing.  For the purpose of this paper, the competitors could represent the different producers of product categories for each brand name of suit made as choices in the survey questions. This factor is therefore deemed to have been made part of the survey since the survey was on a random basis from a certain segment group of people (men) who would most likely buy a suit.

       The third factor is the cost of the product. The cost is the thing that must be recovered in the production or sale of the product.  As a general rule , no one would like to go into business to lose money because money has an opportunity cost. A person’s or businessman’s money in the bank may just be earning money without doing anything; hence if one is engaged in business, there is risk of losing money while having the chances of earn more.   To attain the later as objectives, the cost must consider some  reasonable mark-up that will generate an adequate return on investment, which is normally used by many business in setting their prices.  For the purpose of this paper, the cost will have to be assumed since it was not given in the case.

       Costs include the cost of production as well as operating expenses in bringing the product to the customer. There different costing methods that could be used but this paper would discuss only two choice and make a justification why one costing method is used over the other. The costing methods from which a choice was made are the variable costing and the absorption costing. Variable costing is a method whereby direct materials, direct labour and variable manufacturing overhead are treated as products cost, while fixed manufacturing overhead is treated as period costs (cost expensed currently in the income statement)[3].  Absorption costing on the other hand is the traditional method of product costing in which the direct materials, direct labour, and both variable and fixed manufacturing are treated as product costs are charged to inventories.  The choice of method is influenced by advantages of one over the other.  For this purpose the advantages and disadvantages of direct costing over absorption costing are explained.  By so doing, the result would indicate the advantages of variable costing is considered as disadvantages of the absorption costing, and vice versa for disadvantage one as advantage of other.

         One of advantages is that total fixed cost is reported in the income statement.  The other is that fixed cost is not accounted for as inventoriable cost thus simplifying record keeping. The other advantage is net income that is not being influenced by production and inventory changes[4].  The further advantage is that the income reporting format is extremely useful for management purposes like determining cost-volume relationships and contribution margin data.[5]

         It disadvantages however include: the fact that is not acceptable for external and income tax reporting and the fact the cost are required to be separated into fixed, which could be difficult due to the element of individual judgment which could be subjective

The other disadvantage is the fact costs are not properly matched with revenues in accordance with the generally accepted accounting principles[6]. While the other disadvantage is that too much attention may be given to variable costs at the expense of disregarding fixed cost[7].

      Since the issue here is profit maximization, this paper has chosen variable costing as there is no prohibition the same because the decision to be made is for internal purposes and only the relevant costs are considered. Given the limitations, the same still be considered as precaution for using the conclusion that may be derived or produced by the analyses conducted in this paper.

  1. Analysis of data:

       The options generated include whether to produce first category, second category and third category under three separate assumptions.  Since three brands are asked in the survey, it as assumed that the decision maker could choose to manufacture or deal with any of said brands where he or she could make maximum profit under one the options generated.

       The paper has assumed that variable cost is certain percentage in relation to sales revenues.  There are generally three assumptions made on variable costs under the three different product categories of Burton, Austin Reed and Bespoke or Luxury brand. The first assumption is that all product categories’ total variable costs have the same percentage in relation to the total revenues. The second assumption is that the first category, second and third category has each 50%, 55% and 60% variable cost ratio to sales.  The third assumption of the other hand, assigns the first category, second and third category assign a variable cost ratio to sales at 50%, 60% and 70% respectively. See Appendix A.

       It could be observed that third set of assumption differs only from the second set of assumption in terms of difference in ratios, where second assumption has 5% while the third has 10% in relation to the other. See Appendix A.

       The results of profit maximization under the different assumptions of variable cost ratio to sales. Under the first and second assumption,  the product category that gives the maximum profit level is Austin  Reed suit, while under the third assumption, it is Burton suit.  In other worlds as the variable cost ratio difference is increased,  the one that has the lower cost variable ratio to sales becomes more profitable.

        It might be noticed also the first category has the greatest number of quantities expected to be sold at 45 units compare to 35 for the second and 20 for the third category. Thus a general rule, the greater the quantity the greater should be revenues and therefore the related profit.  Since the first category has the greatest number of expected units to be sold, then it may be assumed to have the maximum profit among the three. However in this particular case, this rule is true only if the second and third categories have significantly higher variable cost ratios.  The words “significantly higher” must be emphasized since under the second set of assumption,  the second category is has higher variable cost ratio than the first category by 5% difference, yet the second category came out having the maximum profit among three. What may explain this deviation from the rule that the high quantity must eventually produce maximum profit is the fact that the part of computing revenue and profit is the price. Thus second product category has the highest average price within the price range of for each product category. Thus the first second and third product categories have £115, £175 and £187.5 as average price under each category respectively. See Appendix A.

       The general rule of higher quantity means higher revenues and higher profits is  modified by the principle law of price and quantity demanded- that is the higher the price, the lower is the quantity demanded[8].

  1. Recommendation:

       The analysis revealed that there are different levels of profitability of each product category under different assumptions of variable cost ratio in relation to total sales revenues.   Maximum profit was therefore found to be a function of price, cost and demand. Although having the higher quantity should increase revenues and profits, the same might rule may not be always true because there is also a limit as to the number of quantity to be sold because other customer would prefer a better quality of product with a higher price.   Bringing up the quality to have the higher price and therefore more revenues could not always be true as customer would have the choice to make lower priced- products. On the part therefore of the businessman or would be seller, the process is balancing to do, that is obtaining a combination of optimum level of quantity sold at optimum price that could produce the optimum profit under different conditions. Using the contribution margin as basis, is the under the first assumption that profits is maximized where the variable cost ratio is uniform at 50%.

       It should however be noted that other assumption could be more likely to happen than first, thus the present case, has still an issue on whether it should be the second category that or first category that should produce the maximum profit. Because of different likelihood happening for each, there appears to have a need to make a choice by assigning equal probability for each category under each set of assumption and getting their expected values. The one with the highest expected value is still under the first set of assumption, that is, the variable cost ratio for all categories is assumed 50%.  This paper therefore recommends production of suit under the first set of assumption, where Austin Reed under the second category bears the maximum profit as against the others.

  1. Conclusion: 

       The overall viability of the suit business depends primarily on the demand for the suit products. Demand for the products connotes already the need for the same and the capacity and willingness to pay at certain plus level.  Based on the survey conducted, there is indeed a market for suit business as even the result of the three products offered under different brands showed profits.  Their profits are however computed after an assumed level of variable cost in relation to total revenues.  Said assumption has the implication that all fixed cost will be covered over relevant period.   Any changes on the assumption could however change the result of analysis and the corresponding conclusion.  Users of this paper are to consider the limitations of assumptions made before they would have to apply recommendations and conclusions reached in this paper.

Appendix A – Profit Computations under for each category under three different set of assumptions, See Excel File

Bibliography:

Need essay sample on "Financial Management and Policy"? We will write a custom essay sample specifically for you for only $ 13.90/page

Kotler, Marketing Management, Analysis Planning, Implementation and Control, London, UK, 1994

Mowen and Hansen , Management accounting: the cornerstone for business decisions, Thomson South-Western, 2006

Ross et. al,  Essentials of Corporate Finance ,IRWIN, London, UK, 1996

Samuelson and Nordhaus, , Economics, McGraw-Hill, Inc, London, UK , 1992

Van Horne, Financial Management and Policy, Prentice-Hall International,  London, UK, 1992

Weston and Brigham, Essential of Managerial Finance, Dryden Publishers  London, UK , 1993

[1] Kotler, P. Marketing Management, Analysis Planning, Implementation and Control, London, UK, 1994

[2] Van Horne, Financial Management and Policy, Prentice-Hall International,  London, UK, 1992;              Weston and Brigham, Essential of Managerial Finance, Dryden Publishers  London, UK , 1993

[3] Mowen and Hansen , Management accounting: the cornerstone for business decisions, Thomson South-Western, 2006

[4] Mowen and Hansen , Management accounting: the cornerstone for business decisions, Thomson South-Western, 2006

[5] Ross et. al,  Essentials of Corporate Finance ,IRWIN, London, UK, 1996

[6] Mowen and Hansen , Management accounting: the cornerstone for business decisions, Thomson South-Western, 2006

[7] Mowen and Hansen , Management accounting: the cornerstone for business decisions, Thomson South-Western, 2006

[8] Samuelson and Nordhaus, , Economics, McGraw-Hill, Inc, London, UK , 1992

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